[Senate Hearing 109-892]
[From the U.S. Government Publishing Office]
S. Hrg. 109-892
A REVIEW OF THE GAO REPORT
ON THE SALE OF FINANCIAL
PRODUCTS TO MILITARY PERSONNEL
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
ON
EXAMINATION OF A GOVERNMENT ACCOUNTABILITY OFFICE REPORT ON THE SALE OF
FINANCIAL PRODUCTS TO MILITARY PERSONNEL, FOCUSING ON ACTIONS NEEDED TO
PROTECT MILITARY MEMBERS
__________
NOVEMBER 17, 2005
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http: //www.access.gpo.gov /congress /senate/
senate05sh.html
______
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
RICHARD C. SHELBY, Alabama, Chairman
ROBERT F. BENNETT, Utah PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky EVAN BAYH, Indiana
MIKE CRAPO, Idaho THOMAS R. CARPER, Delaware
JOHN E. SUNUNU, New Hampshire DEBBIE STABENOW, Michigan
ELIZABETH DOLE, North Carolina ROBERT MENENDEZ, New Jersey
MEL MARTINEZ, Florida
Kathleen L. Casey, Staff Director and Counsel
Steven B. Harris, Democratic Staff Director and Chief Counsel
Justin Daly, Counsel
Stephen R. Kroll, Democratic Special Counsel
Jonathan Miller, Democratic Professional Staff
Patience R. Singleton, Democratic Counsel
Dean V. Shahinian, Democratic Counsel
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
(ii)
C O N T E N T S
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THURSDAY, NOVEMBER 17, 2005
Page
Opening statement of Chairman Shelby............................. 1
Opening statements, comments, or prepared statements of:
Senator Sarbanes............................................. 2
Senator Enzi................................................. 4
Senator Schumer.............................................. 5
Senator Bunning.............................................. 6
Senator Dole................................................. 7
Senator Allard............................................... 8
WITNESSES
Richard J. Hillman, Managing Director, Financial Markets and
Community Investment, U.S. Government Accountability Office;
accompanied by Cody J. Goebel And Jack Edwards................. 9
Prepared statement........................................... 37
John M. Molino, Deputy Under Secretary of Defense for Military
Community and Family Policy, U.S. Department of Defense........ 22
Prepared statement........................................... 62
Lori Richards, Director, Office of Compliance, Inspections, and
Examinations, U.S. Securities and Exchange Commission.......... 23
Prepared statement........................................... 67
Mary Schapiro, Vice Chairman and President, Regulatory Policy and
Oversight, National Association of Securities Dealers.......... 25
Prepared statement........................................... 73
Response to written questions of Senator Sarbanes............ 81
John Oxendine, Commissioner of Insurance, State of Georgia....... 27
Prepared statement........................................... 77
Response to a written question of Senator Sarbanes........... 84
(iii)
A REVIEW OF THE GAO REPORT
ON THE SALE OF FINANCIAL
PRODUCTS TO MILITARY PERSONNEL
----------
THURSDAY, NOVEMBER 17, 2005
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:06 in room SD-538, Dirksen Senate
Office Building, Senator Richard C. Shelby (Chairman of the
Committee) presiding.
OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY
Chairman Shelby. The hearing will come to order.
This morning, the Committee will hold a hearing on a
recently completed Government Accountability Office
investigation examining the sale of financial products to our
Nation's servicemen and -women. Last year, I, along with
Senator Sarbanes, asked the GAO to study the regulatory
oversight associated with the marketing and sale of the
insurance and investment products being offered to
servicemembers. We also asked the General Accounting Office to
assess the range and quality of these financial products,
particularly with respect to the offerings in the civilian
market.
Quite simply, GAO's findings are troubling. The report
makes clear that military personnel are being sold costly,
outdated, and even unnecessary securities and insurance
products. It also indicates that military personnel frequently
are victims of deceptive and illegal sales practices.
Specifically, with respect to securities products, GAO
found that a few financial service companies marketing
specifically to service-members sell an archaic and obscure
investment vehicle called a contractual plan that is
characterized by an unusually high 50-percent sales charge over
the first year. These sales persist notwithstanding the fact
this product all but disappeared from the civilian market in
the early 1980's due to excessive sales commissions.
Furthermore, financial advisers have questions whether this
product is ever a suitable investment given the fact that there
are hundreds of reputable no-load mutual funds available today.
With respect to insurance products, GAO identified six
insurance companies that catered to the military market.
According to the report, insurance agents from these companies
sell expensive life insurance that is oftentimes illegally
marketed as a security. They market these products to the
military even though most service-members automatically carry a
low-cost, government-provided $400,000 life insurance policy
that provides coverage here.
Perhaps most troubling, there is ample evidence that our
men and women in uniform are routinely rushed through stacks of
paperwork as part of a captive audience, unaware of what they
are signing and purchasing.
The report is also quite critical of the Department of
Defense's performance in regulating solicitations on military
installations and sharing information with financial
regulators. To discuss GAO's investigation and related issues
with us this morning, we have Richard Hillman, who authored the
GAO report. On the second panel we will hear from John Molino,
who is the Deputy Under Secretary of Defense for Military,
Community, and Family Policy; Lori Richards, who is Director of
the Office of Compliance, Inspections, and Examinations,
Securities and Exchange Commission; Mary Schapiro, who is the
Vice Chairman of NASD; and John Oxendine, who is the Insurance
and Safety Fire Commissioner for the State of Georgia.
I want to commend you, Mr. Hillman, for the excellent
report and the work GAO has done here, and I look forward to
everyone's testimony.
Senator Sarbanes.
STATEMENT OF SENATOR PAUL S. SARBANES
Senator Sarbanes. Thank you very much, Mr. Chairman, for
calling this hearing and for joining in asking for the GAO
study. We will hear their report this morning on the sale of
financial products to members of our armed forces. Regrettably,
abuses in this area have been widely reported. The New York
Times1 published a series of articles on this subject last
year. In September 2004, you and I asked GAO to conduct a study
of these problems, and we will hear their analysis and then the
comments by relevant regulators here this morning. I would like
to also acknowledge the efforts of Senator Enzi on this issue.
I know he has taken a very keen interest in it.
Chairman Shelby. Very much.
Senator Sarbanes. And he has introduced legislation on the
subject with Senators Clinton, Schumer, Hagel, and others.
In their report, the GAO has found, ``Large numbers of
military servicemembers are being targeted by a few firms
offering life insurance products that provide limited benefits
unless held for long periods, which most military purchasers
were failing to do.''
In fact, at least some of the companies understood, and
apparently counted on, the fact that the target group for the
life insurance sales were enlisted personnel, who have the
highest level of turnover and would not hold these policies for
long periods of time.
GAO also found, ``Military members were being widely
marketed a securities product, the contractual mutual fund
plan, that has largely disappeared from the civilian
marketplace and which had been periodically involved in sales
scandals for decades.''
The GAO reported that the marketing materials used were
misleading and ``misrepresented the advantages of these plans
compared to other investments.''
I think it should be a matter of very deep concern that
these are not new problems. For example, The New York Times has
reported that Army Times has described similar issues in
earlier articles. Some military officials sought to alert
Pentagon officials to the problems in a 1997 report. A 1998
report of the Pentagon's Inspector General, which looked into
life insurance sales on 11 randomly selected military bases,
found, ``misleading sales presentations, presentations by
unauthorized personnel, presentations to captive audiences,
soliciting during duty hours, and soliciting in the barracks.''
This was a Pentagon Inspector General's report.
A May 2000 Pentagon-ordered study by the former Chief Judge
of the Army's Court of Criminal Appeals found that DoD policies
``have been routinely violated'' in this area for the last 30
years. I might also note that the SEC many years ago
recommended banning the sale of mutual fund contractual plans
altogether.
Furthermore, Mr. Chairman, there are also widespread abuses
in the payday lending area directed specifically at our
military personnel.
There are approximately 1.4 million active-duty personnel
and 1.2 million members of the Ready Reserve and our armed
forces. I am very concerned that any insurance company or agent
or stockbroker or dealer would sell inappropriate financial
products to our servicemen and women. I am very concerned that
any lender would require economically abusive terms in loans to
military personnel.
Now, we go marching around here waving the flag and
everything about the military and the sacrifice of our men and
women, and I have complete respect for what they do. But it
seems to me one of the minimal things we could do to show that
respect is to move aggressively against these kinds of
practices which every study has found are abusive. I want to
make that very clear that most of the reputable firms do not
engage in this activity. But there are enough who do it in such
abusive terms that it casts a dark cloud over the entire
economic sector.
We are going to hear from a distinguished panel of
witnesses this morning. I especially want to recognize Richard
Hillman, now GAO's Managing Director for Financial Markets and
Community Investment. Mr. Hillman is no stranger to this
Committee, and I want to take this opportunity to commend him
and his colleagues for their careful and thorough work on this
important study. And I look forward to the second panel as
well, and I should just note that I am delighted that Mary
Schapiro, the Vice Chairman of NASD, will be on that panel. She
is also no stranger to the Committee, and actually prior to
joining NASD, she was Chairman of the Commodity Futures Trading
Commission and also a Commissioner of the Securities and
Exchange Commission. So she is very, very knowledgeable. She
has been very helpful to this Committee in the past, and I look
forward to hearing her testimony, as well as that of Ms.
Richards from the SEC; Mr. Oxendine, who has come to be with us
from the State of Georgia, the Insurance and Safety Fire
Commission; and John Molino, the Deputy Under Secretary of
Defense for Military, Community, and Family Policy of the U.S.
Department of Defense.
Mr. Molino, I would just warn you now, we have this
Inspector General study; we have other studies to the Pentagon
about what is going on and so forth. So we are going to be
curious to know why the Department of Defense itself has not
moved more aggressively in this area heretofore. So, I would
just put that out there so you can mull about it until we get
to your panel.
Thank you very much, Mr. Chairman.
Chairman Shelby. Thank you, Senator Sarbanes.
Senator Enzi, I am going to recognize you next, but I do
want to join Senator Sarbanes in recognizing your work and
leadership in this area. This is a very important subject to
all of us. Thank you.
Senator Enzi.
STATEMENT OF SENATOR MICHAEL B. ENZI
Senator Enzi. Thank you very much, Mr. Chairman, and I
really appreciate your holding this hearing because this is an
issue that is too important to ignore. For years, our men and
women in the armed services have fallen victim to unscrupulous
salespersons who are pushing high-cost financial products and
life insurance. Oftentimes, the Department of Defense
directives and the State regulations would be violated or
completely ignored by these bad actors. The lack of oversight
and information sharing among regulators has only made the
problem more pervasive.
As this GAO report will show, salespersons have been
preying on military personnel, who are often young,
inexperienced in financial matters, and particularly vulnerable
to the aggressive sales tactics used by come companies. In some
examples, life insurance agents have posed as instructors
arranging veterans benefits classes for recruits and trainees.
The sales pitches would start as soon as the commanding officer
left the room. Many young men signed contracts and made payroll
deductions because they believed the policies were endorsed by
the Department of Defense or their military branch. In reality,
they bought life insurance policies with low death benefits and
premiums as high as 14 times the price of similar plans offered
by the Servicemembers' Group Life Insurance.
In other cases, military personnel were sold investments
that have all but disappeared from civilian markets. These
funds, called contractual plans, offer high up-front sales
commissions that rob investors of years of earnings. Today,
there are literally thousands of better investments on the
market. However, financial advisers found a niche outside of
the public mainstream where they could still sell these
disreputable investments on our military bases.
In 1966, the SEC recommended to Congress that they ban
these types of funds, but Congress did not act. It is time to
finally follow through and ban the sale of these funds. My bill
would do that.
One of the most troubling aspects of this issue is the lack
of oversight by the Department of Defense. Throughout this GAO
report, it is noted that the Department of Defense did not
share information about these problems with other regulators
who could have prevented these violations. The report states
that DoD personnel would generally try to resolve issues within
the base. It is very clear, however, that this method has only
allowed the problem to persist. A better system of information
sharing is needed to effectively target bad actors and prevent
them from ripping off our military personnel.
I believe that my bill, the Military Personnel Financial
Services Protection Act, will address these critical needs. My
bill would draw clear lines of jurisdiction for regulators,
create a registry to track violators and ban the worst types of
financial products being sold to our military. These products
have disappeared from the civilian market, and they should
disappear from military installations, too.
I am pleased that the GAO has recommended several steps
that are already included in the bill. I look forward to the
testimony of Mr. Hillman on how these reforms could best be
enacted.
I would like to thank all the witnesses for appearing
before the Committee today and sharing their perspectives. The
investigations recently completed by NASD and SEC helped to
bring this issue into focus for Congress. I appreciate their
hard work. I am also interested to learn about the steps taken
by the Department of Defense to better educate our armed forces
about the financial investments they make, how they will
provide better oversight in the future. I expect this GAO
report and this hearing will advance the discussion of
financial sales to our military personnel. During a time when
so many of our armed services are bravely fighting tyranny
abroad, we have to ensure that they are protected at home.
Thank you, Mr. Chairman.
Chairman Shelby. The Chair recognizes Senator Schumer.
STATEMENT OF SENATOR CHARLES E. SCHUMER
Senator Schumer. Thank you, Mr. Chairman. I want to thank
you and Senator Sarbanes for holding a hearing on this really
important issue, on the sale of financial products to the
military, and I want to thank Senator Enzi for his leadership
in terms of legislation, which I am proud to cosponsor.
We all know the problems here, and when I first read the
stories in The New York Times, it wrenches at your heart that
the people who serve us were taken advantage of, and sometimes
with the complicity not of the military, but with people in the
military. When at Camp Pendleton the marines, 345 marines who
bought life insurance through briefings that were sponsored by
the camp, and they had these private insurance agents come in,
the results, at least the research done by The New York Times,
showed that those who signed up thought this product was
endorsed by the Marine Corps. And that is just appalling. It
really was very bothersome to me.
Now, it is a good question to see what DoD is doing. It is
also a good question to ask the life insurance made available
to military personnel by the Government, why is not that
adequate? That is something we should think about in terms of
our soldiers. But I think we should--and another question to
ask is: Is the Department of Defense--why aren't they
coordinating with other agencies in the Government who may have
more expertise on these kinds of insurance products to try and
figure out what they can do on their own.
I think the GAO's recommendations are exactly right.
Banning the sale of contractual plans, known for the high
front-end sales charge of 50 percent, that makes sense. These
plans, interestingly enough, are not in the civilian market at
all, but they are being used to lure our soldiers. And I
support their recommendations requesting that insurance
regulators conduct reviews to ensure that the products being
sold meet the existing insurance requirements. That seems to me
to be rudimentary and fundamental.
Again, I think that Senator Enzi's bill does a very good
job, and I am proud to be a cosponsor. Let me just make a
couple of other points here.
One thing that was missing from the study were
recommendations on steps to combat the negative effects posed
by the automatic premium payment provisions which are included
in many of these policies unless the servicemember proactively
contacts the insurance company to cancel the policy and request
a refund of the savings fund. This is an area where we might be
able to help our soldiers and look at that.
Also, one legislative area we should look at that goes
beyond the scope of the report, the way to improve disclosure
provisions so that military members will know exactly what they
are signing up for and understand which products automatically
take payments from a member's bank account. That always is done
quietly and people do not know it and they pay less attention
to it.
I would also like to look into whether it may be necessary
to work with DoD if there should be a certification requirement
for the sale of products on military bases. That might go a
long way to protecting people as well.
So, with that, Mr. Chairman, I thank you for this timely
hearing and look forward to a legislative solution in large
part based on the GAO recommendations.
Chairman Shelby. Thank you.
The Chair recognizes Senator Bunning.
STATEMENT OF SENATOR JIM BUNNING
Senator Bunning. Thank you, Mr. Chairman, for holding this
very important hearing, and I would like to thank all of our
witnesses for coming here before us today.
I do not know anyone who read The New York Times'
investigation of sales of financial products to the military
personnel who was not at the very least appalled and concerned
about the practices. Knowing some unscrupulous financial
service companies are taking advantage of our servicemen and -
women, most of whom are very young, deeply disturbed me, as I
know it did many others in Congress.
Mr. Chairman, you and Senator Sarbanes asked for the GAO
report that we are going to hear testimony on today, and
Senator Mike Enzi has introduced a bill to curb some of the
abuses. My good friend and fellow Kentuckian, Jeff Davis, the
Congressman representing my old district in Kentucky, the 4th,
has worked tirelessly on this issue and has introduced a bill
very similar to Senator Enzi's that has already passed the
House of Representatives. The SEC, the Nasdaq, and the State
insurance commissioners have also been very involved in this
issue. All of you should be commended for your efforts.
We have two large Army bases in Kentucky--Fort Knox and
Fort Campbell. Like every other State in the Union, Kentucky
has many Guard and Reserve units called up to fight the war on
terror. If there is anything anyone can do to help facilitate
financial education at the military facilities in Kentucky and
prevent our service people from getting taken advantage of,
please let us know. Let the Committee know and let the military
bases know.
It sickens me to know some very bad actors have tried to
take advantage of these young men and women as they go off to
war. We must make sure that this does not happen anymore, and
we must make sure that those who have abused our service people
in order to make a quick buck are held accountable.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Dole.
STATEMENT OF SENATOR ELIZABETH DOLE
Senator Dole. Thank you, Chairman Shelby. My thanks to the
witnesses this morning.
The unscrupulous sale of flawed financial products to our
servicemen and -women is an extremely critical matter affecting
our military families as well as our military's readiness. It
is an appalling situation. Harmful financial products can cause
serious financial hardships for servicemembers and their
families, not only affecting morale but also causing military
personnel to lose necessary security clearances and lead to
career-ending disciplinary measures.
This is an issue I take very seriously as a Member of both
this Committee and the Armed Services Committee. And with more
than 115,000 military personnel stationed in North Carolina,
these problems truly hit home.
I want to thank you, Mr. Chairman, and Ranking Member
Sarbanes for requesting this important GAO report, which
explains well the many reasons why military personnel are being
targeted by dishonest financial services providers. This report
has effectively painted a picture of the challenges affecting
the men and women serving our country.
As we have already heard, many are young. In fact, the
report points out that the Defense Department is the largest
employer of young adults in the United States, having in 2004
recruited some 20,000 men and women into active duty alone, the
majority of them recent high school graduates.
Also, our military members face lengthy deployments and
frequent relocations, and like most young Americans, they often
lack financial savvy and security. These very factors make them
more vulnerable to predatory financial practices.
The GAO report also details the problems with certain
insurance and securities products marketed to military
personnel that have lower payouts and larger fees and
commissions. Targeting the military to be consumers of these
unscrupulous services deserves our closest scrutiny, and I,
too, thank my colleague Senator Enzi for introducing such
important legislation that takes significant action to stop
these practices in the insurance and securities areas.
Still, I am concerned, Mr. Chairman that this report did
not investigate lending practices to servicemembers. However,
an April GAO report described tools that DoD is not fully
utilizing to fight predatory lending. It revealed that consumer
advocates, State government officials, DoD officials, and
servicemembers in GAO focus groups indicated that the military
is being targeted and harmed by predatory lenders.
In the defense authorization bill that we passed this week,
I was very proud to include an amendment that takes important
action to stop predatory lenders from targeting our military.
This measure requires the Defense Department, in consultation
with Treasury, the Federal Reserve, the FDIC, and
representatives of military, charity, and consumer
organizations to report to Congress within 90 days on the
prevalence of predatory lending and to provide specific
legislative and administrative actions to prevent this
egregious practice.
Indeed, supporting our military is more than just
supporting their mission in the war against terror. It includes
supporting their families and their livelihoods. The targeting
of our servicemembers by unscrupulous financial service
providers is seriously harming both, and I look forward to
working with this Committee as we find ways to put a stop to
all of these practices.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Allard is recognized.
STATEMENT OF SENATOR WAYNE ALLARD
Senator Allard. Thank you, Mr. Chairman. I, too, want to
join my colleagues in thanking you and Senator Sarbanes for
holding this hearing and my colleague from my neighboring State
of Wyoming for taking the lead on this particular issue. I
think it is important that we do closely examine the GAO report
on the sale of financial products to military personnel. I am
proud personally to represent a State with a significant
military presence, and I look forward to the opportunity to
hear from our witnesses.
I want to join my other colleagues also in saying we do owe
our military a great debt. They volunteer to risk their lives
to protect freedom and democracy. Therefore, it is only
reasonable to expect that we would protect them against
inappropriate sales of financial and investment products while
on the job.
