The nascent secondary market for annuities and their guaranteed benefits could be stunted as the result of a vote last week by state insurance regulators to allow carriers to terminate the annuity benefits if a client sells the contract.

Last Monday, the Interstate Insurance Product Regulation Commission, composed of the insurance regulators from 35 states and Puerto Rico, voted in favor of a uniform provision that would allow insurance carriers to terminate at their discretion guaranteed living and death benefits in the event of a change in ownership or assignment.

Indiana was the sole dissenter among the represented jurisdictions.

The vote could make it harder for clients to sell annuities to others, which could limit the attractiveness of the market.

The commission will officially announce the provision this week, and it will likely become effective by the end of May, according to executive director Karen Schutter.

The commission applies uniform structural standards to life insurance policies and annuities sold in the member jurisdictions.

The reasoning behind the commission’s decision, members have said, was concern over the price of the products and the potential for controversial stranger-originated transactions.

The approval of the provision has already struck a nerve with the National Conference of Insurance Legislators. That group’s president, Robert R. Damron, a member of the Kentucky House of Representatives, has since proposed legislation in the state’s General Assembly to exclude the Bluegrass State from having to comply with the commission’s decision.

Although life settlements, which are a secondary market for insurance, and the secondary market for annuities aren’t the same, they share some commonalities. The Life Insurance Settlement Association was in communication with the commission on the proposed provisions, opposing their passage.

Experts in the life settlements field have a hard time determining the exact size of the secondary market for annuities but estimate that it is much smaller than the life settlements market. Last year, life insurance policies with some $8 billion in death benefits were settled, according to estimates from Aite Group LLC.

“We want to preserve consumers’ ability to [sell their products in the secondary market] if their products don’t perform,” said Brian Staples, president of Right LLC, a regulatory-compliance consulting firm that specializes in life settlements.

“We know that there are annuity products that aren’t performing as they were sold,” he said. “We know that there are consumers whose circumstances have changed because of the crisis.”

Some of the better-known players in the small annuity-purchasing business are J.G. Wentworth Inc.and Peach-tree Financial Solutions.

Other companies think that there is a potential for growth when it comes to buying underwater variable annuities from clients who don’t want them.

“Consumers own valuable variable annuity contracts now, and their death benefits are very high,” said an executive at a firm that has been aggregating variable annuities. The executive asked that neither he nor his firm be identified because the company is approaching broker-dealers in the hope of giving firms an option when clients want to sell an annuity.

ADDITIONAL OPTIONS

Advisers and consumer advocates assert that annuity holders could benefit from the existence and growth of such a market.

“I’ve had clients who could have benefited from the legitimate sale of their variable annuity in the secondary market,” said Joy Slabaugh, partner at EST Financial Group. She declined to disclose the amount of assets the firm has under management.

In one situation, a client wanted to surrender his variable annuity because he had a large purchase in mind — a helicopter. Despite Ms. Slabaugh’s attempt to dissuade the client from cashing in the annuity, the client surrendered the product and got his cash.

“There are times like this when a person’s objective changes and the investment that was suitable a few years ago is no longer suitable,” she said.

“The way I see it, there were some riders on this annuity that could’ve been attractive to an institutional investor. Having a secondary market provides more liquidity options,” Ms. Slabaugh said.

Although she has never conducted such a transaction, she noted that her broker-dealer, H. Beck Inc., would call for extensive scrutiny on the sale and questions on the suitability. The firm would most likely have to supervise the business, per the Financial Industry Regulatory Authority Inc.’s rules on how broker-dealers are supposed to approach life settlements with variable insurance products.

The option of turning to the secondary market gives the consumer a chance to bail out if the product was sold inappropriately in the first place, said Birny Birnbaum, executive director of the Center for Economic Justice. He criticized the commission’s decision to push forward with the provision to allow insurers to terminate guaranteed living and death benefits.

“We don’t have effective suitability requirements, so when customers are sold inappropriate annuities, insurers have a monopoly on what you can do,” Mr. Birnbaum said. “This is the life insurance industry getting the government to shield them from competition, so the customer suffers as a result.”

In light of recent news reports on the controversial third-party sales of annuities on sick people so that investors can reap the death benefit and make aggressive investment plays, insurers have raised concerns that a secondary market could encourage stranger-originated-annuity sales.

“Without the ability to terminate riders, there’s a market for [stranger-originated life insurance] with guarantees, which would be detrimental to the genuine consumer’s interest,” Michael Lovendusky, vice president and associate general counsel of the American Council of Life Insurers, said during the conference call.

Mr. Staples argued that it is inaccurate to equate improperly written insurance products with the nature of the overall secondary market.

“The secondary market has been supportive of enforcing insurable interest; we don’t want improper annuities, because they taint the marketplace,” he said.

“Of course there’s concern about stranger-originated annuities, but the response to those types of abuses isn’t to eliminate the market,” Mr. Birnbaum said.

