Equity Indexed Annuities - Seniors At Risk

If you are an elderly investor looking for a conservative way to invest in the stock market, you should be aware of an Investor Alert recently issued by the Financial Industry Regulatory Authority ("FINRA") regarding the dangers of equity indexed annuities ("EIAs"). In contrast to the way they are often sold, EIAs are in fact complicated with confusing features that make them difficult to understand. As a result, they are often misunderstood to be solidly conservative investments.

An annuity is a contract between a purchaser and an insurance company that promises to make periodic payments. Annuities are either "fixed," meaning the insurance company guarantees the rate of return as well as the ultimate payout, or "variable," meaning that the rate of return varies with the performance of the investments (stocks, bonds) purchased within the annuity. Unlike fixed annuities, variable annuities carry the risk of loss if the underlying investments decrease in value. As a result, variable annuities are considered securities and are registered with the Securities and Exchange Commission ("SEC"). Fixed annuities escaped similar regulatory oversight due to a late amendment to the Dodd-Frank Wall Street Reform and Consumer Protections Act passed in July 2010, even though the stocks purchased within the fixed annuity remain subject to SEC regulation. As a result of this exeption, sellers of fixed annuities do not have to be licensed securities brokers.

EIAs have characteristics of both fixed and variable annuities because their value is dependent on the performance of the stock indices they track except they do not decline in value if held to maturity even if the underlying indices they track do decline. As a consequence, the returns vary more than a fixed annuity but less than a variable annuity with a risk of loss that is less than variable annuities but more than fixed annuities.

In the abstract, EIAs may seem to some investors to be an attractive middle ground between fixed and variable annuities. As FINRA describes them, however, EIAs are complex financial instruments that are not well understood by the general investing public. The gains that are linked to the performance of the underlying index is dependent on various features that an EIA uses. For example, insurance companies often limit the percentage of the stock index increases that is credited to the annuity. Moreover, some insurance companies add a spread/margin/asset fee which is subtrracted from any gain in the index linked to the annuity. Other EIAs place a ceiling on the amount of the annual return the annuity can gain. These an other features reduce the gains which EIAs can achieve. Therefore, conservative investors may not find these investments suitable.

EIAs not only limit the upside potential, they are structured to be long-term investments that carry significant penalties if the investor needs to withdraw his or her funds early. Investors who pull their money out of EIAs early may suffer losses that occurred in the underlying stock index. Such investors typically also face surrender charges that further add to the losses. Additionally, any investor who withdraws from tax-deferred annuities before the age of 59 1/2 are subject to a 10% tax penalty in addition to having any gain taxed as ordinary income.  As a result, elderly investors may question the suitability of EIA investments.

Strengthening Public Pension Funds by Attacking Investment Fraud

Public pension funds are under intense financial pressure because of concerns, real and imagined, about their potential inability to meet benefit payment obligations within a few years. Critics fling accusations that often appear more directed at assigning blame than in finding a remedy to relieve the concerns of the funds and, most importantly, the firefighters who benefit from the funds. Now, more than ever before, boards of trustees must evaluate all available options to discharge their fiduciary responsibility to protect public pension fund assets.

The good news, however, is that boards have concrete steps they can take to strengthen their funds' financial position by recovering investment losses caused by inappropriate investment strategies employed by outside investment advisers. Investment fraud by advisers is a scenario that has been all too common in recent years, and public pension funds are not immune from this danger. Between 2001 and 2009, aggrieved investors have filed, on average, nearly 6,500 securities arbitration claims per year against their brokers, a figure that increases by including investors who were able to pursue their claims in court rather than in arbitration. At any given time, pending arbitration disputes between investors and their advisers involve collective losses of more than one billion dollars. Public pension funds in Illinois, and across the country, have begun pursuing their own claims of investment fraud.

The Illinois Pension Code (the "Code") empowers trustees to invest fund assets in specific securities, and in allowable percentages, as defined by statute according to the size of the fund's net assets. Because investment decisions concerning these assets can be complex, the Code permits the board of any Article 3 or 4 pension fund to appoint an investment adviser for professional guidance. For funds seeking to invest in common or preferred stocks (available only to funds with net assets of at least $5 million), retention of an investment adviser is mandatory.

