Not in Barbieland Anymore: Abusive Life Sales May Lead to Jail if Combined with Investment and Tax Advice

What could be risker than Premium-Financed IUL?

Deductible Premium-Financed IUL.

Today, Arthur Postal of Life Annuity Specialist published a story called "Rogue Agents Dubious Indexed Life Investment Schemes Spark Lawsuits" (which you can view if you subscribe) about how a few life-only insurance agents gave advice that had effectively wrecked the financial well-being of hundreds of clients and left hundreds of millions of dollars of damage in their wake. His story focused on several regulatory actions and civil cases in which life-only agents mixed tax, investment, and insurance advice resulting in a disastrous concoction. David approached me with one simple question: “How could this happen?” Below is a summary of my response, which Postal incorporated into his article.

The common thread was that agents–specifically those who had relinquished their FINRA registration and continued to offer financial advice–used “regulatory arbitrage”, which allowed these agents to keep active state insurance licenses and offer advice with little to no standard or supervision. While most life-only agents can (and often do) offer good advice to consumers, a few rogue agents seem to have tied together questionable tax and investment advice that helped sell hefty premiums, resulting in large commissions earned and highly conflicted advice being given. Unlike producers who are actively registered with FINRA, these agents lack comprehensive oversight; there is no mandated review of sales materials, correspondence, principal review of transactions, or best interest standards.??????

In each of these cases, the U.S. Department of Justice, the Internal Revenue Service (IRS), and/or the Securities and Exchange Commission (SEC) brought actions against these rogue agents for inaccurate, and perhaps even fraudulent, tax or investment advice tied to fixed insurance sales. When enforcement was initiated by tax or investment regulators, only then did state insurance regulators belatedly begin to act. In one such case, it was only after the U.S. Department of Justice commenced an action on tax fraud and SEC violations that the agents’ state insurance licenses were suspended. It appears that these agents were compensated for their “advice” in the form of large commissions earned on the policies sold, and not from the investment or tax advice. Increasingly this advice involves IUL policies, many times on a leveraged basis in these complex and questionable transactions. ?

When just looking at “plain premium financing” without even crossing the line into tax or investment advice, I am often faced with a simple question: “What kind of regulatory standards would permit this ‘advice’ (i.e., to take out loans–sometimes far exceeding the client’s net worth–from banks to buy a complicated IUL policy)?” My answer is just as simple as the question posed: “Very low regulatory standards.” The lack of regulatory standards placed upon life-only agents has created an environment in which the consumer must read the contract on delivery and ultimately determine for themselves if the proposed transaction or product is in their best interest, a burden previously belonging to the other side of the transaction. In the case of premium-financed IUL, a life-only agent’s “advice” (if you wish to even call it that) that a policy will “pay for itself and repay the bank loan” is conflicted; the financed policy–and its respective commission–is often four or five times larger than if the premium was paid out of pocket. This temptation has resulted in conflicting advice to clients, as seen in the cases examined in Postal’s article.

We are only made aware of these cases because the rogue agents’ poor advice crossed over the line into regulatory regimes with tougher enforcement (i.e., the IRS and SEC). In several of the cases, the agents advised clients to create new entities (which, through a series of steps, would purportedly make most of the premium’s deductible) or to fund policies with investments that were ultimately discovered as part of a Ponzi scheme.

The cases referenced in Postal’s article are not isolated. Postal also cites a recently published Stanford Law Review article, which examined data from over 1.2 million advisors with varying levels of regulatory oversight. See Colleen Honigsberg et al., Regulatory Arbitrage and the Persistence of Financial Misconduct., 74 Stan. L. Rev. 373, 792. The study shows that those who drop FINRA registration and continue as state-licensed insurance agents (e.g., life-only agents) are “disproportionately likely to proceed under more lenient state-level regulation, thereby exposing investors to harm in the future.” Id. at 742. In fact, the national mega-data supporting the study shows that these agents are 240% more likely to be involved in an incident of serious financial harm for consumers than their industry peers still registered under stricter regulatory regimes. Id. at 772. ????

When these transactions fail and the harm is brought to light, ultimately civil litigation against the insurance company that permitted the use of their policies as part of such schemes ensues. When determining the level of their culpability and the duty to make consumers whole, a mountain of questions become material, such as:

1. Why would someone making X amount a year need a policy with a premium this large?
2. Was the company aware of a pattern of multiple policies all sold the same way under questionable circumstances?
3. Or, why did the company appoint an agent who had a history of client complaints?
4. Did the company attempt to verify the income and net worth inflated by the agent?
5. Why didn’t the company’s wholesalers alert the company when they saw sales materials featuring products funded by questionable tax or investment advice?

As early litigated premium-finance cases work their way through the legal system, there appears to be an increasing number that choose to settle or rescind the contested policy. Whatever the outcome, insurance carriers may soon find that the troubles caused by these wandering financial advisors are coming home to roost, as they are held responsible for the costly cleanup needed to make policyholders whole.?