Self-Regulatory Organizations; National Association of Securities Dealers, Inc. (n/k/a
summary
On September 7, 2007, the SEC granted accelerated approval to FINRA’s amended Rule 2821, establishing suitability, supervision, and training requirements for deferred variable annuity sales to combat widespread misconduct, including over 137 enforcement actions between 2004 and 2007, with mandates for principal approval within seven business days and prohibitions on unsuitable exchanges.
paragraph
On September 7, 2007, the SEC approved Amendments Nos. 3 and 4 to NASD’s Proposed Rule 2821, which became FINRA Rule 2821, imposing new sales practice standards for deferred variable annuities. The rule requires brokers to assess customer suitability based on financial status, tax situation, and investment objectives, mandates principal approval within seven business days for all purchases or exchanges, and prohibits unsuitable exchanges—particularly those occurring more than once every 36 months. The SEC acted in response to 137 enforcement actions and 807 examinations between 2004 and 2007, concluding the rule was necessary to protect investors despite industry objections over compliance costs and perceived duplication with existing rules.
narrative
On September 7, 2007, the SEC granted accelerated approval to Amendments Nos. 3 and 4 to NASD’s Proposed Rule 2821, which was adopted by FINRA to govern sales practices for deferred variable annuities. The rule establishes mandatory suitability obligations requiring brokers to gather detailed customer information—including financial status, tax situation, and investment goals—and to ensure recommendations are appropriate, particularly prohibiting unsuitable exchanges, especially those occurring more than once every 36 months. Principal review and approval of all purchases or exchanges must be completed within seven business days, and firms are required to implement training and surveillance systems to detect misconduct. The SEC’s decision followed 807 examinations and 137 enforcement actions between 2004 and 2007 that revealed widespread abuses in variable annuity sales, including excessive exchanges and inadequate disclosure. Although industry participants raised concerns about compliance burdens, operational complexity, and duplication with existing suitability rules, the SEC determined investor protection outweighed these objections. The rule applies to initial purchases and exchanges of deferred variable annuities but excludes routine subaccount reallocations and subsequent premium payments. A six-month transition period was provided to allow firms time to adapt systems and training programs, and the rule was deemed consistent with Section 15A(b)(6) of the Securities Exchange Act, reinforcing FINRA’s duty to protect investors in complex financial products.
Classified unregistered-securities(confidence 100%). EDGAR detection: forms Form D/S-1· recall 41% / precision 30%. detection rule →
Statutes
15 U.S.C. 78s(b)15 U.S.C. 78o-3(b)15 U.S.C. 78c(f)5 U.S.C. 55217 CFR 240.19b-4Section 19(b)(1) of the Securities Exchange ActSection 19(b)(1) of the Securities Exchange ActRule 19b-4
Parties
national association of securities dealers, inc.Securities and Exchange Commission
Keywords
letternasdproposedvariable annuityvariabledeferred variablevariable annuitiesannuityseeamendmentdeferredcustomercommentscommentersreview
Extracted insights
Dollar amounts 1
- $200K $200,000 $100K–$1M
Entities 2
- company national association of securities dealers, inc.
- agency Securities and Exchange Commission
Triples 9
- National Association Of Securities Dealers, Inc. filed Proposed Rule 2821
- National Association Of Securities Dealers, Inc. filed Amendment No. 2
- National Association Of Securities Dealers, Inc. filed Amendment No. 3
- National Association Of Securities Dealers, Inc. filed Amendment No. 4
- Securities And Exchange Commission received Approximately 1500 Comments
- Securities And Exchange Commission received Approximately 1950 Comments
- Securities And Exchange Commission approved Proposed Rule Change
- Securities And Exchange Commission approved Proposed Rule As Amended
- National Association Of Securities Dealers, Inc. granted consent Securities And Exchange Commission
Text layers
Extracted body text (95,384c)
1
SECURITIES AND EXCHANGE COMMISSION
(Release No. 34-56375; File No. SR-NASD-2004-183)
September 7, 2007
Self-Regulatory Organizations; National Association of Securities Dealers, Inc. (n/k/a
Financial Industry Regulatory Authority, Inc.); Notice of Filing of Amendment Nos. 3
and 4 and Order Granting Accelerated Approval of the Proposed Rule, as Amended,
Related to Sales Practice Standards and Supervisory Requirements for Transactions in
Deferred Variable Annuities
I. Introduction
On December 14, 2004, the National Association of Securities Dealers, Inc.
(“NASD”) filed with the Securities and Exchange Commission (“Commission”),
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
1
(“Exchange Act” or
“Act”) and Rule 19b-4
2
thereunder, proposed new Rule 2821 (“Proposed Rule 2821”)
relating to the sales practice standards and supervisory and training requirements
applicable to transactions in deferred variable annuities.
3
Proposed Rule 2821, as
amended by Amendment No. 1, was published for comment in the Federal
Register on
July 21, 2005.
4
The Commission received approximately 1500 comments on the
1
15 U.S.C. 78s(b)(1).
2
17 CFR 240.19b-4.
3
On July 26, 2007, the Commission approved a proposed rule change filed by
NASD to amend NASD’s Certificate of Incorporation to reflect its name change
to Financial Industry Regulatory Authority Inc., or FINRA, in connection with the
consolidation of the member firm regulatory functions of NASD and NYSE
Regulation, Inc. See
Exchange Act Release No. 56146 (July 26, 2007); 72 FR
42190 (Aug. 1, 2007).
4
See Exchange Act Release No. 52046A (July 19, 2005); 70 FR 42126 (July 21,
2005) (SR-NASD-2004-183).
2
proposal.
5
NASD filed Amendment No. 2 on May 4, 2006, which addressed the
comments and proposed responsive amendments. Amendment No. 2 was published for
comment in the Federal Register on June 28, 2006.
6
The Commission received
approximately 1950 comments on Amendment No. 2.
7
To further explain and modify
certain provisions of Proposed Rule 2821 in response to comments, NASD filed
Amendment No. 3 on November 15, 2006 and Amendment No. 4 on March 5, 2007.
Amendment No. 4 supersedes all of the previous amendments in their entirety. All of the
comments that the Commission has received are available on the Commission’s Internet
Web site (http://www.sec.gov/rules/sro.shtml
). This order provides notice of
Amendment Nos. 3 and 4 to the proposed rule and approves the proposed rule as
amended on an accelerated basis.
8
II. Description of the Proposal
Proposed Rule 2821 would create recommendation requirements (including a
suitability obligation), principal review and approval requirements, and supervisory and
training requirements tailored specifically to transactions in deferred variable annuities.
It is intended to supplement, not replace, NASD’s other rules relating to suitability,
5
Approximately 1300 of these comments, primarily from licensed insurance
professionals and variable product salespersons, are virtually identical. These
letters are referred to herein, and on the list of comments on the Commission’s
Web site as “Letter Type A.” The Commission also received multiple copies of
other letters, which we refer to as Letters Type B, C, D, E, F, G and H, below.
6
See Exchange Act Release No. 54023 (June 21, 2006); 71 FR 36840 (June 28,
2006) (SR-NASD-2004-183).
7
Approximately 1700 of these comments, primarily from licensed insurance
professionals and variable product salespersons, are virtually identical. These
letters are referred to herein as “Letter Type B.”
8
NASD granted consent for the Commission to approve the proposed rule beyond
the timeframes set forth in Section 19(b)(2) of the Act.
3
supervisory review, supervisory procedures, and training. Thus, to the extent Proposed
Rule 2821 does not apply to a particular transaction, NASD’s general rules on suitability,
supervisory review, supervisory procedures, and training continue to govern when
applicable.
9
The text of the proposed rule is available on FINRA’s Web site
(www.finra.org
), at FINRA’s principal office, and at the Commission’s Public Reference
Room.
Proposed Rule 2821 would apply to the purchase or exchange of a deferred
variable annuity and to an investor’s initial subaccount allocations.
10
It would not apply
to reallocations of subaccounts or to subsequent premium payments made after the
investor’s initial purchase or exchange.
11
It also generally would not apply when an
investor’s purchase or exchange of a deferred variable annuity is made within a tax-
9
The general suitability obligation requires a broker-dealer to consider its
customer’s ability to understand the security being recommended, including
changes in the customer’s ability to understand, monitor, and make further
decisions regarding securities over time.
10
As NASD noted in Amendment No. 2, the proposed rule focuses on customer
purchases and exchanges of deferred variable annuities, areas that, to date, have
given rise to many of the sales practice abuses associated with variable annuity
products. See
Exchange Act Release No. 52046A, at 3-5 (discussing various
questionable sales practices that NASD examinations and investigations have
uncovered and the actions NASD has taken to address those practices). The
proposed rule would thus cover a standalone purchase of a deferred variable
annuity and an exchange of one deferred variable annuity for another deferred
variable annuity. For purposes of the proposed rule, an “exchange” of a product
other than a deferred variable annuity (such as a fixed annuity) for a deferred
variable annuity would be covered by the proposed rule as a “purchase.” The
proposed rule would not cover customer sales of deferred variable annuities,
including the sale of a deferred variable annuity in connection with an “exchange”
of a deferred variable annuity for another product (such as a fixed annuity).
However, recommendations of customer sales of deferred variable annuities are
covered by Rule 2310, NASD’s general suitability rule.
11
NASD’s general suitability rule, Rule 2310, would continue to apply to
reallocations of subaccounts.
4
qualified, employer-sponsored retirement or benefit plan.
12
If, however, a member
recommends a deferred variable annuity to an individual plan participant, then Proposed
Rule 2821 would apply to that purchase (or exchange) and to the initial subaccount
allocations.
Proposed Rule 2821 has four main requirements. First, in order to recommend
the purchase or exchange of a deferred variable annuity, a member would be required to
have a reasonable basis to believe that the transaction is suitable in accordance with
NASD’s general suitability rule, Rule 2310.
13
In particular the member must have a
reasonable basis to believe that:
• The customer has been informed, in general terms, of various features of
deferred variable annuities;
14
• The customer would benefit from certain features of deferred variable
annuities, such as tax deferred growth, annuitization, or a death or living
benefit;
15
and
• The particular deferred variable annuity that the member is recommending,
the underlying subaccounts to which funds are allocated at the time of the
12
Proposed Rule 2821 defines such plans as either a “qualified plan” under Section
3(a)(12)(C) of the Act or a plan that meets the requirements of Internal Revenue
Code Sections 403(b), 457(b), or 457(f).
13
See Proposed Rule 2821(b)(1)(A).
14
See Proposed Rule 2821(b)(1)(A)(i). The proposed rule lists the following
features as examples for purposes of this requirement: (1) potential surrender
period and surrender charge; (2) potential tax penalty if customers sell or redeem
deferred variable annuities before reaching the age of 59½; (3) mortality and
expense fees; (4) investment advisory fees; (5) potential charges for and features
of riders; (6) the insurance and investment components of deferred variable
annuities; and (7) market risk.
15
See Proposed Rule 2821(b)(1)(A)(ii).
5
purchase or exchange of the deferred variable annuity, and the riders and
similar product enhancements are suitable (and in the case of an exchange, the
transaction as a whole also is suitable) for the customer based on the
information the person associated with the member is required to make a
reasonable effort to obtain pursuant to subparagraph (b)(2) of the proposed
rule.
16
Prior to recommending that a customer exchange a deferred variable annuity, a
registered representative must not only have a reasonable basis to believe that the
exchange is consistent with the suitability determinations in subparagraph (b)(1)(A) of
the proposed rule, but must also consider whether:
• The customer would incur a surrender charge, be subject to the
commencement of a new surrender period, lose existing benefits, or be subject
to increased fees or charges;
17
• The customer would benefit from product enhancements and improvements;
18
and
• The customer’s account has had another deferred variable annuity exchange
within the preceding 36 months.
19
The associated person recommending the transaction would be required to
document these considerations and sign this documentation. He or she would also have
to make reasonable efforts to obtain from the customer information regarding the
16
See Proposed Rule 2821(b)(1)(A)(iii).
17
See Proposed Rule 2821(b)(1)(B)(i).
18
See Proposed Rule 2821(b)(1)(B)(ii).
19
See Proposed Rule 2821(b)(1)(B)(iii).
6
customer’s age, annual income, financial situation and needs, investment experience,
investment objectives, intended use of the deferred variable annuity, investment time
horizon, existing assets (including investment and life insurance holdings), liquidity
needs, liquid net worth, risk tolerance, tax status, and such other information used or
considered to be reasonable by the member or person associated with the member in
making recommendations to customers.
20
Second, a registered principal would have to review the transaction and determine
whether he or she approves of it prior to transmitting the customer’s application to the
issuing insurance company for processing, but no later than seven business days after the
customer signs the application.
21
The registered principal may approve the transaction
only if he or she has determined that there is a reasonable basis to believe that the
transaction would be suitable based on all of the factors contained in paragraph (b)
(“Recommendation Requirements”) of the proposed rule.
22
20
See Proposed Rule 2821(b)(2).
21
See Proposed Rule 2821(c). NASD has determined that relief is needed to allow
certain broker-dealers to complete their review of deferred variable annuity
transactions as required by proposed NASD Rule 2821 without becoming fully
subject to Exchange Act Rule 15c3-3 and being required to maintain higher levels
of net capital in accordance with Exchange Act Rule 15c3-1. Consequently,
NASD has requested relief from Rules 15c3-3 and 15c3-1 for these broker-
dealers. In conjunction with the Commission’s approval or proposed rule 2821, it
is also granting exemptions from Rules 15c3-1 and 15c3-3 of the Exchange Act to
allow NASD members to comply with proposed Rule 2821 without becoming
fully subject to Exchange Act Rule 15c3-3 and being required to maintain higher
levels of net capital in accordance with Rule 15c3-1.
NASD initially submitted a request for relief to the staff prior to the consolidation
of its member firm regulatory functions with NYSE Regulation, Inc. This request
was replaced by a subsequent request from the consolidated entity, FINRA. For
readability, this second request is referred to as an NASD request throughout this
order.
22
See Proposed Rule 2821(c).
7
For purposes of reviewing deferred variable annuity purchases and exchanges, a
registered principal must treat all transactions as if they have been recommended.
23
However, if a registered principal determines that a transaction, which is not suitable
based on the factors contained in paragraph (b), was not recommended, he or she may
nonetheless authorize the processing of it if the customer has been informed of the reason
why the transaction has not been approved and the customer affirms that he or she wants
to proceed with the transaction.
24
The registered principal that reviews the transaction must document and sign the
determinations that the proposed rule requires him to make.
25
He or she must complete
this documentation regardless of whether he or she approves, rejects, or authorizes the
transaction.
26
Third, Proposed Rule 2821 would require members to develop and maintain
supervisory procedures that are reasonably designed to achieve compliance with the
proposed rule.
27
Members would be required to implement surveillance procedures to
determine if associated persons “have rates of effecting deferred variable annuity
exchanges that raise for review whether such rates of exchanges evidence conduct
inconsistent with the applicable provisions of [the rule], other applicable NASD rules, or
the federal securities laws (‘inappropriate exchanges’).”
28
Members would also be
required to have policies and procedures reasonably designed to implement corrective
23
Id.
24
Id.
25
Id.
26
Id.
27
See Proposed Rule 2821(d).
28
Id.
8
measures to address inappropriate exchanges and the conduct of associated persons who
engage in inappropriate exchanges.
29
Fourth, Proposed Rule 2821 would require members to develop and implement
training programs that are tailored to educate registered representatives and registered
principals on the material features of deferred variable annuities and the requirements of
the proposed rule.
30
III. Summary of Comments on Amendment No. 2
In its solicitation of comments on Amendment No. 2, the Commission stated that
it would consider the comments it previously received,
31
and that commenters could
reiterate or cross-reference previously submitted comments.
32
The Commission has
considered all of the comments it received, including commenters’ reiterations of and
cross-references to previously submitted comments. While the summary below refers to
some comments previously submitted, it primarily discusses new comments on portions
of the proposed rule that Amendment No. 2 did not change and comments on those
provisions of the proposed rule that Amendment No. 2 modified. It also discusses
comments received in response to Amendment No. 1 that are relevant to the timing of
principal review provision in paragraph (c) of the proposed rule.
A. General Comments
A number of commenters reiterated their general opposition to the proposed rule,
viewing it as unnecessary, arguing that NASD has not demonstrated a need for it, and
29
Id.
30
See Proposed Rule 2821(e).
31
See Exchange Act Release No. 54023 (June 21, 2006); 71 FR at 36846 n.84.
32
Id.
9
stating that strong enforcement against broker-dealer sales practice abuses provides the
best deterrent to negative market conduct.
33
Some commenters also stated that existing
NASD rules and the prospectus adequately inform and protect investors.
34
A few commenters suggested that the proposed rule must take into account an
estimate of its competitive and economic impact and asserted that the proposed rule must
be subject to a cost/benefit analysis.
35
One commenter took the position that the
proposed rule would impose economic and competitive burdens upon broker-dealers.
36
The commenter stated that the rule would require expensive new systems and operation
changes that could initially total more than $200,000 for broker-dealers to implement and
33
See, e.g., Letters from Stephen A. Batman, CEO, 1st Global Capital Corp.
(July 19, 2006) (“1st Global Letter II”); Carl B. Wilkerson, Vice President and
Chief Counsel, American Counsel of Life Insurers (July 19, 2006) (“ACLI Letter
IV”); Gary A. Sanders, Senior Counsel, Law and Government Relations, National
Association of Insurance and Financial Advisors and Thomas F. Korb, Vice
President of Policy and Public Affairs, Association for Advanced Life
Underwriting (July 19, 2006) (“NAIFA/AALU Letter II”); Letter Type B. See
also Letter Type D. Unless otherwise noted, all letters are addressed to the
Commission.
34
See, e.g., Letters from Dale E. Brown, CAE, Executive Director and CEO,
Financial Services Institute (July 19, 2006) (“FSI Letter II”); Ari Burstein,
Associate Counsel, Investment Company Institute (July 19, 2006) (“ICI Letter
II”); 1st Global Letter II; ACLI Letter IV; Letter Type B. Two commenters
suggested that the Commission delay action on the proposed rule until there is
some resolution to the Commission’s point-of-sale proposal. See
ACLI Letter IV;
FSI Letter II. Another commenter stated that it is not clear how the proposed rule
would work with the Commission’s point-of-sale proposal, especially with regard
to the disclosure of material features. See
Letter from W. Thomas Conner and
Eric A. Arnold, Sutherland Asbill and Brennan LLP on behalf of Committee of
Annuity Insurers (July 19, 2006) (“CAI Letter II”).
35
See Letter from Joan Hinchman, Executive Director, President and CEO, National
Society of Compliance Professionals, Inc. (July 19, 2006) (“NSCP Letter”); ACLI
Letter IV; NAIFA/AALU Letter II.
36
ACLI Letter IV.
10
monitor enterprise-wide.
37
It also maintained that the ongoing costs of complying with
the proposed rule would be significant and immeasurable.
38
That commenter did not,
however, provide any specific information about the system changes it foresaw, or how it
arrived at its $200,000 estimate.
Some commenters stated that the proposed rule would impose a burden on
competition.
39
One of these commenters stated that the proposed rule would disparately
impact smaller companies without state-of-the-art technological resources.
40
In its view,
small to mid-sized companies may be forced out of the annuity market, thereby reducing
competition and eliminating consumer options.
41
One commenter posited three ways in
which the proposed rule would burden competition, stating:
• The proposed rule would disrupt enterprise-wide uniformity of compliance
procedures. Compliance with the proposed rule would cost more than
compliance procedures for other products, and thus would make variable
annuities more expensive to sell than other products.
