Washington, D.C., Aug. 9, 2004 – Legal news, law news, law firm news & research at LAWFUEL The Securities and Exchange Commission
today brought the first enforcement action charging insurance companies
with securities fraud for facilitating market timing of mutual funds
through the sale of variable annuities. The insurance companies are
subsidiaries of Conseco, Inc. (CIHC, Inc., Conseco Services, LLC, and
Conseco Equity Sales, Inc.), and the company to which Conseco sold its
variable annuity business in 2002, Inviva, Inc., and its subsidiary
Jefferson National Life Insurance Company.
The insurance companies have agreed to settlements that include a total
payment of $20 million in disgorgement and penalties as well as
undertakings of compliance reforms. The Commission’s Orders find that the
prospectuses through which the insurance companies sold the variable
annuities misleadingly represented, among other things, that the annuities
were “not designed for professional market timing organizations.” In
fact, the insurance companies affirmatively marketed and sold the
annuities to professional market timers. Eventually, market timing assets
constituted the majority of assets invested in the variable annuity
products. The insurance companies profited by the fees earned from the
sales of the annuities to the market timers.
Mark K. Schonfeld, Director of the Commission’s Northeast Regional Office,
said, “It is particularly troubling when variable annuities, which are
designed for and sold to retail investors to save for retirement and
purchase life insurance, are affirmatively marketed to professional market
timers. This settlement achieves our primary missions of stopping the
misconduct and compensating investors.”
Stephen M. Cutler, Director of the Commission’s Division of Enforcement,
added: “The variable annuity products at issue here became vehicles for
market timing in mutual funds. The insurance company sponsors were well
aware of this – indeed, they encouraged it, but left their retail
investors and the mutual funds themselves in the dark.”
The Commission’s Orders find:
* Variable annuities are combined securities and insurance
products designed primarily for individual retirement and tax purposes.
Nevertheless, from late 1999 through October 2002, Conseco Variable
Insurance Company (CVIC) (CIHC was the corporate parent of CVIC), Conseco
Services, and Conseco Equity Sales, Inc. (CES), sold the Monument and
Advantage Plus variable annuity products to hedge funds and other
individuals and entities to market time the mutual fund portfolios offered
through the variable annuities. Conseco Services employees were aware
that these market timers, in contrast to the typical variable annuity
customer, had no interest in the tax deferral or retirement features of
* The Monument and Advantage Plus prospectuses stated that
these products were “not designed for professional market timing
organizations” and indicated that CVIC in its “sole discretion” could
restrict exchanges “that we consider disadvantageous” to other annuity
contract holders. The prospectuses failed to disclose that CVIC was
marketing and selling the products to market timers. In addition, the
prospectuses failed to disclose the risk that market timing might have a
negative impact on other variable annuity purchasers’ investment returns.
* In October 2002, Inviva purchased CVIC and later renamed it
Jefferson National. Inviva and Jefferson National continued to allow a
group of hedge funds and other select customers to engage in market timing through the Monument and Advantage Plus variable annuity products.
* The Jefferson National prospectuses repeated the above
language from the CVIC prospectuses. Further, the Jefferson National
prospectus reserved the right to limit any “substantive” transfers that it
determined “in its sole discretion, could adversely affect the
management of the investment portfolio.” However, as at CVIC, Inviva and
Jefferson National failed to disclose that Jefferson National was selling
the products to market timing customers, and was facilitating the market
timers in carrying out a market timing strategy.
* In some cases, mutual fund advisers were aware of and
permitted the market timing of the mutual funds. In other cases,
Respondents did not inform the underlying fund complexes that Conseco
Services and Inviva employees tolerated and actively solicited market
timers. Many of these complexes prohibited market timing or did not
* Ultimately, hedge funds and other market timers invested
approximately $120 million in Monument and Advantage Plus variable
annuities. In the Monument product, the market timing assets dwarfed the
assets of other variable annuity purchasers. Through their frequent
trading, the market timers diluted the value of the underlying mutual
funds that were timed, and caused the funds to incur additional costs.
The Commission’s Orders find that CIHC, Conseco Services, CES, Inviva, and
Jefferson National violated Section 17(a) of the Securities Act of 1933,
Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5
thereunder, and Section 34(b) of the Investment Company Act of 1940. The
Orders require Conseco Services, CES, Inviva, and Jefferson National to
cease and desist from violating these provisions. CIHC, Conseco Services,
CES, Inviva, and Jefferson National consented to entry of the respective
Orders without admitting or denying the findings.
Under the settlements, CIHC, Conseco Services, and CES have agreed to pay
$15 million, including disgorgement of $7.5 million and civil penalties of
$7.5 million. Inviva and Jefferson National will pay $5 million,
including disgorgement of $3.5 million and a civil penalty of $1.5
million. These amounts will be distributed to shareholders of mutual
funds affected by the market timing.
Inviva and Jefferson National will also undertake compliance measures to
protect against future violations. These measures include retaining an
independent consultant to review compliance procedures designed to prevent
and detect market timing.
The Commission acknowledges the assistance of the New York Attorney
Genneral in connection with this matter.