Oh brother! SEC assists insurers

The insurance industry has a real Big Brother in Washington – the Securities and Exchange Commission.

The federal agency has agreed to step in on its behalf to review what insurers claim is a case of bureaucratic overreaching by the regulatory arm of the National Association of Securities Dealers.

At issue are regulations proposed by NASD Regulation that would bar brokers from engaging in the long-standing practice of receiving fees from insurers for group annuities.

The regs would also cut broker commissions and require brokers to determine whether the products they sell are appropriate for their clients.

The SEC has final say over the NASDR’s actions, but the move is unusual because the commission rarely intervenes in NASD matters.

In this case, though, the stakes are high. The regulations would affect a fast-growing segment of the industry. There is $414.9 billion in assets in group variable annuity plans, a 29% increase from a year ago.

The action comes amid NASDR and SEC warnings that brokerages are facing a series of enforcement actions for abusive sales practices (InvestmentNews, Oct. 30).

In one of the most frequent abuses, regulators say, brokers convince customers to buy variable annuities for their tax-qualified retirement plans. Customers end up paying extra fees for the benefits of the tax deferral, which retirement plans already provide.

Those in the industry claim that federal securities laws do not cover group variable annuities, which puts them outside the purview of the NASDR.

Instead, they claim, such investments are regulated under the Employee Retirement Income Security Act, which grants oversight to the federal Department of Labor.

But in 1993, in the wake of a scandal involving government bonds, Congress amended securities laws. The NASDR claims those amendments gave it authority over group variable annuities under its broad mandate to protect investors from fraud.

Carl Wilkerson, chief counsel of securities for the American Council of Life Insurers in Washington, says the industry has never accepted the NASDR’s interpretation of the amendments.

The current controversy came to a head last June when the NASDR asked the SEC to approve its authority over group products on an expedited basis without public comment.

The SEC, however, agreed to let the industry comment on the proposed regulations.

“Misrepresentation doesn’t happen in the group market because you’re dealing with fiduciaries in these pension plans,” Mr. Wilkerson says.

“They’re sophisticated people. They understand the product and buy it for the right reasons, not the illicit reasons.”

The NASDR spokeswoman declined to comment on the matter.

Mr. Wilkerson says there are no regulatory abuses in the group market that need fixing. “It’s sort of a solution in search of a problem,” he claims.

David Winston, vice president of government affairs for the National Association of Insurance and Financial Advisors in Falls Church, Va., says the NASDR rules would put brokers at a disadvantage compared to non-brokers.

“Group annuities are already subject to extensive state regulation with the Erisa statute,” he says.

“It adds another unnecessary layer of regulation upon an already heavily regulated product sale.”

The proposed changes would have other far-reaching effects.

Perhaps most nettlesome are so-called “suitability” rules that would apply to group plan sales.

Like brokers who sell variable annuities to individual clients, group sales reps would be required to make sure that the annuities are appropriate investments, based on such factors as needs and risk tolerance.

“The assumption is that to the extent any recommendation is being made, it’s being made to the plan sponsor,” says Susan Krawczyk, a partner with Washington law firm Sutherland Asbill & Brennan LLP.

While the NASDR has issued an interpretation on suitability analysis for institutional customers, “there’s really not any guidance the NASD has issued for group contracts,” says Ms. Krawczyk, who represents insurance companies and companies that sell group variable annuities.

“The other question is, are plan participants customers, and does the suitability rule apply to them? It’s not clear how they would do that,” she says.

Among other changes, a ban on non-cash compensation for sales, such as luxury trips or cars, would also apply to group annuities.

“What is true historically is that in many cases the insurance company paid the individual sales rep directly,” says Ms. Krawczyk.

Non-cash compensation has also been “common in the insurance industry for a long time.”

Broker representatives would also have to start sharing large commissions with their brokerage firms, which would clear the sales.

Sales reps also could not receive commissions from insurance companies; they could receive payments only from their brokerage firm.