• Conversion to the proposed rule would provide openings for inadvertent and
transitional violations and may dampen distributors’ enthusiasm for selling a
product with suitability and supervision standards that are different from all
other securities.
• Other products have had greater incidences of disciplinary actions and do not
have specific supervision and suitability standards “that would dampen
distributors’ sales enthusiasm for fear of regulatory reprisals or technical
violations.”
42
37
Id.
38
Id.
39
See e.g., ACLI Letter IV; NAIFA/AALU Letter II; NSCP Letter.
40
NSCP Letter.
41
Id.
42
ACLI Letter IV. Another commenter agreed that the proposed rule would place
those that sell variable annuities at a competitive disadvantage in comparison with
those who market other types of investments. See
NAIFA/AALU Letter II. Two
commenters also stated that adopting product specific suitability requirements and
11
This commenter also argued that the rule targets deferred variable annuities in a
discriminatory and burdensome fashion without appropriate rationale.
43
Some commenters stated that implementation of the proposed rule would have
unintended consequences.
44
For example, two commenters asserted that the proposed
rule would raise barriers to access for investors who could benefit from owning a
deferred variable annuity.
45
A few commenters also believed that the product-specific
requirements of the proposed rule would signal to investors that something is wrong with
the product.
46
One commenter stated that the proposed rule would cause expenses and
fees to rise, which in turn would lead consumers to look to other, less expensive
investment products that may not be as appropriate for their needs.
47
NASD responded to concerns regarding the need for the proposed rule, the
process by which it developed and revised the proposed rule, and the statutory
requirements for its rulemaking in a letter to the Commission.
48
With respect to concerns
that the proposed rule is not necessary, NASD reiterated that its examinations,
supervisory procedures would inhibit sales because registered representatives
would be less inclined to sell the product. See
Letter from Michael P. DeGeorge,
General Counsel, National Association for Variable Annuities (July 19, 2006)
(“NAVA Letter III”); FSI Letter II.
43
ACLI Letter IV.
44
See, e.g., Letter from Rick Dahl, CCO, Sorrento Pacific Financial LLC
(July 19, 2006) (“Sorrento Letter”); FSI Letter II; NAVA Letter III;
NAIFA/AALU Letter II.
45
See FSI Letter II; Sorrento Letter.
46
See Letter from W. Burk Rosenthal, President, Rosenthal Retirement Planning,
LP (July 19, 2006); FSI Letter II; NAVA Letter III.
47
See NAIFA/AALU Letter II.
48
See Letter from James S. Wrona, Associate Vice President, NASD (Aug. 31,
2006) (“NASD Response Letter”).
12
investigations, and informal discussions with its members have uncovered numerous
instances of questionable sales practices in connection with the purchase or exchange of
deferred variable annuities, including unsuitable recommendations, and
misrepresentations and omissions.
49
It also stated that member supervision and training
procedures are inadequate.
50
NASD noted that these problems stem from the unique
complexities of deferred variable annuities, which can cause confusion both for the
individuals who sell them and for the customers who purchase or exchange them.
51
Despite issuing Notices to Members, Regulatory and Compliance Alerts, and Investor
Alerts, NASD found that these problems continue to exist.
52
NASD stated that recent
joint reviews with the Commission, as well as NASD examinations and enforcement
actions, demonstrate that an informal approach has not been sufficiently effective at
curbing the sales practice abuses in this area.
53
NASD also discussed its “measured approach” to the rulemaking process.
54
After
NASD determined that a rule specific to deferred variable annuities was necessary and
appropriate, it issued Notice to Members
04-45 (June 2004) to solicit comments from the
public prior to submitting the proposed rule to the Commission.
55
In addition, NASD
sought input on the proposal from five NASD standing committees, including two
49
Id. at 2.
50
Id.
51
Id.
52
Id.
53
Id.
54
Id. at 3.
55
Id.
13
committees with subject matter expertise in variable annuities.
56
NASD Regulation,
Inc.’s Board of Directors then approved the proposal and NASD’s Board of Governors
had an opportunity to review it.
57
NASD modified the proposed rule in light of
comments it received from all of these sources prior to filing it with the Commission.
58
In addition, NASD stated that nothing in Section 15A, Section 19, or any other
provision of the Act requires it to generate a competitive impact statement or otherwise
engage in a cost/benefit analysis.
59
It also noted that, as required under Section 19(b)(1)
of the Act,
60
NASD submitted to the Commission a concise general statement of the
basis and purpose of the proposed rule.
61
As discussed in Part IV below, in approving a proposed NASD rule, the
Commission must find that the rule is consistent with the requirements of Sections
15A(b)(6) and 15A(b)(9) of the Act. Section 15A(b)(6) requires, among other things, the
rules of a national securities association to be designed to prevent fraudulent and
manipulative acts and practices, to promote just and equitable principles of trade, and, in
general, to protect investors and the public interest.
62
Section 15A(b)(9) provides that
56
Id. at 4.
57
Id. at 4. NASD noted that its Board of Governors is composed of both industry
and non-industry members and that one member must be a representative of an
insurance company. Id
. at 4, nt. 6. Similarly, NASD Regulation, Inc.’s Board of
Directors is composed of both industry and non-industry members, and one
member must be a representative of an insurance company or an affiliated NASD
Member. Id
. at 4, nt. 6.
58
Id. at 4.
59
Id.
60
15 U.S.C. 78s(b)(1).
61
NASD Response Letter at 4.
62
15 U.S.C. 78o-3(b)(6). See also 15 U.S.C. 78c(f) (the Commission must consider
whether the action will promote efficiency, competition and capital formation
14
proposed rules may not create a “burden on competition not necessary or appropriate in
furtherance of the purposes of [the Act].”
63
NASD addressed the consistency of the
proposed rule with these requirements, stating:
NASD believes that the proposed rule will enhance firms’
compliance and supervisory systems and provide more
comprehensive and targeted protection to investors
regarding fraud and manipulative acts, promote just and
equitable principles of trade, and increase investor
protection. . . . Like all regulation, NASD’s rules often
impose compliance obligations on the regulated entities. In
every case, the compliance burdens associated with a new
rule will vary from firm to firm depending on the firm’s
customer base, business model, and a variety of other
factors. Section 15A(b)(9) of the Act does not, therefore,
require that NASD rules impose no economic burden on
NASD members or burden on competition, but rather that
any such burdens are necessary and appropriate to further
the purposes of the Act . . . . NASD believes that the
proposed rule is consistent with, and promotes the goals of
the Act.
64
B. Comments on Proposed Rule 2821(b) – Recommendation Requirements
1. Comments on Proposed Rule 2821(b)(1)(A) – Renumbered Proposed Rule
2821(b)(1)(A)(i)
As proposed in Amendment No. 2, Proposed Rule 2821(b)(1)(A) would have
required registered representatives to have a reasonable belief that the customer has been
informed of the material features of deferred variable annuities in general prior to
recommending a particular variable annuity to a customer.
65
One commenter stated that
when it is required to consider whether an action is necessary or appropriate in the
public interest).
63
15 U.S.C. 78o-3(b)(9).
64
NASD Response Letter at 4-5.
65
In response to Amendment No. 1, commenters stated this provision would amount
to a de facto
requirement to provide written disclosure to customers. See, e.g.,
Letters from Beth L. Climo, Executive Director, American Bankers Insurance
15
the rule should clarify what constitutes the material features of a deferred variable
annuity, and should have a safe harbor to protect good faith attempts to disclose the
required information.
66
Some commenters reiterated their support for a plain-English
disclosure document to be provided to investors in addition to the prospectus.
67
The substance of this provision remained the same in Amendment No. 3, but in
response to comments NASD explicitly stated that the type of disclosure required is
generic and not specific to the particular deferred variable annuity being recommended.
The provision now provides that the member or person associated with the member must
have a reasonable basis to believe that “the customer has been informed, in general terms,
of various features of deferred variable annuities . . . .”
2. Comments on Proposed Rule 2821(b)(1)(B) – Renumbered Proposed Rule
2821(b)(1)(A)(ii)
Association/ABA Securities Association (Sept. 20, 2005); Carl B. Wilkerson,
Vice President and Chief Counsel, America Council of Life Insurers (Sept. 19,
2005) (“ACLI Letter II”), Thomas M. Yacovino, Vice President, A.G. Edwards &
Sons, Inc. (Sept. 20, 2005); Roger C. Ochs, President, HD Vest Financial Services
(Sept. 20, 2005); Michael P. DeGeorge, General Counsel, National Association
for Variable Annuities (Sept. 19, 2005) (“NAVA Letter II”); Thomas R. Moriarty,
President, Intersecurities, Inc. (Sept. 16, 2005) (“Intersecurities Letter”); Ira D.
Hammerman, Senior Vice President and General Counsel, Securities Industry
Association (Sept. 19, 2005) (“SIA Letter I”); Ronald C. Long, Senior Vice
President, Wachovia Securities, LLC (Sept. 19, 2005) (“Wachovia Letter”).
Commenters also asserted that this disclosure, along with the other disclosures
already provided to investors who purchase or exchange deferred variable
annuities, would be redundant and would overwhelm investors. See
e.g., Letter
from Leesa M. Easley, Chief Legal Officer, World Group Securities, Inc. (Sept.8,
2005); ACLI Letter II; Intersecurities Letter; NAIFA/AALU Letter II; NAVA
Letter II; SIA Letter I.
66
FSI Letter II.
67
See, e.g., Letters from Patricia Struck, President, North American Securities
Administrators Association (July 21, 2006) (“NASAA Letter II”); Jill I. Gross,
Director of Advocacy, Pace Investor Rights Project (July 19, 2006) (“Pace Letter
II”); Robert S. Banks, Jr., President, Public Investors Arbitration Bar Association
(July 20, 2006).
16
As proposed in Amendment No. 2, Proposed Rule 2821(b)(1)(B) would have
required a registered representative to have a reasonable basis to believe that a customer
would benefit from the unique features of a deferred variable annuity prior to
recommending the purchase or exchange of one. Amendment No. 2 included tax-
deferred growth, annuitization and death benefits as a non-exhaustive list of unique
features.
Some commenters stated that the standard should be that the customer “could”
benefit from the features because stating that the customer would benefit implies a level
of certainty and guarantee that cannot be known at the time of the purchase or
exchange.
68
Other commenters also suggested deleting the modifier “unique,” stating
that the features NASD lists as examples are not unique to deferred variable annuities.
69
In the alternative, one of these commenters suggested that NASD expand the list of
features it gives as examples to include features such as living benefits.
70
NASD agreed that some other products have features similar to those of a
deferred variable annuity, and in Amendment No. 2 deleted the reference to “unique.”
NASD also adopted commenters’ suggestion to include “living benefits” in the list of
features and modified the proposed rule accordingly in Amendment No. 3.
3. Comments on Proposed Rule 2821(b)(2)
68
See, e.g., Letter from Ira D. Hammerman, General Counsel, Securities Industry
Association (July 19, 2006) (“SIA Letter II”); ACLI Letter IV; NAVA Letter III.
These commenters noted that this comment is also applicable to Proposed Rule
2821(c)(1)(A). See
supra note 120.
69
See, e.g., ACLI Letter IV; CAI Letter II; FSI Letter II; NAVA Letter III. These
commenters noted that this comment is also applicable to Proposed Rule
2821(c)(1)(A). See
supra note 120.
70
CAI Letter II.
17
The proposed rule would require registered representatives to make reasonable
efforts to obtain a variety of information about a customer, including age, financial
situation and needs, liquid net worth and intended use of the deferred variable annuity,
prior to recommending a purchase or exchange of a deferred variable annuity to that
customer.
71
A number of commenters raised interpretive issues about or questioned the
relevance of particular information.
72
NASD declined to amend this provision in
response to these comments.
71
In response to Amendment No. 1, some commenters urged NASD to eliminate
this provision, stating that NASD Rules 2310 and 3110, as well as Rule 17a-
3(a)(17)(i)(A) under the Act, should govern the information that members are
required to gather in making recommendations to purchase or exchange deferred
variable annuities. See
e.g., Letters from Daniel A. Riedl, Senior Vice President
and Chief Operating Officer, Northwestern Mutual Investment Services (Sept.16,
2005) (“NMIS Letter”); M. Shawn Dreffein, President and Chief Executive
Officer, National Planning Holdings, Inc. (Sept. 9, 2005); John L. Dixon,
President, Pacific Select Distributors, Inc. (Sept. 16, 2005); NAVA Letter II.
72
Three commenters stated that the proposed rule should not require a registered
representative to obtain information if the customer declines to provide it upon
request. Letter from Kerry Cunningham, Head of Risk Management, ING
Advisors Network (July 20, 2006) (“ING Advisors Letter II”); ACLI Letter IV;
FSI Letter II. One commenter stated that the information should be obtained
during the sales process and not necessarily before any recommendation is made.
ING Advisors Letter II. One commenter stated that the registered representative
should make a reasonable effort to determine overall investment objectives but
not intended use. Id
. A number of commenters questioned the difference
between the intended use of a deferred variable annuity and the customer’s
investment objective. See
, e.g., Letters from Timothy J. Lyle, Senior Vice
President and Chief Compliance Officer, Contemporary Financial Solutions
(July 19, 2006) (“Contemporary Financial Letter”); Timothy J. Lyle, Senior Vice
President and Chief Compliance Officer, Mutual Service Corporation
(July 19, 2006) (“Mutual Service Letter II”); FSI Letter II; ING Advisors Letter
II. Some commenters suggested that a customer’s life insurance holdings are not
relevant to a deferred variable annuity suitability analysis. See
, e.g., CAI Letter
II; Contemporary Financial Letter; FSI Letter II; Mutual Service Letter II; NAVA
Letter III; Sorrento Letter; SIA Letter II.
18
4. Comments on Proposed Rule 2821(c) – Principal Review and Approval
a. General Comments
As proposed in Amendment No. 2, the principal review and approval
requirements of paragraph (c) would have applied to both recommended and non-
recommended transactions.
73
Commenters stated that the factors a registered principal
considers should adequately reflect the differences between recommended and non-
recommended transactions.
74
These commenters noted that if a transaction is not
recommended, a principal may not have information regarding a customer’s overall
investment portfolio and would need to request that information from the customer.
75
In Amendment No. 3, NASD noted some commenters stated that customers
should be free to decide whether they want to purchase a deferred variable annuity, and
thus the proposed rule’s principal review requirements should not apply to non-
recommended transactions.
76
NASD agreed that a fully informed customer should be
able to make his or her own investment decision and modified this portion of the
73
In response to Amendment No. 1, some commenters objected to requiring
principal review of transactions that are not recommended. See, e.g., Letters from
Frances M. Stadler, Deputy Senior Counsel, Investment Company Institute (Sept.
19, 2005) (“ICI Letter”); Henry H. Hopkins, Darrell N. Braman and Sara
McCafferty, T. Rowe Price Investment Securities, Inc. (Sept. 19, 2005) (“T. Rowe
Price Letter”); NMIS Letter. One commenter noted that the information that
would be needed for a principal review is not currently required to be collected
for non-recommended annuity transactions. See
T. Rowe Price Letter. Some
commenters also stated that requiring review for non-recommended transactions
would allow principals to second guess investors’ decisions. See
, e.g., ICI Letter;
NMIS Letter.
74
See Letter from Darrell N. Braman, Vice President and Associate Legal Counsel
and Sarah McCafferty, Vice President and Associate Legal Counsel, T. Rowe
Price Associates, Inc. (July 19, 2006) (“T. Rowe Price Letter II”); ICI Letter II.
75
ICI Letter II; T. Rowe Price Letter II.
76
Amendment No. 3 is available on NASD’s Web site at
http://www.finra.org/web/groups/rules_regs/documents/rule_filing/p017909.pdf.
19
proposed rule. As amended, a registered principal “may authorize the processing [of a
non-recommended transaction] if the registered principal determines that the transaction
was not recommended and that the customer, after being informed of the reason why the
registered principal has not approved the transaction, affirms that he or she wants to
proceed with the purchase or exchange of the deferred variable annuity.”
77
Two commenters took the position that the supervisory requirements of the
proposed rule would run counter to established legal principles and the rules, systems,
and divisions of responsibility already in place.
78
One of these commenters stated that
the proposed rule would impose affirmative duties upon supervisory and compliance
personnel to make individualized suitability determinations, in contravention of the letter
and spirit of Section 15(b)(4)(E) of the Act.
79
Another commenter stated that the proposed rule should provide specific
standards for principal review of age, liquidity needs, and the dollar amount involved.
80
In that commenter’s view, permitting firms to set their own standards would invite
abuse.
81
NASD’s initial filing
82
with the Commission and Amendment No. 1
83
would
77
See Proposed Rule 2821(c).
78
See NAIFA/AALU Letter II; NSCP Letter. In response to Amendment No. 1,
several commenters stated that the proposed principal review requirement was
unduly duplicative of NASD Rule 3110. See
Letters from Deirdre B. Koerick,
Vice President, Lincoln Investment Planning, Inc. (Sep. 19, 2005); Jennifer B.
Sheehan, Assistant Vice President and Counsel, Massachusetts Mutual Life
Insurance Comp. (Sept. 19, 2005); ACLI Letter IV; NAVA Letter II; SIA Letter
II.
79
NSCP Letter.
80
Pace Letter II.
81
Id.
82
NASD’s initial filing is available at
http://www.finra.org/web/groups/rules_regs/documents/rule_filing/p012780.pdf.
20
have required members to establish standards with respect to a variety of factors,
including the customer’s age and the extent to which the amount of money invested in the
deferred variable annuity exceeds a stated percentage of the customer’s net worth.
NASD stated in Amendment No. 2 that “while conceptually appealing, the establishment
of specific thresholds would unnecessarily limit a firm’s discretion in establishing
procedures that adequately address its overall operations. NASD did not intend to require
a firm to reject all deferred variable annuity transactions involving person over a
particular age or dollar amounts over a particular level. Rather, NASD intended only that
principals consider the highlighted factors as part of their review, which is a facts and
circumstances inquiry.”
84
b. Comments on the Timing of Principal Review
Amendment No. 2 would have required registered principals to review all
purchases and exchanges of deferred variable annuities no later than two business days
following the date when the customer’s application is transmitted to the issuing insurance
company.
85
Two commenters stated that the basis for the two-day timeframe is arbitrary
and has not been explained or justified.
86
A few commenters viewed the proposed rule as
prioritizing speed over diligence without adequate justification.
87
One commenter stated
83
See supra note 4.
84
Amendment No. 2 is available on NASD’s Web site at
http://www.finra.org/web/groups/rules_regs/documents/rule_filing/p016480.pdf.
85
Pursuant to Amendment No. 1, registered principals would have been required to
review all purchases and exchanges prior to transmitting a customer’s application
to the issuing insurance company for processing.
86
See ACLI Letter IV; FSI Letter II.
87
See, e.g., FSI Letter II; NAIFA/AALU Letter II; NSCP Letter. Another
commenter stated that difficulty complying with the timeframe would force some
21
that the timeframe was intended to allow principals to catch unsuitable sales before a
contract has been issued, but contracts may be issued before the principal’s review is
completed even under the revised timeframe.
88
One commenter stated that “free look”
provisions that are available under some states’ insurance laws offer a greater opportunity
to redress unsuitable sales.
89
Numerous commenters stated that it would be difficult to comply with the revised
timeframe.
90
Two commenters remarked that the supervisory review timeframe does not
take into account the varied business models of member firms.
91
These commenters
stated that in some instances, the registered principal who reviews transactions is
stationed at the issuing insurance company.
92
In those instances, the commenters stated
that those individuals might not be able to serve as the reviewing principal because the
broker-dealers to cancel contracts once the insurance company has already issued
them. See
CAI Letter II.
88
CAI Letter II.