Having said that, we also want to be sure that we encourage
savings through legitimate products. I think that we do not
want to step over the line here. There are some very good
savings plans, and we need to encourage our young people all
over this country to do more to save, because in my view this
country is not saving enough. Military people, with proper
savings and investment programs, can enhance their future, and
so I am looking forward to the testimony.
This GAO report, along with today's testimony, I think will
be helpful in finding an appropriate balance, and I look
forward to hearing from our witnesses.
Thank you, Mr. Chairman.
Chairman Shelby. Mr. Hillman, of course, the GAO report
will be made part of the hearing record, and we appreciate
that. Your written testimony will be made part of the hearing
record. You proceed as you wish.
STATEMENT OF RICHARD J. HILLMAN
MANAGING DIRECTOR, FINANCIAL MARKETS
AND COMMUNITY INVESTMENT,
U.S. GOVERNMENT ACCOUNTABILITY OFFICE;
ACCOMPANIED BY
CODY J. GOEBEL AND JACK EDWARDS
Mr. Hillman. Thank you very much, Mr. Chairman.
Accompanying me today, to my left, is Cody Goebel and to my
right Jack Edwards. They are Assistant Directors at GAO who
were primarily responsible for the successful design and
implementation of the studies being featured today.
We are pleased to be here to discuss GAO's work on the
sales of financial products to the U.S. military. Today, I will
summarize the results of the report prepared at this
Committee's request entitled ``Financial Product Sales: Actions
Needed to Better Protect Military Members.'' Specifically, I
will discuss, one, the insurance and securities products that
were being sold primarily to military members and how these
products were being marketed; and, two, the ability of
financial regulators and the Department of Defense to oversee
the sales of insurance and securities products to military
members. Where applicable, I will also present results from a
related June 2005 study describing the need for DoD to
implement controls over supplemental life insurance
solicitation policies involving service-members.
In summary, regarding sales of insurance products, we found
that thousands of junior enlisted servicemembers had been sold
a product that combines life insurance with a savings fund
promising high returns. Being marketed by a small number of
companies, these products can provide savings to servicemembers
that make steady payments and have provided millions in death
benefits to survivors and others. However, these products are
much more costly than the $250,000 of life insurance, now
$400,000, that military members already receive as part of
their Government benefits.
In addition, these products also appear to be a poor
investment choice for servicemembers because they included
provisions that allowed any savings accumulated on these
products to be used to extend the insurance coverage if a
servicemember ever stops making payments and fails to request a
refund of the savings. With most military members leaving the
service within a few years, many do not continue their
payments, and as a result, few likely amassed any savings from
their purchase.
Several of the companies who have sold these products have
been sanctioned by regulators in the past, and new
investigations are underway to assess whether these products
were being properly represented as insurance and whether their
terms were legal under existing State laws.
Regarding the sale of securities products, we found that
thousands of military members were also purchasing a mutual
fund product that also requires an extended series of payments
to provide benefit. Known as contractual plans, they expect the
service-member to make payments for set periods, such as 15
years, with 50 percent of the first year's payments
representing a sales charge paid to the selling broker-dealer.
If held for the entire period, these plans can provide lower
sales charges and comparable returns as other funds; however,
with securities regulators finding that only about 10 to 40
percent of the military members that purchased these products
continued to make payments, many paid higher sales charges and
received lower returns than had they invested in alternatively
available products.
Regulators have already taken action against the largest
broker-dealer that marketed this product and are investigating
the few remaining sellers for using inappropriate sales
practices. With the wide availability of much less costly
alternative products, we and the relevant financial regulators
question the need for contractual plans to continue to exist.
Sales to military members were receiving less oversight
because DoD personnel rarely forwarded servicemembers'
complaints to relevant financial regulators. Insurance products
also lacked suitability or appropriateness standards that could
have prompted regulators to investigate sales to military
members sooner. Securities regulators' examinations of
contractual plans were also hampered by a lack of standardized
data showing whether consumers were benefiting from their
purchases.
Although recognizing a greater need for sharing information
on violations of its solicitation policy and servicemember
complaints, DoD has yet to finalize its policies to require
that such information be provided to financial regulators, nor
has it coordinated with these regulators and its installations
on appropriate ways that additional sharing can occur.
Given the concerns over potentially inappropriate financial
product sales to military members, the need for definitive
action to better protect servicemembers appears overdue. The
report we issued to this Committee recommends actions by
Congress that are consistent with the provisions and bills
under consideration by this Committee. More specifically,
because the features of the products being sold to military
members provide limited benefits to many military purchasers,
we believe that Congress should act to have all State insurance
regulators conduct reviews to ensure that only legal products
are being sold to military members and to have regulators work
cooperatively with DoD to develop standards that could help
ensure that companies only market appropriate products for
military members' needs and circumstances.
Similarly, given the wide availability of less costly
alternatives, Congress should act to amend the Investment
Company Act to ban the sale of contractual mutual fund plans.
Because financial regulators' ability to adequately oversee
sales to military members was hampered by a lack of information
sharing about military members' complaints and concerns, we
also recommend that Congress direct DoD to work with insurance
and securities regulators to overcome barriers to sharing
information and to clarify that State regulators have
jurisdiction on military installations.
In the report prepared for this Committee, we also
recommend that DoD issue its revised solicitation policy that
will require military personnel to share complaints with
financial regulators. And, finally, to improve oversight by
State insurance regulators, SEC, and NASD, we recommend these
organizations designate specific members of their staff to
receive complaints and conduct outreach by proactively learning
of problems involving servicemembers. In the event that
contractual plans continue to be sold, we also recommend that
the SEC and the NASD improve the information they have to
evaluate the extent to which customers are successfully
completing their plans.
DoD and the financial regulators have provided comments on
a draft of this report being released today, generally agreeing
with the report's contents and its recommendations.
Mr. Chairman, this completes my prepared statement, and I
and my colleagues would be pleased to respond to any questions
you or other Members may have.
Chairman Shelby. Thank you, Mr. Hillman.
Could you assess for the Committee this morning the range
and the quality of financial products offered to the military
community as well as the sales methods employed to sell these
products? And let me ask you this: What is the average age of
these soldiers they are selling to? Did you do any work on
that?
Mr. Hillman. Yes, we can provide information on that as
well.
Chairman Shelby. Okay.
Mr. Hillman. On the insurance products themselves, they
were typically marketed to junior enlisted service personnel,
those who have just come into the services and really just
coming out of their basic training and being redeployed.
Chairman Shelby. What would be the average age of these
people? Young, would it not?
Mr. Hillman. Young, most often likely right out of high
school, in their late teens and early 20's.
The contractual mutual fund plan, however, was more or less
targeted to more senior, commissioned officers who had and
could afford the ability to make payments for investment
purposes.
The insurance companies targeting servicemembers were
primarily marketing a hybrid product combining a high-cost
insurance policy with a savings component. The product costs
significantly more than other insurance coverage available to
servicemembers. For example, since 2005, the Servicemembers'
Group Life Insurance, or SGLI, provides $400,000 of life
insurance for $26 per month. These other products would provide
death benefits generally ranging from $25,000 to $50,000 for
approximately $100 per month, allocating some funds to the
savings fund, typically much less in the earlier years and more
in the later years, depending on the product.
Another debilitating feature of the insurance products is
that they had this automatic premium payment provision, as
Senator Schumer mentioned in his opening remarks, which allows
companies to deplete the savings fund to pay for any insurance
premium should a servicemember stop making payments. Given that
servicemembers more frequently move and leave the service
within a few years, they are often unable to make payments for
long periods of time, and because of this feature, have not
been able or were likely unable to amass any savings.
Products also were associated with questionable sales
practices where the agents were misrepresenting the products
not as insurance but as an investment or identifying themselves
as representatives of independent benefit and fraternal
organizations. These products also frequently included very
early and stiff withdrawal penalties, and it was common for
companies to credit the amount of accumulated savings on the
basis of either the year-end balance or an average balance,
whichever was less.
So, Mr. Chairman, overall on the insurance side, these
products were more costly than what was available to
servicemembers and were being touted as not insurance but
investments, largely because of the incentive that members had
to purchase insurance more cheaply through the Federal
Government.
Chairman Shelby. It is my understanding the Department of
Defense has been aware of problems related to commercial
solicitations on military installations since the Vietnam War
era. Why are we still today discussing the same troubling
issues 35 years later? And it is my understanding also that a
lot of these contractual plan products they are selling
disappeared from the civilian market 25 years ago due to their
excessive sales charges. It looks to me like there is some
exploitation going on here to kind of a captive young market--
our soldiers.
Mr. Hillman. You are absolutely right. That was the most
surprising thing to us as part of this study. As you have
recounted and as have others, there has been a variety of
reports out there in the 1990's and in the 2000 era that go
back 10, 20, 30 years, recounting the types of problems they
were having with the sales of these products. As we conducted
work for this report before you as well as an earlier report in
June 2005, we visited military bases. We talked with officers.
We talked with junior and senior enlisted personnel. And we
would be finding the same story as we were recounted in those
studies. It is really quite remarkable.
Chairman Shelby. I understand that the Department of
Defense has banned only one company--one company--from military
bases worldwide. I believe that was Academy Life Insurance
Company in 1998.
In light of all the transgressions that have occurred over
the past 20 years or more, I would ask this question: Should
more be done to protect our men and women in uniform from
unscrupulous actors? Senator Enzi has been in the leadership on
this, as you know. Should more be done? And should we pursue
legislation in this regard? Because I am not sure the
Department of Defense could do it without legislation, or has
done it. They have had a long time to do it.
Mr. Hillman. That is absolutely right. We were looking into
the bill that Senators Enzi, Hagel, and Schumer introduced and
find the provisions in the sections in the bill to be very
relevant toward solving the problems servicemembers are facing.
We have articulated certain important provisions within our
report being released today, but believe that each of the
sections in the bill being introduced have valuable
contributions to protecting servicemembers.
In particular, because some States have reviewed the
products sold to servicemembers on the insurance side and found
them to be not in compliance with existing State laws, we are
recommending that all State insurance commissioners review
product provisions to ensure that they are in compliance with
existing laws. As Senator Schumer said in his opening remarks,
that is quite a fundamental requirement.
We have seen the State of Washington and others review
products and find them to not be in compliance, and that is one
quick and easy way to stop the sale of these products to
military installations within those States.
Because State insurance commissioners have no authority to
evaluate whether the products sold are appropriate or suitable
for military members, we are also recommending--perhaps one of
the more controversial recommendations--that State insurance
commissioners and the Defense Department work together to
develop appropriateness or suitability standards for sales of
products to military servicemembers.
This has been a particularly contentious issue within the
insurance industry, Mr. Chairman. As you know, the securities
industry already has suitability standards, but such standards
do not generally exist on the insurance side. On a limited
basis, though, the insurance industry has acted where there are
at-risk populations. For example, they developed suitability
standards for senior citizens aged 65 and over as it related to
the sale of annuity products. We are suggesting that the
servicemember population is a similar at-risk group. Because of
their itinerant lifestyle, moderate income levels, and young
ages, they are particularly susceptible to abuse and,
therefore, we are recommending that such standards be developed
by DoD and the insurance industry to help curb this activity.
Chairman Shelby. Senator Sarbanes is recognized.
Senator Sarbanes. Thank you very much, Mr. Chairman.
Mr. Hillman, I again want to commend you and your
colleagues for this extremely helpful report. I have a number
of questions. The first I want to put to you is, to what extent
was the Department of Defense allowing situations in which the
agents trying to sell these products seemed to be clothed with
some legitimacy from the Department? I mean solicitation on
base or the use of certain military facilities, how they
portrayed themselves so that their recruits did not perceive
them as being as they were, a private vendor just trying to get
a sale, but somehow could come away with the impression that it
was somehow an approved activity by the Department of Defense,
that it carried some imprimatur of approval as they were
dealing with these people?
Mr. Hillman. As you know, Senator Sarbanes, one of the
commonalities associated with the sales of these products--and
I would like to have Jack Edwards also respond to this in more
detail after I complete my initial remarks--one of the
commonalities associated with the sale of these products is
that they are often sold by agents who have had prior military
service. Therefore, they are totally disarming the
servicemembers that they are meeting with, giving them the
impression that they are providing them with a product that is
going to more than meet their needs because the agents have
been where servicemembers are now.
Military personnel overseeing these activities do have a
tough job. They are available and present, but the enforcement
of their solicitation policies have not occurred in a fashion
that we would have expected them to have occurred. There are
requirements in the solicitation policy that go way back,
prohibiting group sales that are prohibiting sales on barracks,
and prohibiting sales during working hours, and repeatedly in
reports you are seeing these types of infractions taking place.
So clearly, much more needs to be done by the Department of
Defense to help ensure that the individuals who are on base
soliciting information are doing in accordance with their
policies.
Mr. Edwards.
Mr. Edwards. Yes. In the case of several of the
installations where we visited, we did hear of cases of group
presentations going on which are a problem because they have
been prohibited by the directive which rules all of the
commercial solicitation that occurs on the installations. This
type of behavior is very difficult to quantify. There are not
any statistics out there to suggest how often it has occurred.
However, one piece of information that we can put forward
is that we did a survey of 175 DoD personnel financial
management managers. These are people who are on military
installations, who are in charge of programs to help enlisted
people and officers with their financial concerns.
Senator Sarbanes. These are DoD employees, is that correct?
Mr. Edwards. Yes. These managers indicated that several of
the prohibited practices are going on. We could not confirm all
of those because we did not visit all the bases. But in several
cases we found 25 percent or more of that sample of 175
installation managers saying that prohibited practices were
occurring on their bases.
Senator Sarbanes. Your report notes difficulties and
resistance in the Department of Defense in talking to other
financial regulators about a number of these issues. Could you
explain that to us a little bit?
Mr. Hillman. Yes. DoD has not shared concerns with
complaints for several reasons. Base personnel prefer to work
directly with the selling agents to resolve any matters, rather
than working directly with the financial regulators. Some were
concerned that discussions between servicemembers and financial
regulators would be prohibited due to installations' legal
advisers involvement in the complaint handling process. When
individual servicemembers contact Judge Advocate General
offices these advisers attorney-client privileges would
prohibit them from sharing information further.
Upon further review with DoD regarding this matter, they
now though believe that any legitimate request from an entity
such as a financial regulator, could overcome the privacy or
Judge Advocate General limitations.
Senator Sarbanes. But generally speaking, they are not
transmitting through to the financial regulators the complaints
that they are receiving; is that correct?
Mr. Hillman. That is correct. They are not sharing
information with the financial regulators, and they largely
have not had a mechanism to even gather internally within DoD
information on the extent to which there are concerns and
complaints out there regarding these products.
Senator Sarbanes. Right.
Mr. Chairman, my time has expired. Thank you very much.
Chairman Shelby. Senator Enzi.
Senator Enzi. Thank you, Mr. Chairman. I want to follow up
just a little bit on what Senator Sarbanes was asking about.
There are known violators. How do they get access to the
base? Is it a communication problem then? Is that what you are
saying, and perhaps there are some base restrictions that keep
them from sharing this information? I was not completely clear
on what you were saying there, by known violators.
Mr. Hillman. The DoD attempts to take action on known
violators, but there are a wide variety of agents that do come
in on base that have not had violations in the past, and they
are allowed in to provide for services to servicemembers in the
insurance and securities area.
Regarding the fact as to whether or not there are
limitations in the ability of the Defense Department to provide
information to financial regulators, initially they were
telling us, through most of our study, that, yes, that indeed
was the case, that there were privacy concerns and other
concerns associated with sharing information outside of the
base, and their preference was to handle matters themselves
rather than to involve the financial regulators.
Our understanding is, as a result of our work though, that
the research that the Department of Defense has done now, they
believe that there are no limitations to them sharing
information about concerns and complaints of servicemembers to
other financial regulators to the extent that they have a
legitimate need to know.
Senator Enzi. Thank you. Along that same line, you examined
the quantity and quality of complaints that were filed against
insurance agents and held within the Department of Defense or
on base. Can you give me a little insight into how a typical
complaint is processed once it is filed, and how that is
communicated?
Mr. Hillman. Maybe I should ask Mr. Edwards to respond to
that.
Mr. Edwards. The actual procedure is probably going to vary
a little bit by service, so what may be done in the Army may be
a little different than in the Marine Corps; also it may vary
somewhat according to the particular installation. But in some
of the discussions that we had while visiting installations,
typically servicemembers who thought that they were
experiencing some kind of problem would go to the commercial
solicitation coordinator for the entire base. This would be the
individual who would certify whether an agent coming on the
base was licensed, had had no problems on the base before and
met certain other requirements.
After that, the coordinator would discuss what the problem
was, whether certain activities had occurred, and whether those
activities were prohibited practices. At that point the
servicemember would be given an opportunity to go forward with
the complaint or not. If it did go forward, then there would be
various ways in which it could go forward. It might be with a
criminal investigation, or it may be through some other
channel.
Senator Enzi. Did you see any consistent patterns in the
substance of these complaints?
Mr. Edwards. That was one of the interesting things. We ran
into a problem in the work that was requested in the June
report. We were asked to look at the incidence of violations.
DoD does not gather information about the incidence of
violations. It only is able to quantify those individuals who
have committed actions that are egregious enough to result in
banning. This is one of the reasons that we recommended that
DoD should be monitoring before something gets that severe. DoD
partially concurred with our recommendation, and said the
current Senate bill requires them only to monitor at the banned
agent level.
Senator Enzi. Thank you. Mr. Hillman, did you encounter
situations where the jurisdiction of the DoD and the State
regulators was confusing, and did that cause inaction on the
part of either party?
Mr. Hillman. Cody.
Mr. Goebel. Yes. We did hear that from regulators. We did
some surveys as part of preparing this report and the report
that Jack Edwards worked on. And although generally State
insurance regulators and State security regulators expressed
the opinion that they did have jurisdiction, there were a few
that had some doubts about their complete jurisdiction. And in
at least a couple of cases at some States that had large
military populations, they definitely knew they did not have
jurisdiction because some of these installations there are
considered Federal enclaves, and so they did not believe they
did, which was a concern.
What some States have done in light of that is, for
example, investigators at the State of Maryland conducted some
work and found violations at bases in that State and in the
surrounding area. They actually reached out to the FBI and
brought them with them in some of their initial consultations
on the base to make sure they had a Federal connection.
Investigators in Virginia also reached out and got permission
from commanders at the base before they did any work. So that
is how they have tried to address it.
Mr. Hillman. So this notion and this uncertainty about the
extent to which they have legal authority is hampering their
ability to go on base whether they have it or not. So
legislation that you are introducing dealing with making it
more clear that State securities regulators and insurance
regulators have the jurisdictional right to go onto base to
deal with sales practice issues is particularly important. We
understand that this legislative jurisdiction requirement
varies from one State to another, and we did not have the
detailed time and resources to go in and look at each
individual State and State activity.
However, we understand that the types of existing
legislative authority over military installations varies
significantly based upon when and how specific tracts of land
were acquired and the like. So it is a confusing area and
clarification would be much welcomed.
Senator Enzi. Thank you. My time has expired.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Bunning is recognized.
Senator Bunning. Thank you, Mr. Chairman.
In your report did you examine the recruitment policies of
the Army, Navy, Marines, Air Force, and their explaining to
recruits what benefits a recruit would have as far as life
insurance or family benefits, and all the things that seem to
be violated after the fact?
Mr. Hillman. Again, I would like to have Jack Edwards
provide any information he may have about the report that he
worked on looking at solicitation practices within DoD's
policy. Our report looked at the quality of the products that
were being sold and the quality----
Senator Bunning. After the fact.
Mr. Hillman. After the fact, and the quality of the
regulation.
Senator Bunning. So, I am a young man being recruited into
the Army, for instance, the recruiter should be telling me now
that, ``Jim Bunning, you are going to have a $400,000 life
insurance policy.'' I would like you to explain what is being
done after the fact though.
Mr. Edwards. The military has a very strong program for
looking at personal financial management. They try to do
training for everyone who comes in. However, they have
experienced some problems making sure that everyone gets
through training. It was not in the report that we are
discussing today about the supplemental life insurance, but
another one of my teams did a report this year that looked at
that education process, and it varies quite a bit among the
different services as to exactly how they do the financial
education. There are a wide variety of issues that are required
as part of that financial training that each new recruit gets
during periods which include the basic training and the initial
follow-on installations where they go.
Senator Bunning. Did you find out in your report that the
violators, the people who violate the young service people, the
people who are trying to sell illegal or unreasonable
contracts, whether it be in mutual funds or life insurance, did
they hit these recruits before they had completed basic
training, or was it after the fact that they had finally made
it through the basic training period, and then were members of
the services?
