The Financial Industry Regulatory Authority, Washington, D.C., is attempting to expand oversight of the securities marketing industry with an initiative that would require broker-dealers not only to supervise their registered representatives when they sell securities, but to also supervise their reps’ sales of fixed annuities and any investment advisory activities in which they are engaged.
The proposal can be found in FINRA Regulatory Notice 08-24, which was published on May 14, 2008 with a comment period that ended June 13, 2008. (See chart for exact wording.)
This development comes on the heels of FINRA’s recent implementation of a regulation that establishes new, increased scrutiny of all sales of deferred variable annuities (Rule 2821). This increased scrutiny is directed exclusively toward deferred variable annuities and singles them out for greater oversight than for any other type of security, despite well-documented problems in other sectors of the securities business.
It also comes at a time when state insurance regulators are adopting new suitability requirements for the sale of all types of annuities.
FINRA’s latest initiative is causing a considerable stir in the financial services industry. The concern is that the initiative may exceed FINRA’s jurisdictional authority.
It should be noted that the proposed rule requires broker-dealers to supervise the “outside securities” and investment advisory activities of their registered representatives; it does not mention the word “annuities.” But it does not need to mention annuities in order to apply to annuities. That is because all annuities are “securities” within the meaning of the federal securities laws. Traditionally, annuities were exempt from registration and regulation as “securities” because they were specifically exempted from such requirements. Then the United States Supreme Court, in the VALIC decision in 1959, determined that one type of annuity–variable annuities–did not qualify for the exemption.
Concerning the new proposed rule, it is not, by its terms, limited to registered securities. Instead, it applies to all securities transactions, exempt or non-exempt.
Unless later iterations of the rule make a differentiation between exempt and not-exempt securities, it would seem to apply to both. After all, why would FINRA need to require broker-dealer supervision of sales of non-exempt securities when FINRA rules already require that registered representatives sell only those registered securities permitted by the broker-dealer?
With that in mind, insurance regulators, as well as industry executives, are questioning whether FINRA may be overreaching and attempting to regulate in areas far beyond its traditional authority.
FINRA, for its part, has pointed to “abuses” it claims have taken place in the sale of deferred annuities–all types of deferred annuities–by registered reps of broker-dealers, with particular emphasis on claimed abuses with sales to seniors.
If this new FINRA initiative is adopted, the main result is likely to be that insurance agents who possess a FINRA registration will have their entire business subject to supervision by their broker-dealer. This would be the case, even with respect to sale of products that are totally exempt from federal securities laws and whose oversight has traditionally been reserved to other regulatory bodies.
This, in turn, will require broker-dealers to cover their increased supervisory costs by sharing agent compensation on sales of traditional insurance products with which the broker-dealers usually have no expertise.
Deferred annuities are already among the most regulated products in the financial services industry. For instance, FINRA suitability and supervision requirements afford protection for VAs, and state suitability regulations are filling the gap with respect to fixed products. In addition, various industry organizations have developed industry-wide suitability standards that will go a long way to afford a uniform basis for suitability.
You could say that the only thing that’s more thoroughly regulated than variable annuities is nuclear waste.
But now, it is beginning to appear that annuities in general, and perhaps all insurance and investment advisory products and services may be in for the same degree of over-regulation.
There is no doubt that abuses in the sale of deferred annuities have occurred, particularly when the products are inappropriate for senior citizens. Indeed, there are abuses in the sale of almost anything. But the existing regulatory and enforcement processes are easily able to handle these abuses and to punish offenders.
As we have pointed out previously, not all seniors are feeble-minded people who need protection from their own improvidence. They are no more in need of such protection than are other non-senior consumers. It is possible for the dishonest to take advantage of almost anyone.
That is why suitability standards have been implemented and enforcement procedures exist. Furthermore, virtually all states have unfair trade practice statutes on their books that are designed to prohibit unscrupulous sales of anything to anyone.
But when certain products are singled out for special treatment, it has the tendency to chill public acceptance of such products.
Annuities–variable and fixed, deferred and immediate–are a critical element in most everyone’s retirement planning. It would be unfortunate if a few highly-publicized abuses caused a chilling effect on the sales of these important products, particularly if that effect is institutionalized in the form of mandatory regulations.
It would be even worse if the chilling effect extended to traditional life insurance products.
“Hard cases make bad law” is a legal axiom that should be remembered before imposing new regulations without adequate thought regarding their consequences. The axiom means that, in an effort to “do justice” and to right individual wrongs, precedents may be created that are untenable when applied to the general intercourse of mankind. The regulatory authorities would do well to avoid such an outcome in their rule-making.