89
ACLI Letter IV. In NASD’s initial filing with the Commission, it disagreed with
commenters who suggested that state-required “free look” periods make early
principal review unnecessary. NASD explained that a “free look” period allows
the customer to terminate the contract without paying any surrender charges and
receive a refund of the purchase payments or the contract value, as required by
applicable state law. Free-look periods, which vary by state law, typically range
from ten to thirty days. NASD went on to state that allowing a suitability analysis
to be reviewed by a principal long after an insurance company issues a deferred
variable annuity contract would be inconsistent with an adequate supervisory
system and would make it difficult for a member to quickly identify problematic
trends. NASD’s initial filing is available on its Web site at
http://www.finra.org/web/groups/rules_regs/documents/rule_filing/p012780.pdf.
90
See, e.g., CAI Letter II; Contemporary Financial Letter; FSI Letter II; ING
Advisors Letter II; Mutual Service Letter II; NAVA Letter III; NSCP Letter;
Sorrento Letter.
91
See NSCP Letter; T. Rowe Price Letter II.
92
Id.
22
triggering event is the transmission to the insurance company.
93
One commenter also
noted that the proposed rule would not accommodate instances in which the application is
transmitted to the issuing insurance company and the member firm simultaneously.
94
Commenters stated that it would be especially difficult to comply with the
proposed timeframe when the principal needs to get additional information from the
customer, registered representative, or Office of Supervisory Jurisdiction (“OSJ”)
manager.
95
One commenter stated that fear of missing the deadline may discourage
principals from seeking this additional information.
96
Another commenter suggested that
a review should be required to take place no later than two business days following the
date the member transmits the application or no later than two business days after receipt
by the insurance company to accommodate instances in which the customer sends the
application directly to the insurance company.
97
In Amendment No. 4, NASD modified the proposed rule to further address these
comments.
98
As amended, the proposed rule would require a principal to review the
93
Id.
94
NSCP Letter. This commenter noted that when this occurs, the application is
reviewed by the insurance company and the member firm simultaneously.
95
See, e.g., CAI Letter II; Contemporary Financial Letter; FSI Letter II; ING
Advisors Letter II; Mutual Service Letter II; NAVA Letter III; NSCP Letter;
Sorrento Letter.
96
CAI Letter II.
97
T. Rowe Price Letter II.
98
NASD also amended the timing or principal review requirement in Amendment
No. 3. That amendment would have required principals to review the transaction
no later than two business days after the application was sent to the issuing
insurance company if no additional contact was necessary with the customer or
the registered representative. If additional contact was needed with either the
customer or the registered representative, then review would have had to be
completed within five business days of the application being sent to the issuing
23
transaction prior to transmitting a customer’s application to the issuing insurance
company for processing, but no later than seven business days after the customer signs
the application.
99
One commenter addressed the safeguarding of customer funds during the
principal review and stated that “clarification is needed regarding the degree of flexibility
afforded to firms with respect to the safekeeping of customer funds during the review
period. Rather than dictating specific procedures, firms should be permitted to design
insurance company. The Commission received several comments on this timing
provision, all of which are available on the Commission’s Internet Web site
(http://www.sec.gov/rules/sro.shtml.) Commenters stated that the limited review
period in Amendment No. 3 was problematic and arbitrary. These commenters
also suggested requiring principal review to be completed within a reasonable
time period, not to exceed the expiration of the free look period, following the
date the broker-dealer transmits the application to the issuing insurance company.
See e.g.
, Letter from Dale E. Brown, Executive Director and CEO, Financial
Services Institute (Mar. 5, 2007) (“FSI Letter III”); Letters Type E and F.
Comments addressing subparagraph (b)(1)(A) of Amendment No. 3 stated that
requiring registered representatives to “determine” whether a transaction was
suitable, rather than having a “reasonable basis to believe” it, raised the bar for
suitability determinations. See e.g.
, FSI Letter III and Letters Type E and F. In
Amendment No. 4, NASD revised this language to require registered
representatives to have “a reasonable basis to believe” that the deferred variably
annuity is suitable.
Commenters also stated the reference in subparagraph (b)(1)(A)(i) to the
“various” features of deferred variable annuities created an “unacceptable level of
ambiguity” and that the prior proposal’s use of “material” features was preferable.
See
e.g., FSI Letter III and Letters Type E and F.
99
In response to Amendment No. 4, commenters requested that the Commission
seek additional comment on the proposed rule. Letter from Clifford Kirsch,
Sutherland Asbill and Brennan LLP on behalf of Committee of Annuity Insurers
(April 9, 2007) (“CAI Letter III”); Letters Type G and H. One commenter stated
that commenters have not had an opportunity to address whether Amendment
No. 4 causes any unintended consequences regarding the safeguarding of
customer funds at the broker-dealer for as many as seven days and to provide
feedback regarding the contours of the proposed no-action relief from Exchange
Act Rules 15c3-1 and 15c3-3. CAI Letter III. See
also infra notes 101-112 and
accompanying text.
24
procedures tailored to their business model.”
100
Exchange Act Rule 15c3-3 requires
broker-dealers to safeguard customer funds and securities. While Rule 15c3-3 requires
that a broker-dealer promptly forward checks and include as a credit in the reserve
formula all customer free credit balances, it does not specify any specific procedures that
a broker-dealer must use to be in compliance with the rule. Rather, it allows a broker-
dealer to tailor its procedures to its particular business model. NASD Rule 2821 will not
affect the applicability of Exchange Act Rule 15c3-3 with respect to the safeguarding of
customer funds.
The Commission also received comments on the timeframe for principal review
proposed in Amendment No. 4.
101
Some commenters addressed NASD’s requested no-
action relief
102
and highlighted related implementation issues.
103
One commenter addressed situations in which an insurer’s contract issuance unit
is physically resident at the same location as one of the insurer’s captive broker-dealer
offices, and both areas share personnel with one another.
104
It asked for clarification of
whether receipt of customer applications by broker-dealer personnel for principal review
in these co-located situations would be considered a transmittal to the issuing insurance
company for processing under proposed Rule 2821(c).
105
NASD responded by stating
that in these situations “[it] would consider the application “transmitted” to the insurance
100
CAI Letter III
101
Letter from Eric A. Arnold and Clifford E. Kirsch, Sutherland Asbill and Brennan
LLP on behalf of Committee of Annuity Insurers (May 24, 2007) (“CAI Letter
IV”); Letters Type G and H.
102
See supra note 21.
103
See CAI Letter IV.
104
Id.
105
Id.
25
company only when the broker-dealer’s principal, acting as such, has approved the
transaction, provided that the affiliated broker-dealer ensures that arrangements and
safeguards exist to prevent the insurance company from issuing the contract prior to
principal approval by the broker-dealer.
106
The Commission believes that NASD can address implementation issues, to the
extent they arise, during the proposed six month implementation period. Notably, the
revised timeframe in Amendment No. 4 is substantially similar to the timeframe that
NASD proposed and that the Commission published for comment in Amendment No. 1,
which would have required a principal to review a transaction prior to sending the
application to the insurance company for processing. The Commission received
numerous comments on the timing of principal review provision as it was proposed in
Amendment No. 1.
107
While some commenters supported it because they believed it
would give principals sufficient time for a thorough review and provide greater
assurances that unsuitable transactions would not be consummated,
108
others objected to
it.
109
Some commenters were concerned that members would be subject to liability for
market changes affecting the value of the deferred variable annuity during the delay for
106
See Letter from James S. Wrona, Associate Vice President, FINRA
(Aug. 10, 2007).
107
A summary of these comments addressing Amendment No. 1 was published in
the Federal Register along with the Commission’s notice of Amendment No. 2.
See
supra notes 4 and 6.
108
Letters from Patricia Struck, President, North American Securities Administrators
Association (September 20, 2005) and Rosemary J. Shockman, President, Public
Investors Arbitration Bar Association (Sept. 9, 2005).
109
See, e.g., Letters from W. Thomas Conner and Eric A. Arnold, Sutherland Asbill
& Brennan on behalf of The Committee of Annuity Insurers (Sept. 19, 2005)
(“CAI Letter I); John S. Simmers, CEO, ING Advisors (Sept. 19, 2005) (“ING
Letter I”); ACLI Letter II; NAVA Letter II.
26
supervisory review.
110
Some commenters stated that a delay in pricing the contract
would be unfair to customers.
111
Others stated that the timing deadline would require
costly reprogramming of broker-dealers’ electronic processing systems that forward
contracts to the insurance company and the registered representative’s home office at the
same time.
112
One commenter stated that the interaction of this provision with other
Commission and NASD rules could limit a firm’s ability to review applications
thoroughly.
113
Another stated that time-linking the application process with supervisory
review would impair the goal under the Investment Company Act of 1940 of timely
processing.
114
A few commenters stated that the time deadline would not work in the context of
direct sales because in those sales an insurance company may not know of an applicant’s
interest in a deferred variable annuity until it receives the application.
115
Another stated
that the timing deadline would not take into account situations in which the registered
110
Letters from Denise M. Evans, General Counsel, Associated Securities Corp.
(Sept. 19, 2005) (“Associated Securities Letter”); John L. Dixon, President,
Pacific Select Distributors (Sept. 16, 2005) (“Pacific Select Letter”); and Julie
Gerbert, Vice President, United Planners’ Financial Services of America
(Sept. 19 2005) (“United Planners Letter”).
111
ACLI Letter II; Pacific Select Letter; and United Planners Letter.
112
CAI Letter I; NMIS Letter.
113
ING Letter I.
114
ACLI Letter II.
115
CAI Letter I; NAVA Letter II; T. Rowe Price Letter I. In direct sales, customers
may apply for an annuity contract by calling the insurance company or by
completing an application on the internet. NAVA Letter II. Receipt of the
application is frequently the first time the insurance company even knows that the
customer has filled out an application. Id
.
27
principal is housed in the insurance company.
116
A few commenters also stated that their current supervisory structure as an Office
of Supervisory Jurisdiction would be incapable of dealing with the prior approval
requirement and they would be forced to eliminate this form of supervisory structure.
117
One commenter stated the requirement could overwhelm principals,
118
and another stated
that it would require members to allocate two to three times the supervisory staff for
deferred variable annuities than for any other product.
119
c. Proposed Rule 2821(c) – Principal Review and Approval
In Amendment No. 2, NASD listed a variety of factors that a registered principal
would be required to consider in reviewing the purchase or exchange of a deferred
variable annuity. In Amendment No. 3, NASD modified this provision to require
registered principals to consider all of the factors that a registered representative must
consider in Proposed Rule 2821(b) (“Recommendation Requirements”) and eliminated
116
NMIS Letter.
117
Letter from Shawn M. Mihal, Chief Compliance Officer, Great American
Advisors (Sept. 19, 2005) and ING Letter I. These comments were submitted in
response to Amendment No. 1, which would have required principals to review
customers’ applications prior to transmitting them to the issuing insurance
company for processing. The commenters assumed that there would be no relief
from Rules 15c3-1 and 15c3-3, and thus broker-dealers would have to forward
checks (along with applications) to the insurance company by noon of the next
business day after receiving those checks. Based on this assumption, the
commenters indicated that there would not be sufficient time for representatives
to forward the paperwork to the OSJ manager and the OSJ manager to review the
application within the time parameters required by Rules 15c3-1 and 15c3-3.
These timing concerns have been addressed by the Commission’s exemptions
from Rules 15c3-3 and 15c3-3 to allow NASD members to comply with the
proposed rule without becoming fully subject to Exchange Act Rule 15c3-3 and
being required to maintain higher levels of net capital in accordance with Rule
15c3-1. See
Exchange Act Release No. 56376 (Sep. 7, 2007).
118
Wachovia Letter.
119
Associated Securities Letter.
28
the references to the considerations in subparagraph (c)(1) (“Principal Review and
Approval”) of the proposed rule. NASD also moved the considerations relating to
exchanges that were in subparagraph (c)(1)(D) of Amendment No. 2 to paragraph (b) in
Amendments Nos. 3 and 4. By doing this, NASD added these determinations to those
factors a registered representative must consider and retained them as considerations for
principal review.
i. Comments on Proposed Rule 2821(c)(1)(A) as Amended by
Amendment No. 2 – Principal Review and Approval
The rule, as amended by Amendment No. 2, would have required principals to
consider the extent to which the customer would benefit from the unique features of a
deferred variable annuity. A number of commenters remarked that their comments on
proposed Rule 2821(b)(1)(B) are equally applicable to this provision and that “would”
should be changed to “could” and that the modifier “unique” should be deleted.
120
In
response to comments, NASD changed “unique” to “various.” As amended by
Amendment No. 3, the rule would require registered principals to have a reasonable basis
to believe that the customer has been informed, in general terms, of the various features
of deferred variable annuities.
121
ii. Comments on Proposed Rule 2821(c)(1)(C) as Amended by
Amendment No. 2 – Principal Review and Approval
The rule, as amended by Amendment No. 2, would have required principals to
consider the extent to which the amount of money invested would result in an undue
concentration in a deferred variable annuity or deferred variable annuities in the context
120
See, e.g., ACLI Letter IV; FSI Letter II; NAVA Letter III; SIA Letter II. See also
supra notes 68 and 69.
121
See Proposed Rule 2821(b)(1)(A)(i).
29
of the customer’s overall investment portfolio. Two commenters stated the term “undue
concentration” is imprecise and capable of multiple interpretations.
122
Some commenters
also viewed the proposed requirement to consider the customer’s liquidity needs as
subsuming the apparent intent of this provision.
123
In Amendment No. 3, NASD deleted
this provision.
iii. Comments on Proposed Rule 2821(c)(1)(D)(ii) as Amended by
Amendment No. 2 – Principal Review and Approval
The rule, as modified by Amendment No. 2 would have required registered
principals to consider the extent to which the customer would benefit from any potential
product enhancements and improvements in the case of an exchange of a deferred
variable annuity. One commenter stated that “would” should be changed to “could”
because whether a customer benefits is determined years after the contract is purchased
and depends on market performance.
124
In Amendment No. 3, NASD deleted this
specific paragraph, but, provided in paragraph (b) (“Recommendation Requirements”)
that principals must consider, in the case of an exchange, whether the customer would
benefit from any potential product enhancements and improvements in their review.
125
iv. Comments on Proposed Rule 2821(c)(1)(D)(iii) as Amended by
Amendment No. 2 – Principal Review and Approval
The rule, as modified in Amendment No. 2, would have required principals, in the
case of an exchange of a deferred variable annuity, to consider the extent to which the
122
See, e.g., NAVA Letter III; ACLI Letter IV. Two other commenters noted that
NASD should provide more guidance on what would amount to an “undue
concentration” because deferred variable annuities often take significant portions
of a customer’s assets. See
FSI Letter II; Sorrento Letter.
123
See, e.g., ACLI Letter IV; CAI Letter II; NAVA Letter III.
124
See NAVA Letter III.
125
See Proposed Rule 2821(c) and Proposed Rule 2821(b)(1)(B)(ii).
30
customer’s account has had another deferred variable annuity exchange within the
preceding thirty-six months. One commenter, while supporting this provision, believed
that the registered principal should also review the total sales production of variable
annuities of associated persons to detect unsuitable sales and other potential abuses.
126
A
number of commenters stated that it would be difficult to comply with this
requirement.
127
In their view, principals may have a difficult time obtaining this
information, especially if the exchange occurred at another broker-dealer.
128
These
commenters also stated that customers may not want to share this kind of information,
citing privacy concerns or policy concerns with the other broker-dealers.
129
One commenter stated that the proposed rule should specify whether principals
have to collect information on exchanges that occurred at the reviewing firm only or also
on exchanges that occurred at other broker-dealers.
130
Two commenters argued that the
proposed rule should clarify whether a registered principal is only obligated to consider
prior exchange information if it is available to him or her at the time of his or her
review.
131
One commenter stated that the provision would impose substantial administrative
and supervisory costs on broker-dealers, which would have to implement cumbersome
126
See NASAA Letter II.
127
See, e.g., CAI Letter II; Contemporary Financial Letter; FSI Letter II; Mutual
Service Letter II; Sorrento Letter; T. Rowe Price Letter II.
128
Id.
129
Id.
130
See CAI Letter II.
131
See Contemporary Financial Letter; Mutual Service Letter II.
31
and expensive additional surveillance tools.
132
Another commenter stated the proposed
rule should clarify the level of inquiry and documentation necessary to comply with this
provision.
133
In Amendment No. 3, NASD eliminated this specific provision, but
provided in paragraph (b) (“Recommendation Requirements”) that principals must
consider, in the case of exchange, the extent to which the customer account has had
another deferred variably annuity exchange within the preceding thirty-six months.
134
NASD has stated that it will announce the effective date of the proposed rule change in a
Notice to Members to be published no later than 60 days following Commission approval
and that the effective date will be 120 days following publication of the Notice to
Members announcing Commission approval. NASD has indicated that it may address the
type of implementation issues commenters raised with respect to determining whether a
customer’s account has had a deferred variable annuity exchange within the preceding 36
months in connection with that Notice to Members
.
d. Comments on Proposed Rule 2821(c)(2) – Principal Review and
Approval
The proposed rule would require the registered principal who reviewed and
approved, rejected, or authorized the transaction to document and sign the determinations
that he or she is required to make pursuant to subparagraph (c) of the proposed rule.
As proposed in Amendment No. 2, the principal who approves a transaction
would have been required to sign the registered representative’s suitability determination.
One commenter stated that this provision should be eliminated because “it would
132
See NSCP Letter.
133
See CAI Letter II.
134
See Proposed Rule 2821(c) and Proposed Rule 2821(b)(1)(B)(iii).
32
establish an unprecedented standard of requiring principals to fully endorse all of the
considerations leading to the salespersons’ recommendations.”
135
In this commenter’s
view, the principal’s role should be to affirm the fact that the salesperson elicited
information for completion of the suitability documents.
136
In Amendment No. 3, NASD
eliminated the requirement that registered principals sign the registered representative’s
suitability determinations.
5. Comments on Proposed Rule 2821(d) – Supervisory Procedures
The rule, as modified by Amendment No. 2, would have required members to
implement procedures and require principals to consider whether the associated person
effecting the transaction has a particularly high rate of effecting deferred variable annuity
exchanges.
Two commenters argued that the phrase “particularly high rate” is vague and
unworkable.
137
A number of commenters noted that the proposed rule implies that
principals would have to implement a transaction-by-transaction review and stated that
members should be able to rely on exception reports as an effective solution to unsuitable
exchanges.
138
One commenter also requested clarification regarding what should happen
if a registered representative does have a particular high rate of exchanges.
139
NASD
modified this provision in Amendment No. 3, eliminating the reference to a “particularly
high rate” of exchanges.
135
See ACLI Letter IV.
136
Id.
137
See ACLI Letter IV; FSI Letter II.
138
See ACLI Letter IV; CAI Letter II; FSI Letter II; NAVA Letter III.
139
See CAI Letter II. The commenter questioned whether the principal has to reject
the transaction or just give it closer scrutiny.
33
6. Comments on Proposed Rule 2821(e) – Training
As provided in Amendment No. 2, members would be required to develop and
document specific training policies or programs reasonably designed to ensure that
associated persons who effect and registered principals who review transactions in
deferred variable annuities comply with the requirements of the proposed rule and that
they understand the material features of deferred variable annuities. Several commenters
questioned the need for this specific requirement, as well as the standards applicable to
the training.
140
NASD declined to amend this provision in response to comments.
7. NASD’s Response to Comments
As discussed above, in response to the comments received on Amendment No. 1
NASD amended portions of the proposed rule and responded to comments. NASD also
filed a response to the comments received on Amendment No. 2 with the Commission
addressing concerns regarding the need for the proposed rule, the regulatory process that
NASD undertook in developing the proposed rule, and the statutory requirements for
SRO rulemaking.