Mr. Edwards. It could be in both situations, both while you
are still in basic training, as well as in the follow-on
assignments. However, one of the things that must be kept in
mind is that the directive that DoD is operating under only
controls the situation on the installations. Some
servicemembers go out to the local mall or somewhere else and
end up buying a policy, and DoD has less control over what
occurs----
Senator Bunning. I understand that. That is not my
question. My question is the time between when they enter as a
recruit until the time they finish, is the Department of
Defense giving the recruit enough information on the benefits,
and therefore, preventing our giving a heads-up to these young
people, that there are people that could be trying to sell them
illegitimate insurance policies, contractual mutual fund
policies and on down the line?
Mr. Edwards. We did not look specifically at that issue.
Senator Bunning. You didn't?
Mr. Edwards. No.
Senator Bunning. All right.
Mr. Goebel. Senator.
Senator Bunning. Yes.
Mr. Goebel. We also, in our report, have a recommendation
to the Department of Defense to expand some of the subjects
they cover in their personal financial management training, not
so much on the benefits of the products as you are discussing,
but on what to do if they do have concerns or complaints,
notifying them of who to complain to, the regulators, the
insurance or the securities regulators. We also found that
although DoD is attempting, as Jack has said, to get that
training to all new recruits, there was some desire expressed
by some servicemembers we talked to to see that held at all
levels, because as we mentioned, not all of these products are
targeted to the early----
Senator Bunning. What I am saying is if something is
eliminated 25 years ago from the civilian sales force, the
recruit would have the same opportunity to complain to the
NASD, to the Securities and Exchange Commission, or any other
regulator. I know they are very young and very unsophisticated
investors, but the fact of the matter is they have the same
rights and privileges that anyone who is not in the service
has. My only desire is to make sure that what is good for
people outside the service is also good for them when they get
in.
Mr. Hillman. Well, the Service Members Life Insurance
Program is well-supported by military servicemembers. Well over
90 percent enroll into that program, so they know that they
have insurance. But oftentimes what regulators are telling us
is, that these insurance products that are being sold to
military members are being not sold as an insurance product,
but are being sold as an investment.
Senator Bunning. I can understand how that would happen,
and that also can try to be happening in civilian life. The
fact that somebody is 19 and right out of high school and the
proximity of going into war, they would never think that they
had enough life insurance. The fact of the matter is that if
informed of what is available at the military level and the
upgrading of the military life insurance policies that we as a
Congress has taken under, would have a great deal of effect on
what they do as individuals.
Thank you.
Chairman Shelby. Thank you, Senator Bunning.
Senator Sarbanes. It is $400,000 now, is it not?
Mr. Hillman. That is correct, absolutely.
Senator Sarbanes. Right.
Mr. Edwards. Plus $100,000 in death gratuity benefit that
everyone would get even if they were not covered by the
insurance.
Chairman Shelby. Plus survivor benefits, education for
children, and so forth.
Senator Bunning. Oh, it is a package.
Chairman Shelby. In addition to that. I am not saying it is
sufficient, but we owe them a lot.
Senator Allard.
Senator Allard. Thank you, Mr. Chairman. The huge benefits
that can occur, such as for a widow, did not used to be true.
But, if they have a family of two children and the widow, you
can easily figure out over a lifetime their accumulated
benefits could be over a million dollars. I do think that they
need some financial consultation. I understand they are
providing that.
But the thing that comes to my mind is what motivates the
Department of Defense to think they need to have a salesman on
the job? I mean these men and women in the armed forces, they
are working. It is on-the-job sales. I would not let a salesman
come in and sell to my employees while they are working for me.
Why do they think that is important? I am trying to think why
an employer would allow that to happen. When I have employees
working for me, I want them to do the job. If they have
something they want to buy, they do it on their own time. So my
question is, why do we even allow a salesman of any kind on the
base?
Mr. Hillman. I may have Jack answer this question as well,
Senator, but I agree with your view that the insurance coverage
that is being made available for military members today is very
generous. The investment options being made available to
military members through their Thrift Savings Plan is equally
very generous. You have no-load programs, low-cost operating
funds available for servicemembers to invest at least 7 to 10
percent of their income into these Thrift Savings Plans.
Chairman Shelby. Do they all know that? That is important,
to communicate that to them.
Senator Allard. Yes, which is available to any Federal
employee.
Chairman Shelby. Right.
Senator Allard. Yes. I need a response to my question of
why do we let salesmen on the base where they are working?
Mr. Edwards. A military installation is a little bit
different than your usual corporate location because we do have
people actually living on the bases. They will be on there
after their work day ends. And in the case of people who are
living in community family housing on the installations, they
may arrange to have someone to actually come to their house. Or
it may be the case that the military member buys a policy from
someone who comes to a designated area that the installation
commander makes available.
So part of it is a difference between the military working
environment and the civilian working environment.
Senator Allard. It sounded to me like, when we were putting
this together, they had a group of soldiers together, and this
guy would come in while they were in uniform, came in and made
this sales pitch, and it does not seem quite appropriate to me.
If they are home or whatever, that is probably a different
story.
Senator Sarbanes. Did they solicit in the context in which
Senator Allard just suggested?
Mr. Edwards. Yes. If you look back at the report from 1999
DoD IG, the Cuthbert Report, and our report, each suggests some
solicitation was going on during work hours in work situations.
You do have some situations like those that are documented for
Camp Pendleton, where individuals did get solicited in groups,
which is a prohibited activity, much like contacting somebody
during the work hours.
Senator Allard. The other thing, when they came in and
marketed, I assume they approached the soldiers pretty much as
this was a savings mechanism, a financial investment. Was this
in relation to IRA accounts or was it Keogh plans, or how were
they structuring the sales to start with? I personally have
been approached by these people with an IRA account, for
example, who say this is strictly a savings account, but when
you get into it, you find out you bought life insurance or some
part of that is life insurance, and it is very expensive. This
sounds to me like the same mechanism that we have here. Are
they coming in and trying to market an IRA account, not knowing
that they have a Keogh plan, or was something like that
available?
Mr. Goebel. Yes. The securities product, the contractual
plan, was largely being sold, from what we understand, as a
Roth IRA, as a retirement vehicle for the servicemembers.
Senator Allard. Same types of stuff we run into in the
private sector. We ran into them in the 1970's particularly, if
I recall, although they just had them as IRA accounts at that
time, and they are deceptive. The salesman persisted that this
was not life insurance, but it was there in black and white if
you read the fine print. I can understand how they can get
misled on that kind of stuff, and I think that it is a shame.
Mr. Hillman. The SEC and the NASD will be on the next
panel, can speak very vividly to practices being undertaken by
the largest seller of this contractual plan, who they
identified through scripts that were being provided to agents,
just how egregiously they were touting the limitations of other
products and services, and propping up the products and
services that they were selling.
Senator Allard. Thank you, Mr. Chairman.
Chairman Shelby. Mr. Hillman, what single action by the
Department of Defense, the insurance commissioners, the
Congress, or any other interested party would have the greatest
impact on this decades-old problem in your judgment? Would it
be strong, meaningful legislation, as Senator Enzi has
proposed, or what would it be?
Mr. Hillman. As it relates to the Department of Defense,
they have a major mission and a massive responsibility. It is
one of the biggest organizations in the world. They need help.
The need to solicit the assistance of experts who know about
the quality of the financial products and who know about
problems concerning sales practice abuses. They need to
outreach more to financial regulators. That, in our view, would
be the one major area where we could help to curb this type of
activity at the SEC, at the NASD, indeed within State insurance
regulators and the NAIC. They do not have resources to look at
every issue that may come up as a part of an examination and
their approach, therefore, is more risk-based, more risk-
focused.
One of the key ingredients in determining the extent to
which risks exist comes from complaints and concerns that they
might hear. That will trigger to them a potential problem, that
will give them an opportunity to review that problem, see to
whatever extent it exists, and to deal with it.
Chairman Shelby. As we all know, we are dealing with a
young population as a rule, a very vulnerable population,
considering they know they are going to be in harm's way, more
than likely. So the tendency would be--I think Senator Allard
or somebody alluded to the fact--to buy insurance to protect
their families, protect their loved ones. Probably more so than
the average person, would you think?
Mr. Hillman. I would think so.
Chairman Shelby. I think we owe them more than we have
done.
Senator Sarbanes, do you have any other questions?
Senator Sarbanes. No, I know we have another panel coming,
Mr. Chairman.
Chairman Shelby. A very important panel, too.
Senator Sarbanes. Yes, it is an important panel. These--
have been very helpful and I am sure we are going to stay in
close touch with them as we proceed on this issue.
Chairman Shelby. Senator Allard has an observation.
Senator Allard. The point I wanted to make is this--they
are not up front about selling life insurance.
Chairman Shelby. Yes.
Mr. Hillman. Right.
Senator Allard. They make the argument they are selling an
IRA account and it is in a savings account.
Mr. Hillman. Right.
Senator Allard. In reality, it is a partial life insurance
policy that they are selling.
Mr. Hillman. And what you are finding also, Senator Allard,
is that the way in which the premiums on these policies are
being allocated in the earlier years, the years that
servicemembers are likely to make payments, a significant
portion of those premiums go toward the high-cost insurance. A
very limited portion go toward the savings fund. Only in the
out years do the maximum portion of the premiums go toward the
savings funds, and of course that is when the servicemembers,
for their own personal reasons, likely have dropped out.
Senator Sarbanes. Is there not information from the
companies, like internal memos and so forth, where they are
relying in fact on these sales items not being carried through
to get the benefit in the later years? It is all part of their
calculation as to how to make a much larger profit out of what
they are doing; is that not correct?
Mr. Goebel. Yes, Senator, in our report we quote from some
of the internal memos that were obtained through depositions in
a previous court case, where one of the company officials was
attempting to overcome objections within his own company as how
can their firm could sell this and promise this high rate of
return that is not feasible. And he told them: ``No, no, do not
worry about it, we won't really ever have to pay that amount
out, 40 percent will drop out in the first year.'' And so the
products, the way they were structured and designed seemed
almost deceptive to us.
Chairman Shelby. I personally believe that companies that
are doing business this way, as you describe, exploiting our
soldiers, should be banned or something. You know, I do not
know exactly how we are going to do it, but we are going to
look seriously, Senator Sarbanes and I working with Senator
Enzi and others, Senator Allard, on legislation.
Thank you so much, Mr. Hillman, you and your other people
at the Government Accountability Office. As usual, you have
done great work.
Mr. Hillman. Thank you. It has been our pleasure.
Chairman Shelby. We are going to call up the second panel.
Mr. John Molino, Deputy Under Secretary of Defense for Military
Community and Family Policy, U.S. Department of Defense; Ms.
Lori Richards, Director, Office of Compliance, Inspections, and
Examinations, the U.S. Securities and Exchange Commission; Ms.
Mary Schapiro, Vice Chairman and President, Regulatory Policy
and Oversight, National Association of Securities Dealers; and
Mr. John Oxendine, Insurance and Safety Fire Commissioner for
the State of Georgia.
I want to welcome all the members of the panel. Your
written testimony will be made part of the hearing record of
the Committee in its entirety. We would like for you to sum up
your top points and your views and observations here, where we
will have a chance this morning to have a dialogue with you.
Mr. Molino, we will start with you.
STATEMENT OF JOHN M. MOLINO
DEPUTY UNDER SECRETARY OF DEFENSE
FOR MILITARY COMMUNITY AND FAMILY POLICY
U.S. DEPARTMENT OF DEFENSE
Mr. Molino. Thank you, Mr. Chairman. Thank you for having
this hearing and for the opportunity to express three basic
sentiments and then, with your indulgence, I have been making
notes all throughout the first panel and would like to say a
few things in that regard.
First, I want to express the Department's appreciation to
the Committee for the interest you have taken in the well-being
of our troops and their families by holding this hearing and by
probing into the quality of the products targeted for sale to
them.
Second, I want to express the Department's eagerness to
collaborate with those who share our goals and are not
motivated by maximizing their profits at the expense of our
servicemembers and their families.
And finally, I want to express the Department's commitment
to maintain the effort to do what is right in this regard and
in the best interests of those men and women who selflessly
serve to protect the freedom that most of us enjoy and,
unfortunately, too many of us take for granted.
We want our troops to be informed consumers with access to
quality products both on and off our military installations.
Working with the Congress, the individual States, regulators,
and other concerned entities, I believe we can achieve this
goal.
Now, all that I have said might be empty rhetoric, and
Senator Sarbanes rightly cited a series of reports and
recommendations that apparently fell on deaf ears across
Administrations and across sessions of Congress. Soon after I
came to the current position I am in, in the second half of
2001, my staff brought to me this historic record that has been
cited frequently. I asked many of the same questions that you
people have asked today--how could this have gone on so long,
how could this be going on today?
Chairman Shelby. But it is.
Mr. Molino. Yes, sir it is. What we did was we began
revising policy, staffing that policy. And of course, when you
begin to staff policy within the Pentagon, it does not stay
within the Pentagon. We reached out to several Government
agencies, we reached out to nonprofits to develop an education
program which is now having an impact, and the statistics are
showing us that there is a dramatic decrease in the number of
servicemembers who report having difficulty making ends meet or
paying their bills. We cooperated, indeed, with The New York
Times reporter who did that wonderful expose. We have
cooperated with the GAO and others in Government, as Senator
Schumer has suggested we should do.
And what are the results to date? We are not there yet, by
no means. There have been several enforcement actions, most
notably at Fort Benning, Georgia, which have come to public
attention. There has been legislation that we find, frankly,
very helpful. There has been collaboration with States and
nonprofits. And this has occurred despite enormous pressure
from the insurance industry. I am happy to report, however,
that many of the letters I received from Congress initially
saying why are you being so tough on the insurance industry
have now shifted to tell me that I am not being tough enough.
And I welcome those letters.
We are still, unfortunately, under a restriction imposed by
the Congress that tells me that I cannot revise my regulations
in this regard without first giving 30 days' notice, and I
presume that is to allow those who do not share our opinions of
moving forward with reform to advise you of why these are bad
ideas.
We welcome the offers of help from the Hill. We want to
cooperate in every way. Many of the actions recommended by the
GAO, we have already taken, and our other actions in the
process are consistent with the GAO's report and their
recommendations. We endorse the GAO's recommendations as they
deal with State regulators and the suitability standards. We
would welcome that kind of guidance.
My commitment is where the Department of Defense is the
problem, we will become part of the solution. We welcome
Congress's help in allowing the good work we are doing on base
and we welcome anything you do to allow that to extend off the
installation, outside the gate.
Why hasn't DoD nor the Congress acted sooner than beginning
a few years ago? I cannot answer the question. I suspect there
are reasons, but I would submit to you that none of those
reasons are acceptable.
Let me end by restating one salient point. This is an issue
that I think is on the road to a solution primarily because the
Department of Defense chose to turn over some rocks that had
been sitting dormant for many years. We welcome the airing that
this issue is getting. We welcome the help of a legislative
nature, of a regulatory nature, from our nonprofit partners,
from Congress, and from those who share our interests.
I would be happy to entertain your questions, Mr. Chairman.
Chairman Shelby. Ms. Richards, on behalf of the Securities
and Exchange Commission.
STATEMENT OF LORI RICHARDS
DIRECTOR, OFFICE OF COMPLIANCE,
INSPECTIONS, AND EXAMINATIONS
U.S. SECURITIES AND EXCHANGE COMMISSION
Ms. Richards. Thank you. Chairman Shelby, Members of the
Committee, I am pleased to appear before you today to testify
on behalf of the SEC and to express the Commission's views with
respect to the GAO's report. My testimony today will address
those portions of the GAO's report that deal with securities
products.
The Commission strongly believes that our servicemen and
servicewomen must be protected from illegal and abusive
practices in the sale of securities. Over the last year, the
Commission and its staff have undertaken a comprehensive
program to address such practices. Our program has included
enforcement activity, extensive examination activity, including
two examination sweeps, close coordination with the Department
of Defense and the NASD, and finally, investor education.
My written testimony summarizes all of these actions in
some detail, so I will just touch on them this morning.
First, the Commission brought an enforcement action against
First Command Financial Planning, a broker-dealer that, as you
heard this morning, specializes in the sale of securities
products, namely contractual plans or also called periodic
payment plans, to military personnel. The Commission's
enforcement action ordered First Command to cease and desist
from illegal and abusive sales practices in the sale of those
securities and also included an order to pay $12 million, $5.2
million in restitution to military customers and the remainder,
importantly, to fund an investor education program for military
members and their families, to be administered by the NASD.
Second, we have also mobilized our troops on this issue.
The Commission's examination staff has conducted numerous
examinations of broker-dealers that sell securities to military
personnel. SEC exam staff initiated two separate risk-targeted
examination sweeps, one focusing on the sales of mutual fund
contractual plans or periodic payment plans, and the other
examination sweep focusing more generally on the sales of
securities products to military personnel. The examination
sweeps included on-site reviews of broker-dealer firms serving
the military market and visits to these firms' sales offices
located in military base communities both in the United States
and overseas.
In total, the SEC staff thus far--and I emphasize that our
work is ongoing--we have examined or are in the process of
examining about 20 broker-dealer firms with locations near base
communities, including firms with sales offices near Marine and
Navy bases in San Diego; near Lackland and Kelly Air Force
bases in San Antonio, Texas; near Fort Hood in Killeen, Texas;
near the Great Lakes Naval Training Center in North Chicago,
Illinois; near Rammstein Air Force Base in western Germany;
near Graffenwoer Army Base in eastern Germany; and finally,
near Aviano Air Force Base in Italy. More examinations are
anticipated.
Third, the Commission staff have worked closely with the
Department of Defense and have established a regular liaison
with the Office of the Secretary of Defense, through which we
have begun to share information and coordinate our
examinations. We have also--and this is very important--
coordinated our efforts with the commands, the local commands
of selected bases where we have had our examiners go and visit.
This coordination is continuing, with the Department of Defense
providing us with information that we are using to target our
examinations.
Finally, our staff in the Commission's Office of Investor
Education and Assistance have initiated an investor education
program directed specifically toward members of the military
and their families. As a charter member of the DoD's Financial
Readiness Campaign, we have assisted in the presentation of
financial education programs to the military. SEC staff have
already conducted several financial education workshops on
military installations. We have also initiated education
materials about periodic payment plans specifically and
published an article in Military Money, a publication that is
distributed free in the military community. In all of these
efforts we have worked closely with the National Association of
Securities Dealers.
With respect specifically to the GAO's report, we strongly
agree with the GAO's recommendation that Congress should take
legislative action in this area to protect military
servicemembers. We recommend that you take steps to address the
particular features of these plans that make them susceptible
to abusive and misleading sales practices and excessive fees.
We strongly agree with the GAO's recommendation that
Congress revisit the law governing mutual fund contractual
plans. As an alternative to an outright ban on these plans, we
believe that Congress could consider addressing the excessive
sales charges which are features of these plans by, for
example, reducing the maximum allowable load or working with
the Commission and the NASD on other mechanisms that would
provide protection against excessive sales loads.
In addition, in the event that periodic payment plans are
not banned, securities regulators will consider various means
of better assuring ourselves that we have adequate information
to assess the sales of these plans. Should the plans not be
banned, we will continue to work with other regulators to
ensure that we can have better oversight over their sales.
In addition, with respect to the GAO's other
recommendation, we have already taken action to enhance our
information-sharing with the DoD, consistent with the GAO's
recommendation, and we will continue to work with DoD to help
us target examinations.
More broadly, we look forward to working with this
Committee, the DoD, the NASD, and other regulators to continue
to protect members of our military as investors in our markets.
Thank you. I am happy to answer any questions you have.
Chairman Shelby. Thank you, Ms. Richards.
Ms. Schapiro. As Senator Sarbanes, welcome again to the
Committee. You spend a lot of time here.
STATEMENT OF MARY SCHAPIRO
VICE CHAIRMAN AND PRESIDENT,
REGULATORY POLICY AND OVERSIGHT
NATIONAL ASSOCIATION OF SECURITIES DEALERS
Ms. Schapiro. Thank you very much. It is very nice to be
here, Chairman Shelby, Senator Sarbanes, and Senator Enzi.
Thank you very much for the opportunity to come before the
Committee and testify about NASD's efforts to protect members
of the armed forces from abusive and misleading sales
practices.
This morning, I would like to briefly summarize NASD's work
in this area. We have prepared a comprehensive written
statement and, with your permission, will submit it for
inclusion in the record.
Chairman Shelby. Without objection, it will be made part of
the hearing record.
Ms. Schapiro. Thank you.
