Broker-dealers are reacting to heat from the NASD in different ways

If the National Association of Securities Dealers expected lockstep adherence to its August 2005 advisory notice on broker-dealer sales of index annuities, the self-regulatory agency was wrong.

Anecdotal evidence provided to National Underwriter indicates that while some independent broker-dealers are following the NASD’s Notice to Members 05-50 almost to the letter, others are not.

The lack of uniform response is upsetting insurance distributors and their registered agents and advisors who place business through independent broker-dealers.

For instance, “brokerage general agents are hurting because no one knows what the rules are,” says Ben F. Ward, managing director of The Leaders Council Agency LLC, Memphis, Tenn.

The NTM effectively has “blindsided” the insurance industry, he says.

At dispute is the NTM’s advice that NASD’s member broker-dealers treat index annuities as if they were securities.

Since the large majority of index annuities traditionally have been sold as fixed products, subject to insurance–not securities–regulation, this advice does not square with current practice. The Securities and Exchange Commission has not declared index annuities to be a security, either.

The varied responses of broker-dealers and other marketers has been the inevitable result.

Brian L. Daniels, chief executive officer of Fortune Financial Services Inc., New Brighton, Pa., is one of the independent B-Ds that is following the notice as if it were a regulation. That is, Fortune Financial is requiring its reps to run all index annuity sales through the B-D for supervision and compliance. The firm has roughly 350 reps.

Yes, Daniels allows, “the notice does say it is ‘suggesting’ and ‘recommending,’ not making a ruling.” But index annuities will probably be declared a security before long, he predicts. “That’s what we hear from various attorneys and others in the know.”

Regardless of when or how that happens, he says, his firm is following the terms of NTM 05-50 because of the legal liability issues it creates.

“Now that the NTM is out, the first place any complaints [concerning an index annuity sale by a rep of a B-D] will go is to the broker-dealer,” Daniels explains. “We’re liable for the sale, whether the sale was right, wrong or indifferent, and whether our rep sold it through us or not.”

His firm “cannot provide this level of liability for free,” he continues.

But Larry Schmitt, president of Southwest Insurance Agency, Dallas, says his firm is using the same screening process for index annuities that it uses for variable annuities (a security) except that the independent broker-dealer “does not have to” place index annuity sales through the firm.

Industry pressure may change that, he allows.

Southwest is a subsidiary of SWS Group Inc. It provides insurance services to its affiliated regional and independent B-Ds.

If a rep places an index annuity through the independent B-D, the same procedures apply to that sale as to a VA or another security, Schmitt says. But if the rep for that B-D places an index annuity outside, “we have to know about it as an outside business activity.”

In the case of sales through the regional B-D, “all reps are captive to us and all insurance business has to be placed here or it is considered selling away,” says Schmitt. The screening in this case is comparable to that provided for a VA. “We want to be sure the client understands what it is and how it works,” he says.

Some advisors have told National Underwriter that they are hustling to meet their broker-dealers’ new NTM-inspired index annuity sales procedures–procedures that are often imposed with deadlines measured in days, not weeks.

Others have told NU they are terminating their securities licenses or thinking of doing so, at least the licenses with their existing broker-dealer.

But neither Daniels nor Schmitt report seeing any major changes in licensing so far.

Even so, unsettled feelings are alive and moving amongst index annuity distributors. Why are broker-dealers not responding to the NTM with a united front?

Broker-dealers are very concerned about compliance, and many believe that existing state laws and regulations already are addressing the areas of concern regarding the sale of indexed, or any fixed, annuities, says Carl R. Stern, chairman of Imeriti Inc., a Del Mar, Calif., independent marketing organization that works with several B-Ds.

State insurance regulations do require suitability, he points out. “In addition, most states, especially California, have stringent rules governing selling to seniors ages 60 or 65 and up. There are certain forms to sign and things to do and not to do.”

Also, “the insurance companies will comply with those state laws, even if a rep is selling away,” Stern says, “because the companies know people will sue if they encounter problems with the product.”

Another factor is that some broker-dealers do not have the time, talent or expertise to handle fixed annuities of any kind, say various insurance experts. So, they’re accustomed to seeing the business going through IMOs and insurance brokerages.

Until recently, this was a non-issue where index annuities were concerned, says Stern. That’s because index annuity sales were still very small. But now that sales are up and the NTM has come out, some broker-dealers are deciding they want to bring all that business in-house, while others want to keep things the same as they have been.

Still another factor is that many producers are registered reps who use insurance company broker-dealers, Stern says. However, some of those insurance companies don’t have their own index annuities to sell. “In my opinion, those insurance company B-Ds will have to allow their top reps to sell away, or the rep will go someplace else,” says Stern.

If the SEC comes out with a decision, saying that index annuities are not securities, this will weaken the position taken by the NASD, predicts Ward of Memphis.

Meanwhile, a lot of activity is going on, with B-Ds setting up rules about what is an accepted index annuity and establishing their own approved grids for the products, Ward continues. Once these things are in place, “if a rep in a broker-dealer wants to sell a product that is not on the grid, the rep will need to go to the compliance officer of the broker-dealer to get approval, just as would happen when selling an unapproved mutual fund.”

That “could turn into a tidal wave,” Ward predicts.

Even though the product is not a security, he cautions, “you still have to do compliance on it as if it were a security, and the B-D has to be somewhere in the compensation stream, because compliance costs money.”

All this is complicated by the fact that many B-Ds do not have the wherewithal to handle fixed annuity business, says Ward. “They don’t know how to track a 1035 exchange or to make it happen faster, for example. They don’t know how to pick the right product for the situation.”

Some insurance wholesalers are attempting to turn this lack of knowledge to their advantage, say various sources. They are doing this by offering to provide annuity selection, education, training and various other services to broker-dealers that want to sell index annuities, whether under the terms of the NTM or not.

In such arrangements, “the B-D still can do the compliance, but we could do the product grid, the processing and so on,” says Ward.

What happens to street-level commissions is still in the air.

At NAILBA’s annual meeting in Phoenix last month, several producers told NU they believe these commissions will take a haircut–and eventually more than that–to make up for the compensation they now expect will flow to the B-Ds. Others say distributors are working hard to keep street-level comp the same, at least for the high performers.

Much of what happens next will be influenced by what the SEC does or does not do, say virtually all NTM watchers.

“We know the SEC is taking a serious look at this,” said Alex DelPizzo during public remarks at the NAILBA annual. So, he said, “we should take it seriously.” DelPizzo is the association’s Washington consultant and vice president of Winning Strategies, Washington, D.C.

“It is possible that the SEC might revise the Safe Harbor rule, tighten it up so everyone is happy,” added Leon Huffman during the same session. He is chair of NAILBA’s public affairs committee and president of Huffman & Associates/LifeMark, Orlando, Fla.

The whole issue is actually broader than stopping insurance reps from talking about and selling securities, says Schmitt of Dallas. It also involves what happens when securities licensed reps start talking about and selling life insurance and annuities.

For many, the real questions may come down to this: When a financial product is sold, what channel should it go through? What is best for the customer? And who has the authority to say so?

Those are certainly questions that are on the table at insurance and securities companies as well as distributor and advisory firms.

Regarding the channel question, the philosophy at American National Insurance Company is “it’s all rep-driven,” says George C. Crume, vice president-independent marketing and brokerage sales, Galveston, Texas. “We’ll work with them and accommodate both scenarios [broker-dealer and BGA]. We won’t eliminate anybody.”