“That’s like saying that there are problems in the secondary-mortgage market, so we should eliminate the market altogether,” he added. “That’s insane.”

E-mail Darla Mercado at dmercado@investmentnews.com.

The Securities and Exchange Commission’s expected move to regulate placement agents as broker-dealers instead of prohibiting investment advisers from using them won’t curb influence-peddling, some critics say.

After facing a storm of industry protest, the SEC is now looking at a regulatory solution to take the place of the ban that it originally proposed.

But “the issue isn’t one of regulating them properly — it’s an issue of [placement agents] selling their influence,” said Mercer Bullard, a former SEC lawyer and founder and president of Fund Democracy Inc., an investor advocacy group.

Even if agents work under the guise of a broker-dealer, the influence-peddling will continue, he said.

The SEC proposed the controversial ban last fall along with limits on how much advisers could give to political candidates and a prohibition on raising money for political parties. Placement agents typically help hedge funds and private-equity managers get business from institutional investors.

The proposal was prompted by a number of scandals involving public pension funds and placement agents, some of whom were politically connected former state officials.

Observers say that many agents aren’t registered as brokers or advisers.

Many large investment firms run their own placement-agent units.

About 400 smaller broker-dealers also work as placement agents, according to Lisa Roth, chief executive of Keystone Capital Corp., and a ban would be a severe hardship for them.

She and other industry observers say that requiring registration would level the playing field — a suggestion that the SEC is considering.

“If broker-dealers were prohibited by [the Financial Industry Regulatory Authority Inc.] from engaging in pay-to-play practices on behalf of investment advisers, then perhaps they could continue … to serve as placement agents,” John Nester, an SEC spokesman, said in a statement.

SEC staff members haven’t yet made a final recommendation to the commission regarding the proposal, he said.

In December, Andrew “Buddy” Donohue, director of the SEC’s Division of Investment Management, asked Finra to consider implementing pay-to-play rules for broker-dealers who work with advisers.

Finra spokesman Herb Perone said that the request is “under discussion.”

Many of the several hundred industry members who submitted comments to the SEC on the proposal suggested that placement agents should be registered and regulated rather than banned.

They argued that placement agents provide valuable services to pension plans and give smaller managers a chance to gain business from large pools of money.

“The ones hurt [by a ban would be] small, emerging managers, minorities and women-owned firms that don’t know how to present themselves to the marketplace,” Ms. Roth said.

Critics of placement agents, though, say that large investment funds shouldn’t have a problem finding smaller, competent managers on their own.

State officials and pension funds also opposed a ban on agents.

In a comment letter, Connecticut Treasurer Denise Nappier said that banning placement agents would deprive “institutional investors of … valuable services” and that “the blanket ban on contributions to political-party committees is fraught with enforcement challenges and unfairly affects party committees in states like Connecticut with … robust campaign-finance laws.”

‘LEGITIMATE PRACTICE’

Sen. Christopher Dodd (D-Conn.), chairman of the Senate Banking Committee, jumped into the fray last month with a comment letter to the SEC reiterating Ms. Nappier’s point that using placement agents is a “legitimate and beneficial business practice.”

“It’s remarkable that someone from Connecticut of all places wouldn’t understand the issue with placement agents,” Mr. Bullard said. “It’s the site of one of the most abusive pay-to-play regimes we’ve seen.”

Connecticut enacted a tough pay-to-play law in 2005 after then-Gov. John Rowland resigned in the midst of a corruption investigation. He later served 10 months in prison.

The state bans lobbyists and prospective state contractors from making campaign contributions to candidates for statewide offices, and requires placement agents to be registered.

A spokeswoman for Ms. Nappier declined to comment.

Public officials and the plans they oversee “have a vested interest” in seeing political contributions continue, said Edward Siedle, founder of Benchmark Financial Services Inc., a consultant to pension plans.

That is why critics say an outright ban is needed.

Placement agents are “basically political insiders, devoid of investment credentials, who are being compensated to sell … unregistered products to funds within a politicized investment process,” Mr. Siedle said.

“The use of placement fees has grown exponentially,” he said, adding that public pension plans have “tripled and quadrupled” the number of money managers they use, and “every one is [paying] a placement fee.”

Although institutional clients generally have a formal bidding and selection process, “you’re much more likely to win a contract if you’ve hired the right people and made political contributions,” Mr. Bullard said.

Getting around consultants and staff designated to review all applicants “is precisely the conduct which is objectionable,” said a comment letter submitted by Common Cause, a good-government group that supports the ban. A call to Common Cause wasn’t returned.

Although Mr. Siedle questions the need for placement agents, he said that a registration requirement would help. “A lot of placement agents would find it very uncomfortable to operate under the level of scrutiny that a broker does,” he said.

Many placement agents are former elected officials, lawyers or lobbyists, and “oftentimes, they’re successful because they don’t appear to have a stake in the outcome” of a successful sale, Mr. Siedle said.

Disclosure requirements and other rules would make it clear to investors that agents are operating on behalf of the money manager, he added.

