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Joint SEC/NASD Report on Examination Findings Regarding Broker-Dealer Sales of Variable Insurance Products

Joint SEC/NASD Report on Examination Findings Regarding Broker-Dealer Sales of Variable Insurance Products

Variable annuity and variable life insurance products (collectively, “variable insurance products" or “variable products”) are being marketed and sold to a large number of investors. While variable insurance products may be appropriate investments for some investors, concerns have been raised about the sale of these products. This prompted the staffs of the Securities and Exchange Commission (“SEC” or “Commission”) and NASD (“Staff”) to conduct examinations of broker-dealers that sell variable insurance products. This report summarizes the findings of those examinations. 

Variable insurance products are hybrid investments containing both securities and insurance features. The insurance features of variable annuities permit the investor to receive a series of periodic payments from the investment over time and provide a death benefit to the beneficiary should the investor die during the accumulation phase. Variable life policies are a form of life insurance. The insurance features of both products provide tax-deferred treatment of any accumulated earnings. In both variable annuity and variable life products, the securities feature provides the investor with an opportunity to participate in potential capital appreciation and income through investments in the securities markets, but also subjects the investor to market risks. 

Variable insurance products, as securities under the federal securities laws and insurance under state insurance laws, are sold jointly through broker-dealers and insurance agencies. In selling securities, broker-dealers must comply with a number of requirements including having reasonable grounds for believing that the recommendation is suitable for the investor, providing adequate supervision over salespersons, ensuring that adequate disclosure is made to customers, and maintaining all required books and records. 

High commissions, typically above 5% for variable annuities, help drive sales of these products. Variable insurance products have higher fees and surrender charges than mutual funds that provide no insurance features. These high fees and surrender charges combine with other factors to make variable insurance products inappropriate for many investors. The Commission, NASD and other regulators have received a large number of complaints from individual investors about variable insurance products. Many of these complaints indicate that the customer was sold a variable product without fully understanding the product, and express concerns that the product was not appropriate for them, given their investment objectives. 

In view of the number of complaints and the unique characteristics of variable insurance products that require special disclosures, controls, and procedures when selling the products, the Staff undertook a number of examinations of broker-dealers to review sales of variable insurance products. These examinations reviewed: the process firms used to ensure that the product was suitable for the investor; the supervision exercised over registered representatives selling the product; relevant disclosure made to investors about the product; the books and records maintained by the firm related to sales of the product; and the training provided to firm employees about the product. 

This Staff report identifies examples of both sound and weak practices that were noted during the examinations.  This report is not a comprehensive roadmap for compliance and supervision with respect to the sale of variable insurance products, but rather points out examples of common problems that may be encountered, and some measures that firms are using to ensure better compliance. Firms should consider the information in this report in assessing their own systems and procedures and in implementing improvements that are tailored to and work best for their firm. We note that while a particular sound practice may work well for a large firm, the same approach may not be effective or economically feasible for a smaller firm. The reverse is also true. Firms must adopt procedures and controls that are effective given their size, structure and operations. Utilizing the information in this report may be beneficial, but will not establish a safe harbor should problems or violations arise. 

In light of the findings from these examinations and recent enforcement actions, NASD recently took steps to propose the adoption of new rules governing the sales of deferred variable annuities. The NASD Board of Governors proposed new requirements tailored specifically to transactions in deferred variable annuities – from new sales practice standards and supervisory requirements to increased disclosure and sales force training. The new rule would codify and make mandatory best-practice guidelines that NASD had previously issued. NASD intends to request public comment on the proposed rule and details of the proposal will be published in a Notice to Members. The key requirements expected to be included in the rule proposal are described in an NASD News Release,  as summarized below.