141
In Amendment Nos. 3 and 4, NASD further responded to comments
and modified the proposed rule.
IV. Discussion and Commission Findings
140
One commenter stated there is no need for additional training requirements
because NASD Rule 2310 requires registered representatives to understand the
material features of the products they sell. See
FSI Letter II; Letter Type C.
Other commenters believed this provision is duplicative of the Firm Element
portion of NASD’s continuing education requirements. See
, e.g., 1st Global
Letter II; FSI Letter II. One commenter believed the training requirements would
interfere with members’ efficient and effective allocation of training resources.
See
FSI Letter II. A number of commenters also suggested members’ programs
be held to the standard of being “reasonably designed to achieve compliance”
with the proposed rule. See
, e.g., Contemporary Financial Letter; ING Advisors
Letter II; Mutual Service Letter II.
141
See NASD Response Letter
34
The Commission has reviewed carefully Proposed Rule 2821, the comments, and
NASD’s responses to the comments, and believes that NASD has responded
appropriately to the concerns raised by the commenters. The Commission finds that
Proposed Rule 2821, as amended, is consistent with the requirements of the Act and the
rules and regulations thereunder applicable to a national securities association, and, in
particular, with Section 15A(b)(6) of the Act, which requires, among other things, that
the rules of a national securities association be designed to prevent fraudulent and
manipulative acts and practices, to promote just and equitable principles of trade, and, in
general, to protect investors and the public interest.
142
Over approximately the past three years, the majority of informal actions brought
against broker-dealers as a result of NASD examinations of variable annuity sales have
involved the failure to establish or follow written supervisory procedures.
143
During this
time period, NASD also brought numerous enforcement actions charging broker-dealers
with failing to supervise sales of variable annuities.
144
In addition, NASD’s examinations
found a substantial number of unsuitable recommendations and instances of failing to
obtain customer account information.
145
It also brought numerous enforcement actions
for making unsuitable recommendations.
146
The proposed rule is designed to curb sales practice abuses in deferred variable
annuities. Its recommendation requirements provide a specific framework for a broker-
142
15 U.S.C. 78o-3(b)(6).
143
See infra note 148.
144
See infra note 150.
145
See infra note 148.
146
See infra note 150.
35
dealer’s suitability analysis of these securities. By setting forth factors that a broker-
dealer must specifically consider in recommending deferred variable annuities and
requiring the registered representative to obtain certain information from his or her
customers, the proposed rule should improve communications between registered
representatives and customers regarding these securities. The supervisory review
component should foster a thorough analytical review of every deferred variable annuity
transaction in a timeframe that will limit the possibility of unsuitable recommendations
and transactions. The proposed rule as a whole is geared to protecting investors by
requiring firms to implement more robust compliance cultures, and to give clear
consideration of the suitability of these complex products.
Commenters asserted that the proposed rule, because it is product specific, would
result in significant burdens on competition. Pursuant to the Act’s requirement, the
Commission has considered the impact of Proposed Rule 2821 on efficiency, competition
and capital formation,
147
as well as whether the rule would impose any burden on
competition not necessary or appropriate in furtherance of the Act.
148
We note that other
products, including options and penny stocks, are subject to product-specific regulations,
due to their complexity or their history of sales practice abuses. NASD has demonstrated
through its history of examinations, enforcement actions, and guidance to members that
regulating variable annuities like other products has not been sufficient to curb sales
practice abuses. Moreover, we note that the Act allows the Commission to approve a
self-regulatory organization rule that imposes burdens on competition so long as those
147
15 U.S.C. 78c(f).
148
15 U.S.C. 78o-3(b)(9).
36
burdens are necessary or appropriate in furtherance of the purposes of the Act.
149
We
believe that to the extent the proposed rule imposes burdens on competition, these
burdens are necessary or appropriate in furtherance of the purposes of the Act, and
particularly the purpose of protecting investors.
Commenters also expressed the view that Proposed Rule 2821 may impose
compliance costs on broker-dealers that exceed their costs of complying with rules
applicable to other products. The complexity of deferred variable annuities warrant more
targeted regulation. NASD has attempted over the past few years to address problematic
and unsuitable sales through non-rulemaking means, but has not found that approach to
be successful. We agree with NASD that Proposed Rule 2821 will lead firms to enhance
their compliance and supervisory systems, which in turn will provide more
comprehensive and targeted protection to investors.
150
While NASD has issued a number of Notices to Members and Regulatory and
Compliance Alerts regarding the suitability of deferred variable annuities,
151
it continues
149
Id.
150
See NASD Response Letter.
151
See Notice to Members 96-86 and Notice to Members 99-35. In 2002, NASD
issued a Regulatory & Compliance Alert
, entitled “NASD Regulation Cautions
Firms for Deficient Variable Annuity Communications,” that, among other things,
discussed NASD’s discovery of unacceptable sales practices regarding variable
annuities. In another Regulatory & Compliance Alert
in 2002, entitled
“Reminder—Suitability of Variable Annuity Sales,” NASD emphasized, in part,
that an associated person must be knowledgeable about a variable annuity before
he or she can determine whether a recommendation to purchase, sell or exchange
the variable annuity is appropriate. NASD has also issued a number of Investor
Alerts regarding variable annuities. In 2001, NASD issued an Investor Alert
entitled “Should You Exchange Your Variable Annuity?” highlighting important
issues that investors should consider before agreeing to exchange a variable
annuity. In 2003, NASD issued an Investor Alert
entitled “Variable Annuities:
Beyond the Hard Sell,” which cautioned investors about certain inappropriate
sales tactics and highlighted the unique features of these products.
37
to encounter numerous questionable sales practices through its examinations,
152
as well as
through its investigations and informal discussions with its members.
153
Just within the
last few years, NASD has brought a number of cases involving failures to supervise,
suitability violations, and misrepresentation in connection with purchases and exchanges
of deferred variable annuities.
154
152
From July 2004 to April 2007, NASD completed a total of 807 routine
examinations involving the review of variable annuities. See Letter from James
S. Wrona, Associate Vice President, NASD (May 15, 2007) (“NASD
Examination/Enforcement Update Letter”). These examinations resulted in 92
Letters of Caution, 45 Compliance Conferences, and 4 Acceptance, Waiver and
Consent letters, in which a respondent accepts a finding of a violation, consents to
the imposition of sanctions, and agrees to waive the right to a hearing. Id
. While
the majority of these actions involved the failure to establish or follow written
supervisory procedures, a number of actions related to the failure to obtain and
maintain customer account information, unsuitable recommendations, and the
failure to comply with standards relating to communications with the public. Id.
These findings do not include cause examinations, many of which result in formal
action that is captured by enforcement actions, discussed in note 150 below. Id
.
Nor do the findings include information from special examination initiatives. Id.
153
See NASD Response Letter.
154
See, e.g., Phillip Nelson, NASD Case No. 2006004829701 (April 3, 2007)
(providing misleading communication to customer regarding a variable annuity);
Victoria C. Smotherman
, NASD Case No. 2006003897501 (March 21, 2007)
(fraudulently inducing purchases of variable annuities); Donna Vogt
, NASD Case
No. EAF0400730002 (Feb. 21, 2007) (making unsuitable variable annuity
recommendations); Raymond James Financial Services, Inc.
, NASD Case No.
EAF0400730001 (Jan. 31, 2007) (failing to properly supervise by permitting
producing branch managers to supervise themselves and by not properly
reviewing variable annuity sales and exchanges); Peter F. Esposito
, NASD Case
No. 2005002689601 (Dec. 8, 2006) (submitting falsified account information to
his firm concerning the liquidation of a variable annuity); Quick & Reilly, Inc.
,
NASD Case No. E102003158301 (Dec. 1, 2006) (failing to supervise variable
annuity sales); Waddell & Reed, Inc.
, NASD Case No. E062004029603 (Nov. 24,
2006) (failing to supervise sales of variable annuities where unregistered persons
were selling such products); David L. McFadden
, NASD Case No.
E2005000226001 (Nov. 15, 2006) (fraudulent and unsuitable sales of variable
annuities, mutual funds, and exchange traded fund shares); CCO Investment
Services, Corp., NASD Case No. E112005014002 (Oct. 16, 2006) (failing to,
among other things, supervise variable annuity sales); Daniel Carlos Lacey
,
NASD Case No. E062004000201 (Aug. 11, 2006) (making unsuitable
38
recommendations regarding variable annuities exchanges); Michael K. Maunsell,
NASD Case No. 2005001939501 (Aug. 2, 2006) (making unsuitable variable
annuity recommendations); Carole G. Ferraro
, NASD Case No. E0520030291
(July 21, 2006) (making unsuitable recommendations regarding variable
annuities); Jerry Swicegood
, NASD Case No. 2005002683001 (July 13, 2006)
(falsifying documents related to variable annuity exchanges); Eric J. Brown
,
NASD Case No. E112003006903 (June 27, 2006) (making unsuitable
recommendations and false statements regarding variable annuities); Joseph
Vitetta, NASD Case No. E10200412250 (June 8, 2006) (making unsuitable
recommendation regarding a variable annuity, among other violations); AmSouth
Investment Services, Inc., NASD Case No. E052004025802 (May 24, 2006)
(failing to establish and maintain reasonable supervisory system in connection
with sales of variable annuities and mutual funds); Charles Snyder
, NASD Case
No. E112004042001 (May 2, 2006) (making unsuitable variable annuity
recommendations); Frank P. Grasse, No. EL120030533 (April 17, 2006)
(falsifying customer information on variable annuity applications); Tyler M.
Kerrigan, NASD Case No. E0520030355 (March 10, 2006) (recommending
unsuitable variable annuity transactions); Angelisa Savage-Bryant, NASD Case
No. E072004064201 (March 6, 2006) (misrepresentation in connection with a
variable annuity exchange); Brian Carr
, NASD Case No. E9B2003043802 (Feb.
22, 2006) (making unsuitable variable annuity recommendations); John Babiarz,
NASD Case No. 2005002047301 (Feb. 10, 2006) (making unsuitable variable
annuity recommendations); Michael Lancaster, NASD Case No. E8A20040995-
01 (Nov. 30, 2005) (making unsuitable recommendations regarding variable
annuity subaccounts); Lawrence LaBine
, NASD Case No. C3A20040045 (Nov.
22, 2005) (unsuitable recommendations to five customers involving variable
annuity subaccounts and mutual funds); Mansell R. Spedding, NASD Case No.
E0220030907 (Sept. 21, 2005) (unsuitable subaccount allocation recommendation
for variable annuity); Rita N. Raymer
, NASD Case No.E0520030131 (Aug. 16,
2005) (unsuitable recommendations of variable annuities); NY Life Sec., Inc.,
NASD Case No. E0520040104 (July 22, 2005) (failing to adequately supervise
sales of variable annuities and mutual funds); Paul Olsen, NASD Case No.
E3A20030539 (June 23, 2005) (negligently failing to tell customers about fees
associated with variable annuity exchanges); Bambi Holzer
, NASD Case No.
E0220020787 (June 17, 2005) (negligently misrepresenting certain aspects of
variable annuities); Ilene L. Sonnenberg
, NASD Case No. C0520050024 (May
11, 2005) (recommending unsuitable variable annuity); Raymond James &
Assocs., Inc., NASD Case No. C0520050020 (May 10, 2005) (finding that
registered representative made unsuitable recommendations and firm failed to
maintain and enforce written supervisory procedures regarding sales of variable
annuities); Issetten Hanif
, NASD Case No. C9B20040086 (Apr. 6, 2005)
(unsuitable recommendations regarding variable annuity and mutual fund
exchanges); Lawrence Labine
, NASD Case No. E02020513 (Nov. 19, 2004)
(unsuitable variable annuity recommendation); Edward Sadowski
, NASD Case
No. C9B040102 (Nov. 17, 2004) (unsuitable variable annuity recommendation);
James B. Moorehead
, NASD Case No. C05040073 (Nov. 11, 2004) (failing to
39
Some commenters expressed the view that NASD must wait before instituting
rulemaking and show that a “demonstrable problem” exists.
155
While we believe
NASD’s examinations and enforcement actions over the years clearly demonstrate an
entrenched problem in the sales culture for these products, nothing in the Act requires
NASD to make such a showing. Rather, the Act requires the Commission to determine
that a proposed rule is consistent with the Act and consider whether the proposed rule
gather suitability information for variable annuity sales); Juan Ly, NASD Case
No. C07040094 (Nov. 9, 2004) (unsuitable variable annuity switches and
misrepresentations); Jenny Chin, NASD Case No. E04030619 (Oct. 29, 2004)
(misrepresentation and omissions regarding variable annuities); Glenn W. Ward,
NASD Case No. C05040075 (Oct. 14, 2004) (recommending unsuitable variable
annuity); Bernard E. Nugent
, NASD Case No. C11040031 (Sept. 1, 2004)
(unsuitable recommendation involving the liquidation of mutual fund shares to
purchase a variable annuity); Samuel D. Hughes, NASD Case No. C07040067
(Aug. 19, 2004) (unsuitable variable annuity switches, unauthorized sub-account
allocations, and misrepresentations); SunAmerica Sec., Inc.
, NASD Case No.
C05040051 (July 12, 2004) (lacking adequate written supervisory procedures
concerning review of variable annuity and variable universal life contracts); Jamie
Engelking, NASD Case No. E3A020441 (July 2, 2004) (unsuitable variable
annuity recommendation); Pan-American Fin. Advisers, NASD Case No.
C05040034 (June 15, 2004) (failing to have adequate supervisory procedures for
variable annuity sales); Scott Weier
, NASD Case No. E04010714 (May 27, 2004)
(unsuitable variable annuity recommendations); Gregory Jurkiewicz, NASD Case
No. E3A030436 (May 4, 2004) (unsuitable variable annuity recommendation);
Michael H. Tew
, NASD Case No.C05040010 (Apr. 7, 2004) (unsuitable
recommendations regarding variable annuities); Steve Morgan
, NASD Case No.
E3A020410 (Mar. 12, 2004) (unsuitable variable annuity recommendation);
Donald Lacavazzi
, NASD Case No. C11040009 (Feb. 24, 2004) (recommending
unsuitable variable annuity switching); Michael Blandchard, NASD Case No.
C11040005 (Feb. 16, 2004) (unsuitable variable annuity recommendations);
Prudential Inv. Mgmt. and Prudential Equity Group, Inc.
, NASD Case No.
C05040008 (Jan. 29, 2004) (failing to supervise and maintain accurate records
relating to variable annuity replacement sales); Waddell & Reed, Inc.
, NASD
Case No. CAF040002 (Jan. 14, 2004) (failing to ascertain suitability of
recommended variable annuity exchanges and failure to supervise). NASD
Enforcement actions are available at
http://www.nasd.com/RegulatoryEnforcement/MonthlyDisciplinaryActions/index
.htm.
155
See supra note 33 and accompanying text.
40
would promote efficiency, competition and capital formation.
156
So long as its proposed
rules meet the requirements of the Act, NASD can – and indeed should – be proactive in
addressing problems in the sale of securities.
Some commenters also took the position that the proposed rule should be subject
to a cost/benefit analysis.
157
The Act sets forth what the Commission must consider in
determining whether to approve a proposed self-regulatory organization rule. It also sets
forth requirements that the self-regulatory organizations must meet. The Act does not
require a cost/benefit analysis with respect to proposed self-regulatory organization rules
that are filed with, and approved by, the Commission.
As a practical matter, however, NASD considered the costs and benefits of the
rule as the rule was developed and modified, and NASD’s members were actively
involved in shaping the proposed rule. As NASD stated in its response to comments on
Amendment No. 2 “[i]ndustry members are keenly aware of the potential costs and
burdens that can result from rulemaking and, as is often the case, they raised and NASD
considered such issues at multiple stages of the rulemaking process.”
158
Accelerated Approval of Amendment Nos. 3 and 4
156
15 U.S.C. 78c(f).
157
See supra notes 35-38 and accompanying text.
158
As discussed in detail above, in its response to comments to Amendment No. 2,
NASD noted the steps it went through as it developed the proposed rule prior to
filing it with the Commission. It published the proposed rule in a Notice to
Members and solicited comment. The proposal also went to five NASD standing
committees (including two committees with subject matter expertise regarding
variable annuities) for consultation and comment. NASD considered the public’s
and the committees’ comments and modified the proposed rule in response. The
NASD Regulation, Inc. Board of Directors then approved the proposed rule and
the NASD Board of Governors had an opportunity to review it. These NASD
boards include members of the broker-dealer and insurance industries. For detail
on the composition of the boards, see
NASD’s Response Letter.
41
As set forth below, the Commission finds good cause to approve Amendment
Nos. 3 and 4 to the proposed rule, as amended, prior the thirtieth day after the date of
publication of the notice of Amendment Nos. 3 and 4 in the Federal Register. The
revisions and clarifications in Amendment Nos. 3 and 4 were made in response to
comments.
In Amendment No. 3, NASD modified the Recommendation Requirements in
paragraph (b) of the proposed rule. Amendment No. 2 required members to have a
reasonable basis to believe the customer has been informed of the material features of a
deferred variable annuity. NASD revised the proposed rule to specify that a member
must have a reasonable basis to believe that a customer has been informed “in general
terms of the various features” of deferred variable annuities. NASD made this change in
response to comments to clarify that the customer need only be informed about the
features of deferred variable annuities in general terms, rather than be informed about the
specific features of the deferred variable annuity the member might recommend.
In addition, in Amendment No. 3, NASD incorporated the factors that a firm must
consider when exchanging deferred variable annuities in the recommendation
requirements rather than in the principal review and approval requirements, while
maintaining a requirement that principals consider these factors. NASD also eliminated
two of the considerations relating to exchanges in response to comments: the extent to
which the customer would benefit from the unique features of a deferred variable annuity
and the extent to which the customer’s age or liquidity needs make the investment
inappropriate.
Moreover, in Amendment No. 3, NASD revised the proposed rule in response to
42
comments relating to the applicability of the proposed rule to non-recommended
transactions. NASD clarified that while principals are to treat all transactions as
recommended, a principal may authorize the processing of a transaction if it determines
that the transaction was not recommended and that the customer affirms that he or she
wants to proceed after being informed of the reason why the registered principal has not
approved the transaction.
In Amendment No. 3, NASD also modified the supervisory procedures provisions
of the rule in response to comments that the term “particularly high rates of effecting
deferred variable annuity exchanges” was vague. NASD revised the proposed rule to
require implementation of surveillance procedures to review associated persons’ rates of
effecting deferred variable annuity exchanges for consistency with the proposed rule,
other NASD rules and the federal securities laws. NASD also clarified that members
must have policies and procedures reasonably designed to implement corrective measures
to address inappropriate exchanges.
In addition, in Amendment No. 3, NASD revised the required timeframe for
principal review, which it further revised in Amendment No. 4. As amended by
Amendment No. 4, the principal must review the application prior to transmitting it to the
issuing insurance company for processing, but no later than seven business days after the
customer signs the application. This “prior to transmittal” standard was also incorporated
in Amendment No. 1, and the Commission received a substantial number of comments
on this standard. Although Amendment No. 1 did not explicitly limit the timeframe for
principal review to no more than seven days, provisions of Exchange Act Rule 15c3-3
would have operated to limit the time in which broker-dealers could hold customer funds.
43
In light of NASD’s requested exemption from Rule 15c3-3, the seven-day limit on
principal review in Amendment No. 4 would replace that rule’s time limitation for
transactions subject to that exemption with a more workable limit.
Thus, the Commission finds good cause to approve Amendment Nos. 3 and 4 to
the proposed rule, as amended, prior to the thirtieth day after the date of publication of
the notice of Amendment Nos. 3 and 4 in the Federal Register
.
