Insufficient advisor exams, tax-free exchanges of variable annuities, binary options and reverse churning of clients with wrap fee accounts are among the top concerns the Securities and Exchange Commission’s Investor Advocate has in the new year.
In his second report to Congress since being appointed in February as the SEC’s first investor advocate, Rick Fleming told lawmakers in his December report that while it is “encouraging” that Congress recently boosted the SEC’s budget by $150 million, the increase, “while helpful, is likely insufficient to provide the full level of [advisor] examination coverage that is needed.”
Therefore, Fleming told lawmakers, “we will assess any remaining need and will continue to explore potential efficiencies and funding mechanisms to further enhance investor protection in this area.”
Indeed, Fleming cited his 2014 Report on Objectives, filed June 30, in which he recommended that Congress provide sufficient resources to enable the SEC to conduct an adequate number of investment advisor exams.
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“This is an issue that does not require a great deal of study to understand,” Fleming said. “In FY 2014, the SEC examined approximately 10% of investment advisors, which equates to an examination cycle of once every 10 years. This level of coverage is simply inadequate to protect investors” from fraud.
Fleming has championed allowing the SEC to collect user fees from advisors in order to boost the number of exams.
Fleming said in his report that another area of concern involves the tax-free exchange of variable annuities, known as 1035 exchanges. Such exchanges allow an investor “to exchange an existing annuity contract for a new annuity contract without paying any tax on the income and investment gains in [his or her] current variable annuity contract,” he explained.
While Section 1035 exchanges can benefit some investors, “some financial professionals try to generate sales by persuading investors to engage in these exchanges, even when the exchange is not advisable because of surrender charges or other features that offset the benefits,” Fleming said.
The benefits of such exchanges can be seen in new developments in features that are now offered in variable annuities, which may provide investors an annuity that offers more preferable features than the one they already own, such as different annuity payout options, a larger death benefit or a broader selection of investment choices, Fleming said.
Yet another area of concern is in binary options, which the report explains are “significantly different” from more conventional options in that binary options have different payouts, fees, risks, and an entirely different liquidity structure and investment process.