Waddell & Reed’s sales practices have been the subject of regulatory inquiry on several occasions.
Back in 2005, FINRA resolved its action against Waddell & Reed, Inc., of Overland Park, KS, arising from thousands of variable annuity exchanges made as part of the firm’s national switching campaign.
Under the terms of the settlement with FINRA (then the NASD) and a separate agreement with a coalition of state regulatory authorities, Waddell & Reed agreed to repay up to $11 million to more than 5,000 customers whose annuities were exchanged by the firm. The firm also paid a fine of $5 million to FINRA and a fine of $2 million to state regulators.
In a complaint filed in January 2004, FINRA had charged Waddell & Reed with violating its obligations under FINRA’s suitability rule by failing to take reasonable steps to ensure that recommended variable annuity exchanges were in the best interests of customers. According to the complaint, between January 2001 and August 2002, the firm engaged in an aggressive campaign to switch customers from variable annuity contracts issued by United Investors Life Insurance Co. (UILIC) to similar annuities provided by Nationwide Insurance Co. The switching campaign was initiated after Waddell & Reed failed to obtain an agreement from UILIC to receive a share of annual mortality and expense (M&E) fees collected by UILIC from Waddell’s customers. Waddell & Reed approached Nationwide, which agreed to a fee sharing arrangement.
FINRA further charged that following that agreement, Robert Hechler, then the firm’s president, and other senior managers encouraged the sales force to engage aggressively in switching customers and made statements to them that – as one broker noted – were intended to “prod and scare” the sales force into making switches. During this campaign, some advisors expressed concern that these switches were not in the best interests of their clients.
Despite repeated requests from Waddell & Reed’s sales force and its supervisors, the firm failed to supply sufficient guidance for the sales force to use in determining the suitability of the exchanges – such as analytical tools or other mechanisms that would measure the cost and the potential long-term benefit or detriment of an exchange for each customer. Waddell & Reed failed to take into account relevant objective factors including age, sex, surrender charges, M&E charges, policy features (including annuitization rates), and the costs and benefits of the particular optional policy features chosen by the customers.
FINRA also determined that many customers were likely to lose money through these switches, thereby raising concerns about the suitability of these transactions. In addition, customers incurred close to $10 million in surrender charges as a result of the switches while Waddell & Reed made money through commissions charged on each exchange as well as through the fee sharing arrangement with Nationwide. Finally, more than 700 customers were switched into one Nationwide annuity product that provided greater compensation to Waddell & Reed’s sales force – but provided fewer benefits and less flexibility – than another Nationwide annuity being sold by Waddell & Reed.
Under the terms of the settlement, Waddell & Reed agreed to repay customers one hundred percent of all surrender charges they incurred in the exchanges, and will compensate the purchasers of the more expensive annuity by repaying the cost difference between the two products. Waddell & Reed will, at its own expense, retain an independent consultant to implement the repayment plan.
In addition, without admitting or denying the allegations, the firm consented to the entry of NASD’s findings of supervisory failures and record keeping violations and agreed to pay a fine of $5 million to FINRA.
The settlement also imposes a six-month suspension and $150,000 fine on former Waddell & Reed President Robert Hechler. Hechler, who neither admitted nor denied the charges, consented to the entry of FINRA’s findings that he caused the firm’s suitability violations by aggressively encouraging the exchanges.
Former Waddell & Reed National Sales Manager Robert Williams, without admitting or denying the charges, consented to a six-month suspension as a supervisor and a $150,000 fine for supervisory failures in connection with the exchanges. FINRA found Williams was involved in the effort to aggressively encourage the sales force to switch customers from UILIC to Nationwide annuities, was aware of instances where inappropriate switches were made, and failed to take reasonable action to supervise the firm’s switching activities.
Waddell & Reed has also been investigated by the State of New York for its sales practices. In 2006, the state of New York reached an agreement with Waddell & Reed to settle charges that the firm permitted illegal trading of its mutual funds.
Under the settlement, Waddell & Reed, Inc., agreed to pay $50 million in restitution to investors and make fee reductions totaling $25 million over the next five years. The company also agreed to adopt a series of management reforms.
The investigation found that Waddell & Reed managers had entered into secret agreements with mutual fund timers. Under these agreements, the timers paid extra fees to Waddell & Reed in exchange for trading privileges that were denied to typical investors.
Specifically, in exchange for fees ranging from 1/4 percent to 1 percent of the timers’ money, the company exempted the timers from trading limits and other anti-timing policies put in place to protect long-term investors.
Investigation also determined that Waddell & Reed’s senior management knew that timing activity was harming the firm’s small investors, and yet the company did nothing to stop the harmful activity for a period of 18 months. During that time, the Company’s prospectus created the false impression that Waddell & Reed vigorously policed timing activity.
Additionally, a customer complaint has led to six felony convictions against a former Waddell & Reed broker.
Former Waddell & Reed broker DeVon J. Carlson recently pleaded guilty to the various charges relating to claims that he stole $235,000 from six clients between 2005 and 2007.
According to the Kansas prosecutors, Carlson diverted funds from clients’ accounts by forging signatures to make withdrawals and then instructed Waddell & Reed to liquidate securities and send the money to a company he controlled.
If you have questions about Waddell & Reed’s sales practices or investments you made with the firm, The White Law Group may be able to help. For a free consultation, call the firm at 312-238-9650.
The White Law Group, LLC is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm with offices in Chicago, Illinois and Boca Raton, Florida.
For more information on The White Law Group, please visit our website at http://www.whitesecuritieslaw.com.