Under the terms of the settlement with NASD and a separate agreement with a coalition of state regulatory authorities, Waddell & Reed will repay up to $11 million to more than 5,000 customers whose annuities were exchanged by the firm. The firm will pay a fine of $5 million to NASD and a fine of $2 million to state regulators.
"Placing the client's interests first and assessing the suitability of any recommendation are two of the fundamental principles under which every firm must operate in every securities transaction," said NASD Vice Chairman Mary Schapiro. "Waddell & Reed violated these principles by engaging in a deliberate campaign, motivated by its own business interests and not those of its clients, to switch customers from one variable annuity to another. These switches were recommended without regard to whether the transactions were in the customers' best interests and caused investors to incur substantial unnecessary expenses."
In a complaint filed in January 2004, NASD charged Waddell & Reed with violating its obligations under NASD's suitability rule by failing to take reasonable steps to ensure that recommended variable annuity exchanges were in the best interests of customers. According to the complaint, between January 2001 and August 2002, the firm engaged in an aggressive campaign to switch customers from variable annuity contracts issued by United Investors Life Insurance Co. (UILIC) to similar annuities provided by Nationwide Insurance Co. The switching campaign was initiated after Waddell failed to obtain an agreement from UILIC to receive a share of annual mortality and expense (M&E) fees collected by UILIC from Waddell's customers. Waddell approached Nationwide, which agreed to a fee sharing arrangement.
NASD charged that following that agreement, Robert Hechler, then the firm's president, and other senior managers encouraged the sales force to engage aggressively in switching customers and made statements to them that - as one broker noted - were intended to "prod and scare" the sales force into making switches. During this campaign, some advisors expressed concern that these switches were not in the best interests of their clients.
Despite repeated requests from Waddell's sales force and its supervisors, the firm failed to supply sufficient guidance for the sales force to use in determining the suitability of the exchanges - such as analytical tools or other mechanisms that would measure the cost and the potential long-term benefit or detriment of an exchange for each customer. Waddell failed to take into account relevant objective factors including age, sex, surrender charges, M&E charges, policy features (including annuitization rates), and the costs and benefits of the particular optional policy features chosen by the customers.
NASD determined that many customers were likely to lose money through these switches, thereby raising concerns about the suitability of these transactions. In addition, customers incurred close to $10 million in surrender charges as a result of the switches while Waddell made money through commissions charged on each exchange as well as through the fee sharing arrangement with Nationwide. Finally, more than 700 customers were switched into one Nationwide annuity product that provided greater compensation to Waddell's sales force - but provided fewer benefits and less flexibility - than another Nationwide annuity being sold by Waddell.
Under the terms of the settlement, Waddell & Reed will repay customers one hundred percent of all surrender charges they incurred in the exchanges, and will compensate the purchasers of the more expensive annuity by repaying the cost difference between the two products. Waddell and Reed will, at its own expense, retain an independent consultant to implement the repayment plan.
In addition, without admitting or denying the allegations, the firm consented to the entry of NASD's findings of supervisory failures and record keeping violations and agreed to pay a fine of $5 million to NASD.
The settlement also imposes a six-month suspension and $150,000 fine on former Waddell & Reed President Robert Hechler. Hechler, who neither admitted nor denied the charges, consented to the entry of NASD's findings that he caused the firm's suitability violations by aggressively encouraging the exchanges.
Former Waddell & Reed National Sales Manager Robert Williams, without admitting or denying the charges, consented to a six-month suspension as a supervisor and a $150,000 fine for supervisory failures in connection with the exchanges. NASD found Williams was involved in the effort to aggressively encourage the sales force to switch customers from UILIC to Nationwide annuities, was aware of instances where inappropriate switches were made, and failed to take reasonable action to supervise the firm's switching activities.
NASD wishes to acknowledge the significant assistance and cooperation provided by state securities and insurance regulators in connection with this matter.
Information for investors considering switching their variable annuities is available on NASD's Web site, in the Investor Alert Should You Exchange Your Variable Annuity? For brokers, NASD provides an informational video Webcast examining suitability considerations in variable annuities exchanges, Understanding Variable Annuities: Exchange Suitability Issues.
Investors can obtain more information about, and the disciplinary record of, any NASD-registered broker or brokerage firm by using NASD's BrokerCheck. NASD makes BrokerCheck available at no charge to the public. In 2004, members of the public used this service to conduct more than 3.8 million searches for existing brokers or firms and requested more than 190,000 reports in cases where disclosable information existed on a broker or firm. Investors can link directly to BrokerCheck at www.nasdbrokercheck.com. Investors can also access this service by calling (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.
("Copyright 2005 National Association of Securities Dealers, Inc.")
