Eric Marhoun can still remember the moment when his summer vacation fell apart in 2008. He had just brought his family up to their cabin in Brainerd, Minnesota when he snuck off to check his e-mail. As the executive vice president and general counsel for Old Mutual Financial Network, he couldn’t afford to be out of touch for very long, and this was a perfect chance to catch up with his inbox.
But the first thing he noticed was a bulletin that the Securities and Exchange Commission had issued Rule 151A, which declared that fixed indexed annuities (FIAs) were not insurance products, but securities. To a lay person, this was a seemingly insignificant distinction, but for Marhoun and the rest of the FIA business, it was a seismic change. Anybody selling FIAs would have to be licensed by the SEC, something many in the industry felt would hurt independent agents who primarily sell FIAs. Many felt the rule would change the nature of FIAs themselves, and essentially collapse the industry.
Marhoun’s family was left to enjoy their vacation without him as he dialed into frantic conference calls and scheduled meetings with insurance commissioners for the following Monday. It would be the first in a long series of lost weekends for Marhoun, who became one of the first draftees in the FIA industry’s nearly two-year-long fight for life. “All I can say is I’m glad my family has other interests than me,” Marhoun says, wistfully.
The battle over FIAs began in June 2008, when SEC Chairman Christopher Cox argued that because fixed indexed annuities were often sold abusively to seniors who did not understand the products, FIAs needed SEC oversight to protect the public. To make his point, he played a clip from an NBC Dateline segment in which reporter Chris Hansen went undercover to try to catch annuity sales reps making bogus sales. Hansen came up short, but the video had its intended impact. The SEC voted 5-0 to issue Rule 151A, and like that, FIAs suddenly transformed from insurance to securities as far as the law was concerned.
For many in the industry, the SEC’s ruling came as a surprise, mainly because the feeling was that annuities were clearly insurance products. The carriers bore the investment risk, and at no point had an annuity customer lost money because of market volatility. So what was the big deal?
For others, 151A was less of a shock. Two years previously, the National Association of Securities Dealers (now the Financial Industry Regulatory Authority, or FINRA) issued rule 05-50, which suggested that fixed indexed annuities should be regulated as securities. According to some in the FIA industry, this was a clear warning that few actually heeded.
But for Marhoun and many others in the FIA world, 151A was bad news. At the very least, it would require anybody who sold fixed indexed annuities to get licensed by the SEC, a costly process that would likely drive many smaller operators out of the FIA business. (For those already registered with the SEC, the rule was a non-issue.) According to Marhoun and others, this would, in turn, lead to fewer choices for consumers and seriously deplete the FIA market. It would also undermine the very nature of FIAs themselves. The idea was that governed under securities law, the FIA would become treated more like a security by manufacturers and distributors. Instead of offering 100% guarantee on returns, FIAs might begin offering 90% with a chance for greater returns, but also a greater risk to the value of the product itself. This would fundamentally change FIAs themselves.
Almost immediately, the SEC’s motivations for issuing Rule 151A came into question. During the unusually short comment period that followed the rule’s issuance (only 70 days), hard data on abusive sales failed to materialize. By the time the initial comment period closed in December 2008, the official reasoning behind the rule switched, no longer citing abusive sales practices, but instead noting that since fixed index annuities have investment risk built into them, they should be regulated as securities.
For many who opposed 151A, a host of urban legends and conspiracy theories arose to explain the SEC’s real motivations. One claimed that the entire thing was orchestrated (or at least encouraged) by the NASD so it could gather regulatory fees on annuities activity. Another theory was that the rule was endorsed by variable annuity writers that could rely on the new regulatory requirements to weed out competition. The most sensational theory is that Cox himself took personal issue with fixed indexed annuities after his father almost purchased one and Cox found the sales approach distasteful. None of these stories have ever been substantiated, but they persist.
Whatever the reason, once Rule 151A had been issued, the FIA industry found itself with two choices: it could either find a way to live with this new rule, or it could fight the ruling itself.
It chose to fight.
The Judicial Battle
Shortly after 151A was proposed, Marhoun and the general counsels of some of the fixed indexed annuity industry’s biggest companies–including Allianz Life Insurance Company of North America, American Equity Investment Life Insurance Company, American Investors Life Insurance Company, Aviva Life and Annuity Company, Conseco Insurance Company, EquiTrust Life Insurance Company, the Life Insurance Company of the Southwest, and Midland National Life Insurance Company–met to form the Coalition for Indexed Products, an industry legal team that would battle 151A in court. Prior to this, the industry did not have any kind of combined legal counsel. Over the course of the battle, trade groups, such as the National Association of Fixed Annuities (NAFA) and the Independent Fixed Annuities Agents Council (IFAAC), would get involved, but the Coalition felt it could mount a compelling legal challenge on its own.
“The rule was baseless. The biggest issue is it turns the concept of investment risk on its head by stating that persons have risk if they don’t have certainty as to what their return above a guaranteed rate will be,” Marhoun says. The other concern, he added, is the proposing release relied heavily on statements about sales practices that simply didn’t have a basis in fact as demonstrated by the statistics maintained by the NAIC.
“The rule’s redefinition of investment risk was dangerous because the potential for a return above a guarantee is true of so many insurance products. And insurance products have been exempt from securities regulation since 1933.”
The day 151A was adopted in the Federal Register, the Coalition filed a petition to challenge it. A few days later, the National Association of Insurance Commissioners, which worked closely with the Coalition, filed its own petition challenging the rule. An IMO in Florida also filed an amicus brief showing that the SEC had not looked at the impact of 151A on independent agents. In July 2009, the D.C. Circuit Court of Appeals ruled that the SEC had acted “capriciously and arbitrarily” in adopting Rule 151A. Furthermore, it found that the SEC did not prove the need for the rule against considerations of efficiency, competition and capital formation. However, the Court stopped short of declaring FIAs an insurance product, leaving the central language of 151A–which said FIAs were securities–intact.
To satisfy the Court, the SEC agreed to conduct a study of its own rule. Once the study was completed, a two-year implementation period would begin, during which time the FIA industry could gets its SEC licenses. For those who opposed the rule, all of this bought precious time to mount a legal challenge.
At this point, Marhoun says, most of the Coalition companies shifted their energies to fighting 151A in the halls of Congress as well. Old Mutual, however, continued the battle in court on its own, asking the Court to vacate Rule 151A entirely. “There were other Coalition members in this fight that continued a strong legislative effort,” Marhoun says, “but they were concerned about bringing a petition that might unduly antagonize the SEC.”