Suitability is a Matter of Opinion. But Who’s Opinion Really Counts?

Today I read a legal document presented by the State of Washington Department of Financial Institutions Securities Division, where they enter a Summary Order to Cease and Desist against Capstone Investments, a broker dealer based in California, and its principle, Anthony Capozza. They additionally seek to have his registration suspended and impose fines and charges. Because this firm had offices and associates in Washington, this action is being taken based upon the activities in that state.

The accusation is that the firm has been illegally helping insurance agents liquidate customer brokerage accounts so that insurance agents could then move the money into an annuity. These insurance friendly transfer brokers have been around for years helping clients easily move money out of brokerage accounts without having to expose them to the attempts of the existing broker to convince them otherwise. While I am not sure if there were actual securities rules violated here or not, and those charged have not yet had a chance to make their defense, it does clearly define another level of the battle between the insurance industry and the securities industry.

When you read the text to this order, it is filled with a “tone” or an opinion about which I want to draw your attention. I have read numerous financial articles that have carried this same “tone” and it has a direct bearing on the credibility of many of the criticisms made against the use of annuities in the senior marketplace. The opinion has to do with an underlying assumption by those writing, that simply moving money from securities into an annuity is inappropriate under any circumstances. In this legal text, the attorney who drafted it implied this very opinion in a number of ways. I want to quote paragraph 14 of the TENTATIVE FINDINGS OF FACT, and let you see what I am talking about. I will comment after each sentence.

“14. Many customers whose securities were liquidated were retired, living on fixed income, and had a limited knowledge of investing.”

Wait a minute! Does that not then make these people unsuitable candidates for accepting risk investments in the first place? Can someone living on a fixed income afford to lose principal value or have negative returns even once? Where will they get sufficient income if there account loses value and their investments are not earning any return at all? And with their limited knowledge of investing, how can any broker ethically place them in risk positions they don’t fully understand?

“Many customers held diversified portfolios of stocks, bonds, mutual funds, or other investments prior to these liquidations. The securities liquidated typically comprised a large percentage of a customer’s assets.”

The implication made here is that these clients had been PROPERLY diversified in the first place, based upon their risk tolerance, which was supposedly accurately assessed by the selling broker. But in reality, there is neither knowledge nor evidence that any of this is true. If you consider the client description shown, and the added statement that the invested assets represented a large part of their assets, it is unsuitable that any such client should own stocks or mutual funds in their portfolio at all, given their fixed income, fixed assets, and limited knowledge of investing.

“After liquidation, many customers were placed in fixed annuities, which were subject to surrender charges, without adequate consideration of each customer’s financial needs, including the need to have sufficient liquidity to meet current or future expenses.”

How in the world does this attorney jump to the conclusion that the customer’s financial and liquidity needs were not properly considered by the insurance agents? If you see the pattern, it is that an assumption is always made giving the securities broker the benefit of the doubt that they have properly assessed the client’s financial needs, but that the insurance agent did not. In this document, with only the facts presented, I would conclude just the opposite. I would hold the broker in contempt for inappropriately putting these innocent seniors’ income and assets at risk in the market, and taking advantage of their naivety in investments to make unsuitable sales.

In any such cases as this, ANY transfer of money by someone from a portfolio with risk securities into a fixed annuity is an immediate improvement in the safety of the financial position of the elderly customer. The annuity has guarantees on the principal value, the securities do not. The annuity can provide a lifetime income the client cannot outlive, the security cannot. The annuity has a minimum guaranteed interest return, the security does not. The annuity indicates up front the minimum guaranteed future value year by year; the securities do not.

As far as surrender charges, if the typical 10% free annual withdrawal provided in most annuities is not enough for a client, it is likely that they will run out of money before they die anyway. At least with an annuity, at any point, they can guarantee a fixed income for life. With the fluctuating values of securities, every time a senior must sell in a down market, they compromise the potential for that remaining asset to generate the amount of future income they need. And if a security is sold when the value is down, that is a very real undisclosed surrender cost of owning any risk investment, that is not being discussed in this concern for the financial well being of seniors.

It is time for the public assumptions about transfers from securities to annuities to change. I challenge any financial journalist, or any person in the securities industry, to present a typical scenario where placing a elderly client with fixed assets, fixed income, and limited understanding of investments into risk investments is EVER more suitable than being in a fixed annuity. Is anyone up for the challenge?