Consider this train of events: A producer tells a client that he will “shop the market” and “get the best deal” for a guaranteed universal life product. After comparing annual premiums for two policies, one from company ‘A’ priced at $98,000 and a second from company ‘B’ priced at $110,000, the producer recommends buying the first.
Weeks after signing the insurance contract, the client alleges the producer engaged in bid-rigging because company B’s policy could have been configured with a $94,000 annual premium using a term rider. A district court agrees, and then slaps the producer with a $50,000 fine–all of which has to be paid out of pocket because the producer’s errors and omissions policy excludes coverage for bid-rigging.
Sounds far-fetched? Think again. The chances of producers getting personally hit with stiff financial penalties or other sanctions stemming from securities violations are increasing, according to Larry Rybka, president of Valmark Securities, Akron, Ohio. Rybka detailed the threats facing independent producers and brokers during a session here of the Association for Advanced Life Underwriting’s annual conference.
“The stakes are high,” said Rybka. “Knowing what transactions are governed by securities regulations can mean the difference between earning a livelihood and loss of net worth because of NASD violations not protected by E&O policies.”
The minefield of uninsurable violations, he added, is growing because of a convergence of trends. Chief among these is heightened federal oversight of the insurance industry because of NASD notices and court rulings that now view certain arrangements–non-recourse financing of life insurance policies, life settlements and the sale of equity-indexed annuities–as securities transactions. Rybka also cited an expanding list of producer and broker actions that E&O policies will no longer cover and a failure among broker-dealers to keep pace with changes in securities laws.
The greatest “mortal sin” that a producer or broker can commit, said Rybka, is “selling away,” to wit: selling a product that one’s broker-dealer has not approved. Doing so can result in suspension or revocation of one’s securities license and/or life insurance license, an NASD investigation, public notice of penalty, and the advisor’s personal liability to investors.
The chances of producers running afoul of their broker-dealer have increased in the wake of NASD Notice 05-50, said Rybka. The ruling extends the association’s oversight to equity-indexed annuities as securities. The notice also makes binding on producers their broker-dealer’s policy with respect to such products.
Rybka added that Notice 05-50 has created a “catch-22.” He described a scenario in which a wholesaler tells a producer that non-NASD-compliant sales materials can be used for promoting a product that the Securities and Exchange Commission hasn’t yet declared a security. Later, the product’s buyer sues when the promised benefits don’t materialize due to poor disclosure on the absence of dividends, disclosure that would otherwise have been mandated by the NASD.
Recent court rulings have contributed to the extension of securities regulations governing insurance transactions. Rybka cited a landmark case in which the SEC brought suit against Life Partners, alleging the firm defrauded investors of more than $1 billion through the sale of life settlements that turned sour. Last year, the 11th Circuit Court of Appeals agreed, holding that “investments in viatical and [life] settlement contracts are investment contracts within the meaning of the Securities Acts of 1933 and 1934.”
Since then, government regulators have ratcheted up oversight of the arrangements, Rybka noted. In March 2006, New York Attorney General Eliot Spitzer issued subpoenas seeking information on life settlement practices. And the NASD gave notice in March that it is considering regulation of the transactions.
“The bottom line is that producers are almost always functioning as brokers in these transactions, as they’re seeking a party that will pay the highest price for the policy to be sold,” said Rybka. “This is a line of business where producers need to exercise extreme caution.”