Florida Securities Fraud Lawyer Blog

Investor demand for variable annuities has grown as a result of significant market downturns. In the third quarter, net sales of variable annuities reached a record $8.8 billion with $2.27 billion in sales by Raymond James Financial Services, Inc. alone.

Many investors looking for a steady stream of retirement income have turned to variable annuities. However, the volatile equities market as well as, the extended low-interest environment has made it difficult and expensive for life insurance companies to hedge variable annuities with living benefits. As such, 2011 found multiple life insurers exiting the variable annuity market or doing away with many of the living benefits that made variable annuities attractive to investors.

Genworth Financial, Inc. and Sun Life Financial, Inc. both announced that they would no longer be involved in variable annuities sales. Similarly, Jackson National Life Insurance Co., MetLife, Inc., Prudential Financial, Inc. and John Hancock Life Insurance Co. announced a significant scale back or elimination of many of the living benefits that made the products so attractive to investors.

These moves by insurers will mean less price competition among the companies still in the variable annuity market. Increased investor interest in the product coupled with a decrease in the products available surely looks to make 2012 a seller's market for variable annuities.

On November 10, 2011, the SEC brought charges against a San Diego-based investment advisory firm and its president for securities fraud based on its failure to disclose a conflict of interest to investors and falsely represented the liquidity of a hedge fund they managed.

The SEC claims that Western Pacific Capital Management LLC and its president, Kevin James O'Rourke, encouraged investors to purchase a security without informing them that Western Pacific received a 10% commission. Western Pacific and O'Rourke also (1) failed to register as a broker, (2) failed to give required written disclosures to investors, (2) wrongly redeemed one hedge fund client's interest before another's, and (4) materially misrepresented to clients about the fund's liquidity.

According to Marshall Strung, an Assistant Director within SEC Enforcement Division, "Investment advisers have a fiduciary duty to act in the best interests of their clients and be forthcoming with them. Western Pacific and O'Rourke fraudulently breached that duty by failing to disclose the commissions they would receive for the recommended investments and lying to clients about the liquidity of the fund they managed."

Specifically, the SEC alleges that Western Pacific and O'Rourke acted as brokers in the non-public stock offering by Ameranth Inc. during 2005 and 2006. In return, Ameranth paid Western Pacific a 10% "success fee." Although Western Pacific and O'Rourke told investors to invest in Ameranth, they failed to advise each investor that they would make money off these investments, and failed to give investors the mandatory written disclosures as to their role in the offering.

Further, the SEC claims that from 2005-2008, Western Pacific and O'Rourke falsely represented the liquidity of The Lighthouse Fund LP, a hedge fund that they formed and managed. Western Pacific and O'Rourke always maintained that illiquid assets comprised only 25% of the Lighthouse Fund, when in reality 90 percent of the fund's assets were comprised of illiquid securities.

The Joint Select Committee on Deficit Reduction, tasked with finding $1.5 trillion in spending cuts or revenue increases to reduce the ballooning U.S. deficit, is considering a proposal to end the tax exemption for the $2.9 trillion municipal bond market.

Municipal bonds are an opportunity for state and local governments to carry out their capital projects in the most cost-effective manner. Currently, the tax exemption on municipal bond interest allows municipalities to borrow money by offering yields below treasury rates. Investors are willing to accept the lower rates because they don't face taxes on the bond payments.

Elimination of the tax exemption could result in rapid price adjustments for some municipal bonds resulting in a major challenge for bond fund managers who oversee $480 billion in nearly 600 separate municipal bond funds. If investors start jumping ship in search of better returns, fund managers will be pressured into selling to meet redemptions. The highest quality bonds are typically liquidated first creating a downward spiral for the fund.

Financial research firm Morningstar, Inc. will begin offering ratings for non-traded real estate investment trust (REITs) as early as the end of the first quarter next year. It is unknown whether Morningstar will apply its well-known star ratings system to the non-listed REITs. Morningstar research is utilized by over 4,000 institutional and advisory clients, along with 7.3 million retail investors. Coverage by Morningstar marks the first time a national financial services firm has performed due-diligence analysis on the $10 billion-a-year industry. Currently, the brokerage firms that sell REITs to clients control the flow of information around the investments.

"It's more scrutiny, research, evaluation and analysis around the industry, and I think that will ultimately be a very positive thing," Kevin Hogan, executive director of the IPA, a trade group for non-traded REIT sponsors and the broker-dealers who sell them said in an interview. "I would have thought the [REIT sponsors] would have more anxiety over it, but to a person, every sponsor has said [Morningstar's coverage] brings non-traded REITs into the mainstream."

Congress is considering a bill that would impose a 3% tax on financial transactions in stocks and bonds at their market value, as well as on derivative contracts, options, puts, forward contracts and swaps at their purchase price. Under the proposal, the broker dealer that places the order for a stock or mutual fund would be responsible for paying the tax.

The bill was written by Senator Tom Harkin, D-Iowa, and Representative Peter DeFazio, D-Oregon. In a press conference, Sen. Harkin stated the revenue generated by the tax is necessary to "reduce the deficit and maintain critical investments in education, infrastructure and job creation." Proponents of the plan estimate that the new tax could generate around $100 billion annually.

However, critics of the bill say it amounts to what is essentially a sales tax on investors and retirees will be hurt when the costs of the tax are passed along in 401(k) fees and other charges.

McCabe Rabin, P.A. is investigating losses caused by investments in church bonds pitched by various brokerage firms to religious-minded investors. The church bonds were purportedly used to provide various Christian mega-churches with financing for construction projects and other large expenses. Financial advisors preyed on the churches' own congregations and other religious supporters in selling these inherently risky and illiquid products. Investors were not always told that church bonds are very risky because there is no reliable source of repayment and the likelihood of default is high. In addition, there is virtually no secondary market in which to sell the bonds.

The sales efforts used by some brokerage firms to sell variable annuities merit scrutiny, particularly when elderly investors are the buyers. Hard-core sales pitches often scare or confuse investors. One such tactic is to claim that a variable annuity will protect investors from their creditors.

While variable annuities may be appropriate in limited circumstances, investors need to be aware of their restrictive features. This includes understanding that substantial taxes and charges may apply if the investor withdraws his or her money early.

Variable annuities offer investment features similar in many respects to mutual funds, a typical variable annuity offers three basic features not commonly found in mutual funds:

- Tax-deferred treatment of earnings;
- A death benefit; and
- Annuity payout options that can provide guaranteed income for life.

The variety of features offered by variable annuity products can be confusing. Here are seven factors an investor should consider before investing:

1. Liquidity and Early Withdrawals
2. Sales and Surrender Charges
3. Fees and Expenses
4. Taxes
5. Bonus Credits
6. Guarantees
7. Variable Annuities within IRAs

Variable annuities can be incredibly complicated products with huge front-loaded commissions for a broker. An investor broker should not buy a variable annuity without understanding the factors above, including getting any material representations in writing. Further, an investor needs to make sure the investments in the underlying sub-accounts are suitable.