The application of com-pliance standards for the sale and exchange of deferred variable annuities has been under scrutiny for quite some time. Why? Because some producers have made inappropriate recommendations and have sometimes failed to properly determine the suitability of the products for their clients at the point of sale. To help correct this problem, the NASD/FINRA, along with the support of the SEC, has stepped in to provide increased consumer protection that is intended to strengthen the standards of suitability and improve supervisory compliance procedures.
Deferred variable annuities, for the most part, are complex and offer numerous contract options, thus creating potential confusion for the registered representatives who sell them and the consumers who buy them -- hence the need for regulation.
Application of Rule 2821 NASD/FINRA's Rule 2821 applies to the point-of-sale purchase and exchange of deferred variable annuities and the initial sub-account allocation.
The ruling does not apply to the surrender of a deferred variable annuity, re-allocations made within the sub-account of an in-force deferred variable annuity, or funds paid in after the initial purchase or exchange of the product. The ruling also does not apply to deferred variable annuity transactions made in any tax-qualified employer-sponsored retirement or benefit plans defined as qualified plans under Section 3(a)(12)(C) of the Securities and Exchange Act of 1934 or if they meet the requirements of the Internal Revenue Code Sections 403(b), 457(b), or 457(f), with one exception -- if a representative of a member firm makes a recommendation to an individual plan participant regarding a deferred variable annuity. This is important -- if you recommend to a participant of an employer-sponsored retirement or benefit plan that they invest in a deferred variable annuity, then this ruling definitely applies to that recommendation.
You should note that before recommending a deferred variable annuity, be sure your new customer account information includes date of birth, risk tolerance, annual income, existing assets (including all life insurance and investments), liquidity requirements, total net worth, all liquid assets, current financial situation and needs, any anticipated financial changes, investment experience, tax status, intended use of the deferred variable annuity, and investment time horizon.
Following are the four main requirements of NASD Rule 2821.
The first requirement: product suitability standards
The ruling's first requirement addresses the suitability of both the benefits and features of a deferred variable annuity. It states that the registered representative must have a reasonable basis for believing that the customer has been informed, in general terms, of the various features of a deferred variable annuity and would benefit from these features. It is important that you recognize the difference between the features and benefits of this product type in order to fully comply with this requirement.
Deferred variable annuity features include potential surrender periods, surrender charges, potential tax penalties, mortality, and expense fees. The benefits of a deferred variable annuity include charges for and the structure of enhanced riders, such as enhanced living or death benefits, insurance and investment components, tax-deferred growth, and annuitization. However, the ruling does not require a registered representative to determine whether the customer would benefit from all of the features.
This section also states that a registered representative must have a reasonable basis for believing that "the particular deferred variable annuity as a whole and the underlying sub-account to which funds are allocated at the time of the purchase or exchange of the deferred variable annuity and its riders and similar product enhancements, if any, are suitable ..." It is the responsibility of the registered representative to determine the suitability of the product recommendation as a whole and to carefully consider the sub-account allocation.
The exchange of a deferred variable annuity is included in this first requirement. A reasonable effort must be made to determine whether your client has been involved in any other deferred variable annuity exchanges within the previous 36 months with any other broker-dealer, and the findings of this effort must be documented. The registered representative must have a reasonable basis for believing that the "transaction as a whole is suitable for a particular customer." There are many factors to consider when maintaining compliance standards in an exchange. These factors include:
o Will the customer be subject to surrender charges or forced to start a new surrender period?
o Will there be loss of any existing benefits, or will increased fees or charges be incurred?
o Will the customer actually benefit from new product enhancements?
All documentation that supports your sale or exchange must be submitted to the registered principal so they can approve your transaction -- and this is what the second requirement addresses.
Don't just "consider" the factors of an exchange. Ask yourself what is the reasonable basis for this recommendation? Then, document this reasoning. Most companies have their own exchange disclosure form. In addition to that, you may find it helpful to create a form of your own to document all the differences between the features and benefits of both the in-force and the proposed exchange product.
The second requirement: review and approval
The registered principal must review and either approve or reject the purchase or exchange of the deferred variable annuity no later than seven business days after the customer signs the original application. It is the registered principal's responsibility to determine whether the sale or exchange meets the "reasonable basis" standard of suitability. This determination is controlled by the submission of suitability documentation provided with the application.
If the registered principal believes the sale is compliant with the suitability standards of Rule 2821, then the transaction is approved in writing.
This second requirement continues to dictate that if the registered principal does not approve the transaction, the written disapproval is taken back to the customer and the customer is informed of why the sale or exchange was rejected. If the customer still chooses to proceed with the transaction, then the sale or exchange may still be completed.
As long as the registered principal is certain that the rejected transaction was not recommended by the registered representative and it is known that the customer was fully informed of the reasons why the transaction was not approved but still chooses to proceed with the transaction, then the registered principal may authorize the transaction.
Detailed documentation regarding the appropriate suitability of your customer is key to getting your transaction approved. The registered principal is not required to reconsider a previously rejected transaction.
The third requirement: supervisory procedures
This is the "watchdog requirement." The member is responsible for having supervisory procedures in place that detect the abuse or potential abuse of inappropriate exchanges. In addition, the supervisory procedures require broker-dealers to establish and maintain written supervisory procedures reasonably designed to comply with the standards set forth in the rule. The procedures used to implement corrective measures should be in compliance with other NASD rules and federal securities laws regarding inappropriate exchanges.
This requirement also allows a firm to determine how to screen and supervise their deferred variable annuity processes for inappropriate exchanges.
If you are in doubt about whether an exchange is appropriate, ask your office of supervisory jurisdiction or your compliance department for clarification.
The fourth requirement: deferred variable annuity training
This final requirement states that the member firm must create training programs for the registered representatives who sell deferred variable annuities and also for the registered principals who review transactions.
Each of us has a responsibility to stay in compliance and to support the improvement of the insurance industry's public image. By maintaining the highest level of professional ethics and standards and keeping compliant, this can be accomplished.
Melody Juge is a registered representative of Financial West Group, managing director of Life Income Management, and founder of The 401(k) Choice. Life Income Management/The 401(k) Choice, and Financial West Group are non-affiliated entities. She can be reached at mjuge@fwg.com.
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