Court Reverses Illinois Department of Securities’ Administrative Order Revoking Investment Adviser’s Registration

On July 29, 2016, the Appellate Court of Illinois entered a decision reversing a circuit court decision that affirmed an administrative order of the Illinois Secretary of State (“Secretary”) finding that Richard Lee Van Dyke, a registered investment adviser with the Illinois Department of Securities (“Department”), had defrauded clients by recommending the sale of indexed annuities in violation of Illinois law.

Section 2.1 of the Illinois Securities Law of 1953 (“Act”) provides that the term “security” is defined to include a “face amount certificate.”  Section 2.14 of the Act further defines a “face amount certificate” to include “any form of annuity contract (other than an annuity contract issued by a life insurance company authorized to transact business in this State)”.  However, Section 12(J) of the Act prohibits fraudulent or manipulative conduct as an investment adviser regardless of whether the investment adviser sells securities.  The Van Dyke case is perhaps most notable for its rejection of the circuit court’s conclusion that Van Dyke’s practices were fraudulent.

In this case, Van Dyke, doing business as Dick Van Dyke Registered Investment Adviser, was registered with the Department as an investment adviser, subject to regulation under the Act.  He was also licensed by the Illinois Department of Insurance as an insurance producer, subject to regulation by the Department of Insurance under the Illinois Insurance Code.  In March 2013, the Secretary filed a notice of hearing alleging that Van Dyke had recommended and sold 31 transactions that resulted in the early surrender of indexed annuities in order to purchase new indexed annuities.  Indexed annuities offer, in addition to a minimum annual return, a potential return on the account value that is linked through a formula to the performance of one or more selected stock market indexes.  The notice also alleged that Van Dyke received $160,937.05 in commissions while his clients, all senior citizens, lost $262,822.13.  Finally, the notice alleged that Van Dyke had sold the surrendered indexed annuities in all but one transaction and received $155,341.51 in commissions.

Van Dyke filed a motion to dismiss alleging that the Department had no jurisdiction because section 2.14 of the Act excluded indexed annuities from the Act’s definition of “security” and because he did not act as an investment adviser.  The Appellate Court reversed the administrative order’s determination that the indexed annuities were securities because they were issued by insurance companies, which fit the exception under section 2.14.  Given the language of the Illinois statute, that conclusion is not particularly unsurprising.  However, the court also determined that Van Dyke did act as an investment adviser because he was a registered investment adviser under the Act at all times, and he held himself out to clients as a registered investment adviser, “Certified Senior Adviser,” and “nationally recognized retirement educator.”  Thus, he was subject to the Act’s antifraud provisions.

Van Dyke’s motion to dismiss also alleged that the Department failed to prove fraud and acted arbitrarily. Illinois law provides that in determining whether an administrative decision should be overturned, it must be demonstrated that “the agency exercised its authority in an arbitrary or capricious manner or the decision is contrary to the manifest weight of the evidence.”  Springwood Associates v. Health Facilities Planning Board, 269 Ill. App. 3d 944, 947, 646 N.E.2d 1374, 1375 (1995). The court determined that the Secretary, in its administrative order, did not set forth any applicable rules or written criteria to evaluate insurance annuities that would indicate its expertise in that area.  The Secretary identified section 130.853 of title 14 of the Illinois Administrative Code as a standard for recommendations by insurers or insurance producers, but section 130.853 had nothing to do with an insurance producer selling an annuity to an insurance client.  Instead, that section provides that:

“Effecting or causing to be effected by or for any client’s account, any transaction or purchase or sale which are excessive in size or frequency or unsuitable in view of the financial resources and character of the account, shall constitute an act, practice, or course of business on the part of the registered investment adviser or its representative effecting such transactions or causing the transactions to be effected that is fraudulent, deceptive, or manipulative.”

The language of section 130.853 makes clear that it covers management of accounts rather than facilitation of the sale of insurance contracts, as Van Dyke was doing.

Moreover, the Department’s securities enforcement director and a Department consultant admitted that they neither performed nor were asked to perform the individualized suitability requirements for the replacement of indexed annuities.  They each admitted that they did not carefully consider the features in the current annuity contracts versus the features in the potential replacement contracts.  For these reasons, the court found that the evidence presented failed to establish that Van Dyke perpetuated a fraud and reversed the Secretary’s final order.

The Van Dyke case addresses sales practices that many courts and administrators would consider to be fraudulent or misleading.  These include the fact that surrender penalty charges ranging from $2,078.39 to $21,291.66 were imposed because five contracts had eight years remaining until they could be surrendered without penalty and 20 contracts had seven years remaining.  There was also the fact that six surrendered contracts had bonus recapture fees ranging from $2,232.01 to $8,940.48.   It was also known that 29 of the surrendered annuity contracts had positive market value adjustments and that the contract value for the 30 surrendered indexed annuities totaled $2,327,904.95, but the final amount credited to the 21 clients was only $2,246,897.59.  It was also found that eleven of the 30 surrendered annuities resulted in eight clients having taxable income reported, and the hearing officer found that all but one of the 33 new indexed annuities featured higher fees and the start of new surrender penalty periods.  Four of the new contracts required the owners to wait 15 years before having access to the full bonus value upon surrender, seven had to wait 12 years, 14 had to wait 10 years, and four had to wait six years.  That the Illinois court did not find these facts sufficient to support a finding of violation of the state’s anti-fraud provision is remarkable in light of industry standards and norms, including analogous FINRA rules governing sales of such products by registered representatives.  Key to the court’s finding, however, was the absence of any individualized analysis by any of the Department’s witnesses.

Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others.  Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including compliance with federal and state laws and rules.  Please visit our website for more information.

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