E-mail Dan Jamieson at djamieson@investmentnews.com.

Clyde Wyatt managed his father’s money for about 18 months before he was abruptly dumped for another adviser: His own son Chris.

“One day my father was asking some questions about investment options for some maturing certificates of deposit while my son was with me,” recalled Mr. Wyatt, managing director of Navigation Financial Group, which manages $900 million in assets. “From that moment, I lost my father as my client and he has been working with my son since. My dad likes having his grandson as his adviser better. There’s no friction.”

Mr. Wyatt’s case shows that a family bond or close friendship doesn’t always translate to a solid client relationship. Since family members and friends can often demand more from advisers than their regular clients — or overstep the bounds of the business relationship — practice management experts agree there are some simple rules to consider when deciding whether to take them on as clients.

First, advisers need to keep their personal relationships and business relationships separate and clearly explain the limits to clients.

For example, advisers should make a rule that they won’t answer business calls on weekends or after hours unless it’s an emergency. They also should refuse to discuss investments or financial planning at social events or parties.

Of course, that’s easier said than done. Roger Streit, a certified financial planner of Key Financial Solutions LLC, which manages $10 million in assets, said he once made an exception in his rule not to take on family members or friends as clients. It was a disaster.

“I received phone calls at night and on weekends that were part social and part business,” he said. “I thought this person was imposing on me and a normal client wouldn’t do this. The business relationship ruined the personal relationship.”

Lauren Klein, an adviser whose firm, Klein Financial Advisors, has $25 million in assets under management, agreed that separating the personal from the business relationship can be dicey. “As an adviser you may think the new kitchen was a bad idea, but as a friend you think it’s just a beautiful kitchen.”

Another key recommendation: Clearly outline fees, and make sure they’re in line with those charged other customers, said Mark Schoenbeck, chief marketing officer and director of practice management for Genworth Financial Wealth Management Inc. Advisers might want to give a discount to relatives, but doing so could trigger a compliance issue, he said. “Regulators do scrutinize why you give these services for this fee.”

Advisers should make sure that the relative or friend fits the firm’s ideal client description, experts say. If an adviser takes on too many friends and relatives that aren’t right for the firm, he or she can end up wasting a lot of time on accounts that aren’t as profitable.

For his part, adviser Mike Foltz, a partner at Balasa Dinverno Foltz LLC, which manages $1.5 billion in assets, has turned down about half a dozen of his relatives because they didn’t meet the firm’s $1 million required minimum. He said, however, that he isn’t opposed to working with relatives or close friends and currently has several relatives as clients.

“You have to keep yourself tight-lipped about your own life,” he said. “You now have family members who are clients and they don’t want to hear anything negative. You have to be tight-lipped about anything that happens in the office.”

If the relative or friend isn’t a good fit with the adviser or the firm, the rep should help them find another planner, said Joni Youngwirth, managing principal of practice management at Commonwealth Financial Network. “I think the adviser has to honestly look within themselves and say, “Am I the right adviser for this family member or friend?’” she said. “The question is: “Would this person be my ideal client if they weren’t family?’”

Perhaps most importantly, advisers must consider the possibility that the business relationship could end up damaging the personal tie. Adviser Fred Amrein said he’s aware that most of his peers manage money for their relatives, but he’s decided to steer clear of such relationships at Amrein Financial, which manages $12 million in assets.

“It’s a conscious decision I made,” he said. “Money makes people change. Family relationships are important to me. If something goes wrong, I don’t want that risk and that tension in the family.”

Indeed, working with a relative can often end badly. In January, a woman and her husband won a $608,000 arbitration decision against their adviser — her brother — and his firm in a case that involved stock churning in the weeks leading up to the 2008 market collapse.

Three Financial Industry Regulatory Authority Inc. arbitrators awarded investors Diana Hojecki and her husband, James, $343,000 in compensatory damages, $15,000 in fees and $250,000 in punitive damages.

Also in January, Bradley Ruderman, the founder and manager of two Beverly Hills, Calif., hedge funds, was sentenced to more than 10 years in prison for cheating investors, including many family members, out of more than $25 million.

But despite the many challenges and potential drawbacks, many advisers say working with relatives is an important part of their business.

Thomas Muldowney of Savant Capital Management Inc. with $1.5 billion in assets, said a majority of the firm’s 60 advisers have family members as clients. He, for example, has counted his sister, Joyce Erb, as a client for the past 20 years. Now, his daughter, Libby Samuelson, a client services representative at the firm, also works with Ms. Erb.

Mr. Muldowney likes having family as clients. “They ask fewer questions,” he said.

James Barnash, a consultant with Stride Consulting Inc., which works with about 35 advisory firms, said he recommends that advisers aim to work with their close friends and relatives, despite the dangers.

“In the back of my mind, whenever someone says, “I don’t want to work with my family and friends,’ I think there’s obviously something in your relationship that I don’t understand. I would think family and friends would line up at the door.”

