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.

Block & Landsman Wins $5 Million FINRA Arbitration Award for Lehman Structured Notes Investments

A FINRA arbitration panel awarded damages in excess of $5,052,500 against Neuberger Berman and it's broker Brian Hahn in connection with the sale of Lehman Brothers Structured Notes to three customers. The investors were represented by Block & Landsman and The Law Firm of Nicholas P. Iavarone.

In the summer of 2008, Neuberger Berman wealth manager Brian Hahn solicited the customers to invest in the comBATS and XLF Lehman Brothers Structured Notes. The customers were all told that the principle of the structured notes were either fully protected (the comBATS note) or partially protected (the XLF note). The Claimants alleged that neither Neuberger Berman or Brian Hahn adequately disclosed the fact that the investments were actually Lehman Brothers debt instruments and not investments the underlying combats and XLF products. When Lehman Brothers declared bankruptcy, the value of the structured notes became virtually worthless. One of the customers had also invested $1 million in Libertyview Credit Select, a Neuberger Berman fund that hypothecated its assets to Lehman Brothers.


The award represents 100% of the money our clients invested in the Lehman Brothers Structured Notes and in Libertyview Credit Select.

Contact Block & Landsman with any questions about the award or any questions about investments in Lehman Structured Notes.

Defrauded Investors Given Hope of Recovery As Morgan Keegan Parent Settles Regulatory Charges for $210 Million

Nearly 40,000 investors who lost $1.5 billion in fraudulent subprime mortgage-backed mutual funds were given a small boost in their claims for recovery as the parent company of investment banking firm Morgan Keegan & Co., Regions Financial Corp., agreed to pay $210 million to settle regulatory charges targeting its subprime mortgage mutual funds.

The Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA) and several state securities agencies brought charges against Morgan Keegan relating to its management of five fixed-income mutual funds that were loaded with subprime mortgages. The agencies accused the firm of manipulating the price of the funds as the underlying mortgages dropped in value, and then misrepresenting the true values of the securities. According to the director of the SEC's Division of Enforcement, "the falsification of fund values misrepresented critical information exactly when invsetors needed it most -- when the subprime mortgage meltdown was impacting the funds."

The investors who purchased these mutual funds will receive $200 million of the Morgan Keegan settlement. Investors who lost money in these investments, however, still have claims for more than $1 billion in losses, and continue to have the right to seek their own damages in individual arbitration claims they can file with FINRA. By consulting with an experienced investment fraud lawyer, investors can determine whether they have a claim for damages as a result of their investments with Morgan Keegan.

The law firm of Block & Landsman represents investors in arbitration and in lawsuits for fraud and breach of fiduciary duty arising out of investment losses. Contact one of the attorneys at Block & Landsman for a free consultation.

Class Action Lawsuit Filed Against FINRA for Violating Brokers' Constitutional Due Process Rights

Block & Landsman joined other firms in filing a class action lawsuit against the Financial Industry Regulatory Authority (FINRA) seeking injunctive relief to stop the regulatory authority from violating the constitutional due process rights of registered representatives. Specifically, FINRA Rule 3010(b)(2), known as the Taping Rule, requires brokerage firms to establish special supervisory procedures, including the tape recording of broker conversations, when they employ more than a specified percentage of representatives who were previously employed by firms that have been expelled or had their registrations revoked for sales practice rule violations (referred to as "disciplined firms").

FINRA's Rule imposes a "guilt-by-association" standard by tainting brokers who worked for a disciplined firm even though the representatives had no involvement in any activity that led to the firm's expulsion or revocation. Even if the registered representatives worked left the firm before the misconduct occurred, they are nonetheless deemed to be "tainted." The special supervisory procedures required of firms that hire enough of these brokers are burdensome and expensive, and can be avoided only by reducing the number of so-called "tainted" brokers. Subsequent employers can avoid having to implement the procedures by reducing the number of affected brokers below a qualifying number.

As a result, brokers who are "tainted" face termination, or the inability to be hired, on the basis of nothing more than their past association with a prior disciplined firm. And FINRA provides no mechanism for a former broker of a disciplined firm to remove the "taint" arbitrarily imposed by FINRA's rule, thereby violating their due process rights and subjecting them to arbitrary termination.

Supreme Court Widens Gap Between Investor Protection and SEC Enforcement

Is punishment an acceptable replacement for reparation? Is it sufficient fidelity to the securities laws for participants in a fraud to be prosecuted but not held accountable to the victims of their criminal behavior? According to the U.S. Supreme Court, the unfortunate answer is yes.

