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Week Ending July 1, 2005
HR 458 An act to prevent the sale of abusive insurance and investment products to military personnel.
BRIEF
The committee report said that the bill “will protect military services members from the sale of questionable financial products, curb abusive sales practices on military installations, and ensure regulatory oversight of financial services sales on military installations. Specifically, H.R. 458 bans the sale of contractual plans, requires written disclosures in conjunction with certain on-installation sales or solicitations, encourages the development of improved products for military personnel, increases investor access to broker registration and disciplinary information, and improves regulatory oversight by coordinating and encouraging contact among insurance companies, Federal and State regulators, and the Secretary of Defense.”
A registry would be established and maintained by the Sec. of Defense that would list those individuals or businesses banned from selling to US military.
Sponsor: Representative Geoff Davis (KY-4th)
Vote: Passed House 405 to 2 (RC 324) June 27, 2005)
Cost to the taxpayers: No discernible cost.
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MORE INFORMATION
There is an extensive history of abusive and misleading marketing and sales of financial services products on military installations. Problems have included abusive and coercive sales tactics, expensive and outdated products, and a lack of uniform regulatory oversight for on-installation sales.
A Pentagon-commissioned study by General Thomas Cuthbert and a separate Navy Judge Advocate General Corps report by Lt. Wayne Hildreth documented the problem of abusive sales practices of life insurance agents on domestic and foreign U.S. military installations. 1
[Footnote] These reports detailed improper solicitation on installations, the use of fraternal military organizations to sell insurance products, a lack of uniform oversight or regulation of insurance sales on installations, and routine and systemic violations of Department of Defense rules. These reports were followed by a series of news articles in the summer of 2004 that alleged abusive sales practices on several military installations throughout the country and overseas.
[Footnote 1: Final Report, Insurance Solicitation on Department of Defense Installations, May 15, 2000; Litigation Report, Investigation of NCOA Standard Procedures for Selling Insurance, November 19, 1997.]
A 1986 Department of Defense Directive limits personal commercial solicitations to licensed and approved entities with specific appointments. 2
[Footnote] The Directive prohibits, among other practices, solicitation of recruits, trainees, and transient personnel in a `mass' or `captive' audience, using misleading advertising and sales literature, and giving the appearance that the Department of Defense endorses any particular company. 3
[Footnote] Despite these prohibitions, `agents have made misleading pitches to `captive' audiences * * * posed as counselors on veterans benefits and independent financial advisers [and] solicited soldiers in their barracks or while they were on duty, [which are all] violations of Defense Department regulations.' 4
[Footnote]
[Footnote 2: DoD Directive 1344.7, Sect. 6.1.]
[Footnote 3: DoD Directive 1344.7, Sect. 6.4.]
[Footnote 4: Diana B. Henriques, Basic Training Doesn't Guard Against Insurance Pitch to G.I.'s, N.Y. Times, July 20, 2004, at A1.]
Witnesses at a September 9, 2004 hearing before the Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises criticized these abusive sales practices. Mr. David F. Woods, CEO of the National Association of Insurance and Financial Advisors, testified that, `We condemn * * * deceptive, and unethical sales practices and have consistently worked to eliminate them from sales on and off base.' 5
[Footnote] In addition to criticizing the sales practices, witnesses before the Subcommittee discussed the lack of regulatory oversight for on-installation sales. As another witness testified, `We are convinced that the reason these issues continue to come up is because of the lack of clarity over who has the authority to oversee such sales and the absence of clear procedures to ensure the highest standards for dealing with men and women in uniform.' 6
[Footnote]
[Footnote 5: Hearing entitled `G.I. Finances: Protecting Those Who Protect Us' before the House Subcommittee on Capital Markets, September 9, 2004, written testimony of David F. Woods, p. 3.]
[Footnote 6: Hearing, written testimony of Hon. Frank Keating, President and CEO, American Council of Life Insurers, p. 4.]