As you know, Mr. Chairman, America's men and women in
uniform make great personal sacrifices to protect our Nation's
security. They in particular should not have to worry about the
honesty and the integrity of those who purport to help them
make sound financial decisions. Yet, thousands of mostly young
men and women who serve in the military have been disadvantaged
by sales of investment products called periodic payment plans,
or contractual plans.
In 2003, NASD learned that First Command Financial Planning
of Fort Worth, Texas, a broker-dealer with many ties to the
military, using misleading pitches and improper sales tactics,
had targeted and sold more than a half a million of these
complicated and often extremely expensive products to
servicepersons, many of whom were young and inexperienced
investors. We have responded forcefully to end these practices
by, punishing those responsible for them, ensuring that their
victims are recompensed for their losses, and establishing an
education campaign about investing and saving aimed at military
personnel.
As you heard this morning from GAO, an investor in one of
these plans makes monthly payments of as little as $50 for a
fixed period of time, usually 15 years. The payments are
invested in mutual funds, and the investor is charged a 50
percent sales load, or up-front fee, on the entire first year's
payments. Payments during the remainder of the 15-year term are
not subject to sales loads, so that the effective sales charge
decreases so long as that investor can continues to make
contributions. However, if the investor stays in the plan for
more than 45 days, yet fails to make contributions over the
full 15-year term, he or she can pay a sales charge of up to 50
percent of the total amount invested.
After a thorough investigation, including taking testimony
from 16 current and former First Command employees, reviewing
more than 25,000 pages of documents, and over 50,000 e-mail
messages, NASD brought disciplinary action against the firm, in
coordination with the Securities and Exchange Commission. The
firm was, as Ms. Richards said, censured and fined $12 million
in December 2004. That amount included restitution to thousands
of customers who had terminated periodic payment plans after
January 1, 1999, and had paid effective sales charges greater
than 5 percent.
As of October 18, over $4.3 million had been returned to
these customers. The remaining funds were transferred to the
NASD Investor Education Foundation to be dedicated to the
development and deployment of comprehensive financial education
programs for members of the armed services and their families.
Working closely with the Defense Department and the SEC, we
expect to launch a multifaceted military financial education
program early next year.
Like any regulator, NASD relies on customer complaints as
an important source of information about improper sales
tactics. Here, there were no complaints to NASD. We
subsequently learned servicepersons had complained to military
attorneys, but those lawyers could not relay this information
to NASD without specific consent from their clients. We
therefore support the GAO recommendations that would facilitate
reporting of military investors' concerns and complaints about
financial products to the appropriate regulators. NASD has
designated staff to receive complaints from military personnel
and to conduct outreach with DoD to proactively learn of issues
concerning securities sales.
Finally, Mr. Chairman, I note that Senator Enzi has
introduced a bill that would ban the sale of periodic payment
plans. His bill also recognizes that in situations where an
investor is highly dependent upon a broker for advice and
guidance, immediate access to full information, including the
disciplinary history of the broker, can be crucial. Learning
about your broker's history after purchasing can be too late. A
provision in the bill would allow NASD to disclose to investors
via the Internet the disciplinary history of brokers and firms.
Currently we can only disclose this information by telephone or
in writing or e-mail. Investors are not able to receive the
information directly from their search. The bill would allow
investors to get this crucial information the way they have
told us they want it--online in real time. Thus far in 2005,
3.7 million online searches were conducted on BrokerCheck, and
only 50,000 over the telephone. Investors clearly prefer to
receive their information via the Internet.
NASD supports this bill and appreciates all of this
Committee's efforts to protect the financial well-being of our
men and women in uniform and, indeed, all investors.
This concludes my statement, and I thank you again for the
opportunity to be here and I would be happy to answer any
questions.
Chairman Shelby. Thank you so much.
Mr. Oxendine.
STATEMENT OF JOHN OXENDINE
COMMISSIONER OF INSURANCE,
STATE OF GEORGIA
Mr. Oxendine. Thank you very much, Mr. Chairman. My name is
John Oxendine. I am the Insurance Commissioner of the State of
Georgia. I want to thank the entire Committee for giving me
this time to testify.
I will be testifying on behalf of insurance regulators from
all of the States which together make up the National
Association of Insurance Commissioners. I am also testifying in
my capacity as the Georgia Insurance Commissioner and will
share some unique experiences.
On behalf of all State regulators, I would like to make
three points. First, that America's men and women serving in
the armed forces are entitled to the same protections under
State law enjoyed by all other American citizens. Protecting
insurance consumers at the local level has been a hallmark of
State regulation for more than a century. Each State has a
strong unfair trade practices law backed by a dedicated staff
that is trained to assist consumers.
Second, State regulators recognize that those serving our
country in the military deserve special attention from
responsible State and Federal officials. We are actively
reaching out to the military authorities to educate them about
States' consumer education and consumer protection resources
and to coordinate with local bases in our enforcement
activities.
Third, State insurance regulators do support Federal
legislation that would clarify our authority to regulate the
business of insurance wherever it occurs, including military
bases both within the United States and overseas. We believe
that H.R. 458, with some minor revisions, would help achieve
these goals.
In Georgia, I have personally been investigating sales
abuses involving military personnel and have recovered
approximately--or proposed $1.5 million in refunds for
Georgia's soldiers alone. And that is the first initial wave.
We have held hearings, we have listened to sworn testimonies of
soldiers stationed in Georgia. Based on my investigation, I do
have two major concerns.
First concern is that insurance agents gain access to young
soldiers through their relationships with the staff sergeants
and that young soldiers place too much trust in the agents
based on the agents' relationships with their sergeants. Many
agents themselves are retired sergeants who know their way
around the bases and know those in charge. Other agents develop
relationships with sergeants by being good citizens. They help
fund projects related to the morale, which of course are needed
for our troops. For example, insurance agents may provide
Thanksgiving turkeys to needy military families or they may
sponsor on-base activities for the enlisted personnel.
While not illegal, such favors do generate goodwill between
the sergeants and the agents. Then, when the agents approach
the young soldiers, they have an in, because they are friends
with the sergeants. If a young soldier asks his sergeant about
an insurance agent who has approached him, he is typically
assured that the agent is a good guy and trustworthy. In some
cases, young soldiers come to this conclusion on their own. For
example, one soldier testified that he willingly got into the
car and rode to a pizza party with an agent who he did not know
simply because he had seen the agent talking to his first
sergeant and assumed that the agent was trustworthy.
The problem, of course, is that some agents are not
trustworthy. Sometimes they sell unsuitable products. Most
soldiers already purchased the affordable SGLI and may not need
supplemental life products. These supplemental policies are
often sold to soldiers as investments rather than as insurance.
While it is true that an insurance policy can be one component
of an individual's investment strategy, the investment portion
of the policy is, in some cases, being overemphasized and/or
misrepresented. Some soldiers have testified that they did not
even realize that they had purchased life insurance. Some also
testified they thought they were opening a savings account.
Second, another concern I have is that nationally there is
a culture that discourages military personnel from requesting
assistance from civilian State agencies, such as insurance
departments. In Georgia, we have recently shown that this
culture can be reversed.
In conclusion, we all share a commitment to serving
insurance consumers who are serving our country in the
military, and there are no easy answers or solutions. To
address the problems, I would suggest, first, that we educate
the NCO's so that they do not appear to endorse or recommend
companies or agents that have provided financial assistance to
our enlisted personnel; and second, that we encourage the
NCO's, the morale and financial counselors, and the JAG
officers to work with State regulators to educate the soldiers
and to share information about potentially abusive sales
practices.
Thank you, Mr. Chairman, and I will be happy to address any
questions.
Chairman Shelby. Thank you.
Secretary Molino, you, I believe, said a few minutes ago
that we were not there--meaning DoD--you are not there yet. But
with all due respect, 35 years to look under all the rocks? You
said we continue to look under the rocks. I think Senator Enzi
and GAO have found a lot of deep problems on top of the rocks.
And we will get more into this as we go, but 35 years is a long
time.
Ms. Richards, I want to direct a question to you toward the
SEC. The dominant retailer of contractual plans has been an
SEC-registered broker-dealer subject to the SEC Commission's
inspection and compliance regime for almost a half a century.
Why did it take a series in The New York Times last year to
trigger an investigation at the SEC into this company's
deceptive marketing materials and sales practice? I understand
that NASD had already begun its inquiry before the Times
investigation was published. We know who this is, but it is
troubling.
Ms. Richards. Yes, sir, we had conducted, and the NASD had
also conducted examinations of this particular firm.
Chairman Shelby. We are glad you are doing it, but we
wonder why it took so long.
Ms. Richards. Yes, sir. During the course of that
examination, we had received information from the firm which
indicated to the examiners a very high persistency rate; in
fact, about 80 percent, we were told, of investors in the
contractual plans maintained them for the full 15-year period.
That is a pretty significant rate. That information, coupled
with the fact that we had no customer complaints--we did not
see any customer complaints either on our own records or in the
firm's books and records--led us not to look further. It was
not until we had early indications from the press that in fact
the persistency rate, that period of time in which the
investors----
Chairman Shelby. The press is doing a good job here.
Ms. Richards. Yes, sir, a very good job.
Chairman Shelby. Give them credit.
Ms. Richards. Yes, a lot of credit.
Chairman Shelby. Maybe not every day, but----
[Laughter.]
Ms. Richards. We then, based on those inquiries, we went
back into the firm, and at that point we were able to obtain
information along with the NASD that led us to conclude that in
fact the earlier persistency rates that we had been provided
with were not accurate. And in fact, that firm had a much lower
rate of investors holding the security through the entire 15
years. In fact, we concluded that about 43 percent of the
firm's investors held the security for the full 15-year period.
The lesson for us, I think, in this examination experience
as well as in additional examinations we have done more
recently of firms that sell periodic payment plans is that
there really should be--and we agree with the GAO--there really
should be better tools to allow securities regulators to see
what the actual persistency rates are. And we would support
requirements for broker-dealers to maintain those kinds of
books and records and make them available to examiners.
Chairman Shelby. Ms. Schapiro, why did the largest retailer
of contractual plans voluntarily decide last year to stop
offering them? I understand that this financial services
company sold about 90 percent of all plans in the United
States. Given their departure from this market right now, what
does the future hold for contractual plans? Which mutual fund
companies sponsor contractual plans and what are the
justifications they offer for sponsoring plans with such high
sales charges? With hundreds of no-load mutual funds available
today, it seems to me that a 50 percent sales charge would be
difficult to justify. It would be out in the marketplace and it
should be on the base. I know this is a lot of stuff.
Ms. Schapiro. That is a multipart question. I probably will
not remember all the parts, so you should interrupt me.
Chairman Shelby. I bet you would.
[Laughter.]
Ms. Schapiro. To start at the last part, you are absolutely
right, there are tremendous alternatives now for investors to a
plan such as First Command Financial Planning was selling.
There are about 1,300 mutual funds, by our count, that allow
you to make monthly or periodic contributions of as little as
$50, and many of those are no-load funds with no up-front costs
at all. So to my way of thinking, this is largely a product
that has outlived its usefulness, because there are much
better, lower-cost alternatives.
Chairman Shelby. I think you have to put this in the
context that these are young soldiers, for the most part,
vulnerable, as I said earlier, worried about getting in harm's
way--living and dying.
Ms. Schapiro. Right.
Chairman Shelby. And so forth.
Ms. Schapiro. Well, they are not----
Chairman Shelby. A little different from the ordinary us,
everyday.
Ms. Schapiro. In fact, that made it easier, I think, for
these broker-dealers to market these plans. This was, as
somebody said earlier, a captive audience and they had----
Chairman Shelby. But not an audience to exploit, I hope.
Ms. Schapiro. No, absolutely not. This is an audience that
deserves the highest levels of protection in every aspect of
what they do, whether it is insurance purchases or securities
sales or anything else.
I believe First Command stopped selling the product as a
result of the enforcement actions taken by the NASD and the
SEC. They realized that this is not a product that is suitable
for the vast number of young, inexperienced investors to whom
they were selling it, particularly given the fact that so few
were able to maintain their contribution levels over the entire
15-year period, which was the only way this plan made any sense
for these young people.
Chairman Shelby. Mr. Oxendine, what is the status of the
investigations under way by various State commissions? I know
you represent the State of Georgia, but you also are
representing your fellow commissioners here at the table today.
That is, examining the activities of the companies that market
to military members.
Mr. Oxendine. Yes, Mr. Chairman. I actually am the lead
investigator, or lead State, on a multistate investigation into
numerous different companies.
Chairman Shelby. But you come from a State with some huge
military bases.
Mr. Oxendine. We do. We have seen a lot of activity both at
Fort Benning, Fort Steward, and a little less at Fort Gordon.
We were the first State to initiate an investigation.
Therefore, when the NAIC decided to do a multistate national
investigation, Georgia was asked to chair that, and we are
chairing that. We are actually very close to wrapping up and,
hopefully, settling the first of those investigations that we
started. That was with American Amicable. We are working with
that. The other investigations with several other companies are
ongoing.
Chairman Shelby. The GAO, among other things, reported here
today that some States--I do not know about Georgia, but maybe
some others--are finding that the products being sold to
military members do not actually comply with your own State
insurance laws. How did such products obtain approval
originally, and what are the individual State commissioners
doing to ensure that only legal products are sold? Has
something fallen through the cracks here?
Mr. Oxendine. What has happened is one product, Horizon
Life was a product that was offered, that product has been
removed from the streets in Georgia and in several other
States. But they were often filed with our offices as separate
products. And where as separate products there was nothing
wrong with them, when they were bundled into a package, then we
had concerns with them and they started to violate various
portions of State laws. They were not--there was no indication
that they would ever be sold as a package. In the civilian
market, you would have people starting to complain. What
happened in the military community, people did not complain.
Chairman Shelby. This is a captive audience, too, is it
not?
Mr. Oxendine. And they know soldiers are not going to call
their State government. We found that that was not happening.
And the military was not calling their State government. That
can be changed. Fort Benning, Georgia, for example, we share
confidential documents together, we work together on sensitive
issues, and have a great relationship, and I think that
relationship can be done throughout the country and I think the
Senate can help promote that.
Chairman Shelby. Thank you.
Senator Sarbanes.
Senator Sarbanes. Thank you, Mr. Chairman. I see a vote has
started so I will be very brief, because I know you will need
to draw to a conclusion.
First of all, I want to thank the panel. It has been very
helpful testimony. I have just a couple of questions I want to
put.
I would say to NASD and the SEC, I commend you for the
actions you took. I mean, this company found it could push the
Air Force around but it could not push NASD and the SEC around.
You have had to deal with some pretty big players in the past,
in terms of meting out sanctions and punishments. So, I mean, I
think they came up--you know, they finally got into a league
where they could not just rely on old contacts and to get
people to back off of trying to curb these practices.
Mr. Molino, why does the military allow pay allotments to
be used to pay for private-sector products? Am I correct that
these recruits could do a check-off here and the money would be
withheld and sent to the company for these products? Is that
correct?
Mr. Molino. That is correct, Senator.
Senator Sarbanes. Why do you allow that?
Mr. Molino. The allotment system has been around for a very
long time.
And the reason for that is in recognition of the nature of
military duty, there are many deployments, there are many times
even when you are not deployed, you are off training. And when
the bills come into the mailbox, without the allotment system
what you would find are people missing payments of their bills
because they are not writing the checks.
Senator Sarbanes. Who can get on the allotment system?
Mr. Molino. What we found, Senator, was that the abuse of
the allotment system was the nature of the problem--thanks to
the people who did the investigations--where salesmen had
actually worked out deals on some installations where they were
delivering allotment forms to finance offices and getting them
processed.
Senator Sarbanes. Well, how could that be happening? How
can the military allow that practice?
Mr. Molino. That is in direct violation of existing policy,
and that should not have happened. And where it has been
exposed, it has been stopped. But you are exactly right in that
the allotment system is provided as a aid and a resource for
our servicemembers that has been abused by some of these
predator salesmen.
Senator Sarbanes. It seems to me, I mean, I am supportive
of what Senator Enzi is trying to do. Those are steps beyond.
But there are a lot of existing regulations or practices that
the military has which have not been enforced--they have not
been implemented here--which would have at least avoided some
of these exploitations that have taken place. Am I correct in
that perception?
Mr. Molino. You are correct, yes, Senator.
Senator Sarbanes. I mean, that could be done immediately.
Mr. Molino. It should have been done years ago. And in
fact, our inquiries into the status of this undertaking and
this activity have revealed these violations that we have
addressed and attacked.
Senator Sarbanes. Do you challenge the right of the State
regulators, their authority over insurance sales on military
bases? Or do you think--I am asking Mr. Molino, but it is a
point that Mr. Oxendine raised--or is it your view that they
have the authority to regulate these----
Mr. Molino. It is our view that there is sufficient
authority out there to permit that. And as Mr. Oxendine points
out, Georgia being a good example, that with a little
communication we realize that these barriers are not
nonexistent, that we can actually work together and
collaborate, share information.
Senator Sarbanes. Is it your perception that the military
is any way inhibiting or putting up roadblocks to the State
regulators' exercise of authority?
Mr. Molino. I would agree with what I think the GAO's
conclusion was; that if that is occurring, it is occurring out
of a misinterpretation of the existing statute and regulations
and that we clear that up as we clarify with our attorneys.
Senator Sarbanes. Well, could you go back from this hearing
and start clarifying that immediately? You do not need any
authority to do that.
Mr. Molino. I think it is fair to say that we are already
engaged in that. And I think my colleagues would agree.
Senator Sarbanes. Why do we not intensify it a little bit
so the State regulators can get on the job?
Mr. Molino. Happy to do it, Senator.
Senator Sarbanes. Mr. Chairman, I have a lot of other
questions, but I will defer to my colleague.
Chairman Shelby. Keep the record open on this, if we would.
Senator Enzi.
Senator Enzi. Mr. Chairman, I was just going to make a
request that you keep the record open.
I have a number of questions. This is an outstanding panel
and, as you know, my accounting background tends to make for
fairly detailed questions and those usually result better in
written answers------than they do in spoken answers. So if you
will leave the record open and I can submit questions.
Chairman Shelby. We respect that.
I want to say before--we have a vote on the floor and I am
going to recognize Senator Schumer next--but I want to say
again, Senator Enzi, that your leadership in this area is very
much appreciated. And this has been noted by us up here, your
colleagues, but also everywhere else today.
Senator Enzi. Thank you.
Chairman Shelby. Senator Schumer.
Senator Schumer. I am not an accountant, so I will ask the
more direct questions. Lawyer. Never practiced. Was elected to
the Assembly instead of practicing.
I know Senator Shelby touched on this, Mr. Molino, but I am
just amazed that this went on for so long and it took a
newspaper to uncover it. What have you done to prevent the next
scandal from occurring so it does not go on another 30 or 35
years and we need another newspaper to uncover it? I mean--and
not just on insurance or even mutual funds, but all these kinds
of things. Payday lending is an example.
Mr. Molino. Senator, I am not an accountant and I am not a
lawyer, I am a soldier. But I grew up in Brooklyn, so that
might help.
Senator Schumer. Oh, well. I think, then, you are doing a
great job.
[Laughter.]
What high school did you go to, Mr. Molino?
Mr. Molino. I went to Xavier, sir, on 16th St.
Senator Schumer. Oh, Xavier is a great school.
Chairman Shelby. And he wants to know how many family
members you have voting.
[Laughter.]
Senator Schumer. That is why the Chairman has been so
successful for so long.
Mr. Molino. Mr. Chairman, I suspect the Senator's success
relies on the fact that he already knows how many family
members I have voting.
[Laughter.]
Senator, you are asking me to predict something that is
very, very tough to get at.
Senator Schumer. I just want to know what steps the
military has taken to prevent the next problem.
Mr. Molino. Let me just say one thing about--I alluded to
it in my oral statement, but the conversations that I have had
with Diana Henriques, who is The New York Times reporter who
wrote the outstanding series of articles, began not with ``I
think you have a problem, let me ask you some questions,'' it
began with something akin to ``I understand you have uncovered
some problems and I want to write about it.'' And we then
opened a very aggressive dialogue to ensure that she had access
and information so that she would be able to reflect an honest
portrayal of where we were.
What I said in my statement is I cannot and, Senator
Sarbanes, I will not even begin to apologize for 35 years of
neglect in this regard. I have a frustration. I have been in
this job since June 2001, and I am frustrated that we have not
moved further than we have. In the oral statements of my
colleagues here, I counted 13 references to close collaboration
or coordination with the Department of Defense. Not a very
lucky number, but I am proud of it. That has come about because
the Department said we have a problem here, we need to address
it.