V. Solicitation of Comments
Interested persons are invited to submit written data, views and arguments
concerning Amendment Nos. 3 and 4, including whether the proposed rule is consistent
with the Act.
159
Comments may be submitted by any of the following methods:
Electronic Comments:
• Use the Commission’s Internet comment form
(http://www.sec.gov/rules/sro.shtml
); or
• Send an e-mail to [email protected]. Please include File Number
SR-NASD-2004-183 on the subject line.
Paper Comments:
• Send paper comments in triplicate to Nancy M. Morris, Secretary,
Securities and Exchange Commission, 100 F Street, NE, Washington, DC
20549-1090.
All submissions should refer to File Number SR-NASD-2004-183. This file number
should be included on the subject line if e-mail is used. To help the Commission process
and review your comments more efficiently, please use only one method. The
159
The Commission will consider the comments we previously received.
Commenters may reiterate or cross-reference previously submitted comments.
44
Commission will post all comments on the Commission’s Internet Web site
(http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent
amendments, all written statements with respect to the proposed rule change that are filed
with the Commission, and all written communications relating to the proposed rule
change between the Commission and any person, other than those that may be withheld
from the public in accordance with the provisions of 5 U.S.C. 552, will be available for
inspection and copying in the Commission’s Public Reference Room, 100 F Street, NE,
Washington, DC 20549, on official business days between the hours of 10:00 am and
3:00 pm. Copies of such filing also will be available for inspection and copying at the
principal office of FINRA. All comments received will be posted without change; the
Commission does not edit personal identifying information from submissions. You
should submit only information that you wish to make available publicly. All
45
submissions should refer to File Number SR-NASD-2004-183 and should be submitted
on or before [insert date 21 days from publication in the Federal Register].
VI. Conclusion
IT IS THEREFORE ORDERED, pursuant to Section 19(b)(2) of the Act,
160
that
the proposed rule, as amended (SR-NASD-2004-183), be, and it hereby is, approved.
By the Commission.
Nancy M. Morris
Secretary
160
15 U.S.C. 78s(b)(2). OCR text (95,505c · tika · 95% conf)
1
SECURITIES AND EXCHANGE COMMISSION
(Release No. 34-56375; File No. SR-NASD-2004-183)
September 7, 2007
Self-Regulatory Organizations; National Association of Securities Dealers, Inc. (n/k/a
Financial Industry Regulatory Authority, Inc.); Notice of Filing of Amendment Nos. 3
and 4 and Order Granting Accelerated Approval of the Proposed Rule, as Amended,
Related to Sales Practice Standards and Supervisory Requirements for Transactions in
Deferred Variable Annuities
I. Introduction
On December 14, 2004, the National Association of Securities Dealers, Inc.
(“NASD”) filed with the Securities and Exchange Commission (“Commission”),
pursuant to Section 19(b)(1) of the Securities Exchange Act of 19341 (“Exchange Act” or
“Act”) and Rule 19b-42 thereunder, proposed new Rule 2821 (“Proposed Rule 2821”)
relating to the sales practice standards and supervisory and training requirements
applicable to transactions in deferred variable annuities.3 Proposed Rule 2821, as
amended by Amendment No. 1, was published for comment in the Federal Register on
July 21, 2005.4 The Commission received approximately 1500 comments on the
1 15 U.S.C. 78s(b)(1).
2 17 CFR 240.19b-4.
3 On July 26, 2007, the Commission approved a proposed rule change filed by
NASD to amend NASD’s Certificate of Incorporation to reflect its name change
to Financial Industry Regulatory Authority Inc., or FINRA, in connection with the
consolidation of the member firm regulatory functions of NASD and NYSE
Regulation, Inc. See Exchange Act Release No. 56146 (July 26, 2007); 72 FR
42190 (Aug. 1, 2007).
4 See Exchange Act Release No. 52046A (July 19, 2005); 70 FR 42126 (July 21,
2005) (SR-NASD-2004-183).
2
proposal.5 NASD filed Amendment No. 2 on May 4, 2006, which addressed the
comments and proposed responsive amendments. Amendment No. 2 was published for
comment in the Federal Register on June 28, 2006.6 The Commission received
approximately 1950 comments on Amendment No. 2.7 To further explain and modify
certain provisions of Proposed Rule 2821 in response to comments, NASD filed
Amendment No. 3 on November 15, 2006 and Amendment No. 4 on March 5, 2007.
Amendment No. 4 supersedes all of the previous amendments in their entirety. All of the
comments that the Commission has received are available on the Commission’s Internet
Web site (http://www.sec.gov/rules/sro.shtml). This order provides notice of
Amendment Nos. 3 and 4 to the proposed rule and approves the proposed rule as
amended on an accelerated basis.8
II. Description of the Proposal
Proposed Rule 2821 would create recommendation requirements (including a
suitability obligation), principal review and approval requirements, and supervisory and
training requirements tailored specifically to transactions in deferred variable annuities.
It is intended to supplement, not replace, NASD’s other rules relating to suitability,
5 Approximately 1300 of these comments, primarily from licensed insurance
professionals and variable product salespersons, are virtually identical. These
letters are referred to herein, and on the list of comments on the Commission’s
Web site as “Letter Type A.” The Commission also received multiple copies of
other letters, which we refer to as Letters Type B, C, D, E, F, G and H, below.
6 See Exchange Act Release No. 54023 (June 21, 2006); 71 FR 36840 (June 28,
2006) (SR-NASD-2004-183).
7 Approximately 1700 of these comments, primarily from licensed insurance
professionals and variable product salespersons, are virtually identical. These
letters are referred to herein as “Letter Type B.”
8 NASD granted consent for the Commission to approve the proposed rule beyond
the timeframes set forth in Section 19(b)(2) of the Act.
3
supervisory review, supervisory procedures, and training. Thus, to the extent Proposed
Rule 2821 does not apply to a particular transaction, NASD’s general rules on suitability,
supervisory review, supervisory procedures, and training continue to govern when
applicable.9 The text of the proposed rule is available on FINRA’s Web site
(www.finra.org), at FINRA’s principal office, and at the Commission’s Public Reference
Room.
Proposed Rule 2821 would apply to the purchase or exchange of a deferred
variable annuity and to an investor’s initial subaccount allocations.10 It would not apply
to reallocations of subaccounts or to subsequent premium payments made after the
investor’s initial purchase or exchange.11 It also generally would not apply when an
investor’s purchase or exchange of a deferred variable annuity is made within a tax-
9 The general suitability obligation requires a broker-dealer to consider its
customer’s ability to understand the security being recommended, including
changes in the customer’s ability to understand, monitor, and make further
decisions regarding securities over time.
10 As NASD noted in Amendment No. 2, the proposed rule focuses on customer
purchases and exchanges of deferred variable annuities, areas that, to date, have
given rise to many of the sales practice abuses associated with variable annuity
products. See Exchange Act Release No. 52046A, at 3-5 (discussing various
questionable sales practices that NASD examinations and investigations have
uncovered and the actions NASD has taken to address those practices). The
proposed rule would thus cover a standalone purchase of a deferred variable
annuity and an exchange of one deferred variable annuity for another deferred
variable annuity. For purposes of the proposed rule, an “exchange” of a product
other than a deferred variable annuity (such as a fixed annuity) for a deferred
variable annuity would be covered by the proposed rule as a “purchase.” The
proposed rule would not cover customer sales of deferred variable annuities,
including the sale of a deferred variable annuity in connection with an “exchange”
of a deferred variable annuity for another product (such as a fixed annuity).
However, recommendations of customer sales of deferred variable annuities are
covered by Rule 2310, NASD’s general suitability rule.
11 NASD’s general suitability rule, Rule 2310, would continue to apply to
reallocations of subaccounts.
4
qualified, employer-sponsored retirement or benefit plan.12 If, however, a member
recommends a deferred variable annuity to an individual plan participant, then Proposed
Rule 2821 would apply to that purchase (or exchange) and to the initial subaccount
allocations.
Proposed Rule 2821 has four main requirements. First, in order to recommend
the purchase or exchange of a deferred variable annuity, a member would be required to
have a reasonable basis to believe that the transaction is suitable in accordance with
NASD’s general suitability rule, Rule 2310.13 In particular the member must have a
reasonable basis to believe that:
• The customer has been informed, in general terms, of various features of
deferred variable annuities;14
• The customer would benefit from certain features of deferred variable
annuities, such as tax deferred growth, annuitization, or a death or living
benefit;15 and
• The particular deferred variable annuity that the member is recommending,
the underlying subaccounts to which funds are allocated at the time of the
12 Proposed Rule 2821 defines such plans as either a “qualified plan” under Section
3(a)(12)(C) of the Act or a plan that meets the requirements of Internal Revenue
Code Sections 403(b), 457(b), or 457(f).
13 See Proposed Rule 2821(b)(1)(A).
14 See Proposed Rule 2821(b)(1)(A)(i). The proposed rule lists the following
features as examples for purposes of this requirement: (1) potential surrender
period and surrender charge; (2) potential tax penalty if customers sell or redeem
deferred variable annuities before reaching the age of 59½; (3) mortality and
expense fees; (4) investment advisory fees; (5) potential charges for and features
of riders; (6) the insurance and investment components of deferred variable
annuities; and (7) market risk.
15 See Proposed Rule 2821(b)(1)(A)(ii).
5
purchase or exchange of the deferred variable annuity, and the riders and
similar product enhancements are suitable (and in the case of an exchange, the
transaction as a whole also is suitable) for the customer based on the
information the person associated with the member is required to make a
reasonable effort to obtain pursuant to subparagraph (b)(2) of the proposed
rule.16
Prior to recommending that a customer exchange a deferred variable annuity, a
registered representative must not only have a reasonable basis to believe that the
exchange is consistent with the suitability determinations in subparagraph (b)(1)(A) of
the proposed rule, but must also consider whether:
• The customer would incur a surrender charge, be subject to the
commencement of a new surrender period, lose existing benefits, or be subject
to increased fees or charges;17
• The customer would benefit from product enhancements and improvements;18
and
• The customer’s account has had another deferred variable annuity exchange
within the preceding 36 months.19
The associated person recommending the transaction would be required to
document these considerations and sign this documentation. He or she would also have
to make reasonable efforts to obtain from the customer information regarding the
16 See Proposed Rule 2821(b)(1)(A)(iii).
17 See Proposed Rule 2821(b)(1)(B)(i).
18 See Proposed Rule 2821(b)(1)(B)(ii).
19 See Proposed Rule 2821(b)(1)(B)(iii).
6
customer’s age, annual income, financial situation and needs, investment experience,
investment objectives, intended use of the deferred variable annuity, investment time
horizon, existing assets (including investment and life insurance holdings), liquidity
needs, liquid net worth, risk tolerance, tax status, and such other information used or
considered to be reasonable by the member or person associated with the member in
making recommendations to customers.20
Second, a registered principal would have to review the transaction and determine
whether he or she approves of it prior to transmitting the customer’s application to the
issuing insurance company for processing, but no later than seven business days after the
customer signs the application.21 The registered principal may approve the transaction
only if he or she has determined that there is a reasonable basis to believe that the
transaction would be suitable based on all of the factors contained in paragraph (b)
(“Recommendation Requirements”) of the proposed rule.22
20 See Proposed Rule 2821(b)(2).
21 See Proposed Rule 2821(c). NASD has determined that relief is needed to allow
certain broker-dealers to complete their review of deferred variable annuity
transactions as required by proposed NASD Rule 2821 without becoming fully
subject to Exchange Act Rule 15c3-3 and being required to maintain higher levels
of net capital in accordance with Exchange Act Rule 15c3-1. Consequently,
NASD has requested relief from Rules 15c3-3 and 15c3-1 for these broker-
dealers. In conjunction with the Commission’s approval or proposed rule 2821, it
is also granting exemptions from Rules 15c3-1 and 15c3-3 of the Exchange Act to
allow NASD members to comply with proposed Rule 2821 without becoming
fully subject to Exchange Act Rule 15c3-3 and being required to maintain higher
levels of net capital in accordance with Rule 15c3-1.
NASD initially submitted a request for relief to the staff prior to the consolidation
of its member firm regulatory functions with NYSE Regulation, Inc. This request
was replaced by a subsequent request from the consolidated entity, FINRA. For
readability, this second request is referred to as an NASD request throughout this
order.
22 See Proposed Rule 2821(c).
7
For purposes of reviewing deferred variable annuity purchases and exchanges, a
registered principal must treat all transactions as if they have been recommended.23
However, if a registered principal determines that a transaction, which is not suitable
based on the factors contained in paragraph (b), was not recommended, he or she may
nonetheless authorize the processing of it if the customer has been informed of the reason
why the transaction has not been approved and the customer affirms that he or she wants
to proceed with the transaction.24
The registered principal that reviews the transaction must document and sign the
determinations that the proposed rule requires him to make.25 He or she must complete
this documentation regardless of whether he or she approves, rejects, or authorizes the
transaction.26
Third, Proposed Rule 2821 would require members to develop and maintain
supervisory procedures that are reasonably designed to achieve compliance with the
proposed rule.27 Members would be required to implement surveillance procedures to
determine if associated persons “have rates of effecting deferred variable annuity
exchanges that raise for review whether such rates of exchanges evidence conduct
inconsistent with the applicable provisions of [the rule], other applicable NASD rules, or
the federal securities laws (‘inappropriate exchanges’).”28 Members would also be
required to have policies and procedures reasonably designed to implement corrective
23 Id.
24 Id.
25 Id.
26 Id.
27 See Proposed Rule 2821(d).
28 Id.
8
measures to address inappropriate exchanges and the conduct of associated persons who
engage in inappropriate exchanges.29
Fourth, Proposed Rule 2821 would require members to develop and implement
training programs that are tailored to educate registered representatives and registered
principals on the material features of deferred variable annuities and the requirements of
the proposed rule.30
III. Summary of Comments on Amendment No. 2
In its solicitation of comments on Amendment No. 2, the Commission stated that
it would consider the comments it previously received,31 and that commenters could
reiterate or cross-reference previously submitted comments.32 The Commission has
considered all of the comments it received, including commenters’ reiterations of and
cross-references to previously submitted comments. While the summary below refers to
some comments previously submitted, it primarily discusses new comments on portions
of the proposed rule that Amendment No. 2 did not change and comments on those
provisions of the proposed rule that Amendment No. 2 modified. It also discusses
comments received in response to Amendment No. 1 that are relevant to the timing of
principal review provision in paragraph (c) of the proposed rule.
A. General Comments
A number of commenters reiterated their general opposition to the proposed rule,
viewing it as unnecessary, arguing that NASD has not demonstrated a need for it, and
29 Id.
30 See Proposed Rule 2821(e).
31 See Exchange Act Release No. 54023 (June 21, 2006); 71 FR at 36846 n.84.
32 Id.
9
stating that strong enforcement against broker-dealer sales practice abuses provides the
best deterrent to negative market conduct.33 Some commenters also stated that existing
NASD rules and the prospectus adequately inform and protect investors.34
A few commenters suggested that the proposed rule must take into account an
estimate of its competitive and economic impact and asserted that the proposed rule must
be subject to a cost/benefit analysis.35 One commenter took the position that the
proposed rule would impose economic and competitive burdens upon broker-dealers.36
The commenter stated that the rule would require expensive new systems and operation
changes that could initially total more than $200,000 for broker-dealers to implement and
33 See, e.g., Letters from Stephen A. Batman, CEO, 1st Global Capital Corp.
(July 19, 2006) (“1st Global Letter II”); Carl B. Wilkerson, Vice President and
Chief Counsel, American Counsel of Life Insurers (July 19, 2006) (“ACLI Letter
IV”); Gary A. Sanders, Senior Counsel, Law and Government Relations, National
Association of Insurance and Financial Advisors and Thomas F. Korb, Vice
President of Policy and Public Affairs, Association for Advanced Life
Underwriting (July 19, 2006) (“NAIFA/AALU Letter II”); Letter Type B. See
also Letter Type D. Unless otherwise noted, all letters are addressed to the
Commission.
34 See, e.g., Letters from Dale E. Brown, CAE, Executive Director and CEO,
Financial Services Institute (July 19, 2006) (“FSI Letter II”); Ari Burstein,
Associate Counsel, Investment Company Institute (July 19, 2006) (“ICI Letter
II”); 1st Global Letter II; ACLI Letter IV; Letter Type B. Two commenters
suggested that the Commission delay action on the proposed rule until there is
some resolution to the Commission’s point-of-sale proposal. See ACLI Letter IV;
FSI Letter II. Another commenter stated that it is not clear how the proposed rule
would work with the Commission’s point-of-sale proposal, especially with regard
to the disclosure of material features. See Letter from W. Thomas Conner and
Eric A. Arnold, Sutherland Asbill and Brennan LLP on behalf of Committee of
Annuity Insurers (July 19, 2006) (“CAI Letter II”).
35 See Letter from Joan Hinchman, Executive Director, President and CEO, National
Society of Compliance Professionals, Inc. (July 19, 2006) (“NSCP Letter”); ACLI
Letter IV; NAIFA/AALU Letter II.
36 ACLI Letter IV.
10
monitor enterprise-wide.37 It also maintained that the ongoing costs of complying with
the proposed rule would be significant and immeasurable.38 That commenter did not,
however, provide any specific information about the system changes it foresaw, or how it
arrived at its $200,000 estimate.
Some commenters stated that the proposed rule would impose a burden on
competition.39 One of these commenters stated that the proposed rule would disparately
impact smaller companies without state-of-the-art technological resources.40 In its view,
small to mid-sized companies may be forced out of the annuity market, thereby reducing
competition and eliminating consumer options.41 One commenter posited three ways in
which the proposed rule would burden competition, stating:
• The proposed rule would disrupt enterprise-wide uniformity of compliance
procedures. Compliance with the proposed rule would cost more than
compliance procedures for other products, and thus would make variable
annuities more expensive to sell than other products.
• Conversion to the proposed rule would provide openings for inadvertent and
transitional violations and may dampen distributors’ enthusiasm for selling a
product with suitability and supervision standards that are different from all
other securities.
• Other products have had greater incidences of disciplinary actions and do not
have specific supervision and suitability standards “that would dampen
distributors’ sales enthusiasm for fear of regulatory reprisals or technical
violations.”42
37 Id.
38 Id.
39 See e.g., ACLI Letter IV; NAIFA/AALU Letter II; NSCP Letter.
40 NSCP Letter.
41 Id.
42 ACLI Letter IV. Another commenter agreed that the proposed rule would place
those that sell variable annuities at a competitive disadvantage in comparison with
those who market other types of investments. See NAIFA/AALU Letter II. Two
commenters also stated that adopting product specific suitability requirements and
11
This commenter also argued that the rule targets deferred variable annuities in a
discriminatory and burdensome fashion without appropriate rationale.43
Some commenters stated that implementation of the proposed rule would have
unintended consequences.44 For example, two commenters asserted that the proposed
rule would raise barriers to access for investors who could benefit from owning a
deferred variable annuity.45 A few commenters also believed that the product-specific
requirements of the proposed rule would signal to investors that something is wrong with
the product.46 One commenter stated that the proposed rule would cause expenses and
fees to rise, which in turn would lead consumers to look to other, less expensive
investment products that may not be as appropriate for their needs.47
NASD responded to concerns regarding the need for the proposed rule, the
process by which it developed and revised the proposed rule, and the statutory
requirements for its rulemaking in a letter to the Commission.48 With respect to concerns
that the proposed rule is not necessary, NASD reiterated that its examinations,
supervisory procedures would inhibit sales because registered representatives
would be less inclined to sell the product. See Letter from Michael P. DeGeorge,
General Counsel, National Association for Variable Annuities (July 19, 2006)
(“NAVA Letter III”); FSI Letter II.
