Caution: Are you acting as an unregistered investment advisor?Article added by David Millar on November 18, 2009
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David Millar

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There is a growing trend among securities regulators to discipline insurance agents who convince clients to liquidate securities to fund fixed or indexed annuities. The regulators are viewing this action as giving investment advice while not being securities licensed. On August 8, 2007, Alabama Securities Commissioner Joseph Borg stated in the Wall Street Journal, "If the [insurance only] agents are advising people to sell mutual funds or get out of 401(k)s, they are acting as investment advisors. And in my state, being an unregistered investment advisor is a felony."

Another example is Florida, where state regulators have begun asserting a similar jurisdictional theory. They claim that if investment advice is given to liquidate a security for any type of investment, including fixed or indexed annuities, they will look at the suitability of the whole transaction. In their determination, if investment advice was given to convince the client to liquidate a security, they will commence disciplinary action against the non-securities licensed insurance agent.

This trend means insurance agents should examine the definition of "investment advisor" to determine if they are at risk. The following is a quick and non-exhaustive review of that definition. While each individual's situation will vary, this will show how easily an insurance agent who funds fixed or indexed products with securities could fall into the definition and potential disciplinary action.

The definition of "investment advisor" can be found in every state's securities laws, with most mirroring the definition found in the Investment Advisors Act of 1940. Section 202(a)(11) of the Act defines an investment advisor as, "any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities..." (emphasis added.)

This definition can be broken down into three elements: 1) advice concerning securities; 2) in the business of providing investment advice; and 3) for compensation. If an insurance agent meets all three of the elements, he could be deemed an unregistered investment advisor and subject to disciplinary actions by a state's securities department or even the Securities and Exchange Commission.

When looking at the first element, "advice concerning securities," the SEC and the courts have interpreted this language broadly. The advice can be about securities in general, such as the stock market or a specific security. In fact, the following have all been considered giving investment advice by the courts: telling a client when to purchase or sell a stock; telling a client when to switch to a different investment; explaining how a security is valued; and whether to invest in securities at all.

Of course, the advice must concern securities, but this too is broadly defined in the Advisors Act. The definition of securities includes notes, bonds, stock (common and preferred), options, investment contracts, and much more. Each of these investments is commonly found in a client's portfolios. Insurance agents need to be concerned that they are giving investment advice, as defined above, when telling a client to sell a mutual fund, stock, bond or other security to purchase any insurance product, especially a fixed or indexed annuity, which are currently being scrutinized by the regulators. Unless an insurance agent tells a client to fund the sale through an exchange or other fixed insurance product, he will likely be considered to be giving investment advice on securities.

The second part of the "investment advisor" definition asks whether the advice giver is in the "business" of providing investment advice. As with the first element, the interpretation of "business" has been painted with a broad brush. The regulators will look at several factors when analyzing this element, including the frequency of the advice given. Insurance agent should be concerned when there is a pattern of replacing securities with fixed or indexed products. The more often this happens, the more likely they will meet this part of the element.

There are other ways this element can be proved, according to SEC Release No. 1092. These include: 1) holding oneself out as an investment advisor; 2) receipt of separate or additional compensation clearly associated with the advice; or 3) specific investment advice is provided other than in rare, isolated instances. Once again, an insurance agent could easily fall into any one of these categories. For example, many agents offer "free portfolio analysis" when marketing their services. If that phrase is mailed as part of an advertising campaign to the public, the insurance agent may be holding himself out as an investment advisor. After all, he will be advising clients about the investments held in their portfolios.

The final element, and arguably the easiest to prove, concerns whether the advice given is "for compensation." In other words, as a result of giving the advice, will the advice-giver receive some form of compensation? Once again, it is subject to broad interpretation. According to SEC guidance, the compensation does not have to be large or come directly from the client. It can come from a third party. In fact, the receipt of any economic benefit satisfies the analysis. Receiving a commission for the sale of a fixed or indexed annuity that was funded by a security would easily be considered "for compensation" under the definition.

This quick and non-exhaustive analysis shows how funding a fixed or indexed annuity with a security can pull an insurance agent into the definition of investment advisor. With the current hard line approach on this issue by the regulators, it may be time for insurance agents to re-evaluate their sale practices and licensing situations. By giving investment advice on the sale of securities to fund fixed or indexed insurance products, insurance agents may be putting their careers at risk!

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