From January through July 2018, the Financial Industry Regulatory Authority (FINRA) has continued its focus on variable annuities (VAs), particularly related to exchanges and multi-share class VAs. FINRA has thus far settled 16 VA cases through Letters of Acceptance, Waiver, and Consent (AWCs) and has filed two complaints related to VA misconduct. This review of FINRA’s VA cases identifies 2018 enforcement trends, including exchanges, multi-share class VAs and restitution.
FINRA continues to focus on VA cases and has already imposed almost four times the amount of 2017 VA-related fines. In 2017, FINRA reported 23 VA cases with $1.9 million in fines.1 As reported on FINRA’s Disciplinary Actions Online Database, the regulator has already settled 16 cases through July 2018, imposing $7.51 million in fines. Three of these settlements levied fines exceeding $750,000, which was the largest fine assessed in a VA case in 2017. Notably, four of the 16 VA settlements issued in 2018 (or 25%) also required firms to pay at least a total of $8.1 million in restitution to customers. Of the 16 settlements, nine related to supervisory failures, and four focused on suitability issues.2 In addition, three of the 2018 settlements focused on the sale of multi-share class VAs, while seven of the settlements related to VA exchanges.
Multi-Share Class VAs: FINRA has continued to focus on multi-share class VAs, particularly L-share contracts. On July 24, 2018, FINRA entered into two settlements alleging that eight firms failed to establish, maintain and enforce adequate supervisory systems and procedures and training for the sale and supervision of multi-share class VAs.3 For example, both settlements noted that the firms’ procedures did not address “the suitability concerns raised by the sale of an L-share contract when combined with a long-term income rider or to a customer with a long-term investment horizon.” One settlement imposed a total of $1.69 million in fines against four affiliated firms,4 and the second settlement imposed a total of $1 million in fines against four affiliated firms.5
In one of these settlements,6 FINRA also alleged that three of the firms failed to identify a pattern of red flags associated with the large number of L-share VA sales accompanied by long-term riders, and failed to investigate the suitability of these potentially incompatible recommendations. As described below, that settlement required the firms to provide at least $6 million in restitution to customers who purchased L-share contracts with long-term income riders. FINRA’s focus on multi-share VA misconduct will likely continue.
VA Exchanges: Two of the three largest 2018 VA settlements have included allegations related to VA exchanges. In the largest 2018 VA settlement, FINRA fined a firm $4 million for recommending VA exchanges without a reasonable basis to believe that the exchanges were suitable.7 The firm’s registered representatives allegedly did not consider or compare information about VA exchanges and misstated the costs and benefits of VA exchanges to customers. The settlement also identified supervisory failures related to these suitability issues, including failures related to the training of registered representatives and supervisory principals and the implementation of surveillance procedures.
One of the firms charged in one of the July 2018 settlements described above8 also allegedly failed to reasonably supervise the rates of VA exchanges. For example, the firm allegedly reviewed only a limited number of representatives using criteria unrelated to the volume of their VA recommendations, and the firm did not have “surveillance procedures” designed to identify representatives with problematic rates of VA exchanges. FINRA will likely continue to pursue misconduct related to VA exchanges as an Enforcement priority.
Restitution: FINRA’s VA enforcement cases show that FINRA views restitution as an Enforcement priority. Twenty-five percent of the 2018 VA settlements included restitution to customers. Those four settlements imposed a combined restitution amount of at least $8.1 million. The two largest restitution amounts were at least $6 million imposed in the exchange settlement and $2 million imposed in one of the July 2018 multi-share settlements. Consistent with past settlements, FINRA applied a “rough justice” approach in determining the amount of restitution in these cases. The settlements did not explain how the parties determined the appropriate minimum restitution amount. Rather, the amount of restitution appears to be a negotiated amount and is not necessarily correlated to the losses suffered by customers.
Prior Bad Acts: FINRA continues to weigh a firm’s “recidivism” or prior disciplinary record in determining fines, as evidenced by the AWC involving exchanges. FINRA specifically referenced a firm’s failure to comply with its prior 2009 FINRA settlement. For example, the settlement noted that the firm failed to comply with the recommendations of an independent consultant retained pursuant to the prior settlement. Firms previously subject to disciplinary action should be cognizant that FINRA is focused on repeat offenders and those who fail to fully comply with the terms of settlements.
Use of Sample Transactions: A recent trend in FINRA enforcement settlements is the use of sample transactions to identify misconduct. For example, in a case involving VA exchanges, FINRA sampled only 250 of 1,400 exchange transactions to reach its conclusions. FINRA noted that 77% of the “Sample Set” included at least one material misstatement or omission about the costs or benefits of the VAs at issue, which made the proposed VA exchanges appear more attractive to customers than they were. To conserve FINRA’s and firms’ resources and to expedite case resolution, FINRA likely will use a similar analysis in future enforcement actions.
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It appears that FINRA will continue to bring enforcement actions related to VAs, including exchanges and multi-share class VAs, and will include restitution in its settlements. Therefore, firms should consider focusing on maintaining systems and procedures reasonably designed to ensure compliance with the suitability and supervisory requirements of Rule 2330.
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1 The 2017 data comes from FINRA’s “Statistics” webpage, monthly disciplinary reports, press releases and other major news sources. https://www.finra.org/newsroom/statistics.
2 Cases may involve more than one alleged violation.
3 AWC No. 2015047177001 (July 24, 2018); AWC No. 2016047636601 (July 24, 2018).
4 The AWC imposed fines of $650,000, $115,000, $325,000 and $600,000 on the four firms, respectively. FINRA also charged two of the firms for violations relating to the supervision of unit investment trust sales charge discounts.
5 The AWC imposed fines of $350,000, $200,000, $200,000 and $250,000 on the four firms, respectively. The $350,000 fine was levied against the firm with alleged violations relating to VA share classes and VA exchanges.
6 AWC No. 2015047177001 (July 24, 2018).
7 AWC No. 2013035051401 (May 8, 2018).
8 AWC No. 2016047636601 (July 24, 2018).
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