The United States Court of Appeals for the D.C. Circuit has sent Rule 151A, which is designed to treat fixed index annuities as securities for regulatory purposes, back to the Securities and Exchange Commission for further consideration. The full decision is available here. Accordingly, at least for now, Rule 151A cannot be put into effect as the SEC intended. That's the good news. The bad news is that the Court specifically upheld the SEC's rationale for treating FIAs as securities for purposes of regulation and producer licensing. Therefore, the regulatory future of FIAs is still unknown.
In its decision, the Court began by noting the appropriate standard for review. A decision by the SEC, such as the enactment of Rule 151A, is entitled to considerable deference, essentially meaning that it only needs to be reasonable to be upheld. It doesn't matter that the court might have reached a different -- or better -- conclusion than the SEC. The Court held that the SEC's interpretation of the applicable law in enacting Rule 151A was indeed reasonable. This finding of reasonableness was largely predicated upon the fact that FIAs "appeal to the purchaser not on the usual insurance basis of stability and security but on the prospect of `growth' through sound investment management." With respect to the argument that investment risk doesn't exist where there is no risk of loss of principal, the Court noted that even though such a view was surely defensible, "that is not sufficient to establish that the SEC's rule is arbitrary or capricious."
But that is not the end of the story. Whenever the SEC uses its rulemaking power, it is required to consider and determine whether the action "is necessary or appropriate in the public interest" by analyzing the protection of investors as well as whether the proposed "action will promote efficiency, competition, and capital formation." In other words, the SEC has an obligation to consider the economic implications of certain rules it proposes before it enacts them. Since the SEC did not do that in this case, the matter was remanded back to the SEC for further consideration.
So what does this decision mean?
1. As of now, Rule 151A cannot go into effect as originally planned by the SEC. The SEC must undertake additional administrative proceedings considering the economic impact of Rule 151A before putting it into effect.
2. According to the D.C. Circuit, the SEC does have the authority to regulate FIAs as securities.
3. At this point, the SEC can move in a variety of directions. It could seek review of this decision from the United States Supreme Court. It could review the economic considerations of Rule 151A and decide either to enact it or not to enact it. It could propose and consider a new rule altogether or some amended version of Rule 151A.
4. Legislative efforts to overturn Rule 151A are ongoing. Since the law is clear that Congressional intent trumps the SEC's interpretation of the underlying statutes (as the D.C. Circuit acknowledged), if the proposed legislation is passed, Rule 151A cannot be implemented, irrespective of what the SEC does.
What should producers do?
a. Producers aren't required to do anything at this point, and should not panic. As noted above, multiple scenarios could ultimately play out.
b. Given the Court's approval of the SEC's regulatory framework, producers who oppose Rule 151A should focus on legislative efforts to overturn the rule.
c. That is not to say that the SEC's response to the decision is pre-determined. Producers opposed to Rule 151A should also be involved in trying to influence what the SEC does next. We expect that more information will be available in this regard shortly.
d. Producers should continue to evaluate how to respond to the possibility that Rule 151A or something very much like it will be enacted. Producers who sell FIAs and who do not have a securities license should also consider obtaining one irrespective of what happens with Rule 151A in order to avoid compliance problems relating to the source of funds when clients liquidate securities positions to make an FIA purchase.
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