Fraud Against Seniors, Warning!

(Washington, D.C.) The position of the Securities Exchange Commission is one of a bulldog. Just as a life insurance policy is an umbrella of protection, so is the SEC the protection of fraud and other violations that border on unethical in the exchange of money for promises.

Aging has become a business. The aging value and begin to take to heart all that will bequeath their wealth to the next generation. This natural desire for protection can be a risk factor for gullibility and vulnerability. The desire for protection creates a demand for insurance.

With the fiduciary responsibility over this protection comes responsibility. This is the attitude of the SEC as they monitor insurance products for the senior citizen population. The SEC makes an effort to require that the variable insurance industry provide products that meet the needs of investors and are sold in a manner that is forthright and honest.

Since there is enormous capital poured into this industry, there are a growing number of frauds and crimes targeted at the most "at risk" populations. Chairman Cox has made protecting senior citizens a priority. The Commission's ongoing initiative to protect senior citizens has several components, including educating older investors about investing wisely and avoiding scams, and using the Commission's examination and enforcement resources to root out problematic practices and prosecute fraudulent conduct that may harm older investors.

In August, the Commission held its second Seniors Summit in Washington, D.C. At this conference regulators, law enforcement officials, and community groups gathered to discuss how to protect older Americans from abusive sales practices and investment fraud.

Securities regulators announced the results of the "free lunch" investigation and the results were troubling as reported by the examination staff of collaborators, which included the Commission's staff, state securities regulators, and FINRA. The "free lunch" investigation examined the sales, disclosure, and supervisory practices of firms that sponsor "free lunch" sales seminars targeting senior citizens.

The regulators found that, despite the format of the seminars, 100% were sales presentations. They also found that 59% of the examinations reflected weak supervisory practices by firms, 50% uncovered exaggerated or misleading advertising claims, 23% found possibly unsuitable recommendations, and 13% uncovered possible fraudulent practices. The examiners found that among the most commonly discussed products at these sales seminars were variable annuities, equity-indexed annuities, and mutual funds.

The Division of Enforcement has taken an aggressive stance in combating fraud and uncovered 45 enforceable violations and scams including the following (general summary of each) against senior citizens:

A claim alleging that an adviser representative who fraudulently liquidated his elderly clients' securities holdings without their knowledge or consent by inducing clients to sign pre-printed, fill-in-the-blank forms.

A licensed insurance agent used the proceeds of the unauthorized sales to purchase equity-indexed annuities for which he received substantial, undisclosed commissions totaling about $2 million.

A case against a registered representative who recommended to his customers that they sell variable annuity contracts which were already owned so they could purchase new variable annuity contacts with higher principal amounts. The representative persuaded his customers to let him temporarily invest the proceeds from the sale of their existing variable annuity contracts but, instead of investing the money as promised, he submitted forged documents to the variable annuity companies to obtain the customers' contract proceeds, and misappropriated the money for his own use. The court enjoined the representative from further violations of the anti-fraud provisions of the federal securities laws, and ordered him to pay disgorgement, prejudgment interest and a civil penalty totaling $5.5 million. In a related criminal action, the representative pleaded guilty to mail fraud charges and was sentenced to more than 11 years in federal prison.

The SEC obtained a preliminary injunction against the principal of an advisory firm, the firm itself, and a related company he operated who targeted primarily elderly investors and advised them to surrender existing variable annuity policies, mortgage their residences, and transfer the proceeds to his companies for him to manage. According to the complaint, he misrepresented to investors that the investments would pay a 12 to 15% guaranteed return and that he would pay their mortgages and would accrue in the investor's account any investment returns in excess of the amount necessary to pay the investor's mortgage. Rather than using investors' money as promised, the principal failed to make their mortgage payments, and misappropriated their money for his own benefit.

A settlement against MetLife for failing to reasonably supervise a registered representative who defrauded the Fulton County, Georgia, Sheriff's Office by investing $2 million of the Office's money with an entity the representative falsely stated was an affiliate of MetLife, but was actually a company with ties to the representative. In connection with this conduct, the representative pleaded guilty to criminal wire fraud charges in federal court and is currently serving a 30-month prison term. The Commission found that the registered representative induced the Sheriff's Office to purchase a $5.2 million MetLife variable annuity by misrepresenting to the Sheriff's Office that the annuity was a permissible investment for the Office under Georgia state law. Further the SEC found that MetLife failed reasonably to supervise the representative. In particular, the SEC claimed that the MetLife was aware of compliance concerns about the representative from the time he was hired, yet failed to implement heightened supervisory procedures for him and, in fact, allowed him to work from a "detached location" despite continuing compliance concerns and red flags regarding the representative's conduct.

There is also growing concern about the sales practice and suitability issues that may arise in the sale and exchange of these products. The high level of exchange activity involving variable insurance products, combined with the complexity of these products, high commission payouts to representatives, and the heavy marketing of these products to senior investors or investors planning for retirement, makes sales of variable insurance products at risk for abuse by the unscrupulous.

The Commission recently approved FINRA's new rule intended to enhance broker-dealer sales practices with respect to purchases and exchanges of variable annuities, on the same day that FINRA issued a regulatory notice to its members reminding them of their obligations relating to senior investors. The new FINRA rule has several specific requirements intended to make sure that variable annuities are sold in an appropriate manner.

First, the rule imposes a suitability obligation tailored to the specific characteristics of variable annuities.

Second, it includes standards and requirements for supervisory review of variable annuity transactions.

