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SEC's Own 'Best Interest' Regs Might Ban Sales Commissions: Legal Analyst

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Many observers are assuming that the U.S. Securities and Exchange Commission’s Regulation Best Interest proposal would be easier on life insurance agents and brokers than some states’ tough fiduciary rule, best interest and suitability measures might be.

But, in the real world, the SEC’s Regulation BI might be tougher on agents than expected, because the courts might focus purely on the text of Regulation BI itself, and ignore SEC supplementary materials that appear to soften the effects of Regulation BI, according to a lawyer who is helping state insurance regulators analyze the U.S. Securities and Exchange Commission’s Regulation Best Interest proposal.

(Related: Senate Dems Call SEC Reg BI ‘Confusing,’ Prod FINRA for Answers)

Douglas Schmidt, a partner at Husch Blackwell LLP in Kansas City, Missouri, told state insurance regulators recently, in a memorandum dated March 31, that how the courts read Regulation BI could depend on how clear, or fuzzy, they think the term “best interest” is.

Commissions and Captive Agents

If the courts thought “best interest” was a vague term, they might use the SEC’s supplementary materials to figure out what the SEC meant, Schmidt writes in the memo, which was prepared for the National Association of Insurance Commissioners (NAIC).

SEC officials have suggested in the supplementary materials that, in the age of Regulation BI, there would not necessarily a single best product recommendation. Schmidt says.

SEC  officials have also suggested in the supplementary materials that use of commission-based sales compensation arrangements, and “captive” agents, would still be possible, Schmidt says.

A captive agent can recommend only products issued by one or more specified companies.

But, Schmidt writes, if the courts believed that the term “best interest” had a “plain and ordinary” meaning, they might look solely at Regulation BI itself, without using the supplementary materials.

“In this scenario, a court may conclude that the ‘best’ recommendation really is required, regardless of the SEC’s proclamation in supplementary material that Regulation Best Interest does not require the single ‘best’ recommendation,” Schmidt writes. “The broker-dealer would be required to show it was reasonable to believe that the recommendation was best.”

Schmidt says he and Husch Blackwell colleagues believe the no-supplementary-materials scenario is a likely scenario.

“Although it is a close call, we believe that a court would hold that Regulation Best Interest as it stands today is unambiguous, and would find that the term ‘best interest’ has a plain and ordinary meaning,” Schmidt writes.

The Regulation BI Effort

The SEC has been drafting Regulation BI in an effort to address concerns about financial services products sales standards, in response to the end of the U.S. Department of Labor’s first major effort to develop a fiduciary rule standard for the sale of retirement savings products.

The SEC has not defined “best interest” in Regulation BI.

SEC officials have given some ideas about what they mean by “best interest” in the supplementary materials that go along with Regulation BI.

Where the NAIC Fits In

The NAIC is a Kansas City, Missouri-based group for state insurance regulators. States often use NAIC models when developing their insurance laws, regulations and procedures.

State insurance regulators oversee insurance agents’ sales of annuities and savings-oriented life insurance products. Insurance regulators have spent decades developing annuity sales standards.

State insurance regulators’ current annuity suitability standard requires annuity sellers to verify that the products being sold suit the buyers’ needs.

The NAIC is now looking into the idea of updating and, possibly, extending its own sales standards models, to offer an alternative to federal sales standards efforts.

The NAIC’s Life Insurance and Annuities Committee and the committee’s Annuity Suitability Working Group included Schmidt’s analysis in a document packet for a session held Saturday in Orlando, Florida, at the NAIC’s spring national meeting.

‘Best Interest’ Analysis Details

Schmidt says in the Husch Blackwell analysis memorandum that he and his colleagues believe the term “best interest” would require a broker-deal to show that or she had:

…made a reasonable inquiry into available investment options and that, under similar circumstances, an ordinarily prudent broker-dealer, with an understanding of both the complexities of the investment strategy options, as well as an understanding of the customer’s investment profile and goals, could have similarly concluded that a given recommendation was the best option for the retail customer.

“This is a higher standard than the former suitability rule and places a higher standard of conduct upon broker-dealers,” Schmidt writes.

Schmidt notes that the plain language of Regulation BI does not use the term “fiduciary.”

“We do not believe a court would insert this higher standard without clear language by the SEC indicating this was the intent,” Schmidt writes.

Schmidt talks about the possible impact of the text of Regulation BI itself on sales rep compensation and sales team structure in a reference to comments from the Iowa Insurance Division.

“As the Iowa Insurance Division Comment aptly points out, and the Commission [SEC] explicitly recognizes in the supplementary material, Regulation Best Interest, though not per se prohibiting many scenarios that create a conflict of interest that may arise from the nature of the relationship with a customer — including charging commission, receiving different compensation depending on the product sold, receiving third party compensation, recommending complex products, and accepting an order that is contrary to the broker-dealer’s recommendations — notes that these may at times be inconsistent with the obligations under Regulation Best Interest,” Schmidt writes. “Regulation Best Interest may also raise issues with regard to the industry practice of captive agents only being allowed to sell their employers’ products, complying with the new rule.”


A link to the materials packet for the Life Insurance and Annuities Committee and Annuity Suitability Working Group session is available here, under the Meeting Materials tab.

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