In a 5-4 decision handed down on June 14, 2011, the Court held that mutual fund investors do not have a right of action under Rule 10b-5 to parties other than the issuer for fraudulent disclosures of risk. The decision does mean that the other participants have not committed securities law violations. Rather, it merely shields them from liability for their conduct. As a result, the victims of the misbehavior by non-issuing parties are foreclosed from seeking compensation for their losses even if the perpetrators admit that they engaged in misconduct.

In Janus Capital Group, Inc. v. First Derivative Traders, the Court narrowed the application of Rule 10b-5, which makes it illegal for "any person, directly or indirectly. . .[t]o make any untrue statement of material fact" in connection with the purchase or sale of a security. In that case, shareholders in a Janus mutual fund sued Janus Capital Management LLC, the management company for the fund, in connection with alleged fraudulent disclosures in the fund's prospectus. The plaintiffs alleged that the management company participated in the preparation of the misleading prospectus, and was liable for their losses resulting from the fraudulent disclosures. In an impressive display of linguistic gymnastics, the Court focused on the meaning of the phrase "make any untrue statement" in Rule 10b-5. Rejecting the arguments of the investors as well as the arguments of the SEC itself, the majority adopted a restrictive definition of the phrase, limiting its reach only to those who had ultimate legal control over the content of the prospectus. Because the management company did not "issue" the prospectus, it cannot be held liable for the investors' resulting damages, even if the management company drafted the misleading disclosure that appeared in the prospectus. While they may be guilty, they are not responsible.

The Court's decision does not exonerate the non-issuing participants, and it does not inhibit the SEC's ability to bring regulatory enforcement actions against them for their misconduct. Instead, the Janus ruling is just the latest in a string of opinions by the Court that impede the securities laws from protecting the very investors for whose benefit the laws were enacted. 

Public Investment Fund Overcharged $1 Million on Dozens of Bond Trades

Brokers at UBS Securities and Morgan Stanley are alleged to have overcharged Harris County more than $1 million in the sale of new bond issues between March and September 2010. According to an investigation by the Houston Chronicle, the brokers charged the County a premium above par value for newly issued bonds of federal agencies.

The size of the Harris County, Texas investment fund, reported to exceed $4 billion, allowed for large bond purchases that generated enormous commissions for the brokers. The typical commissions for such trades range between $250 to $350 per $1 million in bonds, earning a broker a $6,250 commission on a $25 million purchase. In contrast, by charging a premium above par for new bond issues, the UBS and Morgan Stanley brokers would generate a ten-fold commission of $62,500. In and of themselves, premiums above par for bonds are not unusual, for instance when purchasing a bond paying a higher interest rate than new bonds being issued. But paying such premiums on new bond issues is extremely rare.

Public investment funds, whether belonging to municipalities or public pension funds, are responsible for hundreds of billions of dollars of taxpayer money, and can be a prime target for a wide variety of investment fraud opportunities. The attorneys at Block & Landsman are experienced investment fraud lawyers who can investigate misconduct regarding the purchase and sale of securities. 

SEC and FINRA Issue New Warning About Investing in Principal Protected Structured Notes

A type of high risk investment product that imploded with the economic meltdown in the Fall of 2008, leading to investors' losses of hundreds of millions of dollars, continues to concern securities regulators. The Securities and Exchange Commission (SEC) has joined with the Financial Industry Regulatory Authority (FINRA) to issue a joint Investor Alert to warn investors about complex financial products known as "structured notes with principal protection." While the name of this security suggests safety, the structured notes present a variety of extreme risks to uninformed investors.

The notes combine a zero-coupon bond, which pays no interest until the bond matures, with an option or other derivative product whose payoff is linked to an underlying index, benchmark or other asset. These notes are designed to return some of all of an investor's money at a set maturity date (which can be as long as ten years) and offer a potential interest payment linked to a predetermined change in the value of the underlying asset.

There are many risky variations of both components that make up the structured note product. For example, although some notes return the entire amount of an investor's principal at maturity, many return less than 100 percent. Moreover, the principal guarantee -- that investors will receive all or some of their principal at maturity -- is entirely dependent on the creditworthiness of the securities firm that structures and issues the note. If the issuer goes bankrupt -- as was the case with Lehman Brothers, which issued large volumes of these type of notes -- investors have no protection and become unsecured creditors of the defunct firm.

