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Preparing for VA Suitability Litigation

A new round of VA litigation is probably inevitable, so be prepared.

Judith A. Hasenauer, 02/12/2009

The bursting of the dot-com bubble in 2000 spawned a flurry of litigation over variable annuities that had been sold prior to that time. Plaintiff's lawyers were running television and newspaper advertisements and even renting billboards asking "did you lose money on your variable annuity," with the promise that they would get it back, with no cost to the client if they did not win. It seemed that when the market went up, it was due to the variable annuity purchaser's financial acumen, but when it went down, it was the fault of the stock broker/financial planner for allowing the customer to make such a "speculative" investment. After all, everyone knows that the stock market only goes up--right?

This flurry of litigation primarily took the form of FINRA (then the NASD) arbitration proceedings. However, some cases were brought in state and even in federal courts, depending on the operating procedures of the brokerage firms involved. When in doubt, the plaintiff's lawyers sued everyone involved: the stock broker, the brokerage firm and the insurer that issued the variable annuity contract. They seemed to work on the old paratrooper's policy (worn above a picture of a death's head on many paratroopers' tee shirts) that said "kill them all and let God sort them out."

Predicting the results of litigation is much like trying to predict earthquakes--an imprecise science at best! Added to this is the exorbitant cost of hiring lawyers to defend, preparing all the records for discovery and taking the time of key personnel to review files and prepare for testimony. It is little wonder that a large percentage of the cases get settled, even when the defense has an overwhelmingly strong case. It is cheaper to settle than it is to fight. Obviously, plaintiff's lawyers know this fact and rely on it when they take cases that they would otherwise reject as being too speculative for them to gamble on if the litigation were to proceed to conclusion.

In my firm we have observed situations with stock brokerage firms and insurers who have established policies not to settle cases unless they are clearly in the wrong. As the word gets out in the plaintiff's bar, the lawyers quit bringing actions against those firms that vigorously resist and go after those that are more prone to settle. Regardless of whether the action goes all the way or is settled somewhere along the way, the stock broker involved will, in most instances, have a permanent blot on his or her record, no matter how thorough the analysis and no matter how conscientious was the advice that was given. This combined with the expense involved and the emotional upheaval of being a defendant whose motives are called into question has left a very bad taste in the mouths of many financial advisors.

The current financial crisis in our (and the world's) economy is very likely to cause a new round of litigation that could be even worse than that that occurred in 2000-2002. The market has gone down further than it did then and the downturn is much more likely to be extended than was the downturn at the beginning of the new century. Everyone involved in the variable annuity business would be well-advised to stop now and give consideration to what they can do to make the inevitable flood of litigation less likely to succeed.

We have had the opportunity to observe (albeit as bystanders) a substantial amount of litigation involving questions as to whether the sale of a variable annuity was or was not suitable to the needs of the customer. This litigation often confuses the issues of the suitability of the annuity with the suitability of the underlying investments. We are not sure if plaintiff's lawyers are knowledgeable enough to do this on purpose or if they do not really understand the difference. Nevertheless, the tribunals, whether FINRA arbitration panels or judges and juries, frequently do not seem to understand the difference.

Plaintiff's lawyers are very good at raising issues about the motivation of the financial planner/stock broker who sold the variable annuity. They introduce copies of articles from financial pundits that claim that variable annuities are too expensive for the value received and that the motivation for selling them rests more with the commissions paid to the sales personnel than with the benefit to the purchaser. Then, once they have questioned the validity of the sale of the variable annuity they use that as the basis to establish that the loss in value was the annuity's fault, not the fault of a general downturn in the stock market--a downturn that would have adversely affected any equity investment, even if there were no variable annuity involved.

We have seen cases where the plaintiff testified that he redeemed shares from a mutual fund, purchased a variable annuity with the proceeds, used similar investments underlying the variable annuity as he had before and claimed that his loss was the fault of the financial planner! This all based on the highly-publicized opinions of financial pundits that variable annuities offer no real value to the customer. That this is illogical does not seem to have much affect on the tribunals hearing the cases.

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