Senator Schumer. Can you--I am sorry to interrupt----
Mr. Molino. No, no, I understand the time limitation.
Senator Schumer. --but, first, we are both from Brooklyn,
we always interrupt one another----
Mr. Molino. Absolutely.
Senator Schumer. But second, can you please tell me
specifically what steps have been taken to prevent the next
scandal from happening? Do you go monitor now what is
happening? Do you survey soldiers at random as to what kind of
products they are buying? Do you check about those products?
Mr. Molino. We do. We post on our website those who have
been banned, whether their company or the agent has been
banned. We have a policy that is about ready to be implemented,
once we get the approval and we pass the 30-day waiting period
imposed by the Congress, that will require all individuals who
have been solicited to complete a questionnaire--who solicited
you, what is the quality of that solicitation, do you think you
were pressured?
Senator Schumer. And that would be given out randomly, even
to bases that----
Mr. Molino. No, sir, it will be given out in 100 percent of
the cases. It is a requirement----
Senator Schumer. Not in the--100 percent of the soldiers?
Mr. Molino. Yes, sir. It will be a requirement for someone,
to solicit on an installation, to, at the end of that
solicitation, leave the form with the individual. And that form
does not get returned through the agent, it gets returned
through the commanding office.
Senator Schumer. Would you support certifying
representatives who are selling products?
Mr. Molino. Absolutely.
Senator Schumer. That is good.
Mr. Molino. Yes, sir.
Senator Schumer. That is very good.
Mr. Molino. Absolutely we would do that.
Senator Schumer. Okay. That would be a dramatic change.
Mr. Molino. And, sir, insofar as payday lending, which is
my next campaign that we are currently undergoing, I can assure
you that I get besieged with requests from individuals who
would like to be on my calendar to tell me how noble a business
that is and how they are much better than credit unions and
banks. I do not believe that is the case. I am not on their
Christmas list and they are not on mine.
Senator Schumer. Right. Okay, let me ask you this. You
talked about coordination, you mentioned 13 times. Is there a
set system in place? Because we are hearing from some other
agencies that they think coordination could be better.
Mr. Molino. Yes, sir. The GAO, in fact, has said that.
Senator Schumer. I know.
Mr. Molino. That coordination could be better. And I
suspect----
Senator Schumer. So what can you do to make that better so
there is real coordination between your colleagues here and
everybody else in the military? We do not expect the military
to be financial experts. We do expect them to rely on the
financial experts in Government to protect the soldiers.
Mr. Molino. You are exactly right. We have memorandums of
understanding with upward of 30 private agencies and
governmental agencies to enhance our education effort. And I
think, through the memorandum of understanding and the
memorandum of agreement systems, we can secure that. And we
endorse the GAO's recommendation that others who are experts
advise us on suitability of these products. We welcome that
advice.
Senator Schumer. And you will do that as part of the
certification process as well?
Mr. Molino. Absolutely.
Senator Schumer. That is good.
Mr. Molino. Yes, sir.
Senator Schumer. Let me ask you this. Again, you are not a
lawyer. Do we expect any--or have criminal laws been violated
and would we expect, from your knowledge--I know we do not have
U.S. attorneys here, we do have some of the people who might
refer cases--do we expect any criminal indictments coming out
of this?
Mr. Molino. I cannot answer that, Senator. I know that at
the installation level the staff judge advocates look to see if
there are criminal violations that should be recommended to the
commands. And there have been cases--Fort Benning, as Mr.
Oxendine cited--where nonjudicial punishment in the Uniform
Code of Military Justice was employed on some of the situations
that he cited, where----
Senator Schumer. So it is a possibility; you just cannot
comment on it, is what you are saying?
Mr. Molino. I think if you break the law you deserve to get
punished in that way.
Senator Schumer. And is that a possibility that that could
happen in some of these cases?
Mr. Molino. I suspect that is always a possibility, yes,
sir. But I would not want to prejudice----
Senator Schumer. I am not asking a specific case, I am
asking--you do not prejudice. I can tell you that much as a
lawyer, I know.
Mr. Molino. The bottom line is I do not want anybody to get
off just because I prejudiced a statement that says they
probably will be punished.
Senator Schumer. Okay. Would any of the other panelists--
Ms. Richards, Ms. Schapiro--want to comment on the possibility?
Have potential criminal laws been broken here?
Ms. Richards. The SEC, as you know, Senator, is a civil
enforcement agency.
Senator Schumer. I know. But you do referrals.
Ms. Richards. We do. As an examiner, I am not aware of any
ongoing criminal probes.
Senator Schumer. And Ms. Schapiro.
Ms. Schapiro. I am not aware of any ongoing criminal
probes. We do have several investigations still ongoing within
the NASD of other brokerage firms.
Senator Schumer. Let me ask you to just look into that, to
see if there are criminal violations. Because if there are, I
mean, as everybody here said, you read these stories and it
just wrenches your guts out. And if somebody broke the law,
they should be punished for it. I mean, it will set an example
as much as the prophylactic things we are doing in the future.
So, I would make a request that you redouble your efforts and
see if that has happened and then make the appropriate
referrals--which you do, both agencies do.
Ms. Richards. Absolutely.
Senator Schumer. Are you both willing to do that?
Ms. Richards. Yes.
Ms. Schapiro. Yes.
Senator Schumer. Thank you, Mr. Chairman.
Chairman Shelby. Our time on the floor is about gone,
Senator. I hope they will wait for Senator Schumer, and I will
tag along.
Thank you very much for appearing here today. I believe it
has been an informative panel, and this gives us some more
insight as to why we need to correct this problem. Thank you.
[Whereupon, at 12:04 p.m., the hearing was adjourned.]
[Prepared statements and response to written questions
supplied for the record follow:]
PREPARED STATEMENT OF JOHN M. MOLINO
Deputy Under Secretary of Defense, Military Community & Family Policy
U.S. Department of Defense
November 17, 2005
Mr. Chairman, Members of this distinguished Committee, thank you
for the opportunity to be here today and for your interest in
protecting the financial well-being of the men and women who serve in
our armed forces.
Allow me to provide the Committee with historical information on
the personal commercial solicitation issue, and to address what the
Department has done, and intends to do to improve commercial
solicitation oversight and enforcement. I will focus on the sale of
supplemental life insurance and financial products on Department of
Defense (DoD) installations.
Servicemembers have long been seen as targets for charlatans, con
men and others who seek to steal their money with deals ``to good to be
true,'' or presented under false pretenses. Why is this?
Servicemembers are typically young and inexperienced. They are
often motivated by idealism and cannot imagine that their fellow
citizens and, in some cases, their senior NCO's, officers, and military
retirees would take advantage of them.
They are often earning a steady paycheck for the first time and,
though their pay will never make them rich, it is often far more money
than they have ever laid their hands on in their lives. Those who
enlisted are motivated to serve. They also tend to be concerned about
the future--providing for themselves and their families.
The confluence of these otherwise noble characteristics makes
servicemembers subject to swindlers and fast-talking salesmen and
women.
When we permit someone to sell a product to some degree we provide
the appearance of an endorsement of that product and the behavior of
the salesperson.
As you know, members of the military have the opportunity to
purchase up to $400,000 worth of term life for a reasonable premium of
$26 per month. For many--indeed most--military members, $400,000 is a
sufficient amount of insurance, especially if combined with Thrift
Savings Plan (TSP) participation or another savings plan. I will speak
more of our Financial Readiness program later. For now, let me say that
a better informed Servicemember/consumer will be able to make wiser
decisions about the products he or she buys.
We must provide a degree of protection that ensures we do not
facilitate deceptive practices on the installation. We also must
provide training and education that better equips our members and their
spouses to a ``smell a rat'' outside the gate.
The Department's concern with the sale of insurance and investment
products on DoD installations dates back to the Vietnam War era. At
that time, problems with private sector associations using their quasi-
military status to sell life insurance products led to establishment of
the first DoD personal commercial solicitation policies. These included
DoD Directive 1344.7, ``Personal Commercial Affairs,'' dated July 1,
1969 and DoD Directive 1344.1, ``Solicitation and Sale of Insurance on
Department of Defense Installations,'' dated August 31, 1977. These
directives were later combined into our current DoD Directive 1344.7,
``Personal Commercial Solicitation on DoD Installations,'' dated
February 13, 1986. Though these directives established important rules
and prohibited practices concerning on-base solicitation, there is
ample evidence to prove they have not been easily or consistently
enforced.
1996 USAREUR IG Report: In 1996, the US Army Europe (USAREUR)
Inspector General (IG) investigated insurance solicitation activities
by the Noncommissioned Officers Association (NCOA) and Academy Life
Insurance Company. The IG found:
Senior NCO's (NCOA members) improperly used their authority to
require soldiers to attend assemblies/meetings for the purpose of
signing up new NCOA member in violation of Army USAREUR
Regulations.
NCOA and Academy Life improperly conducted commercial
solicitation during duty hours.
NCOA improperly received preferential treatment over other
nonprofit organizations in violation of Army and USAREUR
regulations.
The chain of command improperly pressured subordinates to join
NCOA.
NCOA/Academy Life improperly conducted deceptive solicitation
practices in violation of DoD Directive 1344.7 and Army and USAREUR
Regulations.
NCOA/Academy Life improperly used the military postal system
for commercial or business purposes in violation of USAREUR
Regulations.
In September 1998, as a result of USAREUR IG investigation, Academy
Life and its agents were barred from conducting commercial activities
on DoD installations worldwide for a period of 3 years.
1999 DoD IG Report: In January 1998, the Department of Defense
Inspector General (DoD IG) was asked to evaluate the Department's
enforcement of personal commercial solicitation policy. The DoD IG
visited 11 installations and issued a report in March 1999. The IG
found policy violations at all 11 installations. The DoD IG found:
Quasi-military associations failed to disclose their
relationship to insurance
companies and in some cases, these associations were allowed to
make group presentations to military personnel in order to collect
personal information for follow-on solicitation.
Insurance agents were permitted to make ``financial
education'' presentations at four installations in direct violation
of Department policy.
The Services failed to provide sufficient training on
insurance to servicemembers.
Commercial sponsorship, where funding, goods, or services is
offered to installation Morale, Welfare, and Recreation activities
in return for public recognition or advertising promotions, was
being used to foster commercial solicitation.
Administrative personnel at two Army installations accepted
allotments forms directly from insurance agents, rather than
requiring they be submitted by the military member.
The DoD IG recommended the Assistant Secretary of Defense (Force
Management Policy) establish a task force to:
Develop consistent controls to administer and enforce the
policies regarding commercial solicitation process.
Develop the approval and oversight procedures when allowing
outside organization personnel from military associations to
conduct financial training.
Cuthbert Report: On May 15, 2000, Brigadier General Thomas
Cuthbert, U.S. Army (Ret), an employee of the Science Applications
International Corporation (SAIC) on contract with the Department,
issued a report on solicitation practices on DoD Installations. The
Cuthbert Report validated the findings of the DoD IG Report and
highlighted 30 years of deceptive commercial solicitation practices.
The Cuthbert Report found:
DoD policies are routinely violated.
DoD allotment systems facilitate the violation of insurance
solicitation policies.
A coercive and high pressure sales environment remains in
effect.
Deceptive insurance sales practices continue unabated.
Deceptive and coercive solicitation has a clear and present
adverse effect on morale, discipline, and unit integrity.
Current personal financial education programs are inadequate.
Insurance companies have unlawfully retained insurance
premiums from cancelled allotments.
State insurance regulators do not effectively protect military
consumers.
On-base insurance sales provide no value added to war fighting
capacity.
The Cuthbert Report recommended:
Eliminate on-base insurance solicitation.
Improve consumer protection surrounding the allotment system.
Conduct an inquiry into the disposition of unlawfully withheld
allotment payments.
Improve personal finance training in all enlisted schools.
Establish minimum standards for all personal finance training
conducted by non-DoD personnel.
DoD Commercial Solicitation Working Group: In response to the DoD
IG and Cuthbert reports, the Assistant Secretary of Defense (Force
Management Policy) established a DoD commercial solicitation working
group in January 2001. The group recommended:
Establish commercial solicitation points of contact for each
military service.
Establish new policy to control third-party financial
counseling.
Establish new policy to limit the use of commercial
sponsorship to foster commercial solicitation.
2001 DoD IG Report: In response to the Cuthbert Report finding
regarding insurance premiums being unlawfully retained by insurance
companies following cancellation of a policy, the Department requested
the DoD IG conduct an audit on
insurance allotment premium refund processing procedures. The IG's
report found:
Four Defense Finance and Accounting Service (DFAS) sites did not
consistently process insurance company requests to cancel allotments
and one DFAS site would not accept returned allotments.
In response, DFAS issued standardized guidance requiring the
different sites to stop allotments when a properly documented request
is received from an insurance company and to accept returned allotment
payments.
Financial Education Policy: In April 2002, the Under Secretary of
Defense (Personnel and Readiness), issued a policy memorandum that
established parameters for nongovernmental organizations to provide
financial education training to servicemembers. The policy directed
that any participating non-Federal entity must be qualified as a
501(c)(3) nonprofit organization and that the training be approved by a
presidentialy appointed, Senate-confirmed civilian official of the
military department. The policy memo also reemphasized the existing
prohibition against agents of insurance or financial product companies
presenting financial training.
Initial Revision of DoD Directive 1344.7: After nearly a year of
revision and information coordination, the Department forwarded
proposed changes to DoD Directive 1344.7 to the military services for
coordination and comment. Proposed policy changes included a
requirement for junior enlisted personnel to obtain approval from their
chain of command to purchase supplemental commercial life insurance.
The insurance industry strongly opposed this proposed change and sought
the involvement of Congress to block the reform effort. In November
2003, Public Law 108-136, Sec. 586, required the Department provide
Congress 30 days notification prior to implementing any changes to DoD
personal commercial solicitation policy. To try to maintain the
momentum, the Department also agreed to conduct two public forums. The
first, to obtain public comment on existing DoD personal commercial
solicitation policy, and the second, to obtain comment on any proposed
changes.
Financial Readiness Campaign: In May 2003, the Department, in
cooperation with the Department of the Treasury and the Securities and
Exchange Commission, initiated a DoD Financial Readiness Campaign. The
campaign established agreements with Federal agencies and nonprofit
financial education organizations. Through the expertise and donated
resources of these Federal agencies and nonprofit organizations, the
Department has extended the capability of the Military Services to
train and counsel servicemembers and their families on a range of
personal financial issues, to include insurance and financial products.
We have included a list of over 20 of the partner organizations on our
quality of life portal: www.militaryhomefront.dod.mil, under
``Financial Readiness.'' Examples of these collaborations include: The
American Savings Education Council, which has provided over 57 public
service announcements to the Armed Forces Radio and Television Service
for broadcast overseas, and the InCharge Institute, which in
collaboration with the National Military Family Association, has
distributed 250,000 copies of their Military Money Magazine (developed
for the military spouse) through Defense Commissaries and other high
traffic areas on military installations.
First Public Forum: The first meeting to seek public comment on
existing DoD personal commercial solicitation policy was held on August
22, 2003. Fifty-nine persons, mostly representatives from insurance and
financial services companies, submitted comments. The primary themes of
comments received were:
DoD's personal commercial solicitation policy is basically
sound but needs to be better enforced.
DoD should not regulate insurance and financial products
because that is a State and Federal regulator responsibility.
Commercial Sponsorship Policy Revision: In March 2004, the
Principal Deputy Under Secretary of Defense (Personnel and Readiness)
issued new MWR program commercial sponsorship policy. An April 2004,
policy memorandum directed the military departments to decline
commercial sponsorship offers that do not reflect favorably upon DoD.
In addition, this memorandum directed the military departments to
ensure commercial sponsors do not use their sponsorship to obtain
personal contact information for future solicitation without the
written consent of the person to be solicited.
First GAO Audit: In March 2004, the Chairmen of the House
Government Reform Committee and the House Armed Services Committee
requested the Government Accountability Office examine DoD and military
services policies and procedures for the marketing and sale of life
insurance policies to military personnel and the processing of
financial allotments for military personnel. This audit was requested
in response to insurance industry complaints, which alleged officials
at Fort Lewis and Fort Bragg had deliberately failed to process
hundreds of life insurance allotments and military personnel were being
directed to cancel their supplemental commercial life insurance. During
this audit, the GAO conducted site visits at Fort Lewis, Washington,
Naval Training Center Great Lakes, Illinois, Marine Corps Base Camp
Pendleton, California, Fort Bragg, North Carolina, Lackland Air Force
Base, Texas, and Fort Campbell, Kentucky. On August 2004, Public Law
108-287, Sec. 8133, prohibited the Department from amending or changing
its personal commercial solicitation policies until 90-days after the
GAO issued their final report. In its final report, issued on June 29,
2005, the GAO could not substantiate the original allegations
pertaining to Fort Lewis and Fort Bragg, but made three recommendations
to improve DoD personal commercial solicitation policy and two
recommendations to improve insurance allotment coding and processing.
This audit did not examine the suitability of insurance and financial
products being sold primarily to military personnel or how they were
sold. The Department partially concurred with the GAO's first two
recommendations and concurred with the other three. The first partial
concurrence concerned a GAO recommendation that the department develop
and maintain a DoD-wide searchable database to record all violations of
DoD personal commercial solicitation policy. The Department has
developed and maintains a current list of companies and agents that are
barred from soliciting on an installation and believes that this list
is more useful and appropriate than the one the GAO recommends. In the
second partial concurrence, the GAO recommended all violations of DoD
solicitation policy involving insurance or financial products be
reported to State or Federal regulators. The Department believes only
violations that involve licensing, compliance with State or Federal
laws or regulations, or that result in the company or agent being
barred from an installation, should be reported to regulatory
authorities. The Departments believes reporting only actionable
violations to State and Federal regulators will serve everyone's best
interests.
New York Times Investigative Reports: Beginning in July 2004, The
New York Times published a series of investigative reports that focused
much needed attention on the DoD personal commercial solicitation
issue. Among other things, the reports highlighted DoD policy
violations by several insurance companies soliciting Army trainees at
Fort Benning, Georgia and potentially costly periodic payment plans
marketed by First Command Financial Planning, Inc., mostly to military
personnel. The Department took these reports very seriously. I asked
the Assistant Secretary of the Army (Human Resources) to advise my
office of actions taken at Fort Benning and to recommend whether or not
the findings warranted Service-wide or DoD-wide action. Fort Benning
has conducted detailed proceedings and has taken decisive
action locally. I understand that the Fort Benning commanding general's
recommendation for broader actions is currently at Department of the
Army headquarters for legal review. In addition, I requested the
Military Departments report all documented personal commercial
solicitation policy violations that have occurred since January 1, 2000
and to provide quarterly update reports. This information is used
maintain a list of insurance and financial product companies and agents
currently barred from soliciting on a DoD installations that is posted
on our DoD Commanders Page website. Following enforcement action by the
National Association of Securities Dealers (NASD) and the Security and
Exchange Commission (SEC) against First Command Financial Planning, I
met with First Command's President and Chief Executive Officer, who
informed me that they have ceased selling, and will no longer sell,
periodic payment plans. The Department has collaborated with the
National Association of Insurance Commissioners on an educational
brochure to assist military personnel considering the purchase of
supplemental commercial life insurance. This brochure includes contact
numbers for Insurance Commissions in all 50 States and the District of
Columbia. The Department's Financial Readiness Campaign is educating
our military servicemembers to closely examine products being offered
and to seek legal advice before signing contracts. This program is
intended to make servicemembers and their spouses better informed, more
discriminating consumers.
Second GAO Audit: Mr. Chairman, in late 2004, you and the Ranking
Member of this Committee requested the Government Accountability Office
review the sale of financial products to military members.
Specifically, the GAO was asked to ``examine the types and variety of
financial products'' commonly marketed to military members; regulatory
oversight by insurance and securities regulators and DoD; the
regulatory oversight and consumer protections afforded to military
personnel compared to the general public; and how regulators have
assessed the suitability of such products. The Department thanks this
Committee for its concern, not only in how, where, and when insurance
and financial products are being sold to military personnel, but also
what kinds of products are being sold. This is the first time the
suitability of insurance and financial products sold primarily to
military personnel has been examined. This focus is much needed, long
overdue, and much appreciated. The recommendations in the GAO's draft
report, issued on September 29, 2005, are reasonable and appropriate.
DoD Instruction on Personal Financial Management Education: The
Miltiary Services have established training for servicemembers on a
list of topics that includes insurance, saving, and investing as part
of their initial orientation in the military. DoD Instruction 1342.17
was released in November 2004, providing the first comprehensive policy
document describing personal financial education and counseling
requirements for servicemembers and their families, to include the
already established training being delivered to junior servicemembers.
