Speech by SEC Commissioner:
Remarks at the National Association for Variable Annuities 2006 Compliance and Regulatory Affairs Conference
Commissioner Annette L. Nazareth
U.S. Securities and Exchange Commission
June 26, 2006
Good morning. Thank you very much Mike for that kind introduction. I appreciate the opportunity to speak to you today, and would like to thank Mark Mackey and others at NAVA for inviting me to be here. From a look at your agenda for the next two days, you will have many opportunities to learn about recent developments in the areas of compliance and regulation. These matters are of utmost importance, and I applaud your efforts to attend events such as this where they can be discussed and carefully considered.
If you have occasion to visit the Commission's stately new building hopefully not for enforcement related reasons you will notice a display in our lobby that emphasizes the SEC's mission statement: to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation.
I will focus my remarks today on the first part of our mission-investor protection. My primary goal is to convey to you that investor protection is a universal principle, indeed a creed, that should be embraced by all of us to our very core, and universally applied in practice not only by regulators, but by all industry participants as well. I will discuss investor protection from a historical perspective, explore the identity of America's investors, and explain how I believe that regulators and industry participants can better protect investors. Before I begin, I must remind you, however, that my remarks represent my own views, and not necessarily those of the Commission, my fellow Commissioners, or the staff.1
II. The Principle of Investor Protection
Investor protection is one of the most important principles embodied in our federal securities laws, including the rules and regulations of the Commission. Indeed, it is an important part of their foundation and purpose. The investor protection provisions that Congress included in our statutory regime are best understood from a historical perspective.
As you undoubtedly know, long before the Internet bubble and the debacles at WorldCom and Enron, there was the stock market crash of 1929, when the fortunes of countless investors were lost. With the crash and the ensuing Great Depression, public confidence in the markets plummeted. There was a strong consensus that for the economy to recover, the public's faith in the capital markets needed to be restored. Just as they would do today, Congress held hearings to identify problems and search for solutions.
Based on the findings in those hearings, Congress passed the Securities Act of 1933 and the Securities Exchange Act of 1934. These laws were designed to restore investors' confidence in our capital markets by providing more structure and government oversight. The main purposes of these laws can be reduced to two common-sense notions. First, companies publicly offering securities for investment dollars must tell the public the truth about their businesses, the securities they are selling, and the risks involved in investing. Second, persons who sell and trade securities-brokers, dealers, and exchanges-must treat investors fairly and honestly, putting investors' interests first. Congress established the Securities and Exchange Commission in 1934 to enforce the newly-passed securities laws, to promote stability in the markets and, most importantly, to protect investors.
As you know especially those of you who are lawyers Congress did not stop there. Among other laws, Congress went on to pass a pair of statutes in 1940 that govern the investment industry, including the Investment Company Act. This statute is important because, among other reasons, it reflects a congressional recognition that substantive protections beyond the disclosure requirements of the Securities Act and the Exchange Act were needed in this area. Also, the Investment Company Act, along with these other two statutes, governs variable annuity contracts.
Investor protection is not only a principle embodied in our federal securities laws and part of the essential mission of the Commission, but it is also a key component of a successful business model. In the spirit of the theme of this conference, "Maintaining a Competitive Edge in Today's Regulatory Environment," I believe that business decisions that take investor protection into account contribute to success over the long run. Or, put more directly, protecting your customers is just plain good business. Although it may be true that some companies can surge ahead by using aggressive sales tactics and other questionable practices, I believe that a business based on such practices is neither solid nor long term. One need not venture too far into the area of investment management to find that mutual fund companies who engaged in conduct reflecting no consideration for investor protection were among those most hurt by the regulatory and market forces set in motion by recent scandals.
Fortunately, I am not alone in the belief that protecting investors is good business. NAVA's mission statement, for example, is in part to "protect consumers by encouraging adherence to the highest ethical standards by insurers." This is "right on the money," as they say, since the variable annuity industry certainly has a vested interest in protecting the purchasers of variable annuities.
Who, then, are the investors that regulators and industry should protect? And in particular, who are the customers of the variable annuity business? Quite clearly, the answer is that retail investors need the greatest level of protection. On average, they are less sophisticated when it comes to making financial decisions and they benefit the most from our supervisory regime.
The range of retail investors includes seniors in retirement and on fixed incomes, and young men and women saving as they can for their future educational expenses. Retail investors generally purchase a number of investment products, including individual stocks, bonds, mutual funds, and annuities. A recent report showed that, of individuals having some type of savings, 20% owned fixed or variable annuities.2
Other statistical information on equity ownership from the Investment Company Institute and Securities Industry Association reveals something interesting that you may already know. Unlike some investment vehicles, such as mutual funds, the percentage of individuals owning fixed or variable annuities increases dramatically as the individuals age. For example, among equity investors less than 35 years old, 13% own fixed or variable annuities. Among investors 65 years or older, however, 42% own these annuities.3 The Annuity Fact Book seems to be roughly in line with these numbers. It reports, for example, that the average age of an owner of non qualified annuities is 66 years old. In addition, it reports that 37% of annuity owners are at least 72 years old, and that only 14% of owners are less than 54 years old.4 Although there may be a number of explanations for these numbers, it seems reasonable to conclude that retail investors tend to purchase annuities later in their lives. It also seems reasonable to conclude that some of these investors look to variable annuities to help them fund their retirements.