43 ACLI Letter IV.
44 See, e.g., Letter from Rick Dahl, CCO, Sorrento Pacific Financial LLC
(July 19, 2006) (“Sorrento Letter”); FSI Letter II; NAVA Letter III;
NAIFA/AALU Letter II.
45 See FSI Letter II; Sorrento Letter.
46 See Letter from W. Burk Rosenthal, President, Rosenthal Retirement Planning,
LP (July 19, 2006); FSI Letter II; NAVA Letter III.
47 See NAIFA/AALU Letter II.
48 See Letter from James S. Wrona, Associate Vice President, NASD (Aug. 31,
2006) (“NASD Response Letter”).
12
investigations, and informal discussions with its members have uncovered numerous
instances of questionable sales practices in connection with the purchase or exchange of
deferred variable annuities, including unsuitable recommendations, and
misrepresentations and omissions.49 It also stated that member supervision and training
procedures are inadequate.50 NASD noted that these problems stem from the unique
complexities of deferred variable annuities, which can cause confusion both for the
individuals who sell them and for the customers who purchase or exchange them.51
Despite issuing Notices to Members, Regulatory and Compliance Alerts, and Investor
Alerts, NASD found that these problems continue to exist.52 NASD stated that recent
joint reviews with the Commission, as well as NASD examinations and enforcement
actions, demonstrate that an informal approach has not been sufficiently effective at
curbing the sales practice abuses in this area.53
NASD also discussed its “measured approach” to the rulemaking process.54 After
NASD determined that a rule specific to deferred variable annuities was necessary and
appropriate, it issued Notice to Members 04-45 (June 2004) to solicit comments from the
public prior to submitting the proposed rule to the Commission.55 In addition, NASD
sought input on the proposal from five NASD standing committees, including two
49 Id. at 2.
50 Id.
51 Id.
52 Id.
53 Id.
54 Id. at 3.
55 Id.
13
committees with subject matter expertise in variable annuities.56 NASD Regulation,
Inc.’s Board of Directors then approved the proposal and NASD’s Board of Governors
had an opportunity to review it.57 NASD modified the proposed rule in light of
comments it received from all of these sources prior to filing it with the Commission.58
In addition, NASD stated that nothing in Section 15A, Section 19, or any other
provision of the Act requires it to generate a competitive impact statement or otherwise
engage in a cost/benefit analysis.59 It also noted that, as required under Section 19(b)(1)
of the Act, 60 NASD submitted to the Commission a concise general statement of the
basis and purpose of the proposed rule.61
As discussed in Part IV below, in approving a proposed NASD rule, the
Commission must find that the rule is consistent with the requirements of Sections
15A(b)(6) and 15A(b)(9) of the Act. Section 15A(b)(6) requires, among other things, the
rules of a national securities association to be designed to prevent fraudulent and
manipulative acts and practices, to promote just and equitable principles of trade, and, in
general, to protect investors and the public interest.62 Section 15A(b)(9) provides that
56 Id. at 4.
57 Id. at 4. NASD noted that its Board of Governors is composed of both industry
and non-industry members and that one member must be a representative of an
insurance company. Id. at 4, nt. 6. Similarly, NASD Regulation, Inc.’s Board of
Directors is composed of both industry and non-industry members, and one
member must be a representative of an insurance company or an affiliated NASD
Member. Id. at 4, nt. 6.
58 Id. at 4.
59 Id.
60 15 U.S.C. 78s(b)(1).
61 NASD Response Letter at 4.
62 15 U.S.C. 78o-3(b)(6). See also 15 U.S.C. 78c(f) (the Commission must consider
whether the action will promote efficiency, competition and capital formation
14
proposed rules may not create a “burden on competition not necessary or appropriate in
furtherance of the purposes of [the Act].”63 NASD addressed the consistency of the
proposed rule with these requirements, stating:
NASD believes that the proposed rule will enhance firms’
compliance and supervisory systems and provide more
comprehensive and targeted protection to investors
regarding fraud and manipulative acts, promote just and
equitable principles of trade, and increase investor
protection. . . . Like all regulation, NASD’s rules often
impose compliance obligations on the regulated entities. In
every case, the compliance burdens associated with a new
rule will vary from firm to firm depending on the firm’s
customer base, business model, and a variety of other
factors. Section 15A(b)(9) of the Act does not, therefore,
require that NASD rules impose no economic burden on
NASD members or burden on competition, but rather that
any such burdens are necessary and appropriate to further
the purposes of the Act . . . . NASD believes that the
proposed rule is consistent with, and promotes the goals of
the Act.64
B. Comments on Proposed Rule 2821(b) – Recommendation Requirements
1. Comments on Proposed Rule 2821(b)(1)(A) – Renumbered Proposed Rule
2821(b)(1)(A)(i)
As proposed in Amendment No. 2, Proposed Rule 2821(b)(1)(A) would have
required registered representatives to have a reasonable belief that the customer has been
informed of the material features of deferred variable annuities in general prior to
recommending a particular variable annuity to a customer.65 One commenter stated that
when it is required to consider whether an action is necessary or appropriate in the
public interest).
63 15 U.S.C. 78o-3(b)(9).
64 NASD Response Letter at 4-5.
65 In response to Amendment No. 1, commenters stated this provision would amount
to a de facto requirement to provide written disclosure to customers. See, e.g.,
Letters from Beth L. Climo, Executive Director, American Bankers Insurance
15
the rule should clarify what constitutes the material features of a deferred variable
annuity, and should have a safe harbor to protect good faith attempts to disclose the
required information.66 Some commenters reiterated their support for a plain-English
disclosure document to be provided to investors in addition to the prospectus.67
The substance of this provision remained the same in Amendment No. 3, but in
response to comments NASD explicitly stated that the type of disclosure required is
generic and not specific to the particular deferred variable annuity being recommended.
The provision now provides that the member or person associated with the member must
have a reasonable basis to believe that “the customer has been informed, in general terms,
of various features of deferred variable annuities . . . .”
2. Comments on Proposed Rule 2821(b)(1)(B) – Renumbered Proposed Rule
2821(b)(1)(A)(ii)
Association/ABA Securities Association (Sept. 20, 2005); Carl B. Wilkerson,
Vice President and Chief Counsel, America Council of Life Insurers (Sept. 19,
2005) (“ACLI Letter II”), Thomas M. Yacovino, Vice President, A.G. Edwards &
Sons, Inc. (Sept. 20, 2005); Roger C. Ochs, President, HD Vest Financial Services
(Sept. 20, 2005); Michael P. DeGeorge, General Counsel, National Association
for Variable Annuities (Sept. 19, 2005) (“NAVA Letter II”); Thomas R. Moriarty,
President, Intersecurities, Inc. (Sept. 16, 2005) (“Intersecurities Letter”); Ira D.
Hammerman, Senior Vice President and General Counsel, Securities Industry
Association (Sept. 19, 2005) (“SIA Letter I”); Ronald C. Long, Senior Vice
President, Wachovia Securities, LLC (Sept. 19, 2005) (“Wachovia Letter”).
Commenters also asserted that this disclosure, along with the other disclosures
already provided to investors who purchase or exchange deferred variable
annuities, would be redundant and would overwhelm investors. See e.g., Letter
from Leesa M. Easley, Chief Legal Officer, World Group Securities, Inc. (Sept.8,
2005); ACLI Letter II; Intersecurities Letter; NAIFA/AALU Letter II; NAVA
Letter II; SIA Letter I.
66 FSI Letter II.
67 See, e.g., Letters from Patricia Struck, President, North American Securities
Administrators Association (July 21, 2006) (“NASAA Letter II”); Jill I. Gross,
Director of Advocacy, Pace Investor Rights Project (July 19, 2006) (“Pace Letter
II”); Robert S. Banks, Jr., President, Public Investors Arbitration Bar Association
(July 20, 2006).
16
As proposed in Amendment No. 2, Proposed Rule 2821(b)(1)(B) would have
required a registered representative to have a reasonable basis to believe that a customer
would benefit from the unique features of a deferred variable annuity prior to
recommending the purchase or exchange of one. Amendment No. 2 included tax-
deferred growth, annuitization and death benefits as a non-exhaustive list of unique
features.
Some commenters stated that the standard should be that the customer “could”
benefit from the features because stating that the customer would benefit implies a level
of certainty and guarantee that cannot be known at the time of the purchase or
exchange.68 Other commenters also suggested deleting the modifier “unique,” stating
that the features NASD lists as examples are not unique to deferred variable annuities.69
In the alternative, one of these commenters suggested that NASD expand the list of
features it gives as examples to include features such as living benefits.70
NASD agreed that some other products have features similar to those of a
deferred variable annuity, and in Amendment No. 2 deleted the reference to “unique.”
NASD also adopted commenters’ suggestion to include “living benefits” in the list of
features and modified the proposed rule accordingly in Amendment No. 3.
3. Comments on Proposed Rule 2821(b)(2)
68 See, e.g., Letter from Ira D. Hammerman, General Counsel, Securities Industry
Association (July 19, 2006) (“SIA Letter II”); ACLI Letter IV; NAVA Letter III.
These commenters noted that this comment is also applicable to Proposed Rule
2821(c)(1)(A). See supra note 120.
69 See, e.g., ACLI Letter IV; CAI Letter II; FSI Letter II; NAVA Letter III. These
commenters noted that this comment is also applicable to Proposed Rule
2821(c)(1)(A). See supra note 120.
70 CAI Letter II.
17
The proposed rule would require registered representatives to make reasonable
efforts to obtain a variety of information about a customer, including age, financial
situation and needs, liquid net worth and intended use of the deferred variable annuity,
prior to recommending a purchase or exchange of a deferred variable annuity to that
customer.71 A number of commenters raised interpretive issues about or questioned the
relevance of particular information. 72 NASD declined to amend this provision in
response to these comments.
71 In response to Amendment No. 1, some commenters urged NASD to eliminate
this provision, stating that NASD Rules 2310 and 3110, as well as Rule 17a-
3(a)(17)(i)(A) under the Act, should govern the information that members are
required to gather in making recommendations to purchase or exchange deferred
variable annuities. See e.g., Letters from Daniel A. Riedl, Senior Vice President
and Chief Operating Officer, Northwestern Mutual Investment Services (Sept.16,
2005) (“NMIS Letter”); M. Shawn Dreffein, President and Chief Executive
Officer, National Planning Holdings, Inc. (Sept. 9, 2005); John L. Dixon,
President, Pacific Select Distributors, Inc. (Sept. 16, 2005); NAVA Letter II.
72 Three commenters stated that the proposed rule should not require a registered
representative to obtain information if the customer declines to provide it upon
request. Letter from Kerry Cunningham, Head of Risk Management, ING
Advisors Network (July 20, 2006) (“ING Advisors Letter II”); ACLI Letter IV;
FSI Letter II. One commenter stated that the information should be obtained
during the sales process and not necessarily before any recommendation is made.
ING Advisors Letter II. One commenter stated that the registered representative
should make a reasonable effort to determine overall investment objectives but
not intended use. Id. A number of commenters questioned the difference
between the intended use of a deferred variable annuity and the customer’s
investment objective. See, e.g., Letters from Timothy J. Lyle, Senior Vice
President and Chief Compliance Officer, Contemporary Financial Solutions
(July 19, 2006) (“Contemporary Financial Letter”); Timothy J. Lyle, Senior Vice
President and Chief Compliance Officer, Mutual Service Corporation
(July 19, 2006) (“Mutual Service Letter II”); FSI Letter II; ING Advisors Letter
II. Some commenters suggested that a customer’s life insurance holdings are not
relevant to a deferred variable annuity suitability analysis. See, e.g., CAI Letter
II; Contemporary Financial Letter; FSI Letter II; Mutual Service Letter II; NAVA
Letter III; Sorrento Letter; SIA Letter II.
18
4. Comments on Proposed Rule 2821(c) – Principal Review and Approval
a. General Comments
As proposed in Amendment No. 2, the principal review and approval
requirements of paragraph (c) would have applied to both recommended and non-
recommended transactions.73 Commenters stated that the factors a registered principal
considers should adequately reflect the differences between recommended and non-
recommended transactions.74 These commenters noted that if a transaction is not
recommended, a principal may not have information regarding a customer’s overall
investment portfolio and would need to request that information from the customer.75
In Amendment No. 3, NASD noted some commenters stated that customers
should be free to decide whether they want to purchase a deferred variable annuity, and
thus the proposed rule’s principal review requirements should not apply to non-
recommended transactions.76 NASD agreed that a fully informed customer should be
able to make his or her own investment decision and modified this portion of the
73 In response to Amendment No. 1, some commenters objected to requiring
principal review of transactions that are not recommended. See, e.g., Letters from
Frances M. Stadler, Deputy Senior Counsel, Investment Company Institute (Sept.
19, 2005) (“ICI Letter”); Henry H. Hopkins, Darrell N. Braman and Sara
McCafferty, T. Rowe Price Investment Securities, Inc. (Sept. 19, 2005) (“T. Rowe
Price Letter”); NMIS Letter. One commenter noted that the information that
would be needed for a principal review is not currently required to be collected
for non-recommended annuity transactions. See T. Rowe Price Letter. Some
commenters also stated that requiring review for non-recommended transactions
would allow principals to second guess investors’ decisions. See, e.g., ICI Letter;
NMIS Letter.
74 See Letter from Darrell N. Braman, Vice President and Associate Legal Counsel
and Sarah McCafferty, Vice President and Associate Legal Counsel, T. Rowe
Price Associates, Inc. (July 19, 2006) (“T. Rowe Price Letter II”); ICI Letter II.
75 ICI Letter II; T. Rowe Price Letter II.
76 Amendment No. 3 is available on NASD’s Web site at
http://www.finra.org/web/groups/rules_regs/documents/rule_filing/p017909.pdf.
19
proposed rule. As amended, a registered principal “may authorize the processing [of a
non-recommended transaction] if the registered principal determines that the transaction
was not recommended and that the customer, after being informed of the reason why the
registered principal has not approved the transaction, affirms that he or she wants to
proceed with the purchase or exchange of the deferred variable annuity.”77
Two commenters took the position that the supervisory requirements of the
proposed rule would run counter to established legal principles and the rules, systems,
and divisions of responsibility already in place.78 One of these commenters stated that
the proposed rule would impose affirmative duties upon supervisory and compliance
personnel to make individualized suitability determinations, in contravention of the letter
and spirit of Section 15(b)(4)(E) of the Act.79
Another commenter stated that the proposed rule should provide specific
standards for principal review of age, liquidity needs, and the dollar amount involved. 80
In that commenter’s view, permitting firms to set their own standards would invite
abuse.81 NASD’s initial filing82 with the Commission and Amendment No. 183 would
77 See Proposed Rule 2821(c).
78 See NAIFA/AALU Letter II; NSCP Letter. In response to Amendment No. 1,
several commenters stated that the proposed principal review requirement was
unduly duplicative of NASD Rule 3110. See Letters from Deirdre B. Koerick,
Vice President, Lincoln Investment Planning, Inc. (Sep. 19, 2005); Jennifer B.
Sheehan, Assistant Vice President and Counsel, Massachusetts Mutual Life
Insurance Comp. (Sept. 19, 2005); ACLI Letter IV; NAVA Letter II; SIA Letter
II.
79 NSCP Letter.
80 Pace Letter II.
81 Id.
82 NASD’s initial filing is available at
http://www.finra.org/web/groups/rules_regs/documents/rule_filing/p012780.pdf.
20
have required members to establish standards with respect to a variety of factors,
including the customer’s age and the extent to which the amount of money invested in the
deferred variable annuity exceeds a stated percentage of the customer’s net worth.
NASD stated in Amendment No. 2 that “while conceptually appealing, the establishment
of specific thresholds would unnecessarily limit a firm’s discretion in establishing
procedures that adequately address its overall operations. NASD did not intend to require
a firm to reject all deferred variable annuity transactions involving person over a
particular age or dollar amounts over a particular level. Rather, NASD intended only that
principals consider the highlighted factors as part of their review, which is a facts and
circumstances inquiry.”84
b. Comments on the Timing of Principal Review
Amendment No. 2 would have required registered principals to review all
purchases and exchanges of deferred variable annuities no later than two business days
following the date when the customer’s application is transmitted to the issuing insurance
company.85 Two commenters stated that the basis for the two-day timeframe is arbitrary
and has not been explained or justified.86 A few commenters viewed the proposed rule as
prioritizing speed over diligence without adequate justification.87 One commenter stated
83 See supra note 4.
84 Amendment No. 2 is available on NASD’s Web site at
http://www.finra.org/web/groups/rules_regs/documents/rule_filing/p016480.pdf.
85 Pursuant to Amendment No. 1, registered principals would have been required to
review all purchases and exchanges prior to transmitting a customer’s application
to the issuing insurance company for processing.
86 See ACLI Letter IV; FSI Letter II.
87 See, e.g., FSI Letter II; NAIFA/AALU Letter II; NSCP Letter. Another
commenter stated that difficulty complying with the timeframe would force some 21
that the timeframe was intended to allow principals to catch unsuitable sales before a
contract has been issued, but contracts may be issued before the principal’s review is
completed even under the revised timeframe.88 One commenter stated that “free look”
provisions that are available under some states’ insurance laws offer a greater opportunity
to redress unsuitable sales.89
Numerous commenters stated that it would be difficult to comply with the revised
timeframe.90 Two commenters remarked that the supervisory review timeframe does not
take into account the varied business models of member firms.91 These commenters
stated that in some instances, the registered principal who reviews transactions is
stationed at the issuing insurance company.92 In those instances, the commenters stated
that those individuals might not be able to serve as the reviewing principal because the
broker-dealers to cancel contracts once the insurance company has already issued
them. See CAI Letter II.
88 CAI Letter II.
89 ACLI Letter IV. In NASD’s initial filing with the Commission, it disagreed with
commenters who suggested that state-required “free look” periods make early
principal review unnecessary. NASD explained that a “free look” period allows
the customer to terminate the contract without paying any surrender charges and
receive a refund of the purchase payments or the contract value, as required by
applicable state law. Free-look periods, which vary by state law, typically range
from ten to thirty days. NASD went on to state that allowing a suitability analysis
to be reviewed by a principal long after an insurance company issues a deferred
variable annuity contract would be inconsistent with an adequate supervisory
system and would make it difficult for a member to quickly identify problematic
trends. NASD’s initial filing is available on its Web site at
http://www.finra.org/web/groups/rules_regs/documents/rule_filing/p012780.pdf.
90 See, e.g., CAI Letter II; Contemporary Financial Letter; FSI Letter II; ING
Advisors Letter II; Mutual Service Letter II; NAVA Letter III; NSCP Letter;
Sorrento Letter.
91 See NSCP Letter; T. Rowe Price Letter II.
92 Id.
22
triggering event is the transmission to the insurance company.93 One commenter also
noted that the proposed rule would not accommodate instances in which the application is
transmitted to the issuing insurance company and the member firm simultaneously.94
Commenters stated that it would be especially difficult to comply with the
proposed timeframe when the principal needs to get additional information from the
customer, registered representative, or Office of Supervisory Jurisdiction (“OSJ”)
manager.95 One commenter stated that fear of missing the deadline may discourage
principals from seeking this additional information.96 Another commenter suggested that
a review should be required to take place no later than two business days following the
date the member transmits the application or no later than two business days after receipt
by the insurance company to accommodate instances in which the customer sends the
application directly to the insurance company.97
In Amendment No. 4, NASD modified the proposed rule to further address these
comments.98 As amended, the proposed rule would require a principal to review the
93 Id.
94 NSCP Letter. This commenter noted that when this occurs, the application is
reviewed by the insurance company and the member firm simultaneously.