In addition to improper and unethical sales practices, witnesses at the Subcommittee hearing criticized the securities and life insurance products being sold, suggesting that the products were particularly unsuitable for most members of the armed services and superior investments were available for all investors. For example, Ms. Elizabeth Jetton, President of the Financial Planning Association, testified that the American Amicable Insurance Company's sales tactic of pitching insurance as a retirement vehicle was `misguided and misleading' and that `any disinterested third party would have a very difficult time justifying [such] insurance as a rational retirement investment for the typical serviceman.' 7
[Footnote] Mr. Mercer Bullard, President and Founder of Fund Democracy, testified that, `it is particularly offensive that insurance agents peddle overpriced, unsuitable products to the men and women who daily put their lives on the line for America's defense * * *.' 8
[Footnote]
[Footnote 7: Hearing, written testimony of Ms. Elisabeth W. Jetton, CFP, on behalf of the Financial Planning Association, p. 5.]
[Footnote 8: Hearing, written testimony of Mr. Mercer E. Bullard, President of Fund Democracy, Inc. and Assistant Professor of Law, University of Mississippi School of Law, p. 3.]
The Subcommittee investigation in preparation for the hearing revealed that one financial services company was targeting military personnel with the sale of contractual plans, an obscure financial product through which an investor contributes equal monthly payments typically for 15 to 25 years into shares of a designated mutual fund. The hallmark of the contractual plan is a sales load of 50% assessed against the first year of contributions.
First offered in 1930, contractual plans were created to allow the investor of modest means to make monthly payments of as little as $10 and still experience the benefits of investing in the financial markets. Yet, these plans fell quickly into disrepute, beginning a sordid history of abusive selling practices and excessive sales charges. 9
[Footnote]
[Footnote 9: Securities and Exchange Commission, Public Policy Implication of Investment Company Growth 224 (1966).]
In congressional hearings on the investment industry in 1940 that led to the passage of the Investment Company Act of 1940, Securities and Exchange Commission attorney John Boland testified that the SEC's investigation into the contractual plan industry
revealed gross abuses, including rampant misrepresentations concerning the sales loads. 10
[Footnote] To counter these abuses, Congress included in the Investment Company Act provisions applying to sales of contractual plans. First defining a contractual plan as a `periodic payment plan certificate,' 11
[Footnote] Congress then placed restrictions on sales loads, the most relevant being the sales load cannot exceed 9% of the aggregate payments into the plan and cannot be more than 50% of the first twelve monthly payments into the plan. 12
[Footnote]
[Footnote 10: Hearings Before a Subcommittee of the Committee on Banking and Currency on S. 3580, 76th Cong. 3d. Sess. (1940), Testimony of John Boland, Attorney, General Counsel's Office, Securities and Exchange Commission, pp. 168, 172.]
[Footnote 11: Investment Company Act of 1940, Sec. 2(a)(27).]
[Footnote 12: Investment Company Act of 1940. Sec. 27(a).]
Again reviewing these plans in the 1960s in two different congressional reports, the SEC questioned the justification for the high front-end load as well as the product itself. Responding to Congress' request to study investor protection in light of the rules of the securities markets, in 1963 the SEC published the Report of the Special Study of Securities Markets. 13
[Footnote] The report devoted some analysis to the contractual plan, concluding that the high first-year sales load was unjustifiable: `[O]nly compelling reasons can justify the continued existence of the front-end load [on contractual plans]. The study has concluded that the justifications advanced by the industry are hardly persuasive and certainly not compelling.' 14
[Footnote]
[Footnote 13: H.R. Doc. No. 95, 88th Cong., 1st Sess. (1963).]
[Footnote 14: Id. at 211.]
The Special Study Report then called for considering the elimination of the excessively high first-year front-end load. 15
[Footnote] The Special Study Report also noted the likely unsuitability of the product for investors of modest means: `To some extent the industry is reluctant to concede that questions of suitability can ever arise in the sale of funds or plans, but * * * [the] evidence concerning contractual plan redemptions and lapses leave no doubt that a substantial number of plans are sold to persons for whom, because they have insufficient income or inadequate other financial resources, they are likely to be unsuitable investments.' 16
[Footnote]
[Footnote 15: Id.]
