Washington Brokerage firm Waddell & Reed Financial Inc. is repaying as much as $11 million to affected customers in settlements with industry and state regulators who accused it of improperly switching customers from one annuity investment to a similar one.
The switching brought big commissions for Waddell & Reed's brokers but cost some 5,000 customers thousands of dollars in penalties, according to the National Association of Securities Dealers and state regulators. In the agreements announced Friday, the firm also is being fined $5 million by the NASD, which is the brokerage industry's self-policing organization, and $2 million by the state securities and insurance regulators.
Waddell & Reed, based in Overland Park, neither admitted nor denied wrongdoing under the agreements.
The settlement with the NASD also fines former Waddell & Reed President Robert Hechler and former national sales manager Robert Williams $150,000 each and suspends them from the brokerage industry for six months. Hechler and Williams neither admitted nor denied the NASD's allegation that they aggressively encouraged the firm's brokers to switch customers from variable annuity contracts issued by United Investors Life Insurance Co. to similar annuities provided by Nationwide Insurance Co. in 2001 and 2002.
Variable annuities are often described as mutual funds wrapped in an insurance policy. They are contracts between an investor and the company selling it in which the company agrees to make periodic payments to the investor, beginning immediately or at some future date. They are sold through brokerage firms and insurance agencies. Their periodic payouts change depending on the performance of underlying investments.
Sales of variable annuities, which are tax-deferred and often used to save for retirement, have ballooned in recent years. The NASD regulators have received complaints from individual investors about sales practices and have taken numerous disciplinary actions against brokers and investment firms -- including American Express and Prudential -- for alleged sales abuses.
Waddell & Reed began its "switching campaign" after the brokerage firm failed to secure an agreement from United Investors to share fees it collected from customers, the regulators said. The firm then approached Nationwide, which agreed to split fees, they said.
Customers were told the Nationwide annuity would provide a better return than the United Investors product, despite the fact the mutual funds in which each of the products were invested were the same, according to the regulators. The switching is said to have delayed customers' access to the funds for eight years unless they paid substantial penalties.
"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," NASD Vice Chairman Mary Schapiro said. "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."
Gail Sheppick, South Dakota's securities regulator, said the action against Waddell & Reed marked the first time state securities and insurance regulators had combined with the NASD "to resolve a very complex case and one that could have very easily slipped through the regulatory web."
"This case sends a strong message to the brokerage community as a whole that abusive sales practices involving variable annuities will not be tolerated or overlooked, regardless of jurisdiction," Sheppick said in an interview.