The instruction has given us an opportunity to reinvent this training
by requiring junior servicemembers be able to show their competence in
applying basic financial principles on a wide range of financial
topics, to include insurance and savings. In addition, first time
supervisors are to demonstrate their understanding of policies and
practices designed to protect junior servicemembers within their
command/supervision, to include policies and practices concerning
commercial solicitation. We are currently working on the implementation
of a strategic plan for Personal Financial Readiness that includes
establishing the evaluation tools needed to ensure these important
policies are being applied.
Strategic Plan for Personal Financial Readiness: As part of the
answer to a GAO study on personal financial management programs (GAO-
05-638R), the Department has crafted a strategic plan that incorporates
the steps to ensure the implementation of DoD Instruction 1342.17, and
the resources/capabilities of the Financial Readiness Campaign. A key
new component of this strategic plan is the program being developed by
the National Association of Securities Dealers (NASD) Foundation. This
program, funded through the residual proceeds of the settlement with
First Command Financial Services, seeks to give servicemembers and
their families confidence to management their financial resources, by
gaining their attention through an awareness campaign and providing
unbiased educational resources to support their decisionmaking needs.
The NASD Foundation program includes the capabilities and resources of
several of the existing Financial Readiness Campaign partners,
increasing the impact of the overall effort.
Second Public Forum: The Department's proposed policy changes were
published in the Federal Register on April 19, 2005. The substantive
changes focused on financial education, oversight, and enforcement.
They incorporate the financial education, commercial sponsorship, and
violation reporting guidance I mentioned previously. We also include a
new commercial solicitation evaluation form designed to make it easier
for installations to detect and investigate solicitation policy
violations. The Department hosted a second open forum on May 6, 2005,
to obtain public comment on the proposed changes. Twelve persons,
representing various insurance, financial service, veteran and military
fraternal organizations, provided oral comments. In addition, 31 other
individuals and organizations submitted written comments by the June
20, 2005 deadline. A total of 79 specific recommendations were received
during the second public forum and comment period.
Proposed Policy Changes: The Department has carefully considered
all 79 recommendations. We have accepted 31 and partially accepted 9 of
these recommendations for inclusion in our final policy revision. Many
of these additional changes clarify questions of interpretation of
existing policy or new policy to cover new technologies. Examples
include telecommunications aspects of solicitation, electronic versus
paper pay and allotment transactions, and the use of direct deposit
versus military pay allotment forms. Other changes include policies to
incorporate our responses to the GAO's recommendations and provisions
in pending legislation the Department supports and expects will become
law. These include solicitation policy violation reporting and
recordkeeping and enforcement of the military pay allotment cooling off
period. Our proposed final policy is currently being reviewed for legal
sufficiency by the DoD General Counsel.
In conclusion, the Department does not intend to prevent honest
companies from doing business on DoD installations but we must take
prudent steps to protect military members from superfluous products and
predatory sales practices. Problems
associated with on-base commercial solicitation of military personnel
have been ongoing for many years. Prior attempts to implement new
policies to improve DoD's oversight and enforcement met with resistance
on many fronts. We believe now, with the public's attention and the
support of this Committee and the Senate and House Committees on armed
services, long overdue changes to protect the financial well-being of
military members and their families will finally become reality. Any
further delay is unacceptable. Our men and women in uniform, and in
harm's way everyday, deserve no less.
PREPARED STATEMENT OF LORI RICHARDS
Director, Office of Compliance, Inspections, and Examinations
U.S. Securities and Exchange Commission
November 17, 2005
Introduction and Summary
Chairman Shelby, Ranking Member Sarbanes, and Members of the
Committee, I am pleased to appear today to testify on behalf of the
Securities and Exchange Commission (Commission) to express the
Commission's views on the Government Accountability Office's (GAO)
report entitled Financial Product Sales: Actions Needed to Better
Protect Military Members (GAO-06-23). My testimony will address the
portion of the report that discusses sales of securities products.
The Commission strongly believes that our servicemen and women must
be protected from illegal and abusive practices in the sale of
securities. Over the last year, the Commission and its staff have
undertaken a comprehensive program to address such practices. Our
program has included enforcement activity, extensive examination
activity, close coordination with the Department of Defense (DoD) and
the National Association of Securities Dealers (NASD), and investor
education and other outreach activity. These actions are summarized
below, and described in greater detail in this testimony.
The Commission brought an enforcement action against a broker-
dealer, First Command Financial Planning, Inc., that specializes in
sales of securities to military personnel. The Commission's
enforcement action ordered First Command to cease and desist from
illegal and abusive practices in the sale of securities, and
includes an order to pay $12 million: $5.2 million in restitution
to military customers, and the remainder to fund an investor
education program for the military administered by the NASD.
The Commission's examination staff have conducted numerous
examinations of broker-dealer firms that sell securities to the
military personnel. These examinations have included two separate
risk-targeted examination sweeps, one focusing on sales of mutual
fund contractual plans, or ``periodic payment plans,'' and the
other focusing more generally on sales of securities products to
military personnel. These examinations have included on-site
reviews of securities firms serving the military market, and visits
to sales offices located in military base communities, both in the
United States and overseas.
Commission staff have worked closely with DoD, establishing a
regular liaison with the Office of the Secretary of Defense,
through which we have shared information and coordinated our
examinations. We have also coordinated our efforts with the
commands of selected bases. In our work, we have found the DoD and
the individual base commands to be open, responsive, and helpful.
This coordination is continuing, with DoD providing us with on-
going information that we are using to target securities firms for
examinations.
In all of these efforts, Commission staff have worked closely
with the NASD. This joint effort included coordination of
enforcement activity, examinations, and investor education programs
for members of the military.
Finally, Commission staff in the Office of Investor Education
and Assistance have conducted an active investor education
initiative targeted toward members of the military. As a charter
member of the DoD's Financial Readiness Campaign, we assisted in
the presentation of financial education programs to the military.
Commission staff have already conducted several financial education
workshops on military installations. As part of this initiative,
Commission staff prepared an article on periodic payment plans for
Military Money, a not-for-profit publication that is distributed
free in the military community. In addition, an online brochure on
periodic payment plans is available on our website. Finally, we
have also conducted an outreach program to the securities
community, with members of the Commission's staff speaking at
conferences and in other settings, on the need for securities firms
to better protect and serve their military customers.
We strongly agree with the GAO's recommendation that Congress
should take legislative action in this area to protect military
servicemembers. We recommend that you consider taking steps to address
the features of mutual fund contractual plans that make them
susceptible to abusive and misleading sales practices and excessive
fees. In addition, as noted above, we have already taken action to
enhance our information-sharing with DoD.
Regulation of Broker-Dealers and ``Periodic Payment Plans''
The Commission regulates the sales of securities through, among
other things, its regulation of broker-dealers. Broker-dealers operate
in a comprehensive regulatory environment. They must: Register with the
Commission and comply with the laws and rules governing broker-dealers;
become members of the NASD and comply with its rules and oversight; and
comply with regulations governing, among other things, their financial
responsibility and the protection of customer funds and securities.
They must also comply with the antifraud provisions of the Federal
securities laws and NASD rules, which, among other things, impose
duties of fair dealing and an obligation to recommend securities that
are suitable for the customer.\1\
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\1\ A summary of these duties can be found on the Commission's
website. See www.sec.gov/divisions/marketreg/bdguide.htm.
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To evaluate compliance with these requirements, the Commission, the
NASD, and other self-regulatory organizations conduct examinations of
broker-dealers, in which examiners visit broker-dealers, review their
books and records, interview their employees, and seek to identify
violations of applicable laws or regulations or control weaknesses that
could lead to such violations. NASD and other self-regulatory
organizations conduct routine examinations of their member firms, and
the Commission staff conduct oversight of the SROs' programs, ``cause''
exams based on a complaint or a tip, and other types of examinations.
In recent years, SEC staff have conducted more risk-targeted
examination sweeps to quickly identify areas of emerging compliance
problems.
To enforce the Federal securities laws, the Commission can bring
enforcement actions. In 2004, the Commission brought 141 enforcement
actions involving broker-dealers or associated persons, approximately
22 percent of the enforcement actions that it brought in that year.
NASD and other self-regulatory organizations also bring disciplinary
actions against broker-dealers for violations of their rules.
While there are no formal records that categorize broker-dealers by
the types of customers they serve, our work in this area indicates that
securities are sold to members of the military by several different
types of broker-dealer firms. A small number of broker-dealer firms
focus or specialize in selling securities to the military market. These
are firms that have dedicated either their entire organization or a
significant business line to serving the military market. There are
also smaller broker-dealer firms that may have a single office or
offices located near military bases in the United States or overseas,
and that focus sales efforts to military personnel. Finally, there are
also broker-dealer firms that do not focus on sales to military
personnel, but may have a single sales branch office located in a
military community and may develop a local military clientele. In
addition to selling securities, these sales offices may provide a range
of other financial services, including insurance, paycheck loans, and
tax preparation.
In addition to regulating broker-dealers, the Commission also
regulates some of the financial products that have been sold to members
of the military. These include a product known as a mutual fund
contractual plan, or a ``periodic payment plan.'' This product is
governed by the Investment Company Act, which generally defines a
periodic payment plan certificate as a security in which an investor
makes a long-term series of periodic payments to acquire an interest in
a specified unit or fund of securities (Section 2(a)(27) of the
Investment Company Act). Most mutual fund contractual plans contemplate
that the investor will make periodic monthly payments for 15 or more
years. These products contain a high front-end load: Up to half of the
investor's payments made in the first 12 months are deducted as a sales
load. As a result, if the investor redeems his/her investment before
the full term of the contract, the investor would pay an abnormally
large sales load on his/her investment. The Investment Company Act
imposes various limitations on the sale of these products, including a
maximum allowable sales load on the total payments to be made by the
investor (9 percent), and the maximum portion of the first 12 monthly
installment payments that may be deducted as sales load (50 percent),
among other things.
As GAO notes, in the distant past these plans were one of the few
means by which smaller investors could make low-dollar investments in
mutual funds. Over the years, however, alternative means of making such
investments have been developed by fund firms, including both load and
no-load funds that accept low initial investments and low periodic or
automatic investment plans.\2\ These alternatives provide an
opportunity for low-dollar investments without the large up-front sales
load charged by periodic payment plans. As a result, mutual fund
periodic payment plans have ceased to attract large numbers of civilian
investors.
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\2\ A no-load fund charges no sales commissions on share purchases.
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Only a small number of such plans are currently available. As of
October 2005, there were only 8 financial firms that sponsored periodic
payment plans registered with the Commission. These firms have
registered a total of 19 plans with current assets of $12 billion,
which represents less than two tenths of 1 percent (<0.2 percent) of
the assets currently invested in nonmoney market mutual funds. Indeed,
many of the registered periodic payment plans are no longer being sold,
and even the largest plans have shrunk over the last year (measured by
aggregate invested assets).\3\ Nonetheless many members of the military
have continued to invest in these plans.
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\3\ During their most recently completed fiscal years, the six
largest periodic payment plans measured by asset size had aggregate
gross sales of $931 million and redemptions of $950 million; resulting
in net redemptions of $19 million. Of these six, some of the smaller
plans experienced net sales, but the amount of those sales was
insufficient to offset the redemptions at the larger plans.
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The Commission's Program to Protect the Military from Illegal and
Abusive Practices in the Sale of Securities
In 2004, when potentially abusive sales practices in the sale of
securities to military personnel came to the attention of the
Commission's staff, Commission staff
determined that the military community should be identified as an at-
risk group. Following this determination, Commission staff quickly
deployed resources from multiple functional programs of the Commission,
including enforcement, examinations, and investor education, and
initiated a coordinated approach to seek to protect members of the
military from abusive sales practices. Each step is described below.
In the Matter of First Command Financial Planning, Inc.
On December 15, 2004, the SEC and NASD instituted enforcement
proceedings against First Command Financial Planning, Inc., a
registered broker-dealer based in Fort Worth, Texas, whose customer
base consisted almost entirely of active-duty and retired U.S. military
personnel. In coordinated joint actions, the SEC and NASD alleged that
First Command used misleading sales materials to offer and sell
periodic payment plans. In settlement of these actions, First Command
agreed to pay $12 million in disgorgement and prejudgment interest to
be used to reimburse certain customers and to fund an NASD investor-
education program for members of the U.S. military and their families.
In November 2004, First Command stopped selling periodic payment plans
altogether. As the Commission's enforcement order entered against First
Command states, the firm maintained sales offices near U.S. military
bases worldwide and claimed that its customers included approximately
40 percent of the active-duty general officers and approximately one-
third of the commissioned officers. The vast majority of First
Command's sales agents were retired military officers. This firm was
responsible for approximately 90 percent of all sales of periodic
payment plans.
Like other periodic payment plans, and as described in the
Commission's order, the investments sold by First Command allowed
investors to accumulate shares in one of five mutual funds by making
fixed monthly contributions--typically ranging from $100 to $500--over
a period of at least 15 years. Each contractual plan imposed a unique
sales charge, or ``load,'' which equaled 50 percent of the plan's first
12 monthly payments with no sales load thereafter. If the investor made
the plan's scheduled 180 payments over the 15-year period, the
effective sales load worked out to be approximately 3.3 percent. On the
other hand, if the investor failed to make all of the scheduled
payments, the effective sales load could be substantially higher. The
Commission's order further stated that historically, approximately 43
percent of First Command's customers made at least 180 scheduled
payments. Many of the First Command customers were unable to complete
the 180 payments and, consequently, many of them paid loads
substantially higher than 5.2 percent, the approximate average sales
load for all conventional-load equity mutual funds in 2003. In the
worst case, those who discontinued payments after 1 year paid a 50
percent sales load.
The Commission's order against First Command contained findings
that, since at least January 1999, the firm offered and sold
contractual plans using carefully worded sales scripts that made
misleading comparisons between the periodic payment plans and other
mutual-fund investments. For example, First Command claimed that
periodic payment plans are the only funds that are designed for dollar-
cost averaging investors, that no-load funds were primarily for
``speculative'' investors, and that transactions by speculative
investors reduced the opportunity for the no-load fund's manager to
make opportune investments for the fund. In reality, many long-term
investors invest in no-load funds, and many no-load funds maintain
dollar-cost-averaging programs allowing investors to make relatively
small periodic contributions. The Commission found that First Command's
sales materials also contained misleading statements and omissions
concerning the costs of no-load funds, and the availability of the
Thrift Savings Plan, the Federal Government-sponsored retirement
savings and investment plan, which offers military investors many of
the features of a contractual plan, but at a lower cost. The Commission
further found that, in light of the relatively low completion rate in
its periodic payment plans, First Command misrepresented the efficacy
of the upfront load in ensuring that investors remain committed to the
contractual plan. The NASD's action, filed on the same day, contained
similar findings.
As part of its settlement with the Commission and NASD, First
Command agreed to compensate military investors who purchased and
terminated their plans during a specified period who paid an effective
sales load of greater than 5 percent. By prematurely terminating their
plans, these investors incurred effective sales loads well above the
average load charged by conventional-load equity mutual funds.
In addition to the $12 million payment, the Commission ordered
First Command to cease and desist from committing or causing violations
of certain of the antifraud provisions of the Federal securities laws.
The Commission and NASD orders also directed First Command to comply
with certain undertakings, including hiring an independent consultant
to review and make recommendations concerning the adequacy of First
Command's sales scripts, sales training systems and procedures, and
supervisory systems and procedures.
As of November 8, 2005, First Command had paid $6.81 million to the
military investor-education fund operated by the NASD and expects to
pay approximately $37,000 more into the fund by the end of the year,
depending on the final outcome of the investor-reimbursement process.
As of November 2, 2005, First Command had reimbursed approximately $4.3
million to approximately 10,000 military investors that were harmed as
a result of the misconduct. The independent consultant overseeing the
distribution advises that his firm is in the process of tracking down
current addresses for approximately 3,500 additional military investors
to pay out
approximately $860,000 that remains undistributed in the settlement
fund. It is expected that the reimbursement process will be completed
by the end of the year.
Working together, the SEC and NASD brought an end to misleading
sales practices affecting approximately 90 percent of the contractual
plans sold to U.S. military families, provided for reimbursement to
harmed military investors, and obtained significant funding for
military investor-education programs.
Examination Sweeps Focusing on Sales to Military Personnel
Following indications of sales practice problems involving sales to
military personnel, the Commission's examination staff initiated
targeted examination sweeps of certain broker-dealers. First, the
Commission staff initiated an examination sweep of broker-dealers (in
addition to First Command) that sell periodic payment plans. Second,
the Commission staff initiated an examination sweep of broker-dealers
that sell other securities products to members of the military. Each
examination sweep is described generally below. In light of the
confidential nature of SEC examinations, the SEC has not discussed
publicly either the examinations or the names of the firms.
Examinations of Broker-Dealers That Sell Periodic Payment Plans
In addition to First Command, a small number of other broker-
dealers sell periodic payment plans to investors. SEC staff examined
four of these firms that sold significant amounts of contractual plans.
The three largest of the four firms examined were found to sell
periodic payment plans exclusively to the military community. In
combination with First Command's sales to the military community, the
staff believes that our reviews of these products may have captured as
much as 95 percent of the sales of periodic payment plans sold to the
military community. Like First Command, these firms have discontinued
sales of contractual plans.
Unlike First Command, these three firms generally sold contractual
plans to lower-ranking enlisted military members. These contractual
plans also called for a 50 percent load paid out in the first 12
installments, with no additional load after that, and consisted of at
least 120 payments to be made monthly over 10 years. Although the
examinations of these firms did not reveal the systemic
misrepresentation present in the First Command case, they did show that
very few low-ranking enlisted members made at least 120 payments. At
one firm, fewer than 10 percent completed their plans. On average, low-
ranking enlisted members paid loads greater than 10 percent--
significantly higher than they would have paid if they had purchased
mutual-fund shares with a conventional load.
The high incidence of incomplete plans discovered in these
examinations raised concerns that these firms may have routinely
recommended contractual plans to investors that required monthly
installments in amounts greater than the investor could reasonably
afford. Under NASD Conduct Rule 2310, a brokerage firm is required to
have reasonable grounds for believing that its recommendation is
suitable for its customer in light of the customer's financial
situation, among other things. Accordingly, the Commission's staff has
provided its examination results relating to these three firms to the
NASD.
Examinations of Broker-Dealers That Sell Other Securities Products to
Military
Personnel
As noted above, following indications from the First Command matter
that members of the military may be at risk due to abusive or
misleading sales practices, Commission examination staff initiated a
second examination sweep to review how other securities products are
sold to military personnel. This review is on-going. It encompasses
sales of all securities products, such as mutual funds, variable
annuities, stocks and bonds, with a particular focus on sales offices
targeting military personnel and their families.
These examinations are focused on sales practices in both the on
and off-base communities, and on the unique features of the military
market. In particular, examination staff are looking for sales
practices that take advantage of military personnel when they receive
deployment orders or of survivors when they receive large insurance
payments upon a military person's death. In addition, the staff is
considering whether broker-dealers are recommending unsuitable products
to military investors, such as by recommending products that require a
stream of payments that the investor is unlikely to have the resources
to sustain. Finally, the staff are examining how firms characterize the
availability of the Thrift Savings Plan to military investors.
Commission staff began the examination sweep by working with DoD
and the NASD to identify the broker-dealer firms actually selling to
military clients. Because there is no requirement for a broker-dealer
to report the type of customers that the brokerage firm serves, the
initial identification process included combing through various DoD-
related newspapers and periodicals, such as Stars & Stripes and The
Military Times, to identify and evaluate securities product
advertisements. We also reviewed DoD base structure reports to
determine which military facilities, domestic and overseas, have the
largest numbers of enlisted personnel. These locations were cross-
referenced with registration information on broker-dealers.
As a result of this review, and through interviews with
knowledgeable personnel in the military and the securities community,
we identified firms that direct their securities sales efforts to
military personnel. We identified three types of firms that sell
securities to military members:
A small number of broker-dealer firms focus or specialize in
selling securities to the military market. These are firms that
have dedicated either their entire organization or a significant
business line to serving the military market.
There are also smaller broker-dealer firms that may have a
single office or offices located near a military base in the United
States or overseas, and which focus sales efforts on military
personnel.
Finally, there are also broker-dealer firms that do not focus
on sales to the military, but may have a single sales branch office
located in a military community and may develop a local military
clientele. In addition to selling securities, these sales offices
may provide a range of other financial services, including
insurance, paycheck loans, and tax preparation.
