Q: Following-up on February’s question, we occasionally have new reps that come on board who have clients with variable annuities. Often, these annuities cannot transfer over for one reason or another and, since the clients want us to handle everything for them, we’ll try and find similar VAs and do a 1035 exchange.

Of course, we run through all the negatives associated with the exchange, but even so, are you saying we shouldn’t be doing this?


A: I’m not saying never but you’d better have all your ducks in a row.

In FINRA Regulatory Notice 07-36, FINRA noted that “it is incumbent upon firms to educate their prospective representatives in understanding that a change of employment is not by itself a suitable basis for recommending a switch from one product to another and to supervise with respect to such conduct.”

Registered representatives with an established customer base may oftentimes want to bring those clients over to their new firm, FINRA pointed out. Indeed, this is one of the main reasons why reps with established client bases are highly recruited and offered large upfront bonuses. However, the desire to bring over variable annuity assets can present significant problems.

In some cases these variable annuity products may be held directly with the insurer or they may be proprietary to the representative’s previous employer. In those situations, the sponsor may not permit those products to be transferred to the customer’s account at the new firm.

When that happens, the client has to leave the annuity where it is, and unfortunately, many clients are not happy about that. Typically, they expect their rep to service all their assets or they may want everything listed on one consolidated statement and don’t understand why this may not be possible. (Note: If the client’s main issue is having one consolidated statement, that may be possible without having to move the investment. Consider a data aggregator if the broker-dealer can’t provide a consolidated statement).

From the rep’s point of view, you may be thinking about your trailing commissions in addition to the customer service problems. Therefore, you may be inclined to recommend the liquidation and replacement of the customer’s annuity with another, similar annuity. While FINRA pays some lip service to the customer service aspect of the switch, I can tell you that their overriding concern is the suitability of the transaction for the customer and a determination that the transaction is in the customer’s best interests in view of all factors.

FINRA has said that the suitability analysis must include other considerations, including whether the variable product is subject to surrender charges or other penalties, or “has other features that materially affect its value or liquidity, and the fees and expenses associated with the new product being recommended.”

At a minimum, FINRA requires that firms have policies and procedures that include:

  • Requirements that the firm learn the nature of a prospective new representative’s business and the types of products included therein;
  • Advising the customer that the firm is unable or unwilling to service the particular products and providing the customer with his or her options, including that the customer may have to hold the investment elsewhere before recommending liquidation or surrender;
  • Ensuring that any recommendation to liquidate, replace or surrender an investment is suitable for the customer; and
  • Reviewing for a reasonable period of time all recommendations for replacement of investments by newly hired reps.

Be careful to follow all these procedures in evaluating a 1035 exchange.
If you have a question for compliance expert Alan Foxman, please send it to: fpeditor@sourcemedia.com

Alan J. Foxman

Alan J. Foxman

Alan J. Foxman is a senior consultant and vice president at NCS Regulatory Compliance, and a partner at the law firm of Dew Foxman & Haugh in Delray Beach, Florida.