Last week I posted a blog about the dangers of not heeding findings made during a regulatory exam, at least findings of clear, undisputable compliance issues that cannot be meaningfully defended. Today I am writing to highlight a corollary rule: if one customer points out the existence of a real problem, again, a clear problem with significant financial ramifications, any remedy that is implemented to address that problem needs to be applied to all similarly situated customers, regardless of the fact that such customers may not have been aware of the problem and did not complain.

This time, it was Equitable Financial Life Insurance Company that paid the price for breaking this rule – and a pretty hefty price it was: a $50 million civil penalty.

It came in this settlement with the SEC.  The facts are pretty straightforward.  In short, “[s]ince at least 2016, Equitable provided quarterly account statements to approximately 1.4 million investors that included materially misleading statements and omissions concerning significant fees paid in connection with” particular variable annuity investments that were sold principally to educators.  Specifically, while Equitable did disclose fees in several sections of its variable annuity account statements, they created “the false impression that all fees investors paid during the period were being detailed in the account statements.”  In fact, however, “Equitable’s account statements . . . excluded the most significant fees that investors paid from the fees listed on the account statements.  Instead, the account statements listed as fees only certain types of administrative, transaction and plan operating fees – most often amounting to zero or a very small number – which were in fact only a slight fraction of the overall fees paid by the investor.”

As well, “[t]he account statements contained no clarifying language or reference to the prospectus to explain to investors what these different categories of fees represented or to put the investor on notice of the fact that they instead had paid significant Separate Account Expenses and Portfolio Operating Expenses that could amount to thousands of dollars each year.  Though affirmatively presenting an apparently all-inclusive picture of fees and expenses to investors, Equitable’s quarterly account statements actually detailed less than three percent of the revenue that Equitable received from the EQUI-VEST variable annuities.”

This was important because, as the SEC found, investors “reviewed their Equitable account statements in order to assess the impact that fees were having on their investment and to make decisions concerning their ongoing investments, including whether to make additional investments in” their variable annuities.  Compounding this problem, in some of the quarterly account statements, Equitable affirmatively encouraged investors to increase their investments in the variable annuity, knowing that a consideration of the fees paid was an important component of the investors’ analyses.

Anyways…turns out that Equitable was aware of the problem with its account statements for years.  The SEC found that back in May 2017, Equitable learned that “its account statements may have confused investors on fees paid” from one of its customers, a big customer, mind you, namely, “an advisory committee to the school district with which Equitable did the most business in terms of both assets invested and number of investors.  Apparently, that school district, which “was determining whether to renew contracts” with its vendors, including Equitable, told Equitable “that the account statements were unclear on the amount of fees investors paid.”  Two years after that, in May 2019, the same advisory committee “specifically asked if Equitable could list annuity fees on the front page of its account statements going forward,” and Equitable agreed.

That’s the good news.  The bad news, however, is that with respect to all other investors in the same annuity, “including hundreds of thousands of K-12 teachers and administrators employed by hundreds of other school districts located across the nation, Equitable made no changes to the . . . account statements that those investors received and instead continued providing them with account statements that reported fees and expenses in the same manner that Equitable had been employing since at least 2016.”

Not really sure it’s necessary for me to add very much here.  As was the case last week with Barclays, which learned from FINRA during an exam that it had a problem, here, Equitable learned about its own problem, albeit from a customer.  In both cases, the problem was serious and indefensible, and fixable.  Yet, in neither situation did the firm do anything to address the problem immediately and on a company-wide basis.  Not surprisingly, for both firms, their respective failures to have acted sooner and more systematically ended up being cited by the regulator as an aggravating circumstance justifying the imposition of hefty sanctions.

Firm management should be attentive to input from all sources, both internal and external, when it comes to spotting issues.  Not every potential problem is serious, of course, not every potential problem will impact thousands of customers, and not every potential problem will, in fact, turn out to be a real problem after all.  But ignoring potential problems and simply hoping that the regulator will not be clever enough to figure out for itself that there is something going on is a poor strategy to adopt.  Not saying it doesn’t work; to the contrary, to this day, with all their fancy algorithms and computer programs designed to ferret out firms’ most vulnerable risk exposures, regulators still whiff all the time when it comes to finding even big issues.  Thus, many broker-dealers still successfully employ the cross-your-fingers-and-hope-no-one-notices approach to compliance failures.  But that is not something I advise, principally because it is not something I can defend when it doesn’t work.

So, on balance, unless you are prepared to be embarrassed, not to mention prepared to break out your checkbook, the better course of action is to actually fix problems – real problems, anyway – whenever and however they are brought to your attention.