More On Legal & Compliancefrom The Advisor's Professional Library
- Client Commission Practices and Soft Dollars RIAs should always evaluate whether the products and services they receive from broker-dealers are appropriate. The SEC suggested that an RIAs failure to stay within the scope of the Section 28(e) safe harbor may violate the advisors fiduciary duty to clients, so RIAs must evaluate their soft dollar relationships on a regular basis to ensure they are disclosed properly and that they do not negatively impact the best execution of clients transactions.
- Client Communication and Miscommunication RIA policies and procedures must specify what type of communications should be retained. The safest course of action is for RIAs to retain all communicationsto clients, from clients, and about client accounts. To comply with fiduciary obligations, communications must be thorough and not mislead.
The Massachusetts Mutual Life Insurance Co. agreed to settle SEC charges that the firm violated securities rules by failing to sufficiently disclose the potential negative impact of a “cap” it placed on complex variable annuity products.
MassMutual, which the Securities and Exchange Commission says removed the cap after the SEC’s investigation to ensure that no investors will be harmed, has agreed to pay a $1.625 million penalty.
MassMutual consented to the penalty without admitting or denying the charges and agreed to cease and desist from committing or causing any violations and any future violations of Section 34(b) of the Investment Company Act.
According to the SEC, its investigation found that MassMutual included a cap feature in certain optional riders offered to investors, and the cap potentially affected $2.5 billion worth of MassMutual variable annuities. Neither the prospectuses nor the sales literature sufficiently explained that if the cap were reached, the guaranteed minimum income benefit (GMIB) value would no longer earn interest, the SEC says.
Mark Cybulski, a spokesman for MassMutual, says the company "is pleased to have resolved this matter with the SEC." In resolving the matter, he said, "MassMutual neither admits nor denies the SEC’s findings. Importantly, the settlement makes clear MassMutual improved the challenged disclosures beginning May 1, 2009, and that the SEC considered our change to these riders to eliminate the maximum GMIB value or 'cap'–a change that benefits all contract holders with GMIB 5 and GMIB 6 riders. As the SEC notes in its announcement, no investors were harmed in this matter."
Says the SEC: “MassMutual’s disclosures instead implied that interest would continue to accrue after the GMIB value reached the cap, and dollar-for-dollar withdrawals would remain available to investors. A number of MassMutual’s own sales agents were confused by the language in the disclosures, and investors were not sufficiently informed of the potential negative effect of taking withdrawals if they reached the cap approximately a decade from now."
Robert Khuzami, director of the SEC’s Division of Enforcement, said in announcing the charges, “Investors shouldn’t have their retirement nest eggs at risk because of undisclosed investment complexities.” Khuzami said that the SEC’s “proactive investigative efforts,… exposed a problem with a complex variable annuity investment at least a decade before it could have harmed investors.”
According to the SEC’s order instituting settled administrative proceedings, MassMutual offered GMIB 5 and 6 riders from 2007 to 2009 as an optional feature on certain variable annuity products. The GMIB rider sets a minimum floor for a future amount that can be applied to an annuity option, known as the “GMIB value.” Unlike the contract value of the annuity that fluctuates with the performance of the underlying investment, the GMIB value increases by a compound annual interest rate of either 5 percent or 6 percent and allows investors to make withdrawals any time during the annuity’s accumulation phase.
According to the SEC’s order, MassMutual advertised its GMIB riders as providing “Income Now” if investors elected to make withdrawals during the accumulation phase or “Income Later” if they elected to receive annuity payments.
MassMutual’s sales literature highlighted the guarantee provided by the riders by stating, “Even if your contract value drops to zero, you can apply your GMIB value to a fixed or variable annuity.” The riders included a maximum GMIB value, and investors could not reach this cap until 2022. If the GMIB value reached the cap, every dollar withdrawn would reduce the GMIB value by a pro-rata amount tied to the percentage decrease on the contract value. After a number of such withdrawals, depending on market conditions, both the contract value and the GMIB value could decline and adversely affect the amount a customer could apply to an annuity and the future income stream.
The SEC’s investigation found that “a number of MassMutual sales agents and others did not understand that all withdrawals taken after the GMIB value reached the cap would result in such pro-rata reductions.” After reviewing MassMutual’s prospectuses and other disclosures, “they believed that if the GMIB value reached the cap, investors could take withdrawals and the GMIB value would remain at the cap. Some sales agents mistakenly believed that investors could maximize their benefits by waiting until the GMIB value reaches the cap, taking annual 5 percent or 6 percent withdrawals, and annuitizing their contracts in order to receive an income stream tied to the maximum GMIB value.”
But in reality, the SEC goes on to say “following such an investment strategy could have had severe adverse consequences for investors. By taking withdrawals annually after the cap is reached, investors would proportionately reduce their GMIB values and in turn potentially decrease their future income streams. In a worst-case scenario, they would withdraw all of their contract value, the GMIB value would decline to zero, and they would be left with nothing to annuitize and, consequently, no future income stream.”
According to the SEC’s order, while MassMutual was offering GMIB riders, “there were indications that sales agents and others did not understand the effect of post-cap withdrawals on the GMIB value, which should have alerted the company to the fact that its disclosures were inadequate. Beginning May 1, 2009, after it stopped offering the riders, MassMutual revised its prospectuses to better explain the consequences of taking withdrawals after the GMIB value reaches the cap.”
Following the SEC’s investigation, “MassMutual undertook the remedial step of removing the cap entirely from these riders in order to guarantee that no investor will ever reach the cap. This action contributed to the determination of the penalty amount.”