E-mail Lisa Shidler at lshidler@investmentnews.com.

Facing intense pressure from securities regulators and investors, Morgan Keegan & Co. Inc.’s legal fees have skyrocketed during the past two years to $251 million, leaving some industry observers shocked.

The firm’s legal costs are largely the result of defending itself from investor claims stemming from poorly performing bond funds that held toxic mortgage-backed securities.

Legal expenses accounted for 12% of the firm’s total revenue in 2009, versus 6% a year earlier.

In all, Morgan Keegan had revenue of $1.28 billion last year and spent $161 million in “professional and legal fees.” In 2008, it spent $90 million on such fees and reported $1.34 billion in revenue.

The legal expenses were reported last Tuesday in the annual report of Regions Financial Corp., which owns Morgan Keegan.

“It makes you wonder who in the world was calling the shots” at the firm regarding its legal strategy, said Dale Ledbetter, a plaintiff’s attorney with about 75 investor arbitration claims against Morgan Keegan.

“They haven’t yet fought class-action suits, the states and the SEC,” he said. “It’s absolutely staggering.”

The firm will continue to rack up significant legal expenses, industry observers said.

Morgan Keegan is “potentially on the hook for tens of millions of dollars, if not more,” said Andrew Stoltmann, another plaintiff’s lawyer. He has about 15 clients suing Morgan Keegan.

A spokesman for Regions Financial, Tim Deighton, said that the firm wouldn’t comment beyond what was reported in the filing.

Meanwhile, securities regulators are hammering away at the firm.

Last summer, both the Securities and Exchange Commission and the Financial Industry Regulatory Authority Inc. issued Wells notices to Morgan Keegan, a preliminary step in taking disciplinary action against a broker-dealer.

The potential actions relate to the bond funds, Regions Financial stated. The SEC has also filed a Wells notice over the firm’s sale of auction rate securities.

With the fallout still coming from the historic market drop, other broker-dealers face rising legal costs. However, they may not be as stark as those of Morgan Keegan.

In November, Raymond James Financial Inc. said in its annual report for fiscal 2009 that the provision for loan losses, legal proceedings, bad debts and other accruals was $186.4 million. That compared with a $68.8 million provision in fiscal 2008 for the same items.

In its various operations, Raymond James has about four times as many brokers and advisers as Morgan Keegan, which had 1,267 brokers in 324 offices at the end of last year.

MORE CLAIMS

Plaintiff’s attorneys say that Morgan Keegan faces hundreds more arbitration claims from investors who bought the company’s bond funds and watched as the funds lost as much as 95% of their value.

In January alone, Morgan Keegan lost separate claims with awards of $2.5 million and $1.1 million.

Although some high-profile investors such as ex-NBA All-Star Horace Grant have won significant awards in arbitration, Morgan Keegan has also scored significant wins. In November, an $8.2 million investor complaint that alleged unsuitability and breach of fiduciary duty related to the firm’s bond funds was denied.

E-mail Bruce Kelly at bkelly@investmentnews.com.

Senate Banking Committee Chairman Christopher Dodd, D-Conn., is expected to introduce new financial reform legislation this week that excludes applying a fiduciary standard to brokers offering investment advice.

The provision was circulated three weeks ago by Sen. Tim Johnson, D-S.D., a Banking Committee member. Rather than classifying certain brokers as registered investment advisers, his proposal would require the Securities and Exchange Commission to conduct a study of regulatory standards for brokers and advisers, and then propose rules on the issue.

Scrapping the fiduciary requirement will only hurt investors, said Knut A. Rostad, chairman of The Committee for the Fiduciary Standard, a group formed last year to promote higher standards for financial advisers.

“Studying this issue is a straw man,” Mr. Rostad said. “There has been so much study that has been done over the past 15 years that the SEC has become a think tank on the issue of fiduciary issues, but the industry needs to explain why these investor protections should not be afforded to their customers.”

Kirsten Brost, a spokeswoman for the Senate Banking Committee, didn’t return calls seeking comment.

E-mail Jessica Toonkel Marquez at jmarquez@investmentnews.com.

Upper-income investors are taking advantage of a change in the tax law and rushing to convert their traditional individual retirement accounts or old 401(k) plans into Roth IRAs, according to an informal survey of investment companies.

New rules took effect Jan. 1 that allow those who earn more than $100,000 annually to convert to Roth IRAs. Previously, only people who earned less than that amount could convert.

As a result of this expansion of eligibility, investment companies have been doing a huge amount of business.

The Vanguard Group Inc. converted almost 30,000 traditional IRAs into Roth IRAs in January alone — nearly 70% of its 2009 totals.

Vanguard typically converts about 1.5% of its accounts per year and expects the conversion rate to increase to between 4.5% and 5% in 2010, Amy Chan, a company spokeswoman, wrote in an e-mail.

“We are averaging between 400 and 800 calls per day in 2010 on Roth conversions — about 30% of our daily complex retirement call volume,” she wrote.

