Is there ever such a thing as closure when it comes to scandals? Maybe a better question is, do financial services executives become increasingly diffident about regulatory matters as the list of offenders grows longer and the severity of the infractions appears to wane?

Especially following recent news of even more troubles with mutual fund market timing, fund executives may be even more anxious to see an end to the fund scandal. Take a peek into the world of variable annuities to see why the shadow of regulators will always fall on the fund industry. Take a look into the back offices, as well, where regulators are now pointing the finger for late trades.

Mutual funds enjoyed - and many would say grew smugly complacent in - an untainted history and rosy reputation as a consumer-friendly product.

Variable annuities, on the other hand, have long been the favorite whipping boy of many financial planners and the consumer press.

When journalists aren't criticizing fee structures, they assail sales practices, and the press isn't alone in this mission. Last year, the Securities and Exchange Commission and the NASD issued a joint report outlining questionable variable annuity sales practices that broker/dealers should avoid.

The report is a virtual roadmap of past offenses and future charges.

So far, despite the fact that hedge funds and other market timers can often more easily conceal timing activity within annuities, there have been relatively few enforcement actions to date. Perhaps this is a function of the relative size of the two industries: at the end of 2004, investors had almost eight times more money invested in mutual funds, at $8.1 trillion (source: Investment Company Institute, Washington), than variable annuities, at $1.1 trillion (source: National Association for Variable Annuities, Reston, Va.).

Of course, there is the fundamental problem of economics: the fees that journalists so often complain about within annuities also take a bite out of timing profits. But this has not protected the industry from regulatory trouble, and it won't in the future because the fact is that everybody knows that it is not over.

The size and diversity of the fund industry also make for a less complete understanding of industry practices and a less efficient rumor mill. Not so for variable annuities, where the list of top manufacturers is short and talk of dirty laundry does not have to travel very far.

Insurers have been notoriously tightlipped about market timing and other regulatory troubles for some time now. Last year's announcement of the first case involving carrier complicity was not followed by a torrent of additional charges, as many had expected.

The first case, against Conseco of Carmel, Ind., and Inviva, the New York-based company that bought Conseco's book of variable annuity business, was painted by some as a case of regulators going after the weakest member of the herd.

The total fines and disgorgement of $20 million seemed modest at the time yet dwarfed the $500,000 that Greensboro, N.C.-based Jefferson Pilot paid to the NASD for supervisory failures in variable universal life policies earlier this year, the only other variable product case involving carrier complicity that has come to light [see AMN, April 2005].

What kind of regulatory actions do some suspect will come down the pike? Many point the finger at the sales staff, particularly wholesalers, who can represent the weakest link in the chain of compliance. Wholesalers are a main point of contact between the carrier and broker, and their compensation is based upon sales volumes, meaning that the huge account balances that market timers typically play with are ample temptation to fudge some facts. As part of the sales chain and the insurer's payroll, wholesalers can often assure the home office's operations staff that a transaction is not part of a market-timing scheme prohibited by prospectus; omnibus accounting means that the money manager may be none the wiser.

No market-timing case describing this type of activity has come to light, and it may be that none ever will. However, scenarios like this continue to lurk in the variable annuity world and likely exist in the much larger fund industry. The more complicated the issue, the longer it will take regulators to assemble their cases. The sweeps really have been just that, and it is taking a long time for investigators to separate the wheat from the chaff.

Perhaps regulators have information to help them pinpoint the source of problems, or maybe they are just fishing. One example of this is a question that they have asked insurers about whether the company allows individuals who are not policyholders to invest in an annuity's sub-accounts. This question has been described by home office legal staff as "scary," because of one of two implications: either regulators don't understand how annuities work or, worse, other companies have allowed such egregious activities.

The most salient point, however, is not all the misbehavior seemed egregious at the time. Every time I speak with the legal representatives for a defendant, the lawyer always stresses that, as the SEC or NASD will themselves say, market timing itself is not illegal.

No, it's not, but it's not very fair to the other investors in the funds, either. At some point, people should have the common sense and morality to independently come up with the idea that improper market-timing is wrong, and everyone in the financial services supply chain should not support it.

As a small-time investor myself, turning timing abuses into a semantic problem constitutes yet another case of the financial services industry avoiding a good look in the mirror. It is this very lack of introspection that got the industry where it is now and that will condemn it to a repeat performance in years to come.

The scandals will never be over because the financial services world is constantly evolving, with new products and innovations creating novel opportunities for improper behavior that people will later remark was common practice or was legal at the time. Of course, the problems haven't and won't reside in every company, but that is a poor reason to ignore the question of why problems arise and persist. As an industry, the scandalous actions of a few reflect on the whole - and that will be equally true in five years or 10 years as it is today.

Tamiko Toland is senior editor of Annuity Market News.

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