95 See, e.g., CAI Letter II; Contemporary Financial Letter; FSI Letter II; ING
Advisors Letter II; Mutual Service Letter II; NAVA Letter III; NSCP Letter;
Sorrento Letter.
96 CAI Letter II.
97 T. Rowe Price Letter II.
98 NASD also amended the timing or principal review requirement in Amendment
No. 3. That amendment would have required principals to review the transaction
no later than two business days after the application was sent to the issuing
insurance company if no additional contact was necessary with the customer or
the registered representative. If additional contact was needed with either the
customer or the registered representative, then review would have had to be
completed within five business days of the application being sent to the issuing
23
transaction prior to transmitting a customer’s application to the issuing insurance
company for processing, but no later than seven business days after the customer signs
the application.99
One commenter addressed the safeguarding of customer funds during the
principal review and stated that “clarification is needed regarding the degree of flexibility
afforded to firms with respect to the safekeeping of customer funds during the review
period. Rather than dictating specific procedures, firms should be permitted to design
insurance company. The Commission received several comments on this timing
provision, all of which are available on the Commission’s Internet Web site
(http://www.sec.gov/rules/sro.shtml.) Commenters stated that the limited review
period in Amendment No. 3 was problematic and arbitrary. These commenters
also suggested requiring principal review to be completed within a reasonable
time period, not to exceed the expiration of the free look period, following the
date the broker-dealer transmits the application to the issuing insurance company.
See e.g., Letter from Dale E. Brown, Executive Director and CEO, Financial
Services Institute (Mar. 5, 2007) (“FSI Letter III”); Letters Type E and F.
Comments addressing subparagraph (b)(1)(A) of Amendment No. 3 stated that
requiring registered representatives to “determine” whether a transaction was
suitable, rather than having a “reasonable basis to believe” it, raised the bar for
suitability determinations. See e.g., FSI Letter III and Letters Type E and F. In
Amendment No. 4, NASD revised this language to require registered
representatives to have “a reasonable basis to believe” that the deferred variably
annuity is suitable.
Commenters also stated the reference in subparagraph (b)(1)(A)(i) to the
“various” features of deferred variable annuities created an “unacceptable level of
ambiguity” and that the prior proposal’s use of “material” features was preferable.
See e.g., FSI Letter III and Letters Type E and F.
99 In response to Amendment No. 4, commenters requested that the Commission
seek additional comment on the proposed rule. Letter from Clifford Kirsch,
Sutherland Asbill and Brennan LLP on behalf of Committee of Annuity Insurers
(April 9, 2007) (“CAI Letter III”); Letters Type G and H. One commenter stated
that commenters have not had an opportunity to address whether Amendment
No. 4 causes any unintended consequences regarding the safeguarding of
customer funds at the broker-dealer for as many as seven days and to provide
feedback regarding the contours of the proposed no-action relief from Exchange
Act Rules 15c3-1 and 15c3-3. CAI Letter III. See also infra notes 101-112 and
accompanying text.
24
procedures tailored to their business model.”100 Exchange Act Rule 15c3-3 requires
broker-dealers to safeguard customer funds and securities. While Rule 15c3-3 requires
that a broker-dealer promptly forward checks and include as a credit in the reserve
formula all customer free credit balances, it does not specify any specific procedures that
a broker-dealer must use to be in compliance with the rule. Rather, it allows a broker-
dealer to tailor its procedures to its particular business model. NASD Rule 2821 will not
affect the applicability of Exchange Act Rule 15c3-3 with respect to the safeguarding of
customer funds.
The Commission also received comments on the timeframe for principal review
proposed in Amendment No. 4.101 Some commenters addressed NASD’s requested no-
action relief102 and highlighted related implementation issues.103
One commenter addressed situations in which an insurer’s contract issuance unit
is physically resident at the same location as one of the insurer’s captive broker-dealer
offices, and both areas share personnel with one another.104 It asked for clarification of
whether receipt of customer applications by broker-dealer personnel for principal review
in these co-located situations would be considered a transmittal to the issuing insurance
company for processing under proposed Rule 2821(c).105 NASD responded by stating
that in these situations “[it] would consider the application “transmitted” to the insurance
100 CAI Letter III
101 Letter from Eric A. Arnold and Clifford E. Kirsch, Sutherland Asbill and Brennan
LLP on behalf of Committee of Annuity Insurers (May 24, 2007) (“CAI Letter
IV”); Letters Type G and H.
102 See supra note 21.
103 See CAI Letter IV.
104 Id.
105 Id.
25
company only when the broker-dealer’s principal, acting as such, has approved the
transaction, provided that the affiliated broker-dealer ensures that arrangements and
safeguards exist to prevent the insurance company from issuing the contract prior to
principal approval by the broker-dealer.106
The Commission believes that NASD can address implementation issues, to the
extent they arise, during the proposed six month implementation period. Notably, the
revised timeframe in Amendment No. 4 is substantially similar to the timeframe that
NASD proposed and that the Commission published for comment in Amendment No. 1,
which would have required a principal to review a transaction prior to sending the
application to the insurance company for processing. The Commission received
numerous comments on the timing of principal review provision as it was proposed in
Amendment No. 1.107 While some commenters supported it because they believed it
would give principals sufficient time for a thorough review and provide greater
assurances that unsuitable transactions would not be consummated,108 others objected to
it.109 Some commenters were concerned that members would be subject to liability for
market changes affecting the value of the deferred variable annuity during the delay for
106 See Letter from James S. Wrona, Associate Vice President, FINRA
(Aug. 10, 2007).
107 A summary of these comments addressing Amendment No. 1 was published in
the Federal Register along with the Commission’s notice of Amendment No. 2.
See supra notes 4 and 6.
108 Letters from Patricia Struck, President, North American Securities Administrators
Association (September 20, 2005) and Rosemary J. Shockman, President, Public
Investors Arbitration Bar Association (Sept. 9, 2005).
109 See, e.g., Letters from W. Thomas Conner and Eric A. Arnold, Sutherland Asbill
& Brennan on behalf of The Committee of Annuity Insurers (Sept. 19, 2005)
(“CAI Letter I); John S. Simmers, CEO, ING Advisors (Sept. 19, 2005) (“ING
Letter I”); ACLI Letter II; NAVA Letter II.
26
supervisory review.110 Some commenters stated that a delay in pricing the contract
would be unfair to customers.111 Others stated that the timing deadline would require
costly reprogramming of broker-dealers’ electronic processing systems that forward
contracts to the insurance company and the registered representative’s home office at the
same time.112
One commenter stated that the interaction of this provision with other
Commission and NASD rules could limit a firm’s ability to review applications
thoroughly.113 Another stated that time-linking the application process with supervisory
review would impair the goal under the Investment Company Act of 1940 of timely
processing.114
A few commenters stated that the time deadline would not work in the context of
direct sales because in those sales an insurance company may not know of an applicant’s
interest in a deferred variable annuity until it receives the application.115 Another stated
that the timing deadline would not take into account situations in which the registered
110 Letters from Denise M. Evans, General Counsel, Associated Securities Corp.
(Sept. 19, 2005) (“Associated Securities Letter”); John L. Dixon, President,
Pacific Select Distributors (Sept. 16, 2005) (“Pacific Select Letter”); and Julie
Gerbert, Vice President, United Planners’ Financial Services of America
(Sept. 19 2005) (“United Planners Letter”).
111 ACLI Letter II; Pacific Select Letter; and United Planners Letter.
112 CAI Letter I; NMIS Letter.
113 ING Letter I.
114 ACLI Letter II.
115 CAI Letter I; NAVA Letter II; T. Rowe Price Letter I. In direct sales, customers
may apply for an annuity contract by calling the insurance company or by
completing an application on the internet. NAVA Letter II. Receipt of the
application is frequently the first time the insurance company even knows that the
customer has filled out an application. Id.
27
principal is housed in the insurance company.116
A few commenters also stated that their current supervisory structure as an Office
of Supervisory Jurisdiction would be incapable of dealing with the prior approval
requirement and they would be forced to eliminate this form of supervisory structure.117
One commenter stated the requirement could overwhelm principals,118 and another stated
that it would require members to allocate two to three times the supervisory staff for
deferred variable annuities than for any other product.119
c. Proposed Rule 2821(c) – Principal Review and Approval
In Amendment No. 2, NASD listed a variety of factors that a registered principal
would be required to consider in reviewing the purchase or exchange of a deferred
variable annuity. In Amendment No. 3, NASD modified this provision to require
registered principals to consider all of the factors that a registered representative must
consider in Proposed Rule 2821(b) (“Recommendation Requirements”) and eliminated
116 NMIS Letter.
117 Letter from Shawn M. Mihal, Chief Compliance Officer, Great American
Advisors (Sept. 19, 2005) and ING Letter I. These comments were submitted in
response to Amendment No. 1, which would have required principals to review
customers’ applications prior to transmitting them to the issuing insurance
company for processing. The commenters assumed that there would be no relief
from Rules 15c3-1 and 15c3-3, and thus broker-dealers would have to forward
checks (along with applications) to the insurance company by noon of the next
business day after receiving those checks. Based on this assumption, the
commenters indicated that there would not be sufficient time for representatives
to forward the paperwork to the OSJ manager and the OSJ manager to review the
application within the time parameters required by Rules 15c3-1 and 15c3-3.
These timing concerns have been addressed by the Commission’s exemptions
from Rules 15c3-3 and 15c3-3 to allow NASD members to comply with the
proposed rule without becoming fully subject to Exchange Act Rule 15c3-3 and
being required to maintain higher levels of net capital in accordance with Rule
15c3-1. See Exchange Act Release No. 56376 (Sep. 7, 2007).
118 Wachovia Letter.
119 Associated Securities Letter.
28
the references to the considerations in subparagraph (c)(1) (“Principal Review and
Approval”) of the proposed rule. NASD also moved the considerations relating to
exchanges that were in subparagraph (c)(1)(D) of Amendment No. 2 to paragraph (b) in
Amendments Nos. 3 and 4. By doing this, NASD added these determinations to those
factors a registered representative must consider and retained them as considerations for
principal review.
i. Comments on Proposed Rule 2821(c)(1)(A) as Amended by
Amendment No. 2 – Principal Review and Approval
The rule, as amended by Amendment No. 2, would have required principals to
consider the extent to which the customer would benefit from the unique features of a
deferred variable annuity. A number of commenters remarked that their comments on
proposed Rule 2821(b)(1)(B) are equally applicable to this provision and that “would”
should be changed to “could” and that the modifier “unique” should be deleted.120 In
response to comments, NASD changed “unique” to “various.” As amended by
Amendment No. 3, the rule would require registered principals to have a reasonable basis
to believe that the customer has been informed, in general terms, of the various features
of deferred variable annuities.121
ii. Comments on Proposed Rule 2821(c)(1)(C) as Amended by
Amendment No. 2 – Principal Review and Approval
The rule, as amended by Amendment No. 2, would have required principals to
consider the extent to which the amount of money invested would result in an undue
concentration in a deferred variable annuity or deferred variable annuities in the context
120 See, e.g., ACLI Letter IV; FSI Letter II; NAVA Letter III; SIA Letter II. See also
supra notes 68 and 69.
121 See Proposed Rule 2821(b)(1)(A)(i).
29
of the customer’s overall investment portfolio. Two commenters stated the term “undue
concentration” is imprecise and capable of multiple interpretations.122 Some commenters
also viewed the proposed requirement to consider the customer’s liquidity needs as
subsuming the apparent intent of this provision.123 In Amendment No. 3, NASD deleted
this provision.
iii. Comments on Proposed Rule 2821(c)(1)(D)(ii) as Amended by
Amendment No. 2 – Principal Review and Approval
The rule, as modified by Amendment No. 2 would have required registered
principals to consider the extent to which the customer would benefit from any potential
product enhancements and improvements in the case of an exchange of a deferred
variable annuity. One commenter stated that “would” should be changed to “could”
because whether a customer benefits is determined years after the contract is purchased
and depends on market performance.124 In Amendment No. 3, NASD deleted this
specific paragraph, but, provided in paragraph (b) (“Recommendation Requirements”)
that principals must consider, in the case of an exchange, whether the customer would
benefit from any potential product enhancements and improvements in their review.125
iv. Comments on Proposed Rule 2821(c)(1)(D)(iii) as Amended by
Amendment No. 2 – Principal Review and Approval
The rule, as modified in Amendment No. 2, would have required principals, in the
case of an exchange of a deferred variable annuity, to consider the extent to which the
122 See, e.g., NAVA Letter III; ACLI Letter IV. Two other commenters noted that
NASD should provide more guidance on what would amount to an “undue
concentration” because deferred variable annuities often take significant portions
of a customer’s assets. See FSI Letter II; Sorrento Letter.
123 See, e.g., ACLI Letter IV; CAI Letter II; NAVA Letter III.
124 See NAVA Letter III.
125 See Proposed Rule 2821(c) and Proposed Rule 2821(b)(1)(B)(ii).
30
customer’s account has had another deferred variable annuity exchange within the
preceding thirty-six months. One commenter, while supporting this provision, believed
that the registered principal should also review the total sales production of variable
annuities of associated persons to detect unsuitable sales and other potential abuses.126 A
number of commenters stated that it would be difficult to comply with this
requirement.127 In their view, principals may have a difficult time obtaining this
information, especially if the exchange occurred at another broker-dealer.128 These
commenters also stated that customers may not want to share this kind of information,
citing privacy concerns or policy concerns with the other broker-dealers.129
One commenter stated that the proposed rule should specify whether principals
have to collect information on exchanges that occurred at the reviewing firm only or also
on exchanges that occurred at other broker-dealers.130 Two commenters argued that the
proposed rule should clarify whether a registered principal is only obligated to consider
prior exchange information if it is available to him or her at the time of his or her
review.131
One commenter stated that the provision would impose substantial administrative
and supervisory costs on broker-dealers, which would have to implement cumbersome
126 See NASAA Letter II.
127 See, e.g., CAI Letter II; Contemporary Financial Letter; FSI Letter II; Mutual
Service Letter II; Sorrento Letter; T. Rowe Price Letter II.
128 Id.
129 Id.
130 See CAI Letter II.
131 See Contemporary Financial Letter; Mutual Service Letter II.
31
and expensive additional surveillance tools.132 Another commenter stated the proposed
rule should clarify the level of inquiry and documentation necessary to comply with this
provision.133 In Amendment No. 3, NASD eliminated this specific provision, but
provided in paragraph (b) (“Recommendation Requirements”) that principals must
consider, in the case of exchange, the extent to which the customer account has had
another deferred variably annuity exchange within the preceding thirty-six months.134
NASD has stated that it will announce the effective date of the proposed rule change in a
Notice to Members to be published no later than 60 days following Commission approval
and that the effective date will be 120 days following publication of the Notice to
Members announcing Commission approval. NASD has indicated that it may address the
type of implementation issues commenters raised with respect to determining whether a
customer’s account has had a deferred variable annuity exchange within the preceding 36
months in connection with that Notice to Members.
d. Comments on Proposed Rule 2821(c)(2) – Principal Review and
Approval
The proposed rule would require the registered principal who reviewed and
approved, rejected, or authorized the transaction to document and sign the determinations
that he or she is required to make pursuant to subparagraph (c) of the proposed rule.
As proposed in Amendment No. 2, the principal who approves a transaction
would have been required to sign the registered representative’s suitability determination.
One commenter stated that this provision should be eliminated because “it would
132 See NSCP Letter.
133 See CAI Letter II.
134 See Proposed Rule 2821(c) and Proposed Rule 2821(b)(1)(B)(iii).
32
establish an unprecedented standard of requiring principals to fully endorse all of the
considerations leading to the salespersons’ recommendations.”135 In this commenter’s
view, the principal’s role should be to affirm the fact that the salesperson elicited
information for completion of the suitability documents.136 In Amendment No. 3, NASD
eliminated the requirement that registered principals sign the registered representative’s
suitability determinations.
5. Comments on Proposed Rule 2821(d) – Supervisory Procedures
The rule, as modified by Amendment No. 2, would have required members to
implement procedures and require principals to consider whether the associated person
effecting the transaction has a particularly high rate of effecting deferred variable annuity
exchanges.
Two commenters argued that the phrase “particularly high rate” is vague and
unworkable.137 A number of commenters noted that the proposed rule implies that
principals would have to implement a transaction-by-transaction review and stated that
members should be able to rely on exception reports as an effective solution to unsuitable
exchanges.138 One commenter also requested clarification regarding what should happen
if a registered representative does have a particular high rate of exchanges.139 NASD
modified this provision in Amendment No. 3, eliminating the reference to a “particularly
high rate” of exchanges.
135 See ACLI Letter IV.
136 Id.
137 See ACLI Letter IV; FSI Letter II.
138 See ACLI Letter IV; CAI Letter II; FSI Letter II; NAVA Letter III.
139 See CAI Letter II. The commenter questioned whether the principal has to reject
the transaction or just give it closer scrutiny.
33
6. Comments on Proposed Rule 2821(e) – Training
As provided in Amendment No. 2, members would be required to develop and
document specific training policies or programs reasonably designed to ensure that
associated persons who effect and registered principals who review transactions in
deferred variable annuities comply with the requirements of the proposed rule and that
they understand the material features of deferred variable annuities. Several commenters
questioned the need for this specific requirement, as well as the standards applicable to
the training.140 NASD declined to amend this provision in response to comments.
7. NASD’s Response to Comments
As discussed above, in response to the comments received on Amendment No. 1
NASD amended portions of the proposed rule and responded to comments. NASD also
filed a response to the comments received on Amendment No. 2 with the Commission
addressing concerns regarding the need for the proposed rule, the regulatory process that
NASD undertook in developing the proposed rule, and the statutory requirements for
SRO rulemaking.141 In Amendment Nos. 3 and 4, NASD further responded to comments
and modified the proposed rule.
IV. Discussion and Commission Findings
140 One commenter stated there is no need for additional training requirements
because NASD Rule 2310 requires registered representatives to understand the
material features of the products they sell. See FSI Letter II; Letter Type C.
Other commenters believed this provision is duplicative of the Firm Element
portion of NASD’s continuing education requirements. See, e.g., 1st Global
Letter II; FSI Letter II. One commenter believed the training requirements would
interfere with members’ efficient and effective allocation of training resources.
See FSI Letter II. A number of commenters also suggested members’ programs
be held to the standard of being “reasonably designed to achieve compliance”
with the proposed rule. See, e.g., Contemporary Financial Letter; ING Advisors
Letter II; Mutual Service Letter II.
141 See NASD Response Letter
34
The Commission has reviewed carefully Proposed Rule 2821, the comments, and
NASD’s responses to the comments, and believes that NASD has responded
appropriately to the concerns raised by the commenters. The Commission finds that
Proposed Rule 2821, as amended, is consistent with the requirements of the Act and the
rules and regulations thereunder applicable to a national securities association, and, in
particular, with Section 15A(b)(6) of the Act, which requires, among other things, that
the rules of a national securities association be designed to prevent fraudulent and
manipulative acts and practices, to promote just and equitable principles of trade, and, in
general, to protect investors and the public interest.142
Over approximately the past three years, the majority of informal actions brought
against broker-dealers as a result of NASD examinations of variable annuity sales have
involved the failure to establish or follow written supervisory procedures.143 During this
time period, NASD also brought numerous enforcement actions charging broker-dealers
with failing to supervise sales of variable annuities.144 In addition, NASD’s examinations
found a substantial number of unsuitable recommendations and instances of failing to
obtain customer account information.145 It also brought numerous enforcement actions
for making unsuitable recommendations.146
The proposed rule is designed to curb sales practice abuses in deferred variable
annuities. Its recommendation requirements provide a specific framework for a broker-
142 15 U.S.C. 78o-3(b)(6).