Fidelity Investments handled 22,000 Roth IRA conversions in January, about four times the number of such conversions a year earlier.

T. Rowe Price Group Inc. conducted more than 4.5 times as many Roth IRA conversions in January than it did in in January 2009, though the firm declined to provide specific numbers.

And registered representatives at Raymond James Financial Inc. made 1,459 such conversions in January, up from 666 in January 2009. For the year, the firm saw a total of 4,138.

“There’s no doubt about it,” said Russ Shipman, senior vice president and managing director of the retirement strategy unit at Janus Capital Group Inc. “There’s a groundswell of interest.”

Janus hasn’t yet crunched its numbers, but Mr. Shipman said that his conversations with intermediaries suggest that interest will only grow.

“I think the general sense is, this thing will really pick up pace when we get through the tax season,” he said.

Considering the advantages of a Roth IRA over a traditional IRA — for example, withdrawals of principal and income are free of income tax, and heirs don’t pay income tax on withdrawals from inherited IRAs — it would seem an easy decision to convert.

Additionally, though investors still must pay ordinary income tax on each dollar converted, they can spread the tax bill over two years, splitting it between their 2011 and 2012 tax returns.

But some financial advisers warn that Roth IRAs aren’t for everyone, a message that they fear is being lost because financial companies are pushing conversions to collect the fees and commissions that come with them.

“I don’t think there was an inherent curiosity on behalf of the public until financial firms started marketing conversions,” said Richard Schroeder, executive vice president of Schroeder Braxton & Vogt Inc., a financial advisory firm with $170 million in assets under management.

And stoking investor curiosity can lead to disastrous results.

“It’s just not simple,” J. Michael Martin, president of Financial Advantage Inc., said about the decision to convert. His firm has $250 million in assets under management.

For example, many investors and advisers don’t understand that there can be multiple “five-year clocks” running simultaneously that apply to Roth IRA withdrawals, said Susan Hartman, a tax expert in the financial planning department at Raymond James.

A five-year clock starts the day a Roth IRA is opened and funded. Earnings can be withdrawn tax-free without penalty after five years and a qualifying event such as turning 591/2 occurs.

An additional five-year clock, however, is set for each IRA that is converted.

That means that if an investor is younger than 591/2 when a particular conversion is done and that investor withdraws money before the clock associated with that conversion runs out, he or she is hit with a 10% penalty.

It is one of the most common misunderstandings surrounding conversions, Ms. Hartman said.

Having said that, Raymond James is working with its reps to make sure that they understand everything there is to know about Roth IRA conversions, she said.

Ms. Hartman characterized Raymond James’ efforts around Roth IRA conversions not as an attempt to sell clients something they don’t need but an attempt to educate them on a new opportunity.

Fidelity Investments is also “agnostic” with regard to conversions, said Lizanne Campbell, the firm’s senior vice president of product management.

“We’re educating the adviser, home office personnel — and, indirectly, the investor — on the regulations and opportunity surrounding Roth IRA conversions,” she said.

Converting a traditional IRA to a Roth IRA may not be for everyone, Ms. Campbell conceded.

But the tax law changes “certainly offer an opportunity for advisers to call their clients to uncover hidden assets,” she said. “It’s a great conversation to have, whether or not they do a conversion.”

John Moninger, executive vice president of advisory and brokerage consulting at LPL Financial, agrees.

“It really feeds into the planning process,” he said of the changes.

Mr. Moninger, however, was surprised that so many conversions were taking place so soon after the tax law changes went into effect.

He didn’t have data with regard to conversions being completed by LPL’s reps, but “in talking with advisers, they are saying they’re not seeing a lot of conversion opportunity,” Mr. Moninger said.

In many cases, that is because investors don’t have cash to pay for conversions, he said.

And in some cases, after doing the math, investors determine that it just doesn’t make sense, Mr. Moninger said.

E-mail David Hoffman at dhoffman@investmentnews.com.

Against the backdrop of consumer outrage over huge losses in target date portfolios, a handful of big fund companies are revamping their target date offerings in hopes of limiting risk — and preventing another major blowup.

AllianceBernstein LP, Van Kampen Funds Inc., Invesco Ltd. and Putnam Investments have all announced changes to their target date portfolios that will enable managers to provide more active management.

In some cases, the funds now will allow managers to move in and out of different asset classes more quickly during market fluctuations. Others are adding funds to their target date portfolios that are meant to protect investors from market downturns.

Lawmakers and fund providers have been looking for ways to lower risks in target date funds after 2010 funds lost an average of 25% in 2008. Most of the scrutiny has been on the glide paths of these short-horizon funds — those for people nearing retirement — for having stock-heavy allocations, rather than more conservative bond holdings.

About $245.2 billion in assets is held in target date funds, according to Morningstar Inc.

Meanwhile, the Labor Department is planning to issue guidance on how plan sponsors would be allowed to use target date funds in their defined-contribution plans soon.

Most defined-contribution participants are automatically enrolled in target date funds.

