Regulatory Obligations and Related Considerations
FINRA Rule 2330 (Members’ Responsibilities Regarding Deferred Variable Annuities) establishes sales practice standards regarding recommended purchases and exchanges of deferred variable annuities, including requiring a reasonable belief that the customer has been informed of the various features of annuities (such as surrender charges, potential tax penalties, various fees and costs, and market risk); and, prior to recommending the purchase or exchange of a deferred variable annuity, requiring reasonable efforts to determine the customer’s age, annual income, investment experience, investment objectives, investment time horizon, existing assets and risk tolerance. To the extent that a broker-dealer or associated person is recommending a purchase or exchange of a deferred variable annuity to a retail customer, Reg BI’s obligations, discussed above, also would apply.
In addition, the rule requires that firms conduct surveillance to determine if any associated person is effecting deferred variable annuity exchanges at a rate that might suggest conduct inconsistent with FINRA Rule 2330. Firms must also have procedures to implement corrective action to address any exchanges and conduct that violate FINRA Rule 2330.
- How does your firm review for rates of variable annuity exchanges (i.e., does your firm use any automated tools, exception reports or surveillance reports)?
- Does your firm have standardized review thresholds for rates of variable annuity exchanges?
- Does your firm have a process to confirm its variable annuity data integrity (including general product information, share class, riders and exchange-based activity) and engage with affiliate and non-affiliate insurance carriers to address inconsistencies in available data, data formats and reporting processes for variable annuities?
- What is your firm’s process to supervise buyout offers (i.e., does it include pre-approval, exception reports and post-transaction reviews)?
- What do your WSPs require registered representatives to do in order to support a determination that a transaction meets the standard of care requirements and that there is a reasonable basis for it? What is the manner in which they are to obtain, evaluate and record such information such as whether a customer would incur a surrender charge; would be subject to a new surrender period; would lose existing benefits; would be subject to increased fees or charges; would invest a substantial portion of the customer’s liquid net worth in the variable annuity; has liquidity needs that are inconsistent with the variable annuity; would be investing in a share class that is not in the customer’s best interest given his or her financial needs, time horizon and riders included with the contract; and has had another exchange within the preceding 36 months?
- Do your firm’s policies and procedures require registered representatives to inform customers of the various features of annuities, such as surrender charges, potential tax penalties, various fees and costs, and market risk?
- How do your firm’s registered principals supervise variable annuity transactions, including verifying how the customer would benefit from certain features of deferred variable annuities, such as tax-deferral, annuitization, or a death or living benefit? What processes, forms, documents and information do the firm’s registered principals rely on to make such determinations?
- Does your firm have WSPs to address when it decides to stop selling or retires certain products, or opens buyout or exchange periods, including, but not limited to: how it will handle the product termination process; how it decides whether it offers an exchange or buyout; the scope of its exposure (in terms of contracts and customers); how it will notify customers and registered representatives; and how it will monitor for exchange rates?
Exam Findings and Effective Practices
- Not Addressing Buyouts – Not addressing within firms’ systems of supervision (by having applicable WSPs, delivering training, or making appropriate disclosures, etc.) that customers accepting buyouts may be losing valuable benefits associated with their existing products, subject to new surrender charge periods, and paying higher fees and expenses with new products (as was the case when customers were impacted by a recent announcement that an insurer with sizable variable annuity assets will terminate servicing agreements, cancel certain trail commissions for registered representatives, and provide buyout offers to its variable annuity customers).
- Unsuitable Exchanges – Not reasonably supervising recommendations of exchanges that were inconsistent with the customer’s objectives and time horizon and resulted in, among other consequences, increased fees to the customer or the loss of material, paid-for accrued benefits.
- Inadequate Source of Funds Review – Not performing sufficient review of source of funds used to purchase new variable annuities.
- Insufficient Training – Not conducting training for registered representatives and supervisors regarding how to assess fees, surrender charges and long-term income riders to determine whether exchanges were suitable for customers.
- Policies and Reviews – Performing a holistic review of buyout offers; requiring supervisory principal pre-approval (and, in some cases, additional second-level approval) for buyout offers; and requiring registered representatives’ recommendations to consider all changes to customers’ variable annuities, such as possible surrender charges, loss of benefits, contract values, riders, cash surrender values, expenses and fees.
- Training – Providing extensive, ongoing training and communications to all registered representatives about buyout offers and related compliance obligations (including, in some cases, creating dedicated firm telephone or chat helplines).
- Conflicts of Interest – Addressing and mitigating potential conflicts of interest for registered representatives who may recommend that customers pursue buyout offers to free up proceeds for new investments or variable annuity exchanges by, for example, leveling registered representatives’ compensation for buyout offers, exchanges or new investments.
- Additional Disclosures – Developing new buyout offer disclosures or expanding existing variable annuity disclosure forms to address considerations for buyout offers.
- Additional Post-Transaction Review – Creating additional exception reports and conducting additional transaction monitoring for those customers who accepted buyout offers to confirm that those transactions were submitted for supervisory principal pre-approval (and, where required, additional second-level approval) and, if not, evaluating for compliance with FINRA Rule 2330.
- Automated Surveillance – Using automated tools, exception reports and surveillance to review variable annuity exchanges, and implementing second-level supervision of supervisory reviews of exchange-related exception reports and account applications.
- Rationales – Requiring registered representatives to provide detailed written rationales for variable annuity exchanges for each customer (including confirming that such rationales address the specific circumstances for each customer and do not replicate rationales provided for other customers); and requiring supervisory principals to verify the information provided by registered representatives, including product fees, costs, rider benefits and existing product values.
- Review Thresholds – Standardizing review thresholds for rates of variable annuity exchanges; and monitoring for emerging trends across registered representatives, customers, products and branches.
- Data Integrity – Creating automated (rather than manual) solutions to synthesize variable annuity data (including general product information, share class, riders and exchange-based activity) and engaging with affiliated and non-affiliated insurance carriers to address inconsistencies in available data, data formats and reporting processes for variable annuities.
- Regulatory Notice 20-18 (FINRA Amends Its Suitability, Non-Cash Compensation and Capital Acquisition Broker (CAB) Rules in Response to Regulation Best Interest)
- Regulatory Notice 20-17 (FINRA Revises Rule 4530 Problem Codes for Reporting Customer Complaints and for Filing Documents Online)
- Regulatory Notice 10-05 (FINRA Reminds Firms of Their Responsibilities Under FINRA Rule 2330 for Recommended Purchases or Exchanges of Deferred Variable Annuities)
- Notice to Members 07-06 (Special Considerations When Supervising Recommendations of Newly Associated Registered Representatives to Replace Mutual Funds and Variable Products)
- Notice to Members 99-35 (The NASD Reminds Members of Their Responsibilities Regarding the Sales of Variable Annuities)
- Variable Annuities Topic Page
- SEC’s Regulation Best Interest, Form CRS and Related Interpretations
- FINRA’s Regulation Best Interest (Reg BI) Topic Page