Editor's note: This story includes several inaccuracies. Please see the Correction.
A repayment of $1 million will reach 250 Missourians who invested in variable annuities exchanged by Waddell & Reed, a broker-dealer firm based in Kansas.
The company reached an agreement with the National Association of Securities Dealers on April 29 and said it would make a total of $11 million in restitution to 5,000 customers across the nation.
Waddell & Reed also will pay a $5 million fine to the NASD and a $2 million fine to a coalition of state securities regulators. Since 2002, NASD has led an investigation of the company’s variable annuities transactions in 27 states, including Missouri. The case drew wide attention to variable annuities from investors and securities regulators in Missouri and across the nation.
“It’s one of the largest cases in the variable annuities area,” NASD spokesman Herb Perone said.
Variable annuities, often described as a mutual fund wrapped into an insurance policy, gained popularity in the late 1980s. The uncertainty of Social Security and the decline of employer-sponsored pensions contributed to this trend.
Variable annuities sell well across the nation. The combined net assets of U.S. variable annuities had risen to $1.1 trillion by the end of 2004, according to the National Association for Variable Annuities.
The Securities Division of the Missouri secretary of state’s office, however, received complaints from Waddell & Reed customers. One complaint came from a Columbian who invested $146,000 in variable annuities with the company.
Variable annuities carry the advantage of tax deferrals, but the investments come with steep commissions. While an average mutual fund charges commissions of 1.44 percent, variable annuities have combined insurance and fund charges that can add up to more than 2 percent. Extra fees are generated if customers tap the investment.
Between January 2001 and August 2002, Waddell & Reed switched the variable annuity contracts of 5,000 customers, including 250 Missourians, from United Investors Life Insurance Co. to Nationwide Insurance Co. The transactions were deemed unsuitable by the NASD. The switch came after Waddell & Reed failed to obtain an agreement from United Investors to share annual mortality and expense fees, which is typically 1.25 percent of the account value. Nationwide, however, agreed to share fees with Waddell & Reed.
The switch cost the Columbia investor $9,000 in commission fees and $3,000 in surrender fees as a percentage of the amount withdrawn, even though he might have been unaware of the reason for the transaction.
“Many investors stated they were told by Waddell & Reed that if they did not switch their annuity to a Nationwide policy, they could no longer have Waddell & Reed or its agents as their adviser,” Secretary of State Robin Carnahan said in a news release.
In Missouri, the transactions generated about $1 million in commissions for Waddell & Reed, and they cost Missouri investors “hundreds of thousands of dollars and related benefits,” Carnahan said.
The NASD filed a complaint in January 2004 accusing Waddell & Reed of generating $37 million in commissions and costing customers $9.8 million in surrender fees.
In addition to fines and restitution, the April 29 settlement includes a six-month suspension and a fine of $150,000 for former Waddell & Reed president Robert Hechler and former national sales manager Robert Williams.
The agreement came three days before a scheduled hearing in Kansas City on the case that would have lasted six weeks and featured testimony from the company’s customers and its former brokers and managers.
The settlement was possible only because it included full restitution, Perone said. “Anything short of that would have meant the hearing would go on.”
Missouri didn’t wait for the national settlement to take action. On March 25, the Securities Division suspended the broker-dealer registration of Waddell & Reed for 14 days. Carnahan called the company’s transactions “unsuitable for customers.”
Just four days later, a St. Louis circuit judge issued a temporary restraining order prohibiting a suspension of the company’s license. Waddell & Reed had questioned the suspension, citing a lack of due process. The company resumed business after the court order.
“They could have immediately requested a hearing from the securities commissioner,” Carnahan spokeswoman Stacie Temple said. “But instead, they chose to go to the court… At this point we are waiting to hear from the Cole County court.”
Meanwhile, Carnahan on Friday issued a news release criticizing lawmakers and Gov. Matt Blunt for failing to pass a bill seeking tighter regulation of variable annuities, which she believes threaten Missouri investors.
The bill, sponsored by Rep. Sam Page, D-Creve Coeur, would have given the Department of Insurance authority to regulate variable annuity contracts and required the department new standards of suitability for the investments. It failed to make it to the House floor for debate.