Separately, Sen. Herb Kohl, D-Wis., is working on proposed legislation that would mandate that target date fund managers take on fiduciary responsibility under the Em-ployee Retirement Income Security Act of 1974.

“Most firms we talk to are looking at this and trying to figure out how to do it [limit risk in their target date funds],” said Lynette DeWitt, a research director at Financial Research Corp. “They are trying to get prepared because they believe that we are going to have faster market fluctuations than we have had in the past.”

Managers should have more flexibility in how they invest target date funds, said Marcia Wagner, founder and principal of The Wagner Law Group. “The way the old target date funds worked, there was very little flexibility and there was an overconcentration in equities.”

But adding a layer of tactical asset allocation to these funds does not guarantee less volatility, industry experts say.

“If you can do it, well, that’s great. But I think it’s very hard to do,” said Stephen Sexauer, chief investment officer at Allianz Global Investors Solutions, which has no plans to change the way it manages its target date funds.

Allowing fund managers greater flexibility could make it more difficult for investors to see where their money is being invested.

“I think the higher the tactical budget, the less transparency there is going to be,” said Laura Lutton, an analyst at Morningstar. “In most cases you don’t have a record that can point to what is in these strategies.”

Other critics point out that this emerging trend is an admission by target date fund managers that their original premise didn’t work.

“If you had a chance of investing in a fund that acknowledges that it’s too risky — so it has to layer on a strategy to hedge the risk — would not you find one that doesn’t have as much risk to start out with?” asked Joe Nagengast, a principal with Target Date Analytics and president of Turnstone Advisory Group.

Starting next month, AllianceBernstein will allocate up to 20% of funds in its target date portfolios to a “volatility management component.” During normal markets, those funds would be invested in a mix of equities and real estate investment trusts, but in a downturn, the assets can be shifted to bonds and cash to reduce overall portfolio risk, said Thomas J. Fontaine, head of defined contribution.

“This hopefully addresses many of the concerns [about target date funds] that came out of 2008,” he said.

On Feb. 5, Van Kampen filed supplemental documentation with the Securities and Exchange Commission broadening the target allocations for the different asset classes in the 10 Van Kampen Retirement Strategies funds. Previously, the target allocations were expressed in specific targets, but now they will be expressed in ranges, according to the filings.

For example, previously the Van Kampen 2010 Retirement Strategy Fund had a stated target allocation of 46% to equities, 51% to fixed income and cash and 3% to alternative investments. Now, the fund’s prospectus will state that its equity target will range from 25% to 50%; with 50% to 75% for fixed income and 0% to 10% in alternative investment funds, according to the filing.

Invesco Ltd., which recently bought Van Kampen, recently made similar changes to its Aim target date funds. Instead of using a mix of Aim mutual funds and Invesco PowerShares exchange-traded funds as the underlying assets in its target date funds, the firm made the Aim Balanced-Risk Allocation Fund a key component of the portfolios, said Scott Wolle, chief investment officer for global asset allocation.

“The appeal of the balanced-risk allocation fund is that it is specifically designed to limit any downturns,” Mr. Wolle said. At the same time, Invesco also started re-balancing its funds on a monthly basis rather than annually.

Putnam was one of the first firms to revamp its target date funds.

In response to the market crash of 2008, the firm in September incorporated its Absolute Return funds as underlying portfolios within the target date funds to provide more downside protection, said Jeffrey Knight, head of global asset allocation at Putnam.

Not everyone believes that tweaking target date funds is the answer.

“People are being too short-term- focused about target date funds,” said Keith Hartstein, president of John Hancock Funds LLC, which last month filed with the SEC to launch a new series of target date fund using more passive investments.

Mr. Hartstein said he was worried the industry was overreacting to the market crash by becoming too conservative. “What is going to happen when people don’t have enough savings when they retire?” he asked. “Will Congress be there then?”

E-mail Jessica Toonkel Marquez at jmarquez@investmentnews.com.

The Geller Group LLC, a New York retirement plan administrator and registered investment adviser, has confirmed in internal memoranda that it is being investigated by the Labor Department.

“The Department of Labor began an investigation of Geller Advisory Group in December to examine our third-party plan administrator and registered investment advisory business,” James English, head of the firm’s client relationship management unit, wrote to his colleagues this month.

“We responded to a request for information in January. We are examined by regulators from time to time as is common in our industry. We expect no adverse consequences from the investigation,” Mr. English wrote.

As previously reported, people close to the investigation, as well as former employees, said that the government is probing whether Geller had a conflict of interest by recommending to its pension plan clients that they use an auditor in which it allegedly held an undisclosed interest. The auditor, Caesar & Associates, worked out of Geller’s Midtown Manhattan headquarters, its employees for several years received checks directly from Geller, and Geller officials reportedly signed off on some of the audits.

Sheldon Geller, who began the company with his former father-in-law about 25 years ago and sold a majority interest in the firm in 2006 to Focus Financial Partners LLC, said in an interview this month that he was unaware of an investigation of his firm.

