A federal judge in Georgia is threatening to disrupt more than 70 years of precedent under federal securities law by threatening to hold a variable annuity issuer liable for fraud for failing to disclose to broker-dealers the estimated "actuarial value" of the death benefit it provides investors. (Cooper vs. Pacific Life Insurance Company.)
The court has certified a class of VA investors, ruling that Pacific Life owed an unprecedented duty to disclose internal pricing information or risk sweeping civil liability. If the judge's ruling stands, issuers and registered representatives will find themselves in a no-win position, forced either to provide obscure and unhelpful information to investors, or withhold it. Either way, litigation is sure to follow.
Variable annuities are registered investment products that are often sold within a qualified plan, such as an IRA. Class action plaintiff's lawyers have sued numerous VA issuers in recent years, alleging that the issuer failed to disclose to investors that they did not need to purchase a VA within a qualified plan in order to avoid paying income tax on their investment as it grows, because the qualified plan itself already provides tax deferral.
Plaintiffs argue that issuers are required to make this disclosure by NASD Notice to Members 99-35, which states that a registered representative should recommend a VA for use in a qualified plan only when its benefits other than tax deferral support the recommendation.
In response, issuers have pointed out that the tax treatment of qualified plans is public information which they have no duty to disclose, and that NTM 99-35 applies not to issuers but to representatives making a recommendation. Thus far, no case has resulted in a judgment for plaintiffs, or even in a significant settlement.
The Pacific Life case differs from any prior case because the judge in that case has recognized an entirely new duty of disclosure he says issuers owe, one that even the plaintiffs did not argue for in their court filings. The court observed that Pacific Life imposes "insurance charges" on the VA investor of 140 basis points (1.4 %) — what is commonly known as a "mortality and expense" ("M&E") charge — but that the "actuarial value" of the guaranteed minimum death benefit to the investor is as little as 5 basis points (.05%).
The court found the disparity between the M&E charge and the actuarial value is a material fact that a reasonable investor would consider in deciding whether to purchase a VA within a qualified plan. The court ruled that the issuer owed a duty to disclose this disparity to broker-dealers selling its product, and its failure to do so could support a claim for securities fraud, because the representative licensed through the broker-dealer would not be able to disclose this information to an investor.
The Pacific Life decision departs from prior securities fraud cases by focusing on the value received by the investor rather than the price paid for the security. The federal securities laws passed in the early 1930s in response to abuses that led to the stock market crash of 1929 emphasize creating transparency in the securities markets, so investors and the market as a whole can set a price for securities based on the performance and results of the underlying company.
