NASD Action Widens Investigation Into Mutual Funds
By JOSEPH B. TREASTER
The New York Times
January 15, 2004
The investigation into mutual fund improprieties spread further into the insurance industry yesterday with charges that a unit of Waddell & Reed Financial Inc., a midsize brokerage firm and mutual fund company, sold thousands of investments that earned profits for the firm and its sale representatives but also created nearly $10 million in extra costs for customers around the country.
Waddell & Reed, which analysts said specialized in serving middle class customers in rural areas, is accused by NASD, the regulatory arm of the brokerage industry, of persuading owners of 6,700 variable annuities, a combination of insurance and mutual funds, to switch into similar investments that resulted in $37 million in new commissions for the firm.
Keith A. Tucker, the chairman of Waddell & Reed, strenuously denied the charges. "We believe our actions were consistent with NASD rules and guidance," he said in a statement.
The NASD is seeking to force Waddell & Reed to relinquish its profit and to compensate customers for extra expenses or losses. The firm and at least two senior executives could also be forced to pay fines and lose their licenses to deal in securities.
Both NASD and the Securities and Exchange Commission have been investigating the sale of variable annuities for several years and have brought charges against some sales representatives and firms. But Nancy Condon, a spokeswoman for NASD, said she thought the case against Waddell & Reed was far bigger than any previous investigation into variable annuities.
The agency would not say what triggered the investigation. But the firm said in a statement that it thought the investigation was instigated by a former sister company, United Investors Life Insurance Company, which has been involved in a dispute with Waddell & Reed.
State and federal regulators have been investigating abuses in the mutual fund industry for several months, largely focusing on accusations of favorable treatment to large investors or of mutual fund executives trading for their own benefit with potential losses for customers. On Tuesday the S.E.C. reported it had uncovered widespread instances of brokers at 15 of the largest Wall Street firms receiving undisclosed payments for steering investors toward specific funds. As in the S.E.C. cases, these new accusations suggest that individual investors were misled by sales representatives.
The fundamental complaint against Waddell & Reed is that the firm switched customers from one annuity to another without determining whether the benefits of the new annuities exceeded the cost of the exchange and were in the best interest of the client, said Barry R. Goldsmith, who is in charge of enforcement at the NASD.
Variable annuities offer a range of insurance features, including a guaranteed payment, similar to life insurance. With that feature, when an investor dies, the heirs receive at least the full amount of the initial investment, even if the market value drops.
Because of the insurance features, the fees on variable annuities tend to be higher than those on conventional mutual funds, and analysts say investors often find it difficult to evaluate the different features. In the case against Waddell & Reed, the NASD maintains that customers were persuaded to exchange one variable annuity for another in a transaction that generated a new commission for the sales representative but often required customers to pay a penalty. The NASD said the annual fees on the new annuities were lower for the first seven or eight years, but that afterward they were more expensive than the old annuities.
Variable annuities are intended specifically for retirement savings. If they are not held for a fixed term, typically seven or eight years, penalties must be paid to the annuity company and often the federal government.
Waddell & Reed said the new annuities were not only suitable for its clients, but included features that "provided tremendous value." It contended that NASD's complaint was "factually and legally inaccurate in numerous respects."
The company said that, contrary to NASD's assertions, "a case-by-case analysis was conducted at various levels of the company to ensure that each exchange was in the best interest of the client."
NASD would not respond to the company's arguments. "We are going to let the complaint speak for itself," Ms. Condon said.