Monday, May 13, 2013

FINRA, SEC Issue Investor Alert on Pension and Structured Settlement Income Streams

By Tim Dulaney, PhD and Tim Husson, PhD

Last week, both the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) issued investor alerts concerning pension and structured settlement income streams.  The SEC's investor bulletin can be found here (PDF) and FINRA's investor alert can be found here.  We haven't discussed the potential problems surrounding pension or structured settlement income streams before, but these regulatory notices highlight some of the potential issues that we think are important for recipients and investors to understand.

A structured settlement is typically a stream of payments representing the resolution of litigation (e.g. personal injury lawsuits).  Similarly, pensions represent a defined-benefit income stream compensating an employee during retirement.  These income streams are valuable assets and salespeople are hoping to convince recipients to exchange the stream of payments for a lump-sum payment.  Unfortunately, the compensation investors are receiving in exchange for these income streams are often risky, complex and (in many cases) insufficient.*  In addition, there may be substantial tax consequences of participating in such a transfer that might not be understood or appreciated by investors.

The SEC offers guidance on the questions that investors should ask before entering into such a transaction.  For example, are there better alternatives (e.g. bank loans)?   Is the transaction even legal?  The regulators also suggest checking out the company's Better Business Bureau record, as well as the salesperson on the SEC's Investment Advisor Search, FINRA's BrokerCheck, the appropriate state securities regulator or the National Association of Insurance Commissioners.

On the other side of the coin, salespeople are selling investors the rights to pension and structured settlement income streams that they have purchased from other recipients.  These investments often advertise yields exceeding 5% or even 7%, but there are numerous potential risks:  reliable information might not be available for these products, investors "may encounter commissions of 7 percent or higher," the products are usually hard to sell once bought, and investors may face legal challenges enforcing the income stream if it is based upon someone's pension.

Furthermore, investors are exposed to the credit risk of the company or organization that is required to make the stream of payments.  According to the SEC investor bulletin,"if that entity goes bankrupt or becomes insolvent, it may stop paying the income stream."

Investors should be very cautious before entering into one of these transaction (if at all).  There are many risks that are often not fully disclosed and may have long-term financial consequences.
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* Some states require that companies that offer such an exchange, called "factoring companies", disclose the difference in value to avoid the exploitation of income stream beneficiaries.  For more information, see the following document (PDF) from the Los Angeles County Bar Association.

1 comment:

  1. It's really great that you follow the FINRA and SEC releases and give them some extra background and explanation. There aren't a lot of places to get this material in an understandable format. Keep up the good work!

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