On Feb. 9, in response to an InvestmentNews article reporting the investigation, Mr. Geller wrote in an internal memo that the firm’s lawyer had spoken with the Labor Department the previous day and learned that she was investigating “the way in which our clients purchase mutual funds for the retirement plans.”

At least three investigators are working on probes related to Geller, including one who is with the Labor Department’s Office of Labor Racketeering and Fraud, sources said.

In his memo, Mr. Geller noted that Caesar & Associates previously has been reviewed by the Labor Department, without commenting on the results. Mr. Caesar said that the Labor Department’s Employee Benefits Security Administration referred his case to the American Institute of Certified Public Accountants’ ethics division and that he is contesting the EBSA’s conclusions.

Mr. Geller’s memo said that the EBSA investigator told his firm’s lawyer that the Labor Department was the only “agency involved in the investigation.”

Several sources with knowledge of the case and lawyers familiar with other Labor Department probes said that investigators could refer the probe to the Justice Department and share their findings with such agencies as the Internal Revenue Service and the Securities and Exchange Commission.

Mr. Geller’s memo encouraged employees to share its content with “any client or other person” who asks about the article. It also said that executives at Focus Financial Partners, Geller’s parent company, believe that the source of the story was a “former disgruntled employee,” and it was based on “half facts, unwarranted assertions and is blown out of proportion.”

Loretta Mock, a spokeswoman for Focus, said that the company “cannot make any comment on this right now.”

E-mail Jed Horowitz at jhorowitz@investmentnews.com.

Two broker-dealers are coming out swinging against investors and securities regulators who are looking for redress over the sale of private placements that went belly up last year.

Capital Financial Services Inc. and Securities America Inc. have been named in mass investor arbitration complaints over the sale of private placements, including Medical Capital Holdings Inc., a series of deals totaling $2.2 billion and sold to 20,000 clients from 2003 to 2009. The Securities and Exchange Commission charged Medical Capital with fraud last summer.

Both broker-dealers want to break up those group claims and conduct a series of individual arbitration hearings — a move, plaintiff’s attorneys argue, that would slow down the arbitration process and potentially harm investors.

Meanwhile, Securities America responded to a lawsuit filed last month by the Massachusetts Securities Division for allegedly misleading investors over the sale of Medical Capital’s private offering. Last Tuesday, the firm sent a stinging reply, telling Massachusetts regulators that the state’s lawsuit “misstates facts and miscomprehends the regulatory structure” of such deals, known as Regulation D offerings.

Aggressive responses from brokerage firms in lawsuits, including some involving auction-rate securities, have recently proved successful, said attorney Dennis Concilla, a partner in Carlile Patchen & Murphy LLP.

“Sometimes the best defense is a strong offense,” he said.

In general, there are two ways for broker-dealers to handle such “mass litigation,” Mr. Concilla said. “They can try to get it resolved or they can take the scorched-earth policy.”

He added that neither way is clearly superior and that tactics depend on the facts of the case, and the temperament of the attorneys and their clients.

Securities America’s response to Massachusetts, obtained by InvestmentNews, claims that the lawsuit against the company is full of holes — and that the state’s regulators don’t understand the workings of private placements and Reg D deals.

The lawsuit “mischaracterizes or simply ignores the role of selling securities [by] broker-dealers who are not underwriters [such as Securities America], outside analysts’ reports, private-placement memoranda, subscription agreements and selling agreements,” Securities America said in its formal reply to the complaint, which was filed in January.

Brian McNiff, a spokesman for the Massachusetts Securities Division, did not return a phone call requesting a comment.

Both Securities America and Capital Financial are taking clear legal action to push back against arbitration claims brought by investors.

This month, the two firms filed motions with the Financial Industry Regulatory Authority Inc. to “sever,” or separate, the investors’ claims. Plaintiffs’ attorneys grouped together clients into large lawsuits against the broker-dealers. If approved by Finra, each investor would go before a separate Finra arbitration panel.

That would slow down the arbitration process and extend hearings in the matter for as long as five years, said Jeffrey B. Kaplan, a partner in Dimond Kaplan & Rothstein PA. He and his firm are representing 15 investors in a mass-arbitration case against Capital Financial and 17 investors in a group filing against Securities America.

“We believe that the brokerage firms are seeking to sever merely as a delay tactic,” Mr. Kaplan said. “Finra would be overwhelmed with the number of individual cases if grouping … of various, very similar claims were not permitted.”

COUNTER TO FINRA GOALS

Finra likely could not handle the flood of thousands of individual cases that would be filed, he said. “What’s more, Finra arbitration … [is] supposed to foster efficiency and avoid contradictory results. The brokerage firms’ motions to sever would run counter to those goals.”

The investors’ complaint against Capital Financial was filed in November and alleges that they were sold unsuitable investments. It seeks damages of $5.2 million. The complaint against Securities America, which charges that the investments the plaintiffs were sold were “unsuitably risky and illiquid,” seeks $3.7 million in damages.

