When is a structured settlement annuity appropriate for a specific physical personal injury claimant? And what standards exist to help judges, guardians, trustees, mediators, attorneys, settlement planners, structured settlement consultants and other structured settlement stakeholders make this determination?
In two prior blog posts, S2KM has addressed these issues in the context of:
- Part 1 - NSSTA's Code of Ethics; SSP's Standards of Professional Conduct; and the NAIC's Suitability in Annuity Transactions Model Regulation.
- Part 2 - Minors' statutes and state structured settlement protection statutes.
This blog post discusses product suitability standards created by the Uniform Prudent Investor Act (UPIA) and the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) and highlights a general trend to create a more uniform fiduciary, and/or "best interest", standard of care to protect investors.
UPIA
When investing and managing assets (including settlement proceeds and structured settlement annuity payments), trustees historically have been held to a fiduciary standard. According to uslegal.com, "[A] fiduciary duty is an obligation to act in the best interest of another party..... A person acting in a fiduciary capacity is held to a high standard of honesty and full disclosure in regard to the client and must not obtain a personal benefit at the expense of the client." (emphasis added)
More recently and comprehensively, a trustee's investment responsibilities have been re-defined legislatively by the UPIA which was adopted by the National Conference of Commissioners on Uniform State Laws (NCCUSL) in 1994 and approved by the American Bar Association in 1995. The UPIA now serves as the most important reference, external to the trust document itself, for trustees to determine what fiduciary duties their position requires. With some state-specific modifications, 41 states, U.S. Virgin Island, and the District of Columbia have adopted the UPIA.
Prior to the UPIA, courts applied the "prudent man rule" when evaluating trustee investment performance. The prudent man rule required trustees “to observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering probable income, as well as the probable safety of the capital to be invested.”
The UPIA, by contrast, adopts "modern portfolio theory" as a different and more appropriate standard for trustees. Compared with the prudent man rule, modern portfolio theory promotes a holistic view of trust assets by focusing on the total return generated by a trust as opposed to viewing a trust's income and principal separately. By viewing all investments comprehensively, modern portfolio theory and the UPIA hold that a trustee (or other investor) can achieve a positive overall investment return despite the poor performance of specific investments. This new standard allows for greater investment diversification so long as the risk/reward ratio matches the purposes and terms of the trust instrument.
Section 2(c) of the UPIA identifies eight factors a trustee should consider when making any investment:
- General economic conditions;
- The possible effect of inflation or deflation;
- The expected tax consequences of investment decisions or strategies;
- The role that each investment or course of action plays within the overall trust portfolio;
- The expected total return from income and appreciation of capital;
- Other resources of the beneficiaries;
- Needs for liquidity, regularity of income, and preservation or appreciation of capital; and
- An asset’s relationship of special value, if any, to the purposes of the trust or to one or more of the beneficiaries.
Significant for structured settlement annuities, the UPIA's list of investment considerations fails to mention mental or physical disabilities of a trust beneficiary. From a settlement planning and/or special needs perspective, injuries or diseases that reduce an individual's normal life expectancy arguably should receive important consideration when a trustee makes investment decisions.
Dodd-Frank
President Obama signed Dodd-Frank into law on July 21, 2010. Among other reforms, this sweeping legislation created the Consumer Financial Protection Bureau (CFPB) and the Federal Insurance Office (FIO). CFPB's central mission is "to make markets for consumer financial products and services work for Americans ....." Among its core functions are addressing consumer complaints and restricting unfair, deceptive or abusive acts or practices under the Federal consumer financial laws. Dodd-Frank provides the CFPB with significant authority that goes beyond existing consumer protection statutes. CFPB has broad authority to ask questions and demand information including consumer complaints. The FIO is part of the U.S. Department of Treasury and has authority to monitor all aspects of the insurance industry.
In addition to creating the CFPB and the FIO, Dodd-Frank directed the Securities and Exchange Commission (SEC) to study the need for a new, uniform, federal fiduciary standard of care for broker-dealers and investment advisers and to apply such a uniform standard if it deemed necessary. The SEC's assignment also required determining the existence of any gaps, shortcomings, or overlaps in legal or regulatory standards for the protection of retail customers.
Historically, investment advisers and broker-dealers have been subject to differing standards of care. Investment advisers are defined under Federal law as persons who “engage in the business of advising others. . .as to the value of securities or as to the advisability of investing in, purchasing, or selling securities. . .” [15 U.S.C. § 80b-2] They are regulated under the Investment Advisers Act of 1940 and owe a fiduciary duty to their clients.
Broker-dealers are defined under Federal law as persons who engage in “the business of offering, buying, selling, or otherwise dealing or trading in securities. . .” [15 U.S.C. § 78b(12)] and may provide a variety of related services. Broker-dealers generally are not subject to any fiduciary duty under the federal securities laws. They do, however, have a duty of fair dealing which includes a “suitability” standard - i.e. broker-dealers must make recommendations that are consistent with the interests of their customers.
Adding further uncertainty for investors, the existing legislative and regulatory system, according to the Securities Industry and Financial Markets Association (SIFMA), also "leaves states free to develop their own often conflicting definitions of fiduciary standards. This can confuse investors and lead to inconsistent definitions and interpretations under existing state law." SIFMA has recommended adoption of a uniform definition of "fiduciary duty" applicable to broker-dealers and investment advisers that includes both a duty of care and a duty of loyalty. These duties, according to SIFMA, should require both broker-dealers and investment advisers "to act in the best interest of the customer, and to provide full and fair disclosure of material facts and conflicts of interest."
In January 2011, the SEC submitted its "fiduciary standard" study to Congress recommending the adoption of a uniform fiduciary standard for investment advisers and broker-dealers when providing investment advice to retail customers. The SEC's proposed standard would be “no less stringent” than the standard currently applicable to investment advisers, and would include the duty to act in the "best interest" of the customer.
Structured Settlement Annuities
Why are the UPIA and Dodd-Frank relevant and important for structured settlement stakeholders?
- Structured settlement annuities increasingly are paid into trusts (UPIA) that also include financial securities (Dodd-Frank).
- Settlement planners, as opposed to traditional structured settlement sales persons, are increasingly licensed to sell financial securities as well as insurance products.
- The UPIA (settlement trustees) and Dodd-Frank (financial planners; investment advisers; broker-dealers) directly impact structured settlement competitors.
- To be successful in the changing financial and insurance environment, anyone selling structured settlement annuities must understand and compete against the highest product suitability standards and best business practices.
Given the diversity, uncertainty and transition of various product suitability standards, how should structured settlement stakeholders address the issue of whether a structured settlement is appropriate for individual physical personal injury claimants? S2KM will offer practical case-specific advice and strategic industry advice in its next blog post.
For additional information about structured settlement business standards and practices, see the structured settlement wiki and Section 6.02 of "Structured Settlements and Periodic Payment Judgments" (S2P2J).
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