Does Rule 151A require immediate action?
By Bob Seawright
Asset Marketing Systems
The Securities and Exchange Commission's recent adoption of Rule 151A to regulate fixed index annuities (FIAs) as securities is not scheduled to take effect until January 12, 2011. Political action to limit its impact and legal action to overturn the ruling is expected. As a consequence, many have suggested that insurance-only producers wait before implementing any changes to their practices in order to see how matters "shake out."
For example, the Web site Sec151a.com, designed to be the "Annuity Industry's rally point for news and advice regarding proposed Rule 151A," opines as follows: "If you desire to continue selling FIAs, simply stay right where you are. The fastest this process can happen is two years and there are elements already in play that will extend this period in our opinion. The worst thing you can do is run out and take your securities exam and fall into a broker/dealer's supervision prematurely."
The primary justifications provided for this do-nothing/wait-and-see approach are (1) two years is a long time; (2) it is not yet clear which securities license will be required to sell FIAs; and (3) the expected legal action will likely overturn the Rule. However, even though I have repeatedly expressed my view that the SEC has dramatically overstepped its bounds by enacting Rule 151A, I think this approach is dangerous and misses a crucial point -- one that every insurance-only producer should consider carefully before deciding to maintain the status quo.
The Financial Industry Regulatory Authority (FINRA) does not have regulatory authority over an insurance agent who is not licensed as a registered representative under a broker/dealer. Similarly, state securities regulators do not have authority to regulate the offering or sale of insurance products. But, state securities regulators generally do have the authority to enforce their state's securities laws irrespective of whether an insurance agent offering FIAs is a registered representative. At the North American Securities Administrators Association's Annual Conference in late 2007, the NASAA Enforcement Committee reported that even though FIAs fall outside of the state definition of a "security" in many states, state regulators should not view that as an impediment to enforcing investor protection safeguards under state securities laws. Accordingly, a growing number of state securities regulators have been looking to undertake enforcement actions against insurance-only FIA producers. Such actions do not need Rule 151A to be in full force and effect in order to be brought.
Pursuant to the securities laws of most states, an investment advisor is an individual or entity who (1) provides advice or analysis concerning securities or securities markets, (2) provides said advice for compensation,* and (3) engages in the regular business of providing advice regarding securities or securities markets. There is typically no exemption or exception from the registration requirement under state securities laws on account of an individual's status as a licensed insurance agent.
Therefore, when an insurance-only agent discusses the risks of the stock market, or recommends that a client liquidate a securities position to a fixed instrument and then receives a commission from an insurance carrier for selling an FIA to that client, most state securities regulators will argue that the insurance-only producer acted as an unregistered investment advisor. As stated by Joseph Borg, Alabama Securities Commissioner and past president of the NASAA, if the insurance-only agents are advising people to sell mutual funds or to get out of 401(k)s, they are acting as investment advisors. Borg then cautions, "And in my state, being an unregistered investment advisor is a felony." (The Wall Street Journal August 8, 2007)
It is possible that many -- even most -- insurance-only producers will avoid scrutiny in this regard. But state securities regulators have made it clear for awhile now that so-called "free lunch" seminars targeting seniors should receive special scrutiny. It is now a fairly common practice for such regulators to attend seminars without announcing their presence. If the content of the seminar references or relates to securities, there is a substantial risk that the regulators will initiate an investigation of those seminar producers who are licensed only to sell insurance. Even insurance-only producers who do not market using public workshops are at risk in this regard. When a securities product is liquidated and invested in an FIA through an insurance-only producer, it is not uncommon for the previous broker/dealer to report this liquidation and the insurance-only producer's possible role in the transaction to the state securities regulator -- particularly in these troubled economic times. The desire to hold on to clients and business is particularly strong in this environment. Thus, whenever a client liquidates a security position in order to fund an FIA purchase from an insurance-only producer, the producer is at risk.
Needless to say, the regulatory climate is not likely to become more relaxed anytime soon.
On December 18, 2008, then President-elect Barack Obama announced Mary Shapiro as his choice to lead the SEC and gave her a mandate for enforcement and reform, saying that "Financial regulatory reform will be one of the top legislative priorities of my Administration." Indeed, the President-elect was clear that previous regulators had "dropped the ball." As he summed up, "I will ensure that our regulatory agencies are led by individuals who are ready and willing to enforce the law." As most FIA producers will recall, Shapiro was behind the Notice to Members 05-50 from the NASD (the predecessor to FINRA) requiring that broker/dealers supervise FIA sales by their registered representatives. Shapiro has also routinely made it clear that, in her view, an investor in a variable annuity or an FIA -- a customer of an investment advisor, a mortgage broker, a securities broker or an insurance agent -- should all receive "similar levels of protection." (Remarks given at the FINRA Fall Securities Conference, October 23, 2008). If anything, the regulatory environment will become increasingly difficult.
More to the point, with respect to state securities regulators -- charged with ferreting out unregistered investment advisor activity -- we can expect their enforcement activities to pick up in response to the current financial crisis and the overall compliance climate. The NASAA has already indicated its particular focus on the alleged financial exploitation of seniors. And, 34 percent of enforcement actions in this regard are already directed toward FIA sales practices.
An insurance-only producer who does nothing in response to the current regulatory environment, as evidenced by the enactment of Rule 151A, is being short-sighted and is putting his or her livelihood at substantial risk. As always, doing the right thing for one's client in every circumstance should be every producer's credo and the first line of defense against claims of inappropriate activity. Insurance-only FIA producers should also seriously consider obtaining a securities license consistent with the nature of their practice as insurance against a regulatory enforcement action alleging that such producers are acting as unregistered investment advisors and are thus subject to sanction. Indeed, doing nothing is a mistake with tremendous downside risk.
* From a legal perspective, it is arguable that the compensation requirement is not met by the payment of a commission on the sale of the insurance product in this type of scenario since such payment is not made for investment advisory services. But most producers have neither the interest nor the means to fight an enforcement action on this basis. More importantly, the existence of such an action alone, irrespective of ultimate disposition, would be a major blight on one's record. The mere fact that state securities regulators are taking the position that such indirect compensation is enough to trigger unregistered investment advisor status and that they can be expected to act upon that position, even if overreaching (and it probably is from a more objective viewpoint in another compliance climate), is sufficient basis for the prudent producer to avoid the behavior.
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