The Suitability Requirement In The Sale And Regulation Of VAs
Variable annuities currently constitute more than $1 trillion in assets and are the fastest growing product in the insurance industry. Generally, variable annuities are sold to people of modest means as retirement savings vehicles.
In June 2004, the Securities and Exchange Commission and the National Association of Securities Dealers issued a joint report regarding broker-dealer sales of variable insurance products. The report was undertaken in response to a large number of investor complaints. As a result of the examination and findings, the NASD and SEC are recommending that regulators focus upon the suitability of variable product sales.
The proposed rules essentially track the ideas and language of antifraud provisions of federal securities laws and rules from other self-regulatory organizations, which obligate a registered representative to recommend only securities that are "suitable" to any particular customer. That "obligation of fair dealing" means that registered representatives must have reasonable bases for believing that their securities recommendations are suitable for and appropriate to certain customers in light of the customers financial needs, objectives and circumstances.
Among the proposed rules is that a broker-dealer would be required to develop and document training programs for its registered representatives and principals to ensure compliance with the rules requirements and that they understood the features of deferred variable annuities. Further, a registered representative would be required to determine whether a VA is suitable to a customers needs, financial status, investment objectives and other relevant information by asking questions, such as:
Has the customer been informed of the unique features of the variable annuity?
Does the customer have a long-term investment objective?
Is the deferred variable annuity, as a whole and its underlying subaccounts, suitable for the customer, particularly with regard to risk liquidity?
Finally, a registered representative would be required to document those determinations through a series of record keeping and recording procedures, which his or her principal supervisor would be required to review.
As early as 1999, the NASD and the National Association of Insurance Commissioners adopted model rules related to the marketing and sale of variable annuities which anticipated some of these recently proposed rules. The 1999 NASD Notice to Members 99-35, which outlines the "best practices" for the marketing and sale of variable annuities, served as a template for the currently proposed regulations.
In essence, the proposed rules would attempt to put an end to the weak sales practices in connection with VAs by promoting and codifying the sound practices. See the chart for examples of those sales practices in connection with suitability.
The recommendation of the sale of a variable annuity would be undertaken only after the registered representative had obtained and analyzed the customers financial and other relevant information in relation to the product information (of which the registered representative would have a thorough knowledge of the specification of each product) including: liquidity and earnings accrual; income, net worth and contract size thresholds; investment in tax qualified accounts; and variable annuity replacement. As an overlay to those substantive requirements, the broker-dealer would employ appropriate systems, policies and procedures to ensure that the suitability requirements are being met.
Moreover, both the NASD and the SEC have recently brought enforcement and/or disciplinary actions involving the sale of variable annuities. These actions contained allegations of excessive switching, misleading marketing, failure to disclose material facts, unsuitable sales, inadequate written supervisory procedures, failure to maintain adequate documentation, and/or failure to supervise variable product transactions.
Given the regulators recent interest in the regulation and enforcement of regulations governing the sales of variable annuities, companies and individuals engaging in the sale of those products would wisely familiarize themselves with the best practices set forth in the Joint SEC/NASD Report On Examination Findings Regarding Broker-Dealer Sales Of Variable Insurance Products.
Attorney Mary-Pat Cormier is a member of the Financial Services Litigation Practice Group at Edwards & Angell, a national law firm. She may be reached at: mcormier@EdwardsAngell.com.
Reproduced from National Underwriter Edition, October 1, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.
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