The industry feels the NASD’s Notice to Members has several misrepresentations

Las Vegas

“You are primarily the producers of the product, not the manufacturer, so it is important how you sell the product. For instance, you can’t take something that is not a security and make it into a security.”

Attorney Joan E. Boros directed those comments to financial advisors here at the annual Producers’ Forum & Expo sponsored by the National Association for Fixed Annuities, Milwaukee, Wis.

Her purpose was to update advisors on current issues concerning fixed index annuities (also called equity indexed annuities because many of the products link excess interest crediting to gains in an equity index).

A partner in the Washington, D.C., law firm of Jorden Burt, Boros stressed repeatedly that advisors need to focus on how they market EIA products.

Her comments came in response to the controversy now circulating over the August 2005 Notice to Members (NTM 05-50) issued by the National Association of Securities Dealers. That notice lays out the NASD’s views on how its broker-dealer member firms should treat the sale of equity indexed annuities. Though the notice does not define EIAs as securities, it says B-Ds should adopt special procedures in handling EIAs, due to uncertainty over whether a particular annuity may be deemed a security (see NU, Aug. 8 and Aug. 15, 2005).

“The character you give the product is what you are going to have to live with,” Boros told the advisors. This, she said, was the message of the 1967 United Benefit decision regarding annuities (SEC v. United Benefit Life Insurance Company 387 U.S. 202) and it still holds today.

Other aspects of marketing are important, too, she said. For instance, avoid the practice of not pointing out the policy’s surrender charges, riders, fees and so on.

Also, she said, “no back-casting!” Back-casting refers to using past performance, as in: “if you held this policy since 1952, you would have X dollars in the policy today.” Such presentations make “prime cases that the courts and the SEC can make against you,” Boros said.

It’s the advertising and the marketing that most concern the federal regulators, she stressed.

As for the industry, it is concerned that the NASD’s notice to members contains several misrepresentations. “We are trying to chip away at these,” she said.

For example, she said the final version of the NTM says there is an “exemption” for insurance products under federal securities law [Section (3)(8)], Boros noted. But that is not the correct word, she said. “The securities law ‘excludes,’ not ‘exempts,’ insurance from being a security….It says you’re not a security and therefore you don’t have to be sold by registered reps.” The word “exclusion” was in the original version of the NTM, but this was changed in the final version, Boros noted.

There are also some “inconsistencies and inaccuracies” in the NTM, the attorney continued. “We won’t get them all off our back, but we do have the ability to moderate some of them.”

For example, the final version of the NTM says “some” EIAs are registered products. The fact is that there only have been three registered EIAs to date, said Boros. To characterize that number as “some” is “a false and misleading statement,” she said.

The NTM refers to Rule 151, the so-called “Safe Harbor” rule, to clarify when certain annuities are exempted under Section 3(a)(8) of the Securities Act. But the Safe Harbor rule is not an all-encompassing definition for all annuities, Boros said. The concern is that the NTM is trying to move it in that direction, suggesting that Rule 151 is “the” standard. If that were so, then “everything flunks,” Boros said.

Another concern is that the NTM presents EIAs as complex products, because they have minimum guarantees, surrender charges, premium bonuses, etc. “But outliving assets and dying too soon are very complex issues,” Boros said, and so are the products that respond to those issues.

“Complexity per se does not make this product a security.”

What the SEC and NASD will do now is not clear, Boros said. For instance, they could find EIAs to be a security and/or write a separate rule for index products, she explained. However, “I don’t think the SEC is interested in doing that,” though it may want to be sure the marketing materials do not violate the United Benefit decision.

Another possibility is that the SEC could issue a no-action letter, Boros said. Here, the letter would say that if a company proceeds in a certain way, the SEC will take no action against the firm. “This could be a generic type of letter.”

Or, the SEC could do what it did with its concept release on EIAs in 1997, said Boros. “That is, they could drag it out and hope the monster drops into a lagoon.”

That last option is unlikely, she added, due to all the fuss raised by the NASD.

Still another approach would be for the SEC to make one particular EIA product into a poster child for wrongdoing. “The SEC could take an enforcement action on it,” said Boros, noting that this would probably be the most economical response for the SEC.

“If they pick a good case, they also can lay out their principles, [so everyone knows] what to live by and what to die by.”

‘One option for the SEC is to drag the issue out and hope the monster drops into a lagoon’

Ways To Go

? Find index annuities to be a security

? Issue a separate rule on index annuities

? Check the index annuity marketing materials for consistency with the United Benefit decision

? Issue a generic no-action letter on index annuities

? Make a problematic index annuity into a poster child for what to do and not do

? Do nothing