[Footnote 16: Id. at 207.]
Following upon the 1963 Report, in 1966 the SEC released the Report of the Securities and Exchange Commission on the Public Policy Implications of Investment Company Growth. 17
[Footnote] In the report, the SEC noted that early contractual plan redeemers `pay `effective' or cumulative average sales loads which often amount to many times the normal sales loads applicable to the underlying fund shares--effective sales loads which clearly would be `unconscionable or grossly excessive' but for the express provisions of [Section 27(a)] of the [Investment Company] Act with respect to front-end loads.' 18
[Footnote] In addition the SEC noted the potential for sales abuses: `Moreover, though the contractual plan is a long-range program for systematic investing, the front-end load only provides retailers with a strong incentive to get purchasers to initiate such a plan, regardless of their circumstances, in order to realize commissions on at least the front-end portion of the load. After these first-year payments are made, the salesman's interest in the completion of the plans he sells is sharply eroded by the fact that his commissions are substantially decreased.' 19
[Footnote]
[Footnote 17: H.R. Rep. No. 2337, 89th Cong., 2d Sess. (1966).]
[Footnote 18: Id. at 237.]
[Footnote 19: Id. at 244.]
In concluding its analysis of the structure and sales of contractual plans in the Public Policy Implications of Investment Company Growth, the SEC recommended to Congress the abolition of the front-end load on contractual plans and the reduction of the maximum aggregate load during the plan's term from 9% to 5%. 20
[Footnote] In 1967, the SEC drafted a bill to implement those and other policy recommendations. The bill included a provision to abolish the front-end load on contractual plans. Bowing to industry pressure, Congress refused to follow the SEC's recommendation, passing the Investment Company Act Amendments of 1970, which implemented refund and surrender privileges for contractual plan investors, but did not reduce the front-end load.
[Footnote 20: Id. at 246-47.]
After the 1970 Amendments, Congress and regulators focused little attention on contractual plans 21
[Footnote] as sales declined with the advent of no-load and low-load mutual funds and the possibility of dollar cost averaging with minimal monthly contributions. In fact, in a mutual fund market that has over 7 trillion dollars invested, these plans account for only approximately 11 billion dollars of which 90 percent are held by military personnel. Today financial experts decry these investment vehicles. Vanguard Group founder John C. Bogle asserted: `Would I ever recommend that an investor buy contractual plans? No, I would not.' 22
[Footnote] Similarly, Morningstar Inc.'s Senior Fund Analyst Bridget Hughes succinctly stated, `There are really no advantages to these contractual funds; they are old-fashioned, based on old ideas of how to force people to commit to systematic investing.' 23
[Footnote]
[Footnote 21: The only substantive amendment to Section 27 was passed under the National Securities Markets Improvement Act of 1996, which exempted variable life insurance and variable annuities from the strictures of Section 27. See Section 27(i) of the 1940 Act. Note that in 1971, Congress further amended Section 27(f) to clarify that the 60 day notice provision did not apply to periodic payment plans where the sales load was always under 9% of the total monthly payment (i.e. a plan without a disproportionate front-end load).]
[Footnote 22: Diana B. Henriques, Basic Training Doesn't Guard Against Insurance Pitch to G.I.'s, N.Y. Times, July 20, 2004, at A1.]
[Footnote 23: Gary S. Mogel, Congress Questions Sale of High-Fee Funds to Military: Contractual Plans Come under Scrutiny, Investment News, Vol. 8, Issue 34, Sept. 13, 2004, at 21.]
In December 2004, the dominant retailer of contractual plans, a financial services company catering exclusively to military personnel, voluntarily stopped selling them in the wake of last year's Committee action and investigations by the SEC and NASD into its use of misleading contractual plan sales materials. Later that same month the company settled the charges with the SEC and NASD, agreeing to pay $12 million to reimburse certain customers and provide investor education to the military. At the same time NASD issued a warning to investors regarding the high upfront costs associated with contractual plans.
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