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Regulation and Compliance > Federal Regulation > SEC

A Sleeping Dog No More

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A lot of industry people are asking: Why did the Securities and Exchange Commission issue its June 25, 2008, proposal to regulate fixed index annuities as securities?

After all, the SEC did nothing about the subject for a full decade after it issued its 1997 “concept release,” which invited public comment on whether index annuities should be considered securities. It did not even respond in 2005 when the Financial Industry Regulatory Authority (then NASD) issued its controversial Notice 05-50 requiring broker-dealers to treat index annuities as securities.

Because of this absolute silence, the subject became a proverbial sleeping dog. Probably most index annuity professionals thought the dog had gone to sleep for good.

Hence, the industry’s puzzlement over the SEC’s action now. Here’s my take:

Simply put, the SEC is in the hot seat. Not only must it regulate securities in a very rough market; it must also tangle with investor complaints about how it, along with other official bodies, “let” the equity markets plummet in the wake of the subprime mortgage crisis. People howl that until the subprime chickens came home to roost; the various federal bodies did little to protect investors from harm.

So now, the SEC is making moves to signal that it is, in fact, taking action to protect investors and keep markets viable. The index annuity proposal is probably one of several initiatives the SEC will take on in this new burn-and-learn era.

Here is another: The SEC just announced that it and other securities regulators will conduct examinations aimed at preventing intentional spread of false information that aims to manipulate securities pricing. Examiners will, it says, “double check that broker-dealers and investment advisers have appropriate training for their employees and sturdy controls in place to prevent intentionally false information from harming investors.”

That’s laudable. Rumor-mongering helps no one. But one has to wonder: Are there not existing regulations and supervision that could be prevailed upon for this? Could it be that this new initiative is more spin that spunk?

Another sign of the times: a bill (H. R. 6482) was just introduced in the House that, among other things, would require the SEC to approve certain new structured-finance products, effectively barring bond-rating agencies from just putting top ratings on the products. (Incredibly, some of these products have reportedly received top ratings, even though brand new.) The bill, if enacted, should strengthen the SEC’s powers here, which is good. But, again, one has to wonder: Has the SEC used its existing powers to curb potential structured product problems? Or has it just let it slide, pending the new legislation? In any case, the bill is a sure sign of growing sentiment–that the SEC needs to do more.

Now let’s circle back to the SEC’s index annuity proposal. In view of the current mood, the 96-page proposal looks like “good timing.” The SEC is “doing something” to protect investors.

But is that “something” good? In some ways, the document reads more like a blast from the past than a response to pressing current problems. It recounts index annuity history, the old contention that the product’s status is “uncertain,” review of past laws and court decisions, and reruns of complaints about “abusive” and “potentially abusive” sales practices long since addressed by state insurance regulators. Lacking is the “why now” urgency that makes for compelling argument.

Further, it does not ring bells as do proposals born of deliberative process. For instance, its notion that index annuities are securities seems to be more opinion than fact. Indeed, to make it fact, the SEC proposes issuing a new Safe Harbor Rule 151A (since the existing Safe Harbor Rule 151, widely interpreted as permitting index annuities to be regulated as insurance products, is contrary to the proposal’s goal).

And, if adopted, it would supplant state-based insurance regulation with SEC-based regulation and disrupt the industry’s existing infrastructure–at a mighty cost. Is this necessary? Really?

Naturally, the industry is not taking this “action” lightly.

The National Association of Fixed Annuities, Milwaukee, says it supports the SEC’s stated motivation, to ensure consumer protection and enforce suitability standards in fixed index annuity sales. However, NAFA says it strongly opposes the actual proposal and “will pursue all available avenues of recourse.” Other industry groups share this view. And a majority of the 260+ entries on the SEC’s comment page (as of July 14, 2008) oppose SEC regulation of index annuities, too.

So this out-of-the-blue proposal will likely be contested for a long, long while.

That is good. Yes, the SEC is under pressure to take action. And it should take action to protect investors and the markets. But the actions taken should be in the best interests of the public, not the regulators. Where the index annuity proposal is concerned, it is not clear that this is the case.