Variable annuities Spitzer's next stop

October 10, 2004|By JAY HANCOCK

THE ELIOT Spitzer prosecution train seems to have hit the law of diminishing returns. It has been more than a month since the New York lawman rocked Wall Street with a major settlement for financial chicanery.

Lately he has bullied Maryland's Jos. A. Bank Clothiers Inc. for the way it sells $400 suits and issued press releases with these headlines: "Investigation Reveals Deplorable Plight of Restaurant Bathroom Attendants," "Wedding Photographer to Reimburse Jilted Clients" and "Poacher Pleads Guilty to Timber Theft."

He's got two years before he runs for New York governor. What'll he do to get back on the 6:30 news?

Perhaps the insurance industry will find out. Along with the Securities and Exchange Commission, New York Attorney General Spitzer has launched a sweeping inquiry into "late trading" and "rapid trading" in variable annuities that his office says are similar to abuses in the mutual fund business.

Months ago the SEC requested documents from 40 insurers selling variable annuities - a marriage of insurance and investment products that is the industry's fastest-selling product, with more than $1 trillion in assets - including Baltimore-based Aegon USA, MetLife, Conseco, Hartford Financial Services, Prudential, Lincoln National Corp. and other big outfits.

Hartford and others - but not Aegon - have acknowledged getting subpoenas from Spitzer, who is investigating variable-annuity broker fees as well as trading.

A few settlements have surfaced. Indiana-based Conseco agreed to pay $20 million in response to SEC and Spitzer allegations that it hurt small investors by allowing hedge funds and other big guys to rapidly move millions in and out of variable-annuity mutual funds.

Davenport & Co. in Richmond, Va., agreed to pay $738,000 to the National Association of Securities Dealers to settle accusations of similar practices, which damage small investors by racking up trading costs and depriving a fund of long-term gains.

But regulators and analysts suggest the biggest news is still ahead.

"We do have more stuff coming," says an official in Spitzer's office who requested anonymity because of the sensitive nature of the potential prosecutions.

The SEC's civil investigation into rapid-trading in variable annuities "is still definitely under way," says agency spokesman John Nester. "It's basically looking at all the big players."

Aegon, whose parent is based in the Netherlands, held $43.6 billion in variable annuities for its customers as of June 30, says spokesman Todd Bergen. The company is cooperating with the SEC's inquiry, he said, which involves Aegon Transamerica Series Funds. He declined to comment further.

Variable annuities layer insurance over a mutual fund, merging them in one tax-deferred retirement product that can combine a future death benefit with stock market exposure.

Regulators suspect insurance companies may have allowed rapid trading in variable annuities for a privileged few just as Strong Financial, Invesco Funds and other outfits did for mutual funds. They're also investigating variable-annuity "late trading," in which select customers can profit by seizing on market events after the daily trading deadline.

Rapid trading is technically legal, but it becomes a problem for regulators if financial firms say they disallow it but then secretly let preferred clients do it. Late trading, when fund clients buy and sell mutual fund shares after the 4 p.m. market close at the pre-4 p.m. price, is illegal.

Analysts at Lipper Inc. have uncovered large "churn" rates at numerous variable-annuity mutual funds, including Aegon's, that suggest activity other than that of patient, buy-and-hold individuals.

Insurance vehicles may have been especially attractive to hedge funds and others out for a quick buck. Although hedge funds can't benefit from variable annuities' tax advantages, rapid traders, also known as market timers, could have shielded their identities and activities by buying mutual funds through an unaffiliated insurance company.

Mutual funds often take bulk, "omnibus" orders from insurers, 401(k) plans and other outside administrators, so they can't see the underlying accounts.

"That's one of the hard things about identifying excessive traders," says T. Rowe Price Associates' Steve Norwitz. "We might see the action in the fund but we can't pinpoint who it is."

Price hasn't been hurt by variable-annuity abuses that it knows of, he added.

Whatever happens, the insurance trade has taken notice. At a recent meeting of the National Association for Variable Annuities, Aegon lawyer Katherine Schulze moderated a discussion entitled: "Market Timing Policies and Procedures: Developing Effective Solutions to Today's Challenges."

That's a good development. But was the horse in or out of the barn?

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