The brokerage firms certainly don’t see their strategy that way.

“Because of the myriad factual situations giving rise to [investors'] claims, and the fact that there may be different counterclaims and defenses to each of those claims, [Capital Financial is] making this motion to sever those claims,” the firm said in its Finra filing. The 15 investors “have improperly attempted to join together their unique and separate individual arbitration claims.”

The Securities America motion echoes Capital Financial’s. Investors in the claim share little, if anything, other than the fact they bought private placements that went bad, including, for some, Medical Capital notes, the motion states.

“They made these investments in different states, through different registered representatives, at different times and under different circumstances,” it states. “The claimants have no more connection among them than any other investors who purchased the private-placement products,” the motion states.

Janine Wertheim, senior vice president and chief marketing officer for Securities America, declined to comment on the firm’s legal strategy.

Brian Boppre, president of Capital Financial, was unavailable to comment last week.

E-mail Bruce Kelly at bkelly@investmentnews.com.

Fearing a backlash from investors who are still piling into bond funds, mutual fund companies are rolling out sales and marketing campaigns to encourage investors to shift assets into other products.

Rising interest rates are likely to cause a decline in bond fund values. But fund companies are afraid that investors will blame them for their losses.

Whatever their future problems, bond funds currently dominate all other asset classes; they attracted $28 billion in net inflows last month, according to Morningstar Inc. Fixed-income funds now represent about 30% of the mutual fund market, up from 19% at the end of 2007.

What to do is a thorny issue for fund companies, many of which are still working to regain investors’ confidence in the wake of the recession and equity market decline, said Jim Jessee, president of MFS Fund Distributors Inc.

“People have unrealistic expectations of what a portfolio manager can do in a rising-rate environment,” he said at an InvestmentNews mutual fund round table in New York on Feb. 9.

As a result, MFS is educating its sales force about what to expect, anticipating that the message will flow from wholesalers to financial advisers to investors, Mr. Jessee said.

Franklin Templeton Investments is taking a different tack. As part of its new 2020 Vision marketing campaign, the firm is distributing a brochure to advisers encouraging them to discuss the importance of equities with clients.

“Clients have been so roiled by the market that they have been shifting completely out of equities and were not interested in having a conversation about it,” said David McSpadden, senior vice president of global client marketing for Franklin Templeton.

The response from The Dreyfus Corp., a unit of The Bank of New York Mellon Corp., has been to focus on the importance of global investing. The firm is running print ads featuring global and international funds subadvised by Walter Scott & Partners Ltd.

“The next ad we’re doing is a broader, global investing theme, which will feature both global equity and international fixed-income solutions,” Patrice Kozlowski, a spokeswoman for the firm, wrote in an e-mail. “Further, we are developing a new client brochure that will be available next month on the importance of global investing.”

Whether the fund companies’ efforts will work is an open question.

“The fact is, investors are always looking for someone to blame for their mistake,” said Scott Kays, president of Kays Financial Advisory Corp., which manages $120 million in assets. “I’m not sure there’s anything the fund companies can do to avoid that.”

Nor should fund companies try to “hype” alternatives to fixed income, said Stephen Gorman, president of Gorman Financial Management, which manages $100 million in assets.

“Even as rates rise, bonds are not necessarily a bad investment,” he said.

Mutual fund companies, however, have little choice but to try to get investors to diversify, said Don Phillips, a managing director with Morningstar.

“There’s a very legitimate risk that based on the amount of money going into bond funds today, investors don’t fully appreciate the risks they are taking,” Mr. Phillips said.

It would be very easy for the industry to continue to push popular fixed-income products, he said, but suggested that the industry learned its lesson about stoking a hot market from the fallout of the tech bubble. According to Mr. Phillips, Janus Capital Inc. is still trying to recover from pushing tech funds long after it became evident that doing so was dangerous.

“That experience taught the industry to be a little more paternalistic,” he said.

There are other, less altruistic reasons for fund companies to encourage investors to allocate cash away from bond funds, said Benjamin Poor, a director at Cerulli Associates Inc.

One reason is that bond funds are a relatively low-margin business compared with equity funds, he said.

Another is that the bond fund arena is dominated by one player, Pacific Investment Management Co. LLC.

Mr. Poor questioned the assumption that investors don’t understand the inverse relationship between interest rates and bond prices.

“Investors are not just chasing the hot money and getting conservative at the wrong time. I believe some of the preference for bond funds is due to a long-term shift in mindset — a realization that they can handle only so much risk,” Mr. Poor said.

But even if many investors are surprised by the bond fund losses they may incur as rates rise, mutual fund companies won’t have too much to worry about, said Burton Greenwald, a mutual fund consultant.

“Realistically, there aren’t many alternatives to mutual funds,” he said. “The real challenge for the fund companies is to have a broad selection of funds that gives the investor a wider choice.”

E-mail David Hoffman at dhoffman@investmentnews.com.