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Several people have sent me a copy of a Jan. 6, 2005, letter which they say they received from the National Association of Securities Dealers. This letter asked NASD member firms to send in communications regarding “equity indexed annuities.” (Note: The letter is not posted on the NASD Web site.)

The request included sending NASD a list of the firms associated persons who have told the firm they are offering index annuities. Although some of the requests in the letter are directly supported by NASD rules, others could be considered a bit of a stretch.

The request for communications falls under NASD Rule 3030. This rule requires associated persons (registered representatives) of NASD member firms (broker-dealers, or B-Ds) to provide prompt written notice to their B-D of outside business activities.

The term “outside business activities” is not defined. It would appear, however, that registered representatives must disclose any fixed index annuity, life insurance, long term care, or other product wherein the rep acts as an insurance agent outside of the B-D. If that is so, this would include index annuities.

The letter also asked for marketing and product specific index annuity materials under the auspices of NASD Rule 2210. Unless NASD is talking about registered index annuities, this request is a bit of a puzzler because the language of Rule 2210 talks about mutual funds, variable contracts, direct participation programs, and never mentions fixed annuities.

NASD also asked for B-D procedures in determining whether the index annuities are “marketed primarily as investments.”

Amazingly, after spending most of an afternoon going through the Web sites of the NASD and also the Securities and Exchange Commission, I could not find a definition for “marketed primarily as investments.” Perhaps the B-D could ask NASD for its definition before replying to its recent request.

The question of whether or not some financial products are securities is open to interpretation. However, index annuities are specifically excluded from NASD jurisdiction because they meet SEC safe harbor rules to be classified as fixed annuities.

This is not the first time NASD has gone after index annuities. In 1997, the SEC issued a “Concept Release” (Release No. 33-7438: File No. S7-22-97) requesting comments as to whether index annuities should be registered as securities. At that time, the NASD staff indicated it felt index annuities were securities. However, after the comment period ended in 1998, the SEC did not change its position, thus letting stand the interpretation that fixed index annuities are not securities.

The courts have said index annuities are not securities. For example, the 2001 case of Beverly S. Malone v. Addison Insurance Marketing, Inc. et al. [Civil Action No. 3:01-CV-259(H)] was dismissed by a United States District Court because index annuities were ruled not to be securities.

And, although some people in the securities industry tell stories of index annuities being misrepresented as securities, proof of the tales is a little thin. In the last 5 years, there have been a handful of lawsuits filed by individuals that had purchased index annuities; however, the main claims for damages I have seen are based on contract aspects relating to customer age, policy maturity date and/or surrender charges. These suits are focusing on certain features that apply to all fixed annuities, and the main complaints are not about how the index annuity was marketed or how interest was credited.

The point the industry needs to make is that index annuities are not securities, since neither principal nor credited interest can be lost if the index declines and the policy contains minimum guarantees. Further, marketers should take certain steps to minimize concerns that index annuities might be marketed as securities. These steps are shown in the accompanying checklist (see box).

From talking with consumers, I get the feeling there are a lot of people who own investment securities that probably shouldnt. I say this because many consumers clearly do not have the temperament for the risks of the market. For these people, fixed index annuities are an alternative, just as soy milk would be an alternative to “moo milk” for people who are lactose intolerant.

In these cases, its not presenting the index annuity as a better investment that makes the case. Rather, it is presenting it as a financial tool that suits their needs.

To clarify understanding, the index annuity industry should take steps to defend its products, pointing out that index annuities meet all the safe harbors required to be deemed “not securities.” The industry needs to proactively state this message publicly and loudly to insurance regulators, security regulators and the SEC.

is president of Advantage Compendium, a St. Louis-based research and consulting firm. His e-mail address is webmaster@indexannuity.org.


Reproduced from National Underwriter Edition, February 25, 2005. Copyright 2005 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.