The potential upside benefit of being able to participate in an increase in the underlying assets is similarly subject to signficant risks depending upon how the note is structured. As a result, the issuer can limit the amount of interest it owes investors even if the note reaches maturity. The upside potential is linked to the performance of the underlying assets, which are not limited to common benchmarks such as the S&P 500 or the price of a single commodity. Rather, exotic cominbations of assets such as spreads between interest rates or baskets combining unrelated asset types such as an index, a commodity and a currency, are often chosen as the meaure of interest the bond will ultimately pay above the return of principal. The issuer can select unfavorable formulas to calculate the gains or losses linked the the performance of the underlying asset, so-called "market-linked" returns, which can limit the extent to which investors are allowed to participate in the underlying asset's gains. Additionally, the issuer can determine that only a portion of the underlying asset's gain is credited to the note, which has the effect of restricting the interest paid to the investor at maturity.

The unlimited variations to the structure of these complex financial products makes it difficult for typical investors to assess the true risks and benefits of the notes. For this reason, the SEC and FINRA issued their Investor Alert and provided a series of questions that investors should ask their advisers who recommend structured notes with principal protection, such as: (a) what is the level of principal protection offered, (b) describe any conditions to the principal protection, (c) what are the fees and costs, (d) are there limits to potential gains in the underlying asset, (e) what is the credit risk of the issuer, (f) what other risks are associated with the product, and (g) what alternative investments are available.

Complex risks often hide behind the safe-sounding structured notes, and investors should be wary of recommendations to invest without obtaining direct and clear explanations. Any investor who has lost significant monies in these type of structured notes should consider consulting with an investment fraud lawyer to determine any liability on the part of the financial advisor recommending the security.

FINRA Rules Inch Toward Holding Brokers Fully Accountable to their Customers

Later this year, the Financial Industry Regulatory Authority ("FINRA") will put in effect new rules of conduct that narrow the gap between brokers' duties and investors' expectations of their brokers' responsibility.

Many investors would be surprised to learn that licensed brokers generally do not owe a duty to act in the best interests of their customers. Instead, the duty of a broker to a customer with a non-discretionary account has been much more limited: only to recommend investments that are suitable in light of their client's objectives, financial needs and circumstances. This is true even where customers place exclusive reliance on their brokers and always follow their recommendations.

The Securities and Exchange Commission has approved new FINRA Rule 2111, an updated version of the old NASD Rule 2310 (Suitability) requires brokers and their firms to "have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based o n the information obtained through the reasonable diligence of the member or associated person to ascertain the customer's investment profile."

FINRA's new Rule 2111 expands a broker's responsibility toward the customer. While not reaching the level of requiring brokers to act in their customers' best interests, the new standard is an improvement in the protection of investors because it will explicitly cover situations that industry members have historically opposed. Specifically, the new suitability standard will no longer apply only to recommendations concerning the purchase or sale of a security. Rather, it now applies also to the recommendation of investment strategies. Additionally, the new rule directly applies the suitability standard to a broker's recommendation to hold a security, rather than just to purchase or sell a security. This expansion nullifies years of denials by brokers and their firms that a recommendation to "hold" a security constitutes actionable behavior. It recognizes the reality that investors sometimes refrain from executing a transaction on the advice and recommendation of their adviser.

The rule further explains the three primary suitability obligations of a broker. First, a broker must make a reasonable-basis suitability determination, based on reasonable diligence, that the recommendation is suitable for at least some investors. What constitutes "reasonable diligence," however, is undefined, and depends on a variety of factors such as the complexity, the risks and the rewards associated with the security or the investment strategy. Second, assuming the recommendation is suitable for at least some investors, a broker must then make a customer-specific suitability determination to ensure that the recommendation is suitable for a particular customer based on his or her investment profile. Finally, where brokers exercise actual or de factor control over a customer's account, they must have a reasonable basis for believing that a series of recommended transactions, even if individually suitable, are not collectively unsuitable for the customer. Factors relevant to this determination are turnover ratio, cost-equity ratio and the existence of short-term trading.

The new rule is undoubtedly an improvement over the former suitability rule, and will benefit investors in their interactions with their brokers, and in customer arbitration claims where their brokers have violated the rules. The benefits of the revisions, however, are mitigated by the new rule's limitations. For example, the rule leaves much ambiguity regarding the precise contours of a broker's obligations. Additionally  the duty is only triggered by a "recommendation" of the broker, as opposed to an adviser acting under a fiduciary duty, who in required in all respects to provide guidance in the client's best interests. While the regulatory trends appear to favor protecting investors, much work still needs to be done, and investors must remain vigilant to ensure their advisers are recommending securities and investment strategies that are appropriate for their purposes.