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Regulation and Compliance > Federal Regulation

FINRA Is At The Back Door Of Index Annuity Regulation

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Producers in the fixed index annuity market face many questions: Should I become a registered investment advisor (RIA)? Will the Securities and Exchange Commission take over regulation of fixed index annuities (FIAs)? If I am an investment adviser representative (IAR), am I protected when a client uses funds from a security to buy a FIA? What does the future hold in 2008?

To sort it out, let’s begin with what is known. It is true that FINRA (Financial Industry Regulatory Authority, formerly the NASD or National Association of Security Dealers), does not have the authority to regulate FIA products. The McCarran-Ferguson Act of 1945 says the states retain legal authority over insurance products and producers.

Authority to classify FIAs as securities rests with the SEC. To date, SEC’s last overt action regarding FIAs was to create Safe Harbor Rule 151–which excludes from SEC regulation the index annuities that meet the Safe Harbor criteria. In addition to Rule 151, and the Securities Act of 1933 (which exempts annuities from the definition of securities), there are several Supreme Court and federal district court decisions which refuse to classify index annuities as securities.

With the front door to the FIA house shut and locked, why then are insurance producers inundated with messages about becoming an RIA, an IAR, Series 6 or Series 7 licensed? If FIAs are not securities, why would FIA producers explore securities licensure? This is because FINRA is knocking at the back door. Remember, the SEC regulates security products and FINRA regulates the people who engage in securities transactions.

Think back to the August 2005 NASD Notice to Members 05-50. It was a warning to member broker-dealers that close supervision of representatives may be warranted for FIA sales in order to prevent the FIAs from being sold as investments.

This warning highlighted a specific criterion contained in Safe Harbor Rule 151, prohibiting FIAs from being marketed as “investments.” As a result of 05-50, some broker-dealers now require their registered representatives, who also sell FIAs, to run FIA sales through the B-D’s supervisory and compensation chain. Many B-Ds also supply an approved FIA list.

This summer, the NASD changed its name to FINRA, following NASD’s consolidation with the NYSE (New York Stock Exchange) Member Regulation. The new name seems fitting if FINRA seeks to regulate all financial products. Eliminating ‘securities dealers’ from the name seemingly opens the potential sphere of its regulation. Thus, a natural question to ask is: Are FIAs on the road to being considered “financial” products subject to FINRA regulation? Knowing how critical FINRA has been of FIAs and certain sales practices, it is not a stretch to surmise that FINRA may be looking for another back door to FIA regulation.

Is it possible that FIAs will become dual-regulated, as are variable annuities? Again, the legal trail for the SEC and courts to make such a determination is a long–and mostly an uphill–road.

How else can FINRA get in the back door to index annuities? Consider:

In September 2007, the SEC, FINRA and the North American Securities Administrators Association, Inc. (NASAA) released a report on “free lunch” seminars. Most notably, Appendix A of the report provides seminar invitations actually mailed to consumers. While the report barely mentions index annuities, it is no secret that producers market FIAs through seminars. The report makes clear that registered reps engaged in any seminar marketing will need to examine carefully their materials, regardless of the product being offered.

Going forward, scrutiny of FIA sales involving the movement of securities funds will become increasingly intense. If an insurance producer discusses a security, such as a mutual fund or VA, and is not appropriately licensed, the transaction may be tainted. The difficult question is determining where the line is between selling an insurance product and rendering investment advice without a license.

Producers exploring RIA, IAR, and Series 6 or Series 7 securities licenses are banking on the protection of such designations in every situation. Yet one license may not cover all transactions.

The current dynamics in this area are quite amazing. FIAs are not securities, yet insurance producers are contemplating voluntarily subjecting themselves to securities regulation to protect their FIA sales. And while FINRA can not directly regulate FIAs, many registered reps are running their FIA business through their broker-dealers anyhow. Even though the product itself does not require a securities license to sell it, in the end, the front door is locked and the back door has a greeter.

Danette Kennedy is president of Gorilla Insurance Marketing, Inc. Waukee, Iowa. Her e-mail address is [email protected]