NASD Slams Broker-Dealer for VA Market Timing

June 1, 2004 ( - The National Association of Securities Dealers (NASD) has thrown down the gauntlet on the first case brought against a broker-dealer for "facilitating deceptive market timing in variable annuities."

Richmond, Virginia-based Davenport & Co. LLC has been fined $450,000 and ordered to pay more than $288,000 in restitution to the affected funds for the firm’s role in allowing market timing and late trading activities.   In addition, the fine includes Davenport’s failure to establish and maintain a supervisory system and procedure to prevent the late trading of mutual funds in variable annuity products, the NASD said in a news release.  

Per terms of the settlement, Davenport neither admits nor denies the allegations or findings.

NASD said between April 2002 through September 2003, Davenport helped two hedge funds carry out “deceptive market timing in the sub-accounts of variable annuities.”   This was despite the fact that the annuities’ prospectuses stated that they were designed for long-term investors, and not for professional market timers.

Moreover, NASD said, Davenport continued to sell variable annuity policies to the clients’ investment partnerships even after receiving notice that some of the variable annuity companies considered the clients’ trading strategy to be “disruptive and contrary to the interests of long-term investors.”   As a result, Davenport’s clients were able to realize profits in excess of $288,000 through their market-timing activities.  

Additionally, the firm facilitated deceptive practices by its hedge fund clients regarding variable annuities offered by other insurance companies, agreeing to change the annuitants, brokers of record, or the particular name of the hedge fund on the account in order to “evade the attempts of the insurance companies and mutual funds to detect and prevent excessive market timing,” NASD said.

The deception did not need with the alleged market-timing activities.   According to NASD, when Davenport converted its trading platform to a new system in July 2002, the firm set the new system to accept mutual fund trades until 4:30 p.m. Eastern Time.   During the 30-minute period after the close of the market, the firm placed no restrictions on the ability of its representatives to enter orders, regardless of when such orders were received.   This permitted and enabled Davenport’s retail customers to enter trades after the close of the market at the previous day’s net asset value (NAV).

With the system in place to allow late-trading in the funds, the NASD said between July 2002 and September 2003, Davenport routinely received trading instructions from customers after 4 p.m. EST and executed those trades as if the instructions had been received prior to 4 p.m. EST.

“Deceptive market timing in variable annuity sub-accounts can dilute the value of those shares, raise transaction costs and thus harm other annuity investors,” said Mary Schapiro, Vice Chairman of NASD.   “This is an improper and objectionable trading practice that rises to a higher level of abuse when the firm not only knows that its clients intend to deceive the variable annuity companies, but is complicit in carrying out that deception.”

NASD said the investigation of individual brokers and other entities involved in this market timing activity is continuing.