In coordination with NASD, examinations of each type of firm have
been or are being conducted. All firms that specialize in selling
securities products to military personnel have been or are being
examined, and, as well, examinations have been and are being conducted
of the smaller firms and firms that have branch office locations near
base communities. As part of this review, SEC examiners have conducted
unannounced examinations of sales offices located outside the gates of
major military bases. We continue to schedule these examinations.
Initial staff findings have not indicated serious sales practice
abuses, but have noted deficiencies in the internal controls and
supervisory systems of several firms. In some cases, it was unclear as
to whether securities salespersons had ever received any type of
supervisory oversight or compliance training. Our examinations are
continuing and we will make referrals as appropriate.
Coordination with DoD
The staff is committed to working closely with DoD to ensure that
our efforts in this area are fully coordinated. To this end, we have
established a designated liaison on the Commission's examination staff
who has worked closely with the DoD. The liaison regularly communicates
with designated DoD personnel, including frequent meetings and weekly
conference calls. Through these contacts, we have shared information
and coordinated our efforts. For example, DoD has conducted a survey of
base commands, given us information regarding possible examination
candidates and issues, as well as instructed base commands to provide
local support and assistance to our examiners.
We have also coordinated our efforts with the commands of selected
bases. With the assistance of base commanders, we have been able to
conduct a systematic review of base records and interview base
personnel to identify firms selling securities to the local military
community, as well as possible complaints about those sales. Through
this cooperation, we have been able to gain access to a number of
useful records, including complaints, ``off-limits'' procedures, the
issuance of ``solicitation passes'' to securities salesmen who wish to
enter the premises of the base, the revocation of such passes, and
other related matters. In addition, beyond providing us with access to
records and information, base commands have taken active and
affirmative steps to assist us.
In our work we have found DoD and the base commands to be open,
responsive, and helpful. This coordination is continuing, with DoD
providing us with on-going information that we are using to target base
communities and securities firms for future examinations.
Coordination with the NASD
We have coordinated our efforts with the NASD at all levels of this
program. This joint effort has included coordination of enforcement
activity, examinations, and investor education programs for the
military. The enforcement action against First Command Financial
Planners, Inc. was brought after coordinated investigations by
Commission and NASD staff. The risk-targeted examination sweeps
described above were coordinated with the NASD, as are the investor
education programs for military members described below.
Investor Education
The Commission is committed to improving the financial literacy of
our servicemembers and their families. By actively promoting and
supporting financial education for military personnel, we help military
investors become better positioned to achieve personal saving and
investing goals, including retirement, homeownership, and college
education for their children.
Through the Commission's Office of Investor Education and
Assistance, the Commission participates, as a charter member, in the
DoD's Financial Readiness Campaign. The DoD launched the Financial
Readiness Campaign to give servicemembers and their families a chance
to learn more about personal finances and to encourage them to better
manage their money. The effort is directed toward junior enlisted
servicemembers and spouses of servicemembers because they are less
likely to have received the personal finance information that
servicemembers received as part of their training. We have pledged our
support to the personnel at military installations who are responsible
for providing financial education.
Over the past year, the Commission's staff have conducted several
workshops at military installations for military personal financial
managers, educators, command financial specialists, and servicemembers.
We have also distributed brochures to these groups containing neutral,
unbiased information on saving and investing. We continue to work with
DoD to provide useful financial information.
The Commission's staff have also created additional educational
materials to help investors understand and make informed decisions
regarding periodic payment plans. We published an article on these
plans earlier this year in Military Money, a free magazine focusing on
the finances and lifestyle of military families. The magazine is
distributed at most U.S. military bases nationwide, to military
personnel in Europe and Asia via the Stars and Stripes newspaper, and
to approximately 180 DoD commissaries worldwide. We plan to continue to
publish articles in this magazine, as part of the Financial Readiness
Campaign, which is supported by the Office of the Under Secretary of
Defense for Military Community and Family Policy.
In addition, in August 2004, we posted on our website a
comprehensive online brochure on mutual fund contractual plans titled
``Periodic Payment Plans.'' Articles about these plans also appeared in
newspapers distributed to military personnel, such as Army Times and
Marine Corps Times, and have directed readers to our online brochure.
In addition, the Commission's staff have conducted an outreach
program to the securities community. We believe that securities
professionals can play a key role in protecting the financial interests
of servicemembers. Members of the Commission's staff have spoken to
industry conferences and seminars, identifying the military community
as a risk group that should be given extra compliance attention.
GAO's Recommendations
We strongly agree with GAO's recommendation that Congress revisit
the law governing mutual fund contractual plans. As an alternative to
an outright ban, we
believe that Congress could consider addressing excessive sales charges
by, for example, reducing the maximum allowable load or working with
the Commission and the NASD on other mechanisms that would provide
protection against excessive sales loads in this product.
In addition, in the event periodic payment plans are not banned,
securities regulators will consider various means of better assuring
that regulators have adequate information to assess the sales of these
plans. In particular, as GAO notes in its report, SEC and NASD efforts
to review sales of periodic payment plans were hampered by a lack of
standardized data at these firms on the persistency rates of the
investments in the plans. Should these plans not be banned, we will
work with other regulators to ensure that we have adequate information
to assess the sales of those plans.
We fully support GAO's recommendation that the Commission and DoD
share information and coordinate their efforts. As described above, the
Commission and its staff have already taken steps to implement this
recommendation, and have seen positive results from our efforts.
Conclusion
The Commission strongly believes that our servicemen and women must
be protected from illegal and abusive practices in the sale of
securities. Over the last year, the Commission and its staff have
undertaken a comprehensive program to address such practices. Our
program has included enforcement activity, extensive examination
activity, close coordination with DoD and the NASD, and investor
education and other outreach activity. We support the GAO's
recommendations in this regard. We look forward to working closely with
this Committee, DoD, the NASD, and other regulators to continue to
protect members of the military as investors in our markets.
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PREPARED STATEMENT OF MARY SCHAPIRO
Vice Chairman and President, Regulatory Policy and Oversight
National Association of Securities Dealers
November 17, 2005
Mr. Chairman and Members of the Subcommittee: NASD is grateful to
the committee for inviting us to testify on NASD's regulatory
activities regarding inappropriate sales of certain investment products
to members of the armed forces, and for allowing us to submit this
statement for the record.
NASD
Founded in 1936, NASD is the world's preeminent private-sector
securities regulator. In 1939, the SEC approved NASD's registration as
a national securities association under authority granted by the 1938
Maloney Act Amendments to the Securities Exchange Act of 1934. We
regulate every broker-dealer in the United States that conducts a
securities business with the public--about 5,200 securities firms that
operate more than 108,000 branch offices and employ about 664,000
registered representatives.
Our rules regulate every aspect of the brokerage business. Our
market integrity and investor protection responsibilities include
compliance examinations, rule writing, enforcement, professional
training, licensing and registration, dispute resolution, and investor
education. NASD examines broker-dealers for compliance with NASD rules,
MSRB rules and the Federal securities laws, and we discipline those who
fail to comply. Last year, NASD filed a record number of new
enforcement actions (1,410) and barred or suspended more individuals
(830) from the securities industry than in any previous year. NASD has
a nationwide staff of more than 2,400 and is overseen by a Board of
Governors, more than half of whom are not in the securities industry.
During the last 4 years, NASD has been in the process of separating
from The Nasdaq Stock Market.
Executive Summary
America's men and women in uniform make great personal sacrifices
to protect our Nation's security. They should not have to worry about
the honesty and integrity of those who purport to help them make sound
financial decisions for themselves and their families. Yet thousands of
mostly young servicepersons have been disadvantaged by the sale of an
investment product called Periodic Payment Plans or PPP's.
NASD learned in 2003 that a broker-dealer, located in Texas, was
targeting U.S. servicemen and women with these investment products and
was doing so using improper sales practices. We have responded
forcefully to end these practices, punish those responsible for them,
ensure that their victims are recompensed for their losses, and educate
military personnel broadly about investing and saving.
In this statement, we will tell the Committee (a) what we
discovered and what we did about it; (b) our subsequent efforts to
educate servicepersons and civilians about PPP's and investing more
generally, so that they might avoid being taken advantage of; and (c)
about NASD's belief in the need for legislative remedies to deal with
abusive sales practices and enhancing the system by which information
on securities firms and brokers is provided to the investing public.
Sales of Periodic Payment Plans to the Military
First Command Financial Planning Inc., of Fort Worth, Texas, a
broker-dealer with strong ties to the military, had been marketing
Periodic Payment Plans to members of the U.S. military for many years.
In August 2003, NASD learned of concerns about First Command's sales to
military personnel of products that levied huge upfront commissions.
The staff immediately began an investigation and found that First
Command used misleading statements in its sales literature and scripts
to attract military customers to its products. Using these and other
improper tactics, the firm sold more than a half-million of these
complicated and often extremely expensive products to service persons,
many of whom were young and inexperienced investors.
An investor in a Periodic Payment Plan makes monthly payments of as
little as $50 for a fixed time period, usually 15 years. The payments
are invested in an underlying mutual fund and the investor is charged a
50 percent sales load on the first 12 monthly payments. Payments during
the remainder of the 15-year term are not subject to sales loads, so
that the effective sales charge decreases so long as the investor
continues to make contributions. However, if the investor does not
terminate the plan within 45 days, yet fails to make contributions over
the full 15-year term, he or she can pay a sales charge of up to 50
percent of the total amount invested.
In their sales pitches, First Command representatives told
potential customers that the 50 percent first-year sales load would
decrease to 3.3 percent upon completion of the term. They said this
high upfront sales load would serve as an incentive for investors to
complete the plan. However, they failed to divulge that their own data
showed that, historically, only 43 percent of First Command's customers
completed the 15-year term. As a result, more than half of First
Command's customers paid a higher--in many cases, significantly
higher--sales load for their mutual fund purchases.
Company sales representatives also told potential customers that
the 50 percent first-year sales load was intended to ``instill
discipline,'' but they did not inform the customer of the lost earnings
potential from the cash that was not invested during the first 12
months.
Sales representatives also made misleading statements about
alternative products. They said, for example, that no-load mutual funds
had higher costs than other investment products and were primarily for
``market speculators.''
First Command training manuals cautioned its brokers not to suggest
to individuals who preferred no load funds that they talk to people who
had already bought PPP's, as this would be ``like voluntarily spreading
a cancer in your market.'' In addition to the problematic sales
practices, our investigation found that a First Command district
supervisor had inappropriately confronted an Air Force officer who had
complained about First Command's sales tactics in an e-mail to numerous
individuals. The officer wrote that he had lost money on his investment
and advised readers not to do business with the firm. A First Command
district supervisor informed the officer that high-level Air Force
commanders were being told of his complaint and that a temporary duty
assignment might be jeopardized. The supervisor also contacted the
officer's squadron commander and told her First Command might file a
grievance against her subordinate.
First Command eventually sent the officer a written apology, but
took no action against their district supervisor.
How NASD Responded
After a thorough investigation of First Command's sales practices
that included NASD taking testimony from 16 current and former First
Command employees, reviewing more than 25,000 pages of documents and
over 50,000 e-mail messages, NASD and the SEC both brought disciplinary
actions against the firm simultaneously.
NASD censured the firm and fined it $12 million in December 2004.
That amount included restitution to thousands of customers who had
terminated PPP's after January 1, 1999 and had paid effective sales
charges greater than 5 percent. As of October 18, 2005, more than $4.3
million had been returned to these customers.
The remaining funds, about $6.8 million, were transferred to the
NASD Investor Education Foundation to be dedicated to financial
education programs for members of the armed services and their
families.
NASD also ordered First Command to hire an independent consultant
to oversee its restitution payments and review its sales practices. In
addition, NASD required that for 1 year First Command submit its
proposed advertising materials to NASD for review prior to use.
NASD separately fined the First Command supervisor who had
inappropriately confronted the complaining Air Force officer $25,000
and suspended him from acting in a supervisory role for 30 days.
First Command has informed NASD that it has ceased selling PPP's.
We note that First Command was not the only firm selling PPP's to
military servicepersons. NASD has ongoing investigations of additional,
smaller, firms that also sold the plans, although most of them have now
stopped. Statistics show that the rate of new PPP account openings at
one of the largest sponsors has dropped from about 1,000 per month to
about 10 per month.
Like any regulator, NASD is heavily dependent on customer
complaints as an impetus for investigations and enforcement actions. It
is important to note that in the case of First Command, NASD received
no complaints from servicepersons. We subsequently learned that
servicepersons had complained to military attorneys but those lawyers
could not relay this information to NASD without specific consent from
their clients. We began our investigation in August 2003, immediately
after an article about First Command appeared in Kiplinger's Personal
Finance magazine.
We therefore support the GAO recommendation to the Secretary of
Defense that he revise the DoD solicitation policy to require that
information on servicemember's complaints related to financial product
sales be provided to relevant State and Federal financial regulators.
We also support the recommendation that information be provided to
servicemembers of all levels about how and to whom they should raise
concerns or complaints about potentially inappropriate sales of
financial products, including providing the information necessary for
contacting the regulators. NASD has designated staff to receive
complaints from military personnel and conduct outreach with DoD to
proactively learn of issues concerning securities sales to military
personnel.
NASD Financial Education Efforts for the Military
Since the settlement with First Command, NASD has devoted a great
deal of time, money and attention to developing a program for providing
financial education to military servicepersons and their families.
The First Command case illustrates most vividly the need for the
education and protection of military servicepersons and family members
who invest in securities.
NASD established the Foundation in December 2003, inspired in part
by survey data that showed mainstream investors had a troubling lack of
knowledge and understanding of markets and investment products. Since
then, we have contributed $31 million to the foundation, and it has
awarded more than $5 million in grants to universities and nonprofit
organizations that provide research and teaching in the service of
investors.
As mentioned above, approximately $6.8 million of the First Command
settlement funds has been transferred to the NASD Investor Education
Foundation and specifically earmarked for programs designed to help
members of the military and their families better understand basic
investing and the markets.
This money will fund the foundation's new Military Financial
Education Program. We have been working closely with the Department of
Defense and we expect to launch a multifaceted military financial
education program in early 2006. The program will be implemented on
military installations nationwide and will strive to encourage members
of the armed forces to take control of their financial futures--by
providing them and their and spouses with financial information to help
them make intelligent saving and investing decisions.
Through a combination of its own initiatives and partner programs
funded by foundation grants, the foundation will bring the financial
education community together with the goals of empowering individuals
to learn more in less time, helping organizations work together on new
and existing initiatives, and establishing more coordinated and uniform
financial education programs. Specific programs will include:
A military-specific online resource center that will serve as
a centralized, trustworthy source of unbiased information on saving
and investing, including learning centers, interactive tools and
games, links to other resources, frequently asked questions and
more.
On-the-ground training efforts to support the military's
current Personal Financial Management program by establishing a
coordinated and uniform financial education program, including the
training and continued certification of personal financial managers
and other volunteers.
Educational toolkits for trainers and investors offering
multiple levels of personal financial information.
To ensure that these programs and tools are well-exploited by the
military community, the foundation efforts will include a long-term,
public awareness campaign that will:
Provide a coordinated, national financial literacy campaign to
a military population that is often unable to set and achieve
financial goals, unwilling or unable to save, overextended in debt,
vulnerable to fraud and unaware of what can be done to gain control
of the situation.
Help military families understand how the financial choices
they make can either improve or diminish their ability to achieve
goals such as homeownership, a college education, a secure
retirement, and peace of mind.
Communicate positive and motivational messages in a variety of
ways and through a diversity of media so that everyone in the
military has the opportunity to see, understand, and act upon them.
In order to ensure the Military Financial Education Program's
effectiveness, the NASD Investor Education Foundation plans to conduct
both qualitative and quantitative research that will determine current
levels of investment knowledge among military personnel, identify
motivations for seeking educational opportunities, discover how they
typically access saving and investing information, and identify
trustworthy sources of information.
S. 418 The Military Personnel Financial Services Protection Act
NASD supports legislation that not only would ban sales of PPP's,
but would also enhance and improve the method by which basic
information about brokers and firms is provided to the investing
public.
S. 1A418, introduced by Senator Enzi, and cosponsored by several
other Senators, including Senators Hagel and Schumer of this Committee,
would halt completely the sale of PPP's to members of the investing
public, including the military. We agree with Senator Enzi that the
excessive sales charges of these contractually based financial products
make them susceptible to abusive and misleading sales practices and
that a small group of individuals have targeted these products almost
entirely to military.
NASD also agrees with Senator Enzi that there is a great value to
investors having real-time access to information regarding the
background, qualifications, and disciplinary history of securities
professionals with whom they consider doing business. As we saw in the
First Command situation, unsophisticated investors can be subjected to
high-pressure sales tactics. In these situations, immediate access to
information such as the disciplinary history of the salesperson can be
crucial. All too often, learning about your broker after purchasing can
be too late.
A provision in Senator Enzi's bill would revise the requirements
for collecting and retaining registration information about securities
firms and their brokers and for providing such information to
investors.
Under Federal and State law, securities firms and brokers must
provide information to regulators through a system operated by NASD,
called ``BrokerCheck.'' This information, including both administrative
information and disciplinary history, is reported to NASD by securities
firms, brokers, and other regulators, including the States.
In 1990, Congress mandated that NASD make relevant portions of the
information available to the public without charge through a toll-free
telephone number, the easiest and most convenient solution at the time.
In so doing, Congress accorded NASD immunity from liability for the
release of such information to the public--recognizing that the
disclosure of key information about securities firms and brokers is a
critical part of NASD's regulatory and investor protection mission and
that the veracity of the information reported to NASD cannot be
independently verified. Therefore the grant of immunity from liability
for release of this information was needed.
Because of the narrow language of the existing statute, NASD is not
able to make ``disclosure information'' available online. Investors
must request and wait for a written disclosure report to be mailed or
e-mailed to them.
Informed investors are critical to market integrity and investor
protection. Ready access through NASD BrokerCheck to complete
information about their brokers and the firms that employ them is
critical to informing investors and building their confidence.
Investors have embraced the Internet as their preferred means of
obtaining information about securities firms and brokers. Of the more
than 3.75 million inquiries the NASD BrokerCheck program has received
thus far this year, over 98 percent came through the Internet and less
than 2 percent by telephone.
Investors want and need online access to disclosure information to
help them
decide whether to do business with a securities firm or broker. The
proposed legislation will permit NASD to put disclosure information
online with appropriate protections against indiscriminate access and
exclusion of information that could be used for ``identity theft.''
The legislation NASD favors would:
Provide an appropriate limitation of liability for acts taken
or omissions made in good faith.
Require NASD to continue its BrokerCheck program, without
charge to individual investors.
Provide NASD flexibility in providing investor access to the
program through the Internet and future technology.
Maintain the requirement for toll-free telephone access for
those investors who do not use, or prefer not to use, the Internet.
Expressly provide for SEC review and approval of the scope,
presentation, and procedures of the NASD BrokerCheck program.
Require NASD, subject to SEC approval, to implement
appropriate procedures for brokers or others to dispute the
accuracy of information disclosure through the BrokerCheck program.
Conclusion
Thank you for giving us the opportunity to testify on these
important topics and for your important work on this issue. America's
men and women in uniform deserve honesty and integrity from those who
sell them financial products. NASD will continue its work to protect
all investors, including those in our Nation's military.
----------
PREPARED STATEMENT OF JOHN OXENDINE
Commissioner of Insurance, State of Georgia
November 17, 2005
Introduction
My name is John Oxendine. I am Commissioner of Insurance for the
State of Georgia, a State that has been active in investigating and
preventing sales abuses involving military personnel. Today, I am
testifying on behalf of the National Association of Insurance
Commissioners (NAIC). We appreciate the opportunity to testify
regarding the role of the State insurance departments and NAIC in
better protecting military insurance consumers from faulty life
insurance products and abusive sales practices.
Today, I want to make three basic points:
First, America's men and women serving in the armed forces are
also American consumers entitled to the same protections under
State law enjoyed by all other citizens. Protecting insurance
consumers at the local level in the communities where they live has
been the hallmark of State regulation for more than a century.
Every State in this Nation has a strong unfair trade practices law
backed by an insurance department staffed with dedicated employees
trained to assist consumers who purchase insurance products and
file claims.
Second, State regulators recognize that insurance consumers
serving our country in the military deserve special attention from
State and Federal officials responsible for supervising the sales
of life insurance and investment products on military bases in the
United States and overseas. We are actively reaching out to
military authorities to educate them about State consumer
protection resources and coordinate our enforcement activities. The
military's chain of command structure emphasizing obedience to
superiors poses unique consumer protection challenges that differ
from civilian society. The same training, working, and living
environment that produces highly disciplined and loyal military
units to defend America's freedoms can also create pressures on
individuals that may negatively affect their ability to make fully
independent and informed decisions regarding the most sensible
financial products for their own personal security.