Third, the rule requires firms to establish and maintain specific written supervisory procedures that are reasonably designed to ensure compliance with the standards set out in the rule.

Fourth, the rule contains specific requirements regarding training.

There were 124 actions since September 2003 involving market timing. Variable insurance products, including both variable annuity and variable life insurance products, have proven to be attractive trading vehicles for market timers and late traders. This is because of these products' tax deferral advantages and the potential anonymity provided by the omnibus accounts through which insurance companies submit trades in the underlying mutual funds to those funds.

Market timing is the strategy of making buy or sell decisions of financial assets, generally stocks by attempting to predict future market price movements. The prediction is usually based on factors like economic conditions, technical and fundamental analysis of the market and trends in the outlook for an aggregate market, rather than for a particular financial asset.

Although Market Timing is not illegal, it is controversial; some consider it gambling since there can be no accurate prediction of the future. The SEC has brought late trading cases against insurance companies, including our cases against CIHC, Conseco, Inviva, and Jefferson National Life Insurance Company and General American Life Insurance Company. In the Commission's settled order in the General American case, the executive entered into a written agreement that gave a New York family exclusive late trading privileges in mutual funds underlying private placement life insurance policies the family purchased from General American. The life insurance policies represented about 50% of General American's private placement life insurance business for 2002, and the sales resulted in a significant bonus for the executive. According to the order, various General American personnel became aware of the late trading activity, but failed to take adequate steps to investigate and make sure it was stopped. The Commission fined General American $3.3 million, and imposed disgorgement, interest, and penalties of $163,000 against the executive. In all of these cases, allowing the market timing or late trading activity resulted in financial benefits to the insurance companies involved, at the expense of other shareholders in the mutual funds, who suffered financial harm from the dilution in the value of their investments.

The SEC has filed claims in recent cases against traders, such as hedge fund managers, that engaged in fraudulent market timing through variable insurance products. Unlike the cases against insurance companies, in these cases insurance companies actively attempted to prevent market timing through their variable insurance products, but were thwarted in their efforts by traders who employed deceptive tactics to evade the insurance company's detection, or to continue their market timing activities after the insurance company restricted trading in their accounts.

The SEC received final judgment against one such trader, a hedge fund manager and his firm that carried out a fraudulent scheme to purchase variable annuity contracts in order to engage in market timing for the benefit of the hedge fund. The defendants utilized various deceptive tactics to hide their identities from the insurance company, including using trusts and limited liability companies as nominee contract owners and beneficiaries. Through this deception, they made hundreds of thousands of dollars in profits for themselves at the expense of the other shareholders in the underlying mutual funds.

In some complaints affiliates have sometimes acted in their own best interests, rather than those of fund shareholders, is revenue sharing. In two settled administrative orders, the Commission found that certain insurance company-affiliated mutual fund or variable annuity trust advisers used the funds' or trusts' brokerage commissions to satisfy their own or their affiliated distributors' revenue sharing obligations to broker-dealers for the marketing and distribution of mutual fund and variable annuity products. The advisers failed to disclose to the funds' or trusts' boards this use of fund assets, thusly violating their fiduciary duty to disclose material conflicts of interest.

The Commission also found and filed complaints of affiliated distributors, which negotiated and were directly involved in the marketing arrangements, aiding and abetting and causing the advisers' violations. In a recent case against several John Hancock and Manulife Financial entities, the Commission ordered respondents to pay a total of $19.2 million in disgorgement and interest, and total penalties of $2 million. In our case last year against several Hartford entities, the Commission ordered respondents to pay $40 million in disgorgement and $15 million in penalties.

This theme of fiduciaries failing to disclose material conflicts of interest has become all too common. Last year the SEC filed against BISYS Fund Services, a mutual fund administrator, for aiding and abetting and causing the violations of certain bank advisers to mutual funds and the funds themselves. BISYS entered into side agreements with fund advisers in which BISYS agreed to pay a portion of its administration fee to, or for the benefit of, the adviser, often to pay marketing-related expenses, so that the adviser would continue to recommend BISYS to the funds' boards. These side agreements were not disclosed in the funds' prospectuses. The boards were not given enough information about the side agreements to evaluate whether the terms of the agreements.

Fraud also plays out at the personal level, rather than the firm level, involving gifts and gratuities, in which financial service firm employees took advantage of their position for personal gain, to the detriment of their duties to the firm and clients. The Commission brought a settled administrative proceeding against a broker-dealer representative of Jeffries & Co., Inc. in which we the representative aided and abetted and caused certain mutual fund traders' violations of one of the Investment Company Act's conflict of interest provisions. The broker-dealer representative provided traders from whom he received substantial brokerage business with extensive travel, and lavish entertainment and gifts. The Commission also brought a settled administrative action against his firm and supervisor for failing reasonably to supervise him, including ignoring numerous red flags suggesting he was engaged in misconduct.

Finally, the simple kickback scheme is ever prevalent as example in 2005 when a broker-dealer provided substantial cash kickbacks and other personal benefits to a trader at New York Life, in exchange for order flow and trades at favorable and excessive prices. The New York Life trader and the sales representative who provided the kickbacks both pleaded guilty to criminal fraud charges in connection with their roles in the scheme.

The IRS, the Securities Exchange Commission and the reporting agencies are not something to take lightly in any manner. These agencies police the financial world of insurance, trusts and corpoations and hold all violators responsile for their wrongs.