According to FINRA, Philip Norris Smith was fined $5,000 and suspended for three months for making unsuitable recommendations for a family trust formed by a senior married couple. Restitution was not ordered because Smith's member firm compensated the trust in connection with settlement of an arbitration claim.
Smith and another registered representative at the firm recommended that the trust purchase a deferred variable annuity for approximately $540,000 and fund that purchase through two withdrawals from an indexed annuity owned by the trust. Smith was aware that funding the purchase of the variable annuity with withdrawals from the trust's existing annuity could result in negative tax consequences for the trust and was also aware that the recommendation to purchase the variable annuity would not be suitable if it caused negative tax consequences.
However, neither Smith nor the other representative researched how the trust might purchase the variable annuity without negative tax consequences. Instead, Smith recommended that the trust withdraw funds from the indexed annuity via two checks payable to the trust and immediately endorse the checks as payable to the firm to fund the purchase of the variable annuity. The trust, through its trustee, followed Smith's recommendations.
Smith mistakenly believed that having the trust immediately endorse the checks as payable to the firm would avoid adverse tax consequences, but he did not confirm that belief. The withdrawal of funds from the indexed annuity were, in fact, taxable events that resulted in negative tax consequences to the trust. The adverse tax consequences could have been avoided if Smith or the other representative had recommended the new variable annuity be purchased as a tax-free 1035 exchange, but they failed to research that option.
A 1035 exchange allows for tax-free exchanges of annuities and certain other insurance products. This well-established provision of the tax code exists specifically to allow policyholders to exchange annuities without triggering immediate tax liability. The representatives' failure to research and recommend this option when they knew tax consequences were a concern represents a serious lapse in their professional duties.
Smith's case is part of the same unsuitable transaction as Camille Cordova's case described earlier. Both representatives worked together on this transaction and both failed to properly research the tax implications. The fact that both representatives were aware of potential tax consequences but failed to research how to avoid them makes this violation particularly problematic. They knew they needed to avoid tax consequences for the recommendation to be suitable, yet they proceeded without confirming whether their approach would succeed.
For investors with trusts or other complex financial structures, this case emphasizes the critical importance of working with representatives who understand tax implications and take time to research proper transaction structuring. The suspension is in effect from June 21, 2022, through September 20, 2022.
