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How The Industry And NAIC Will Make Their Case Against The SEC

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Oral arguments are scheduled for Friday May 8 in the U.S. Court of Appeals for the D.C. Circuit on a suit filed by underwriters of indexed annuities and state regulators to forestall regulation of these products by the Securities and Exchange Commission.

A three-judge panel of the Appeals Court that includes Chief Judge David Sentelle, along with Justices Douglas H. Ginsburg and Judith Rogers, will review the final SEC rule, which was approved on Dec. 17, 2008.

The industry has asked for expedited review of the SEC rule because, according to court documents, even the SEC admits that it could cost the industry up to $100 million to implement the rule “in the first year alone.” The agency also “did not dispute commenters’ estimates of lost revenues of $1.5 billion for independent marketing organizations and their agents and $300 million for insurance companies.”

Unless reversed by the courts, most EIAs will be subject to SEC regulation as of January 12, 2011.

The case is American Equity Investment Life Insurance Company, et al, v. the Securities and Exchange Commission.

The industry and the National Association of Insurance Commissioners contend in their briefs that merely because a product is marketed as an “annuity” and because “insurance” involves some-risk-taking doesn’t make the product subject to federal regulation.

Eugene Scalia, a lawyer with Gibson, Dunn & Crutcher in Washington, D.C., said he will contend in oral arguments that what he terms “fixed index annuities” should continue to be regulated by the states because they are recognized as insurance products by all 50 states “and satisfy all generally applicable state requirements for insurance products in the allocation of risk in insurance.”

Therefore, Scalia said, he will argue “they are exempt from regulation as securities by the SEC.”

The NAIC, representing state regulators, will also participate in oral arguments, according to a spokesperson.

In an interview, Scalia said he believes the SEC erred in adopting the rule because of a “mistaken belief that it can pick and choose and decide to regulate ‘certain annuities.’”

Our argument, Scalia said, is that the SEC is not assigned the task of defining annuity under section 3(a)(8) of the Securities Act of 1933, “and is therefore subject to no deference,” as the SEC cites in its brief.

But, he said, even if the SEC were subject to deference, “this rule fails because it is unreasonable, arbitrary and capricious in how it goes about dealing with the governing case law.”

Moreover, he said, in outlining what he will argue, “even if it did, the SEC made obvious mistakes in adopting the rule.”

He said he will contend that the SEC “adopted this rule in the belief that any uncertainty in the purchaser rate of return or any link to the performance of equities in an annuity disqualifies it for treatment as an annuity [exempt from federal regulation] under Section 3(a)(8).

“That is obviously a mistake,” he said. “The SEC also purported to rest its rule on a definition of investment risk that can’t be squared with its own regulations, Supreme Court precedent, and industry practice,” he added.

Among the industry’s arguments, as cited in the brief submitted by the industry, EIA interest credits historically have averaged 1% to 2% higher than fixed annuities, and EIAs “have experienced no loss in contract value in the volatile markets of recent years,” citing a chart in the rulemaking record that plots the performance of one EIA since 1996.

“Except for this interest crediting feature, the essential attributes of EIAs are identical to traditional fixed annuities,” the industry brief argues.

In its brief, the NAIC argues that the SEC proposes a definition of “risk” that is “overbroad” in seeking to regulate EIAs as securities.

And, contrary to the view of the SEC, the state insurance regulators it represents “have a congressionally-recognized interest in exclusive regulation of insurance [under the McCarran-Ferguson Act],” as specified under Section 3(a)(8) of the Securities Act of 1933, the brief says.

Federal regulation in these spheres by virtue of Rule 151A, which would regulate some EIAs as securities “constitutes injury per se” to each state insurance regulator, the NAIC brief says.


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