Pursuant to the Code, any investment adviser hired by a public pension fund is considered a fiduciary, imposing a heightened standard of care that requires the adviser to act in the best interests of the fund. The adviser must act only pursuant to a written contract with the board, and the contract must contain, among other things, an acknowledgement that the adviser is a fiduciary to the fund and will follow the board's investment policy which is based on the allowable investments identified in the Code.

Despite these statutory requirements, trustees, like any investor, can find themselves relying on the guidance of an investment adviser who provides inappropriate investment advice, and which results in significant investment losses. Where an investment adviser engages in wrongdoing that causes a fund to lose money, the trustees (who are themselves fiduciaries to their funds) may have a reason, and indeed an obligation, to investigate and pursue claims against the fund's adviser to recover those losses. Fortunately, the Code specifically provides the funds with a remedy for an adviser's misconduct. Section 114 provides that any fiduciary of a fund who breaches a fiduciary duty imposed by the Code "shall be" liable to a pension fund for any losses resulting from such breach. The Code also allows for additional remedies, including recapture of the adviser's profits and all other equitable or remedial relief that may be appropriate given the circumstances. Section 115 of the Code authorizes a board of trustees to bring an action against the investment adviser for such losses. Moreover, other statutory and common law causes of action exist to use for recover of these losses.

Understanding a fund's right to recover wrongfully caused investment losses, and deciding to act to protect those rights where appropriate, is becoming an urgent matter for public pension fund boards. Recent volatility in the securities markets has exposed the unsuitable nature of many investment strategies, but there are various time limitations that may be running which may restrict or eliminate a fund's ability to recover these losses if too much time passes before a claim is filed. Because the limitations periods which apply to any given investor depend on several factors, they should be discussed with an experienced attorney as soon as the board becomes concerned that investment losses may have resulted from inappropriate investments or strategies. Because trustees are themselves fiduciaries, and are required to act in the funds' best interests, they should not unduly delay their investigations into the causes of their investment losses.

Recovery of improperly caused investment losses can help strengthen the financial position of a public pension fund, and would allow the trustees to ultimately concentrate on the important tasks of caring for the health and well-being of the firefighters they serve. 

The Epidemic of Financial Abuse Against The Elderly in the United States

Senior citizens deserved to be protected against financial scams. And, like anybody who has been victimized by investment fraud, the elderly need the people who care for them to ensure that our nation's elderly do not have to deal with the devastating consequences caused by fraud. A pilot project initiated by Baylor College of Medicine trained physicians to detect elderly patients who were victims fo financial fraud and report their concerns to the state securities department. The project uncovered several instances of fraud, including one Ponzi scheme that raised $10 million from 130 investors and which resulted in a conviction for that fraudster

Mickey Rooney, the 90 year old legend who starred in more than 200 movies, exposed painful and embarrassing details of his personal life when he testified before a Senate panel that he was the victim of financial abuse. Rooney's testimony was offered in support of pending legislation called the Elder Abuse Victims Act, which would establish an Office of Elder Justice within the Department of Justice.

Financial abuse of senior citizens is serious problem. According to a study by Duke University, nearly 9 million Americans over the age of 71 are susceptible to financial exploitation because of cognitive difficulties ranging from mild impairment to Alzheimer's disease. Indeed, according to a wide-ranging study by the Investor Protection Trust ("IPT"), one in five elderly U.S. citizens have been victims of fraud.

The exploitation of seniors who are vulnerable to financial fraud is made more likely because the people closest to these victims -- their adult children -- are unaware of the dangers to their parents. For example, the IPT study found that 37% of elderly Americans are solicited to buy into one of several financial schemes. Yet, only 19% of all adult children believe that their elderly parents are the targets of fraudsters. In addition, only 5% of adult children who speak with their parents' physicians said that the healthcare providers expressed concern regarding their parents' ability to handle their own money. In contrast, nearly 20% of these same physicians reportedly raised concerns with these adult children about their parents' mental comprehension.

The combination of vulnerability and lack of family appreciation of the danger of elder financial abuse fuels the efforts of scam artists to target senior citizens. In response to this looming danger, the North American Securities Administrators Association ("NASAA"), in cooperation with IPT and various medical associations across the country, created the "Elder Investment Fraud and Financial Exploitation" prevention campaign intended to education medical professionals to identify seniors who are vulnerable to financial fraud and to refer suspected victims to the appropriate state securities departments. This program deserves the whole-hearted support of the medical community, securities regulators across the country, and family members of the elderly.