143 See infra note 148.
144 See infra note 150.
145 See infra note 148.
146 See infra note 150.
35
dealer’s suitability analysis of these securities. By setting forth factors that a broker-
dealer must specifically consider in recommending deferred variable annuities and
requiring the registered representative to obtain certain information from his or her
customers, the proposed rule should improve communications between registered
representatives and customers regarding these securities. The supervisory review
component should foster a thorough analytical review of every deferred variable annuity
transaction in a timeframe that will limit the possibility of unsuitable recommendations
and transactions. The proposed rule as a whole is geared to protecting investors by
requiring firms to implement more robust compliance cultures, and to give clear
consideration of the suitability of these complex products.
Commenters asserted that the proposed rule, because it is product specific, would
result in significant burdens on competition. Pursuant to the Act’s requirement, the
Commission has considered the impact of Proposed Rule 2821 on efficiency, competition
and capital formation,147 as well as whether the rule would impose any burden on
competition not necessary or appropriate in furtherance of the Act.148 We note that other
products, including options and penny stocks, are subject to product-specific regulations,
due to their complexity or their history of sales practice abuses. NASD has demonstrated
through its history of examinations, enforcement actions, and guidance to members that
regulating variable annuities like other products has not been sufficient to curb sales
practice abuses. Moreover, we note that the Act allows the Commission to approve a
self-regulatory organization rule that imposes burdens on competition so long as those
147 15 U.S.C. 78c(f).
148 15 U.S.C. 78o-3(b)(9).
36
burdens are necessary or appropriate in furtherance of the purposes of the Act.149 We
believe that to the extent the proposed rule imposes burdens on competition, these
burdens are necessary or appropriate in furtherance of the purposes of the Act, and
particularly the purpose of protecting investors.
Commenters also expressed the view that Proposed Rule 2821 may impose
compliance costs on broker-dealers that exceed their costs of complying with rules
applicable to other products. The complexity of deferred variable annuities warrant more
targeted regulation. NASD has attempted over the past few years to address problematic
and unsuitable sales through non-rulemaking means, but has not found that approach to
be successful. We agree with NASD that Proposed Rule 2821 will lead firms to enhance
their compliance and supervisory systems, which in turn will provide more
comprehensive and targeted protection to investors.150
While NASD has issued a number of Notices to Members and Regulatory and
Compliance Alerts regarding the suitability of deferred variable annuities,151 it continues
149 Id.
150 See NASD Response Letter.
151 See Notice to Members 96-86 and Notice to Members 99-35. In 2002, NASD
issued a Regulatory & Compliance Alert, entitled “NASD Regulation Cautions
Firms for Deficient Variable Annuity Communications,” that, among other things,
discussed NASD’s discovery of unacceptable sales practices regarding variable
annuities. In another Regulatory & Compliance Alert in 2002, entitled
“Reminder—Suitability of Variable Annuity Sales,” NASD emphasized, in part,
that an associated person must be knowledgeable about a variable annuity before
he or she can determine whether a recommendation to purchase, sell or exchange
the variable annuity is appropriate. NASD has also issued a number of Investor
Alerts regarding variable annuities. In 2001, NASD issued an Investor Alert
entitled “Should You Exchange Your Variable Annuity?” highlighting important
issues that investors should consider before agreeing to exchange a variable
annuity. In 2003, NASD issued an Investor Alert entitled “Variable Annuities:
Beyond the Hard Sell,” which cautioned investors about certain inappropriate
sales tactics and highlighted the unique features of these products.
37
to encounter numerous questionable sales practices through its examinations,152 as well as
through its investigations and informal discussions with its members.153 Just within the
last few years, NASD has brought a number of cases involving failures to supervise,
suitability violations, and misrepresentation in connection with purchases and exchanges
of deferred variable annuities.154
152 From July 2004 to April 2007, NASD completed a total of 807 routine
examinations involving the review of variable annuities. See Letter from James
S. Wrona, Associate Vice President, NASD (May 15, 2007) (“NASD
Examination/Enforcement Update Letter”). These examinations resulted in 92
Letters of Caution, 45 Compliance Conferences, and 4 Acceptance, Waiver and
Consent letters, in which a respondent accepts a finding of a violation, consents to
the imposition of sanctions, and agrees to waive the right to a hearing. Id. While
the majority of these actions involved the failure to establish or follow written
supervisory procedures, a number of actions related to the failure to obtain and
maintain customer account information, unsuitable recommendations, and the
failure to comply with standards relating to communications with the public. Id.
These findings do not include cause examinations, many of which result in formal
action that is captured by enforcement actions, discussed in note 150 below. Id.
Nor do the findings include information from special examination initiatives. Id.
153 See NASD Response Letter.
154 See, e.g., Phillip Nelson, NASD Case No. 2006004829701 (April 3, 2007)
(providing misleading communication to customer regarding a variable annuity);
Victoria C. Smotherman, NASD Case No. 2006003897501 (March 21, 2007)
(fraudulently inducing purchases of variable annuities); Donna Vogt, NASD Case
No. EAF0400730002 (Feb. 21, 2007) (making unsuitable variable annuity
recommendations); Raymond James Financial Services, Inc., NASD Case No.
EAF0400730001 (Jan. 31, 2007) (failing to properly supervise by permitting
producing branch managers to supervise themselves and by not properly
reviewing variable annuity sales and exchanges); Peter F. Esposito, NASD Case
No. 2005002689601 (Dec. 8, 2006) (submitting falsified account information to
his firm concerning the liquidation of a variable annuity); Quick & Reilly, Inc.,
NASD Case No. E102003158301 (Dec. 1, 2006) (failing to supervise variable
annuity sales); Waddell & Reed, Inc., NASD Case No. E062004029603 (Nov. 24,
2006) (failing to supervise sales of variable annuities where unregistered persons
were selling such products); David L. McFadden, NASD Case No.
E2005000226001 (Nov. 15, 2006) (fraudulent and unsuitable sales of variable
annuities, mutual funds, and exchange traded fund shares); CCO Investment
Services, Corp., NASD Case No. E112005014002 (Oct. 16, 2006) (failing to,
among other things, supervise variable annuity sales); Daniel Carlos Lacey,
NASD Case No. E062004000201 (Aug. 11, 2006) (making unsuitable
38
recommendations regarding variable annuities exchanges); Michael K. Maunsell,
NASD Case No. 2005001939501 (Aug. 2, 2006) (making unsuitable variable
annuity recommendations); Carole G. Ferraro, NASD Case No. E0520030291
(July 21, 2006) (making unsuitable recommendations regarding variable
annuities); Jerry Swicegood, NASD Case No. 2005002683001 (July 13, 2006)
(falsifying documents related to variable annuity exchanges); Eric J. Brown,
NASD Case No. E112003006903 (June 27, 2006) (making unsuitable
recommendations and false statements regarding variable annuities); Joseph
Vitetta, NASD Case No. E10200412250 (June 8, 2006) (making unsuitable
recommendation regarding a variable annuity, among other violations); AmSouth
Investment Services, Inc., NASD Case No. E052004025802 (May 24, 2006)
(failing to establish and maintain reasonable supervisory system in connection
with sales of variable annuities and mutual funds); Charles Snyder, NASD Case
No. E112004042001 (May 2, 2006) (making unsuitable variable annuity
recommendations); Frank P. Grasse, No. EL120030533 (April 17, 2006)
(falsifying customer information on variable annuity applications); Tyler M.
Kerrigan, NASD Case No. E0520030355 (March 10, 2006) (recommending
unsuitable variable annuity transactions); Angelisa Savage-Bryant, NASD Case
No. E072004064201 (March 6, 2006) (misrepresentation in connection with a
variable annuity exchange); Brian Carr, NASD Case No. E9B2003043802 (Feb.
22, 2006) (making unsuitable variable annuity recommendations); John Babiarz,
NASD Case No. 2005002047301 (Feb. 10, 2006) (making unsuitable variable
annuity recommendations); Michael Lancaster, NASD Case No. E8A20040995-
01 (Nov. 30, 2005) (making unsuitable recommendations regarding variable
annuity subaccounts); Lawrence LaBine, NASD Case No. C3A20040045 (Nov.
22, 2005) (unsuitable recommendations to five customers involving variable
annuity subaccounts and mutual funds); Mansell R. Spedding, NASD Case No.
E0220030907 (Sept. 21, 2005) (unsuitable subaccount allocation recommendation
for variable annuity); Rita N. Raymer, NASD Case No.E0520030131 (Aug. 16,
2005) (unsuitable recommendations of variable annuities); NY Life Sec., Inc.,
NASD Case No. E0520040104 (July 22, 2005) (failing to adequately supervise
sales of variable annuities and mutual funds); Paul Olsen, NASD Case No.
E3A20030539 (June 23, 2005) (negligently failing to tell customers about fees
associated with variable annuity exchanges); Bambi Holzer, NASD Case No.
E0220020787 (June 17, 2005) (negligently misrepresenting certain aspects of
variable annuities); Ilene L. Sonnenberg, NASD Case No. C0520050024 (May
11, 2005) (recommending unsuitable variable annuity); Raymond James &
Assocs., Inc., NASD Case No. C0520050020 (May 10, 2005) (finding that
registered representative made unsuitable recommendations and firm failed to
maintain and enforce written supervisory procedures regarding sales of variable
annuities); Issetten Hanif, NASD Case No. C9B20040086 (Apr. 6, 2005)
(unsuitable recommendations regarding variable annuity and mutual fund
exchanges); Lawrence Labine, NASD Case No. E02020513 (Nov. 19, 2004)
(unsuitable variable annuity recommendation); Edward Sadowski, NASD Case
No. C9B040102 (Nov. 17, 2004) (unsuitable variable annuity recommendation);
James B. Moorehead, NASD Case No. C05040073 (Nov. 11, 2004) (failing to
39
Some commenters expressed the view that NASD must wait before instituting
rulemaking and show that a “demonstrable problem” exists.155 While we believe
NASD’s examinations and enforcement actions over the years clearly demonstrate an
entrenched problem in the sales culture for these products, nothing in the Act requires
NASD to make such a showing. Rather, the Act requires the Commission to determine
that a proposed rule is consistent with the Act and consider whether the proposed rule
gather suitability information for variable annuity sales); Juan Ly, NASD Case
No. C07040094 (Nov. 9, 2004) (unsuitable variable annuity switches and
misrepresentations); Jenny Chin, NASD Case No. E04030619 (Oct. 29, 2004)
(misrepresentation and omissions regarding variable annuities); Glenn W. Ward,
NASD Case No. C05040075 (Oct. 14, 2004) (recommending unsuitable variable
annuity); Bernard E. Nugent, NASD Case No. C11040031 (Sept. 1, 2004)
(unsuitable recommendation involving the liquidation of mutual fund shares to
purchase a variable annuity); Samuel D. Hughes, NASD Case No. C07040067
(Aug. 19, 2004) (unsuitable variable annuity switches, unauthorized sub-account
allocations, and misrepresentations); SunAmerica Sec., Inc., NASD Case No.
C05040051 (July 12, 2004) (lacking adequate written supervisory procedures
concerning review of variable annuity and variable universal life contracts); Jamie
Engelking, NASD Case No. E3A020441 (July 2, 2004) (unsuitable variable
annuity recommendation); Pan-American Fin. Advisers, NASD Case No.
C05040034 (June 15, 2004) (failing to have adequate supervisory procedures for
variable annuity sales); Scott Weier, NASD Case No. E04010714 (May 27, 2004)
(unsuitable variable annuity recommendations); Gregory Jurkiewicz, NASD Case
No. E3A030436 (May 4, 2004) (unsuitable variable annuity recommendation);
Michael H. Tew, NASD Case No.C05040010 (Apr. 7, 2004) (unsuitable
recommendations regarding variable annuities); Steve Morgan, NASD Case No.
E3A020410 (Mar. 12, 2004) (unsuitable variable annuity recommendation);
Donald Lacavazzi, NASD Case No. C11040009 (Feb. 24, 2004) (recommending
unsuitable variable annuity switching); Michael Blandchard, NASD Case No.
C11040005 (Feb. 16, 2004) (unsuitable variable annuity recommendations);
Prudential Inv. Mgmt. and Prudential Equity Group, Inc., NASD Case No.
C05040008 (Jan. 29, 2004) (failing to supervise and maintain accurate records
relating to variable annuity replacement sales); Waddell & Reed, Inc., NASD
Case No. CAF040002 (Jan. 14, 2004) (failing to ascertain suitability of
recommended variable annuity exchanges and failure to supervise). NASD
Enforcement actions are available at
http://www.nasd.com/RegulatoryEnforcement/MonthlyDisciplinaryActions/index
.htm.
155 See supra note 33 and accompanying text.
40
would promote efficiency, competition and capital formation.156 So long as its proposed
rules meet the requirements of the Act, NASD can – and indeed should – be proactive in
addressing problems in the sale of securities.
Some commenters also took the position that the proposed rule should be subject
to a cost/benefit analysis.157 The Act sets forth what the Commission must consider in
determining whether to approve a proposed self-regulatory organization rule. It also sets
forth requirements that the self-regulatory organizations must meet. The Act does not
require a cost/benefit analysis with respect to proposed self-regulatory organization rules
that are filed with, and approved by, the Commission.
As a practical matter, however, NASD considered the costs and benefits of the
rule as the rule was developed and modified, and NASD’s members were actively
involved in shaping the proposed rule. As NASD stated in its response to comments on
Amendment No. 2 “[i]ndustry members are keenly aware of the potential costs and
burdens that can result from rulemaking and, as is often the case, they raised and NASD
considered such issues at multiple stages of the rulemaking process.”158
Accelerated Approval of Amendment Nos. 3 and 4
156 15 U.S.C. 78c(f).
157 See supra notes 35-38 and accompanying text.
158 As discussed in detail above, in its response to comments to Amendment No. 2,
NASD noted the steps it went through as it developed the proposed rule prior to
filing it with the Commission. It published the proposed rule in a Notice to
Members and solicited comment. The proposal also went to five NASD standing
committees (including two committees with subject matter expertise regarding
variable annuities) for consultation and comment. NASD considered the public’s
and the committees’ comments and modified the proposed rule in response. The
NASD Regulation, Inc. Board of Directors then approved the proposed rule and
the NASD Board of Governors had an opportunity to review it. These NASD
boards include members of the broker-dealer and insurance industries. For detail
on the composition of the boards, see NASD’s Response Letter. 41
As set forth below, the Commission finds good cause to approve Amendment
Nos. 3 and 4 to the proposed rule, as amended, prior the thirtieth day after the date of
publication of the notice of Amendment Nos. 3 and 4 in the Federal Register. The
revisions and clarifications in Amendment Nos. 3 and 4 were made in response to
comments.
In Amendment No. 3, NASD modified the Recommendation Requirements in
paragraph (b) of the proposed rule. Amendment No. 2 required members to have a
reasonable basis to believe the customer has been informed of the material features of a
deferred variable annuity. NASD revised the proposed rule to specify that a member
must have a reasonable basis to believe that a customer has been informed “in general
terms of the various features” of deferred variable annuities. NASD made this change in
response to comments to clarify that the customer need only be informed about the
features of deferred variable annuities in general terms, rather than be informed about the
specific features of the deferred variable annuity the member might recommend.
In addition, in Amendment No. 3, NASD incorporated the factors that a firm must
consider when exchanging deferred variable annuities in the recommendation
requirements rather than in the principal review and approval requirements, while
maintaining a requirement that principals consider these factors. NASD also eliminated
two of the considerations relating to exchanges in response to comments: the extent to
which the customer would benefit from the unique features of a deferred variable annuity
and the extent to which the customer’s age or liquidity needs make the investment
inappropriate.
Moreover, in Amendment No. 3, NASD revised the proposed rule in response to
42
comments relating to the applicability of the proposed rule to non-recommended
transactions. NASD clarified that while principals are to treat all transactions as
recommended, a principal may authorize the processing of a transaction if it determines
that the transaction was not recommended and that the customer affirms that he or she
wants to proceed after being informed of the reason why the registered principal has not
approved the transaction.
In Amendment No. 3, NASD also modified the supervisory procedures provisions
of the rule in response to comments that the term “particularly high rates of effecting
deferred variable annuity exchanges” was vague. NASD revised the proposed rule to
require implementation of surveillance procedures to review associated persons’ rates of
effecting deferred variable annuity exchanges for consistency with the proposed rule,
other NASD rules and the federal securities laws. NASD also clarified that members
must have policies and procedures reasonably designed to implement corrective measures
to address inappropriate exchanges.
In addition, in Amendment No. 3, NASD revised the required timeframe for
principal review, which it further revised in Amendment No. 4. As amended by
Amendment No. 4, the principal must review the application prior to transmitting it to the
issuing insurance company for processing, but no later than seven business days after the
customer signs the application. This “prior to transmittal” standard was also incorporated
in Amendment No. 1, and the Commission received a substantial number of comments
on this standard. Although Amendment No. 1 did not explicitly limit the timeframe for
principal review to no more than seven days, provisions of Exchange Act Rule 15c3-3
would have operated to limit the time in which broker-dealers could hold customer funds.
43
In light of NASD’s requested exemption from Rule 15c3-3, the seven-day limit on
principal review in Amendment No. 4 would replace that rule’s time limitation for
transactions subject to that exemption with a more workable limit.
Thus, the Commission finds good cause to approve Amendment Nos. 3 and 4 to
the proposed rule, as amended, prior to the thirtieth day after the date of publication of
the notice of Amendment Nos. 3 and 4 in the Federal Register.
V. Solicitation of Comments
Interested persons are invited to submit written data, views and arguments
concerning Amendment Nos. 3 and 4, including whether the proposed rule is consistent
with the Act.159 Comments may be submitted by any of the following methods:
Electronic Comments:
• Use the Commission’s Internet comment form
(http://www.sec.gov/rules/sro.shtml); or
• Send an e-mail to [email protected]. Please include File Number
SR-NASD-2004-183 on the subject line.
Paper Comments:
• Send paper comments in triplicate to Nancy M. Morris, Secretary,
Securities and Exchange Commission, 100 F Street, NE, Washington, DC
20549-1090.
All submissions should refer to File Number SR-NASD-2004-183. This file number
should be included on the subject line if e-mail is used. To help the Commission process
and review your comments more efficiently, please use only one method. The
159 The Commission will consider the comments we previously received.
Commenters may reiterate or cross-reference previously submitted comments.
44
Commission will post all comments on the Commission’s Internet Web site
(http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent
amendments, all written statements with respect to the proposed rule change that are filed
with the Commission, and all written communications relating to the proposed rule
change between the Commission and any person, other than those that may be withheld
from the public in accordance with the provisions of 5 U.S.C. 552, will be available for
inspection and copying in the Commission’s Public Reference Room, 100 F Street, NE,
Washington, DC 20549, on official business days between the hours of 10:00 am and
3:00 pm. Copies of such filing also will be available for inspection and copying at the
principal office of FINRA. All comments received will be posted without change; the
Commission does not edit personal identifying information from submissions. You
should submit only information that you wish to make available publicly. All
45
submissions should refer to File Number SR-NASD-2004-183 and should be submitted
on or before [insert date 21 days from publication in the Federal Register].
VI. Conclusion
IT IS THEREFORE ORDERED, pursuant to Section 19(b)(2) of the Act,160 that
the proposed rule, as amended (SR-NASD-2004-183), be, and it hereby is, approved.
By the Commission.
Nancy M. Morris
Secretary
160 15 U.S.C. 78s(b)(2).