|Wednesday, January 14, 2004
Nancy A. Condon 202-728-8379
Michael Shokouhi 202-728-8304
NASD Charges Waddell & Reed with Suitability Violations Relating to Thousands of Variable Annuity Exchanges and Seeks Customer Compensation; Two Senior Execs Also Charged
Washington, DC — NASD today filed a complaint charging Waddell & Reed, Inc. of Overland Park, Kansas, for recommending 6,700 variable annuity exchanges to its customers without determining the suitability of the transactions. These exchanges, known as "switching," generated $37 million in commissions and cost Waddell's customers nearly $10 million in surrender fees. NASD also alleged that according to its quantitative analysis, at least 1,400 of the firm's customers were likely to lose money by making these switches. Charges were also brought against the firm's former President, Robert Hechler, and its National Sales Manager, Robert Williams. In addition to other sanctions, NASD is seeking an order requiring the firm to disgorge commissions and compensate customers.
"Today's action should make crystal clear that brokers may not recommend that clients replace their variable annuity contracts when the broker has no reasonable basis for believing the replacement is in the client's, not the broker's, best interest," said Mary L. Schapiro, NASD Vice Chairman and President of Regulatory Policy and Oversight. "Engaging in a campaign to make such recommendations without an assessment of the suitability of the exchange, simply because it will advance the firm's own commercial interests, is completely unacceptable."
According to the complaint, between January 2001 and August 2002, Waddell engaged in an aggressive campaign to switch the variable annuity contracts of its customers from those issued by one insurance company, United Investors Life Insurance Co. (UILIC), to very similar annuities provided by another insurance company, Nationwide Insurance Co. In doing so, Waddell & Reed failed to take adequate steps to determine whether there were reasonable grounds for the customers to enter into these exchanges, such as determining whether the customers were likely to benefit or lose money from the exchanges, and failed to establish sufficient guidance for the sales force to use in determining the suitability of the exchanges. In fact, many customers were likely to lose money through these switches, which typically would raise concerns about the suitability of these transactions.
In addition, over 700 customers were switched into one Nationwide annuity, rather than another Nationwide annuity that was less expensive and offered far more benefits and greater flexibility to the clients, but provided a lower payout to Waddell's sales force. One of the firm's advisors, in comparing the payouts, noted, "I have no problem selling an annuity that may cost .45 (basis points) more on M&E charges because I have to support my family and pay my assistant and other business overhead."
The misconduct began after Waddell failed to obtain an agreement to receive a share of certain fees collected by UILIC, the original issuer of annuities sold by Waddell. Waddell found another issuer, Nationwide, which agreed to share with Waddell, some of the fees it collected from Waddell's customers. From the customer's perspective, the underlying investment options available in Nationwide's annuities were otherwise virtually identical to the UILIC contracts.
Beginning in late January 2001, following the agreement with Nationwide, Hechler and others engaged in an aggressive campaign to encourage Waddell's sales force to replace UILIC annuities previously sold with those offered by Nationwide. Among other things, Hechler issued a series of memoranda to the sales force repeatedly encouraging them to replace existing UILIC variable annuities with Nationwide variable annuities by questioning UILIC's intentions to provide service to Waddell's clients, and compensation to the sales force, along with questioning UILIC's financial strength.
In response to the pressure from senior management, some Waddell regional vice presidents took steps to encourage exchanges. One vice president sent an e-mail to his division managers on March 6, 2001, encouraging a "campaign of every advisor contacting every UILIC client" to explain what was happening with the UILIC relationship, and later set up a "Call-a-Thon" for advisors in his region to call all of their customers with UILIC variable annuities. During this campaign some Waddell advisors expressed concern that these switches were not in the best interests of their clients. One advisor even noted that management's comments were intended to "prod and scare" advisors into making switches.
Although the president of UILIC assured Hechler on March 14, 2001, that UILIC would continue to provide compensation to Waddell's advisors and provide service to both policyholders and advisors, Hechler did not relay this information to Waddell's sales force for almost two months, during which the switching campaign continued unabated. During that time, Hechler's actions led to a dramatic increase in the number of switches from UILIC to Nationwide variable annuities.
During March 2001, the number of switches from UILIC contracts to Nationwide contracts jumped 540 percent over the previous month, and the number jumped another 490 percent in April 2001. By August 2002, Waddell had replaced 6,772 UILIC variable annuities, moving approximately $617 million in assets away from UILIC, costing customers more than $9.8 million in surrender charges, and generating approximately $37 million in commissions to Waddell. Additionally, Waddell earned approximately $700,000 from fee-sharing arrangements with Nationwide in 2001, and Waddell will continue to accrue such fees annually.
These exchanges of variable annuities were costly to customers in a number of ways. Many customers had to pay surrender charges to switch out of their old policies, and all customers who switched incurred a new surrender charge period that limited their ability to surrender their new annuity contracts. In addition, customers who switched into the Nationwide variable annuities paid higher ongoing expense fees than they had been charged under the old policies. Waddell, on the other hand, made money through the commissions charged on each exchange and through the portion of the annual fees paid by customers that Nationwide shared with Waddell.
Despite repeated requests from its the sales force and their supervisors, Waddell failed to provide adequate guidance, analytical tools or criteria for making the critical suitability analysis required under NASD rules for recommending exchanges. As a result, many variable annuity exchanges were recommended by the sales force without having reasonable grounds for believing that the recommendations were suitable for the customers based on their security holdings and their financial situations and needs. In addition, based on NASD's quantitative analysis, in over 1,400 instances, at the recommendation of Waddell, customers entered into exchanges that were likely to result in customers losing money.
Williams, Waddell's National Sales Manager, who actively participated in the switching campaign and had supervisory authority over the sales force and its management, had responsibility for ensuring that transactions are appropriately reviewed for suitability. He was aware, through communication with the sales force, that there were serious shortcomings with Waddell's process for reviewing the suitability of switches from UILIC to Nationwide variable annuities, and that members of the sales force felt pressure to make switches from the firm and Hechler.
NASD has charged the firm with suitability and supervisory violations, Hechler with causing the firm's suitability violations by encouraging the sales force to switch customers and Williams with supervisory failures in connection with the variable annuity exchanges.
Under NASD rules, the individuals and the firms named in the complaint can file a response and request a hearing before an NASD disciplinary panel. Possible sanctions include a fine, suspension, bar, or expulsion from the NASD.
Information regarding variable annuities can be found in the following NASD Investor Alerts:
Investors can obtain more information and the disciplinary record of any NASD-registered broker or brokerage firm by calling NASD's BrokerCheck. NASD makes available BrokerCheck at no charge to the public. In 2003, members of the public used this service to conduct more than 2.9 million searches for existing brokers or firms and requested almost 180,000 reports in cases where disclosable information existed on a broker or firm. Investors can link directly to the program by going online to www.nasdbrokercheck.com. Investors can also continue to access this service by calling 1-800-289-9999.
NASD is the leading private-sector provider of financial regulatory services, dedicated to investor protection and market integrity through effective and efficient regulation and complementary compliance and technology-based services. NASD touches virtually every aspect of the securities business - from registering and educating all industry participants, to examining securities firms, enforcing both NASD rules and the federal securities laws, and administering the largest dispute resolution forum for investors and member firms. For more information, please visit our Web Site at www.nasd.com.