NASD Turning Up The Pressure On VA Suitability

By Jeffrey S. Puretz and Nicole Griffin

A recent enforcement action shows that the National Association of Securities Dealers has turned up the pressure on suitability determinations by broker-dealers in the sale of variable contracts. This action marks the 10th major action that the NASD has brought against broker-dealers respecting the sale of VAs in the last three years.

This most recent action marks a shift in the regulators focus. In most of the prior actions, the NASD found fault with supervisory procedures–finding them inadequate–and with the documentation compiled on specific sales–literally finding the files incomplete.

In this most recent action announced in December, the NASD has singled out a particular type of sale–those to qualified plans–and started to set forth particular ways in which the product must meet a clients needs and specific information that must be analyzed and presented to the client.

The scrutiny given by the regulator on these sales of annuities is far deeper than that given to sales of mutual funds or other packaged products, and shows a deep skepticism on the part of the regulator on annuities in general.

The December action was accompanied by a warning from Mary Schapiro, president of Regulatory Policy and Oversight, that the NASD will continue to focus on variable annuity sales practices to ensure that “customers receive important disclosures concerning these complex products and that they are sold only to customers for whom they are suitable.”

The action was against a broker-dealer affiliated with a major insurer. The firm did not admit the NASDs allegations but accepted the NASDs findings and consented to the imposition of a censure and a fine of $350,000.

In sales of VA contracts to tax-qualified pension plans, the NASD found fault with two aspects of the broker-dealers sales practices. First, noting that qualified plans do not need the tax deferral provided by annuities, the NASD said the firms salespeople needed to determine that another aspect of an annuity contract rendered it suitable for a qualified plan. These other aspects could include a death benefit or annuity options that provide guaranteed payments for life.

Additional aspects, according to a study by the brokerage firm, could include the availability of fixed and variable options within the same product and an owners ability to transfer between multiple fund families without a transactional charge.

Second, the NASD focused on costs. The NASD said salespeople need to “explain,” as opposed to disclose, the costs associated with VAs. In selling to a qualified plan, the NASD said a salesperson needs to compare the costs and features of a VA contract with those of mutual funds where a customers needs might have been better met with mutual funds. The NASD said the firms registered representatives did not adequately explain these costs and features.

This action is reminiscent of guidelines published by the NASD in 1999 on sales of VAs to qualified plans. There, as here, the NASD said a broker-dealer should disclose to a customer that tax deferral is provided by a retirement plan and that this “feature” of a VA contract is unnecessary. But, the NASD has gone further in this most recent action in calling for that firms salespeople to compare an annuitys costs with those of mutual funds.

In responding to the NASD, the broker-dealer said it and its related insurer would take several “corrective actions.” These measures arguably represent the state of the art in suitability compliance in the industry respecting sales to qualified plans. (See chart.)

Through vigorous enforcement actions, the NASD is sending a signal that it is scrutinizing sales of VAs very carefully–much more than other products–and expecting very high standards for suitability determinations.

Mr. Puretz is a partner and Ms. Griffin is an associate with the law firm of Dechert LLP, resident in the Washington, D.C., office. Their respective e-mail addresses are: Jeffrey.puretz@dechert.com and Nicole.griffin@dechert.com.


Reproduced from National Underwriter Edition, April 7, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.