by Howard Haykin

Principal Securities (fka Princor Financial Services) agreed to pay a $250K fine to settle FINRA charges that, for at least 3 years, its system for supervising additions to existing variable annuities was not reasonably designed to ensure that they complied with applicable securities laws and rules, including those governing suitability.

FINRA FINDINGS.    This Des Moines, IA-based broker-dealer is a long-time FINRA member and an affiliate of several insurance companies. As of July 2017, it had 739 branch offices and 3,300 registered persons.

From October 2013 to September 2016, Principal Securities customers added money to existing variable annuities (“V/A’s”) on more than 6.000 occasions. Those additions accounted for approximately one-sixth of Principal Securities' revenue from variable products during that period. While Principal Securities reviewed some of those additions by 3 exception reports and periodic branch and desk audits, more than 2/3’s of V/A additions were never reviewed.

Here’s where the scope of supervision was deemed unreasonably limited:  

• Exception reports covered only transactions involving one of Principal Securities' affiliates, not all or the existing variable annuities that Principal Securities' customers held.
• Exception reports covered only additions to existing variable annuities that were funded by surrendering insurance products, not all sources - thus, for example, exception reports did not cover additions that were funded by rolling over a retirement plan.
• Supervisors used exception reports to identify trading trends and patterns, rather than to evaluate the propriety of individual additions.
• Periodic audits did not cover: (i) additions to existing variable annuities generally or (ii) patterns of recommendations to make such additions.

As a result of Principal Securities’ failures ...  the review system did not detect harmful impacts upon customer accounts, including: (i) additions that resulted in high concentrations of customers' net worth in V/A contracts; and (ii) additions by customers whose financial needs and goals had changed since they initially purchased their contracts.

The supervisory lapses also failed to detect the following actions by a particular broker: (i) recommendations of in-and-out trading between a customer's variable annuities that resulted in frequent and unnecessary surrender charges; and, (ii) excessive concentration in a customer’s variable annuity account resulting from a $300,000 addition to a contract that more than doubled the customer's initial investment.

FINRA Note:  Principal Securities remedied the harm to affected customers and, in November 2016, the associated person who initiated those transactions was barred from the industry.

This case was reported in FINRA Disciplinary Actions for December 2017.

For details on this case, go to ...  FINRA Disciplinary Actions Online, and refer to Case #2015047322502.