After filing over 80 disciplinary actions in the past two years, the National Association of Securities Dealers is tightening its noose on the variable annuities industry. Late last month, the regulator proposed new rules for variable annuity sales that would increase disclosure and make best-practice guidelines mandatory and enforceable.
These best-practice guidelines were put together with the involvement of the industry, said Herb Perone, a spokesman for the NASD. "But clearly, not everyone has adopted the guidelines, or we wouldn't have 80 enforcement cases." While the disciplinary actions were filed for violations of existing regulations, he said that due to the growing complexity of variable annuities, "the NASD felt it was necessary to heighten suitability, supervisory and disclosure requirements for the sales of this product."
Variable annuities were already the focus of extra attention over the last couple of years for both the NASD and the SEC, Perone said, particularly with regard to "switching" from one annuity product to another. This year alone, Waddell & Reed, Prudential, American Express Financial Advisors and InterSecurities were fined for unsuitable sales of variable annuity products or for switching clients between variable annuities so that the broker could collect fat commissions, while the client racked up surrender fees.
Under the proposed new rules, a registered representative would be required to determine that the customer had been informed of the unique features of the variable annuity, including tax advantages and disadvantages where withdrawal of funds is concerned. The representative would also need to determine that the customer has a long-term investment objective and that the variable annuity as a whole and its underlying sub-accounts are suitable for the customer, where risk and liquidity are concerned.
In addition, the rep would be required to provide the customer with a current prospectus and a separate document highlighting features of the transaction, including:
Liquidity issues, such as potential surrender charges and IRS penalties.
a Sales charges.
Fees, including mortality and administrative fees, investment advisory fees and charges for riders or special features.
Federal tax treatment for variable annuities.
Any applicable state and local government premium taxes.
In addition, registered representatives would have to obtain an approval from a registered principal before a transaction may be processed, and firms would have to draw up specific procedures to help the company comply with the rules.
Finally, training policies or programs would need to be developed to make sure reps and principals understand variable annuities and that they will comply with the rules.
It could be a while, however, before the proposed rules are passed. Regulation of the variable annuity industry is a complicated matter, with the SEC and the NASD overseeing sales of the products alongside 51 state insurance commissioners. "Regulation does get messy," said Stephan Christiansen, director of research at Conning Research & Consulting. "Securities regulations and insurance regulations come together in the annuity world, because you have the pure insurance products, the guarantees, and the underlying securities products. It can get very complex, and that can get expensive. It's a basis for cost in this industry," he said.
"It's a controversial issue as to whether regulation needs to be streamlined," Christiansen continued. "I would tend to be on the side of those who say yes, it needs to be streamlined and easier to understand. Most of these products are increasingly national in orientation, so the range of differences that can exist on a state-by-state basis or between securities and insurance regulations should be rationalized."
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