In the early days of the insurance industry, before NASD Notice 05-50 was released on Aug. 8, 2005, things were radically different than they are today. Since then, the financial services world has changed dramatically. Compliance, once an issue that mostly concerned only NASD-registered representatives, is now of paramount concern to all industry professionals. As an agent, you must now jump through some pretty big hoops — and when you fail to follow the rules, you may be badly burned. Consider the following case studies:

o In a suit filed against two insurance agents in Massachusetts, the state’s attorney general charged that the pair provided unlicensed investment advice to two elderly clients. The suit also alleges that while helping these clients transfer assets from mutual funds into fixed annuities, the advisors tacitly provided investment advice without being properly licensed to do so.

o The SEC recently overturned the so-called “Merrill Rule.” That rule allowed NASD registered reps to open “wrap accounts” and charge fees based on the value of the account’s assets, as do Registered Investment Advisors (or Investment Advisory Reps under a corporate RIA). Although the rule change is being repealed, it has at least temporarily stopped non-RIAs from charging fees. Broker-dealers with wrap account programs are also closing the doors on the establishment of all new accounts.

o NASD 05-50 strongly suggested that broker-dealers should supervise the sale of index annuities, as the NASD considers these fixed insurance products to be securities. This effectively put the brakes on many index annuity sales.

o Most recently, a May 30, 2007 Wall Street Journal article quoted Joseph Borg of the Alabama Securities Division and president of the North American Securities Administrators Association (NASAA). He said that the initial probes of “free dinner and lunch” seminars resulted in 26 actions against reps who allegedly provided unregistered investment advice or misleading information to seminar attendees. Borg went on to say that they are now expanding the pilot probe beyond the initial seven test states and that he hopes to soon have investigations under way in all 50 states.

o In an address to the Society of Certified Senior Advisors in May 2007, Borg said that his group classifies index annuities as securities, even though these annuities are not classified as such by the SEC. The NASAA took the position that because assets in index annuities may be lost because of a surrender charge, they are therefore securities. While Borg admitted that they do not have jurisdiction to regulate the products, they do have jurisdiction over how they are marketed.

How does this affect you?
These examples help show how your practices are being scrutinized. If you hold lunch or dinner seminars, you should assume that someone from the state securities division will be there, listening and taking notes on everything you say. You should also assume that someone from that division will set an appointment to hear what you say during your appointment process.

If you say the word “investment” and you are not a Registered Investment Advisor (or IAR), you’re sunk. But there is a simple solution to this situation: Become a Registered Investment Advisor, and then integrate investment advice into your practice. (See sidebar for more information.)

The truth is, some insurance reps classify themselves as “financial advisors” or “financial consultants” while, in reality, they hold only life or health insurance licenses. Those reps then lead prospects to believe that they are providing unbiased advice. Instead, the reps are primarily placing assets into fixed annuities or life insurance. This is neither balanced nor unbiased.

Protect yourself – and your clients
1. Obtain your Series 65 license in order to protect yourself and your practice.

2. Help your clients establish a balanced portfolio that incorporates the more traditional asset classes such as equities and debt (stocks and bonds) side-by-side into conservative savings vehicles such as fixed annuities.

3. Use risk tolerance questionnaires to help you determine the right asset allocation on a case-by-case basis. Having these in your file will help protect you if a client becomes dissatisfied in the future, and it gives you a better understanding of how to help clients allocate their money.

By following this path, not only can you make sure there is not a target painted on your back, but you can also do the right thing for your clients. As an added benefit, in most cases you earn the right to manage all of your clients’ assets and not just the small portion that might be suitable for an annuity. And by building a portfolio of assets under management from which you earn an annual fee, you are building a recurring income stream. This income builds over time, which means that on Jan. 1 every year, clients are no longer starting from zero. When they decide to retire, they’ll have an asset with a known value that you can sell to help fund your own retirement.

Dean Zayed is founder and CEO of Brookstone Capital Management LLC in Chicago. He can be reached at 630-653-1400.

10 Steps to Establishing Your Own Independent RIA

o Build a business plan. Determine your financial needs and start-up costs and set a launch date.
o Secure legal council. Retain an attorney that can help protect your interest.
o Choose your legal structure and complete corporate filings. Decidewhat type of establishment (e.g., LLC, S-Corp, limited partnership) will best suit your needs.
o Review agreement with current employer. Your current employer or broker-dealer may have restrictions or limitations on building your own RIA. Make sure you address this early in the process.
o Review and select strategic custodian. Wherever you select a fee model, commission model, or a combination of both, select your provider well in advance. Remember there are many custodians to choose from. They want your business, so be sure to shop around and find a good fit for you and your clients.
o Obtain necessary license. Review your state requirements for investment professionals (i.e., Series 65 and 66 if you are currently a Series 7). Remember, passing the Series 65 is a prerequisite to receiving your license, and is not the license itself. In order to obtain your license, you must file form U-4, pay a state fee, and pass the background check as mandated. You may file form U-10 and simply specify “not applicable,” under the sponsorship section of the form. Once your paperwork is filed, you have a 120-day window to take the exam.
o Complete required regulatory filings. Submit form ADV: Other filings will vary depending on the state and assets under management.(Registration cost is approximately $2,500 depending on complexity.)
o Develop compliance policies and procedures. Every investment advisor must develop and maintain written procedures that define the supervisory process the firm implements to ensure compliance. You should consider hiring a consulting group that specializes in compliance to help you build your manual.
o Obtain Insurance. Obtain errors and omission (E&O) coverage. If you currently have E&O coverage for your insurance practice, be sure to contact your provider to discuss adding additional coverage for your new securities practice.
o Select technology solutions. This includes portfolio management systems and back office support.
Source: Jeremy Rettick, vice president of marketing for Covenant Reliance Producers LLC.