The Commission and other regulators, for their part, seek to protect investors in variable annuities through, among other things, disclosure and suitability requirements. For example, the Commission prescribes requirements for the information that must be disclosed in prospectuses for variable annuities and their underlying mutual funds. Also, regulators impose suitability requirements to ensure that sales practices meet certain ethical standards. In addition, the Commission and NASD have published a summary of sound practices with respect to the sale of variable annuities that were identified through compliance examinations of firms that sell the product.5
But regulators should not be alone in their efforts to protect investors through these and other means. I am heartened by evidence that the variable annuity industry is making efforts in this regard. For example, it is my understanding that NAVA is putting considerable thought into a simplified disclosure regime and intends to make recommendations to the Commission. In addition, last year it published 10 questions that seniors should ask when considering the purchase of an annuity.
Indeed, these are positive developments. I would encourage the industry and each of you, however, to strive to do more. To my way of thinking, the Commission and other regulators continue to witness too many abuses relating to variable annuities. Although variable annuities provide investors with a host of underlying investments and optional features, the myriad features and fee structures inherent in some products have resulted in confusion for both the representatives who sell them and the investors who purchase them. As you may know, the sales of variable annuities have raised suitability concerns in areas such as excessive switching of annuity contracts and inadequate consideration of important tax implications. Also, a particular suitability issue that I am concerned about is the use of annuities to fund qualified retirement accounts such as IRAs because there is no further tax benefit to be gained from using variable annuities to fund these accounts. In addition, I am concerned that investors may not always receive sufficient disclosure of the fees and charges associated with the variable annuities to make informed financial decisions.
Do not let these types of compliance issues define you as an industry. Instead, in whatever role that each of you plays, actively seek to ensure that the principle of investor protection is applied in business decisions. Applying this principle will go a long way towards instilling investor confidence in your product and your firm. Continue to seek to understand the problem areas and take action to address them if they exist in your organizations. This conference presents the opportunity to discuss, among other things, recent Commission actions, product distribution issues, risk management, suitability, and litigation trends. Take advantage of this.
Also, continue to contemplate best practices and other industry standards that take investor protection into account and make it a priority. I believe that the protection of consumers should be something that is intuitive; something that should be considered regardless of whether a regulator such as the Commission says so. In this regard, I believe that investor protection is a universal principle that should govern business decisions despite a mandate, rule, or regulation requiring it.
Moreover, I believe that the principle should apply regardless of the particular product or issue du jour. We are seeing reports of broker dealers selling to retail investors complex financial products that may be prone to confusion and raise compliance issues. For example, the Wall Street Journal recently reported that firms are now increasingly selling structured products to such investors. Investment professionals must be mindful of suitability and disclosure issues that may be associated with these sales.6
With some emerging financial products, such as Equity Indexed Annuities, a debate may arise as to whether they are securities and who should regulate them. I am not here to opine on the legal issues concerning which agency should regulate EIAs. Instead, I am here to tell you that I believe that the individuals purchasing these products should be protected, regardless of how the jurisdictional lines are drawn. And doesn't that make sense? Don't we all have an interest in ensuring that purchasers of financial products understand what they are getting and that the products are appropriate for their needs? I believe that we do.
While all investors deserve to be treated fairly and honestly, there are some investors for whom special emphasis on protection is warranted. For example, in the variable annuity context, I believe that it is especially important to be vigilant in sales to seniors. As you know, many individuals who own annuities are over 50 years old.
A significant portion of the population in the United States is preparing to enter into retirement, with some of its members taking substantial retirement assets with them. It was recently reported that by 2010, almost half a trillion additional dollars will be rolled into IRAs each year by aging investors looking for more options to fund their retirements.7 In anticipation, the financial services industry has gone to great lengths to anticipate the demands and opportunities created as a result of this retiring generation.
I would urge you to treat sales to seniors with particular care. The Commission has recently announced initiatives that go straight to the heart of investor protection for seniors. Last month, the Commission announced an initiative with NASAA that would seek to protect seniors from investment fraud and sales of unsuitable products. With NASD and state securities regulators, our Office of Compliance Inspections and Examinations has already initiated examinations of firms sponsoring "free lunch" investment seminars in Florida that are designed to determine whether high pressure sales practices are used to sell unsuitable financial products to seniors. These exams will be expanded to include other states with a concentration of seniors.
Also, our Enforcement Division has been active in bringing cases aimed specifically at protecting senior investors, and our Office of Investor Education and Assistance has been active in ensuring that seniors are armed with the information they need to assess the various financial products available to them. As more of the baby boomer generation retires, I believe that the Commission's emphasis on protecting senior investors will only increase.
I appreciate the opportunity to be with you today and to share my thoughts. As you know by now, I believe that investor protection is a universal principle that should be embraced and applied by regulators and industry participants alike. As former Chairman Arthur Levitt so aptly noted, "If we stand by and for investors, above all else, we protect the vitality of our markets, the richness of our heritage, the weight of political independence and high ideals of our country." I hope that my remarks today will assist you in making decisions that contemplate investor protection. Thank you.