Third, State insurance regulators and the NAIC support Federal
legislation that would clarify our authority under the McCarran-
Ferguson Act and the Gramm-Leach-Bliley Act (GLBA) to supervise the
business of insurance wherever it occurs, including military bases.
We agree with the Government Accountability Office (GAO) that the
Federal Government should facilitate cooperation among the
Department of Defense (DoD), military base commanders, and State
insurance departments by opening up lines of communication and
sharing relevant information about consumer complaints and known
violations. We believe that H.R. 458, the Military Personnel
Financial Services Protection Act, would help achieve those goals.
However, the version passed by the House of Representatives needs
to be amended to remove unnecessary directives that could undermine
State supervision authority under GLBA and deflect State efforts to
address the real problems identified by State insurance regulators
and GAO.
State Insurance Regulators Have Expertise and Resources to Help the
Military
Paying for insurance products is one of the largest annual
household expenditures of any kind for most Americans. Consumers--
including military personnel--have an enormous financial and emotional
stake in making sure the promises made by
insurance companies are kept. Because people often have trouble
understanding insurance products and sales practices, State governments
devote substantial resources toward educating and assisting the public
on insurance matters, as well as licensing and monitoring insurance
companies and agents. When problems arise, State insurance departments
are fully staffed to handle consumer inquiries and complaints quickly
with a local phone call.
People who live and work on military bases are an integral part of
the communities where they are located. Like other citizens, they can
rely upon the expertise and help of State regulatory staff who are also
local residents to understand and benefit from the laws that govern
insurance products. As regulators, we are responsible for making sure
their legitimate expectations are met regarding financial safety and
fair treatment by insurance providers. During 2003, State insurance
departments handled approximately 3.4 million consumer inquiries and
complaints regarding the content of their policies and their treatment
by insurance companies and agents.
NAIC and State Regulators Are Actively Assisting Military Personnel and
DoD
As recognized by GAO in its report, ``Financial Product Sales;
Actions Needed to Better Protect Military Members'', State regulators
must be aware of insurance problems before they can help remedy them.
Prior to media reports last year, military insurance sales problems
were not being brought to our attention because there were few
complaints to State regulators about the products involved and there
was no NAIC coding of complaints to signify they came from military
sources. Once we became aware of problems, enforcement investigations
were launched in States where they occurred, and NAIC commenced an
active program to educate regulators, military personnel, and DoD about
State resources for protecting military insurance consumers.
We believe State insurance regulators and the NAIC are taking
actions that will meet the major recommendations of GAO in its report.
Here are the key initiatives being undertaken:
The NAIC set up the Sale of Life Insurance to Military Service
Members Collaborative Group, which has 30 States participating.
There are currently targeted market conduct examinations underway
involving nine insurers.
The NAIC, in conjunction with the DoD, developed a consumer
brochure specifically addressing life insurance information for
military personnel. We have encouraged DoD to make this brochure
freely available to members of the armed services during training
and on-base at convenient locations.
The NAIC created an extensive online resource specifically
aimed at helping military personnel purchase life insurance as well
as other insurance products. In
addition to explanations and tips about buying insurance, the NAIC
military insurance webpage includes information on how to
electronically file a complaint with State insurance departments,
as well as links and contact information for the insurance
department in each State, links to consumer help sites maintained
by the military services and Federal agencies, and links to pending
legislation in Congress. The military assistance webpage is
featured on NAIC's main page at www.naic.org.
Since becoming aware of military sales problems, State
insurance regulators have reached out to the DoD. Diane Koken, the
Pennsylvania Insurance Commissioner and NAIC President, visited
twice this year with DoD leaders to foster a relationship of
ongoing cooperation. The NAIC's efforts include: (1) compiling a
list of insurance department contacts for the DoD to ensure
military officials have proper information for getting State
assistance; (2) updating the NAIC's Complaint Database System form
to identify complaints that are submitted by military personnel;
and (3) providing the DoD with a State-by-State premium volume
summary for those companies that state insurance regulators know
are soliciting or have solicited insurance products on military
bases.
The NAIC believes basic financial literacy training of
military personnel should include assistance information and
contact data for State insurance departments. Many people are not
aware these valuable resources exist to help them at no cost as
part of State government, or that State regulators can help prevent
or resolve insurance problems that occur on military installations
not otherwise under State jurisdiction. We intend to keep working
with DoD to develop training programs and materials that
communicate with military insurance consumers in clear and direct
language which is easily understood.
During 2006, the NAIC's Life Insurance & Annuities (A)
Committee will be reviewing the types of life insurance which has
been sold to military personnel in order to recommend a position on
the products being offered in the marketplace.
Finally, State insurance departments already have strong
prohibitions against misleading and deceptive sales practices, and
will continue to enforce these prohibitions when inappropriate
activity is identified.
The GAO report recommends that Congress direct State regulators to
conduct legal compliance reviews of existing insurance products, and
cooperate with DoD in developing ``suitability'' standards for
insurance products sold to military personnel in the future. The NAIC
does not believe Congress needs to ``direct'' State officials or NAIC
to meet their public responsibilities, especially in view of the strong
actions taken by them in response to problems identified in the media.
While the NAIC will continue to provide full cooperation and technical
assistance to Federal officials, we believe it is appropriately within
the sole domain of DoD to determine what is best for military personnel
since DoD understands and is responsible for the military command
structure and financial benefits that apply to America's men and women
in uniform.
In Order to Better Help Soldiers, State Regulators Need More Help from
DoD
In its report, the GAO noted that DoD should provide State
insurance regulators with complete access to data on complaints by
military personnel, but is reluctant to do so. The NAIC agrees with GAO
regarding the need for State insurance departments to obtain all
complaint information and administrative actions from DoD as early as
possible. Insurance regulators review complaint information and
regulatory actions to identify potential patterns and practices of
conduct that could indicate violations that might not be apparent to
local base commanders. State regulators can take corrective actions
sooner rather than later if timely and complete information is
available for review. We encourage DoD to improve its ability to fully
share information with us for the benefit of military insurance
consumers.
To facilitate State cooperation and information sharing with
military authorities on insurance matters, the NAIC plans to invite DoD
representatives to attend the NAIC's Winter National Meeting, which
will be held in Chicago, Illinois from December 3-6, 2005.
Representatives of the Federal banking agencies already attend NAIC
meetings, and have found it useful as a way of promoting our common
regulatory goals under GLBA. We believe personal interaction between
DoD and State insurance regulators would further enhance our ability to
communicate and protect military personnel from inappropriate sales
practices. The NAIC would also like to extend an offer to develop a
Memorandum of Understanding between DoD and individual State insurance
departments to address any outstanding confidentiality issues
surrounding the sharing of information.
Comments on H.R. 458
H.R. 458, the ``Military Personnel Services Protection Act'',
passed the House of Representatives by a vote of 402-2 on June 28,
2005, and is now pending before the Senate Committee on Banking,
Housing, and Urban Affairs. The NAIC would like to offer these comments
regarding the sections of H.R. 458 that affect State insurance
regulation.
Section 105--This section clarifies the jurisdiction of State
insurance regulators on Federal land and facilities, as well as which
State's law should apply. The NAIC fully supports enactment of this
section.
Section 106--This section expresses a Congressional intent that
States should work cooperatively with DoD to ensure implementation of
appropriate standards to protect armed forces personnel, and
additionally that each State should identify its role in promoting
uniform standards within 12 months. The section also says NAIC should
conduct a study of State compliance and issue a report to Congress.
State regulators and the NAIC are already meeting the intentions
expressed in Section 106 through the enforcement of long-standing State
prohibitions against misleading and deceptive sales practices, and will
continue to do so because we are just as much concerned as Congress
about protecting military personnel. Moreover, the statutory intention
that States spend their time and resources adopting uniform national
standards at the direction of Congress diverts attention and effort
from fixing the real problems that occur in States with major military
bases, while also needlessly undercutting the equal authority of states
as functional regulators of insurance that is mandated in GLBA. As a
practical matter, State regulators and NAIC are effectively working
together and cooperating with DoD at the present time. Consequently,
the NAIC recommends that Section 106 be deleted from H.R. 458 because
it is unnecessary and counterproductive to enhancing the authority of
State insurance regulators set forth in GLBA and other parts of H.R.
458.
Section 107--This section provides that insurers and producers
shall not sell life insurance products to members of the armed forces
without proper disclosures. It also provides that States will be
involved in enforcing these disclosure requirements. The NAIC fully
supports the disclosure and enforcement provisions in Section 107.
Section 108--This section expresses a Congressional intent that
NAIC should consult with DoD and submit a report to Congress within 12
months on ways of improving the quality and sales of insurance on
military installations. If NAIC does not submit a report, the GAO is
directed to do it. The NAIC has always cooperated fully with requests
of Congress and GAO for information and assistance. There is no need
for the statutory directive to NAIC in Section 108, since a simple
request is sufficient to produce the desired results. The NAIC
recommends deleting any statutory inference which infers that NAIC
might not meet a Congressional request for information and assistance
on military insurance issues.
Section 109--This section requires that insurers operating on
military bases implement a system to check and report to State
officials regarding disciplinary actions against producers representing
the insurer, and that States set up a collective system to receive such
reports. There is also an expression of Congressional intent that
States achieve this goal within 2 years. The NAIC supports the goals of
this section, but questions whether a Federal statutory directive to
States is needed to achieve the desired results.
Section 111--This section expresses a Congressional intent that
State agencies provide advice to Federal entities regarding insurance
coverage issues. The NAIC is already meeting this goal, and will
continue to do so.
Conclusion
All of us share a commitment to assuring that America's armed
forces personnel receive fair treatment, solid advice, and strong
consumer protections with respect to the insurance products they
purchase. State insurance regulators and NAIC are meeting that
commitment with effective outreach to the military, useful educational
resources, and active enforcement of State laws to protect military
insurance consumers. We look forward to continuing our efforts, and to
working more closely with Congress and DoD to make the consumer
protection system meet the high expectations which military personnel
rightly deserve.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SARBANES
FROM MARY SCHAPIRO
Q.1. Did the National Association of Securities Dealers
encounter a lack of cooperation from the Air Force or the
Department of Defense during the NASD investigation of First
Command Financial Planning, Inc.?
A.1. NASD did not encounter a lack of cooperation from the Air
Force or the Department of Defense during the investigation of
First Command Financial Planning, Inc. However, we were
informed by a JAG officer working in the Air Force headquarters
for legal assistance that, because of Air Force regulations, he
could not give us information about complaints that had been
filed with Air Force legal offices without specific individual
client consent. While he also informed us that he encouraged
individuals with complaints to contact NASD, the staff did not
receive any complaints.
Q.2. The GAO reported that ``contractual plans have been
periodically involved in sales scandals for decade.'' Why did
misconduct in sales of this type of product persist ``for
decades?'' As a result of the recent occurrences, what have the
regulators learned?
A.2. As noted in the statement that NASD submitted, we agree
that the excessive sales charges of these contractual-based
financial products make them susceptible to abusive and
misleading sales practices. NASD supports legislation that
would ban sales of these products. NASD rules preclude
brokerage firms from charging customers sales loads at this
level for ordinary mutual funds, and absent specific
legislative authorization of this product's sales charges, NASD
members would not be permitted to sell any financial product
with 50 percent first year sales charges. Section 27 of the
Investment Company Act of 1940 permits contractual plans to
impose huge front-end sales loads, which naturally leads to
sales practice abuses. While this authority does not limit
NASD's obligation to examine broker-dealers that sell
contractual plans, eliminating the potential for huge front-end
loads by amending Section 27 of the 1940 Act would also lead to
fewer abuses related to the sales of these plans.
Q.3. The GAO report states that ``although sales of securities
products are covered by suitability standards, securities
regulators also rely on receiving complaints to initiate
actions and were, therefore, not generally aware of problems
involving military members and contractual plans until press
reports appeared.'' Do you agree with this conclusion? What
means other than investor complaints enable the regulators to
identify sales practice abuses?
A.3. NASD agrees that customer complaints are a significant
source of information alerting regulators to potential problems
in the sale of investment products. We are also alerted to
sales practice abuses through NASD's periodic brokerage firm
examinations, focused sweep examinations, filings required to
be made by brokerage firms (for example, when the firm
terminates a registered representative for cause), discussions
with industry representatives through NASD Board standing
committees, conferences, and other channels, press reports, and
anonymous tips. In addition, NASD focuses resources on
monitoring industry trends and seeking out problematic areas
likely to occur.
Q.4. The NASD, in a press release dated December 15, 2004,
announced the settlement of disciplinary proceedings against a
major seller of periodic payment contracts to military
personnel that was ``[u]sing misleading sales scripts,
inappropriate comparisons and omissions if important
information.'' The NASD's long-standing rule on ``Communication
with the Public'' requires broker-dealers to file certain
advertisements and sales literature concerning registered
investment companies'' with NASD ``within 10 business days of
first use of publication.''
Please describe the NASD's process of reviewing the
advertisements and sales materials used by brokerage firms. In
light of recent public concern about sales practices involving
the systematic investment plans, has the NASD reviewed or
modified the standards it uses to review advertising and sales
materials?
A.4. Over the past 4 years, NASD has reviewed in excess of
350,000 \1\ brokerage advertisements and other items of sales
material. NASD conducts these reviews through several different
programs involving staff in its Advertising Regulation
Department as well as the District Offices and the Department
of Enforcement.
---------------------------------------------------------------------------
\1\ Year by year, NASD reviewed the following:
Year--Communications Reviewed: 2005--89,653; 2004--88,301; 2003--
85,735; 2002--87,855.
---------------------------------------------------------------------------
Filings
NASD reviews the largest volume of brokerage firm
advertisements and other sales material through routine filings
made with the Advertising Regulation Department (the
Department). As noted in the inquiry, brokerage firms file
certain communications with the Department pursuant to rule
requirements. The majority of material filed concerns
registered investment company securities including mutual
funds, variable annuities, variable life insurance, and unit
investment trusts. Historically, communications about
systematic investment plans reflect a very tiny subset of the
investment company communications reviewed. In the past year,
since the disciplinary proceeding referenced in the inquiry,
this volume has declined further.
When a brokerage firm files an advertisement or other
communication with the Department, the analyst assigned to the
specific firm conducts a review for compliance with NASD rules
as well as applicable SEC, MSRB, and SIPC standards. These
reviews reflect the staff's analysis of the given communication
based on the information available to the staff member at the
time of the review. For example, it is expressly assumed that
members' submissions are complete and accurate.
In response to each filing, staff provides the brokerage
firm with an advisory review in the form of a written letter.
When the staff observes substantive rule violations, it will
refer them for further investigation and potential disciplinary
action.
Investigations
Department staff also reviews materials submitted by third
parties as a complaint or inquiry. For example, NASD District
Office or Enforcement Department staff will uncover
advertisements in connection with their examinations of
brokerage firms. Where they detect problematic or questionable
material, they will refer those items to Department staff for
review and appropriate action. Generally, the Department staff
will work with the referring office in resolving any rule
violations observed in connection with an ongoing examination.
For example, Department staff will provide ongoing analysis and
support to the Enforcement Department as it pursues a formal
disciplinary action against a given brokerage firm.
The Department also receives referrals from brokerage firms
that are in competition with the firm that has used a given
communication. Regulators at the Federal or State level may
also refer items to the Department as will the occasional
investor. The Department reviews every advertisement or other
item of sales literature for compliance with applicable NASD,
SEC, MSRB, and SIPC rules. If there are rule violations
indicated, staff will contact the brokerage firm with
commentary on the relative compliance of the subject
advertisement and will provide a recommended course of action,
for example, advise the firm to stop using a given
advertisement completely or advise the firm to correct an
advertisement before it is used further. The Department will
obtain a written response from the brokerage firm as to its
course of action, the origins of the problem advertisement and
its immediate impact on the public. Depending on the rule
violations and their scope, the Department may determine no
further action is required, issue an informal disciplinary
action against the firm, or refer the matter to the
Enforcement Department requesting that the staff pursue formal
disciplinary action.
Sweeps
Department staff conduct sweep reviews of brokerage firms'
advertising and other sales material. The staff will contact a
group of member firms to request specific types of
communications that are not normally filed and may reflect an
area of current regulatory interest for NASD. For example,
recent sweeps have focused on communications about equity-
indexed annuities, research reports, and hedge funds.
The Department reviews any sales communications provided in
response to the sweep request and provides written commentary
to the brokerage firm on items that fail to comply with
applicable rules. As with investigations, the Department staff
will request information in response to its comment letter and,
upon receipt of such information, make a determination as to
whether to close the matter or pursue disciplinary action from
the sweep.
Standards NASD Uses to Review Systematic Investment
Plan Communications
NASD continuously seeks to update and improve the standards
it applies to members' communications. For example, NASD has
recently proposed amendments to the rules governing advertising
to require firms to file prior to use all television, radio,
and video advertisements that are 15 seconds or longer as well
as advertisements concerning new products.\2\ Similarly, NASD
has also proposed stricter standards for the internal review
and approval of correspondence (for example, letters, e-mail,
and instant messages) with existing retail customers. \3\
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\2\ See Notice to Members 05-25, copy attached.
\3\ See Notice to Members 05-27, copy attached.
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The standards implicated in the disciplinary proceeding
noted above were some of the most fundamental applicable to
brokerage firm communications, that is, the prohibition on
misleading statements, the requirement that members'
communications be fair, balanced, and complete, and the
requirement that comparisons include all relevant material
differences between the subjects of the comparison.\4\
Accordingly, NASD appears to have sufficient standards in place
to pursue rule violations in this area going forward. In
addition, should Congress adopt the proposed ban on systematic
investment plans advocated by NASD, there would be even less
need to adopt specialized rules.
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\4\ NASD Rule 2210(d)(1) states, in part:
(A) All member communications with the public shall be based on
principles of fair dealing and good faith, must be fair and balanced,
and must provide a sound basis for evaluating the facts in regard to
any particular security or type of security, industry, or service. No
member may omit any material fact or qualification if the omission, in
the light of the context of the material presented, would cause the
communications to be misleading.
(B) No member may make any false, exaggerated, unwarranted, or
misleading statement or claim in any communication with the public. No
member may publish, circulate, or distribute any public communication
that the member knows or has reason to know contains any untrue
statement of a material fact or is otherwise false or misleading.
Further, NASD Rule 2210(d)(2)(B) states ``Any comparison in
advertisements or sales literature between investments or services must
disclose all material differences between them, including (as
applicable) investment objectives, costs and expenses, liquidity,
safety, guarantees or insurance, fluctuation of principal or return,
and tax features.''
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RESPONSE TO A WRITTEN QUESTION OF SENATOR SARBANES
FROM JOHN OXENDINE
Q.1. GAO notes that many States lack appropriateness or
suitability standards for sales of insurance products to
military members, so that investigators must prove that
companies are misrepresenting products, which is difficult to
do. Does the NAIC support GAO's recommendation that
appropriateness or suitability standards for sales of insurance
products to military personnel be developed? If not, why not?
A.1. In 2000, the NAIC adopted the white paper, ``Suitability
of Sales of Life Insurance & Annuities,'' which recommends that
rules be developed requiring that suitability be determined by
the producer and carrier in the sale of nonregistered life
insurance and annuity products. While the NAIC agreed in
concept that the development of suitability standards is
necessary, the implementation of suitability standards is more
difficult. Because of this, the NAIC first focused on the
development of standards for seniors, which is the segment of
the marketplace in which significant problems were identified.
The NAIC membership adopted the Senior Protection in Annuity
Transactions Model Regulation model in 2003. Today,
approximately one-third of the States have some form of
suitability standards that apply to seniors or the broader
marketplace.
In testimony to Congress in November of 2005 the NAIC
recognized the Department of Defense (DoD) is in the best
position to know the needs of military personnel and pledged
its full cooperation and technical support to the DoD in
meeting the needs of military personnel. In addition, the
NAIC's Life Insurance & Annuities (A) Committee has the
following charge for 2006: Review life insurance sold with a
side fund to recommend a position on the products being offered
in the marketplace. Life insurance with a side fund is the
predominate life insurance product being sold to the military
today.
In early February 2006, the NAIC will hold its annual
commissioners conference to discuss critical issues facing
State insurance regulators in 2006 and to set the NAIC's
strategic plan for 2006. The NAIC will discuss the development
of suitability standards for life insurance products sold to
military personnel during this conference and will provide
additional comment on future NAIC activity after this
conference.