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09-32 SEC Approves Amendments to NASD Rule 2821 Governing Purchases and Exchanges of Deferred Variable Annuities; Effective Date: February 8, 2010
Deferred Variable Annuities
Referenced Rules & Notices
NASD Rule 2310
NASD Rule 2330
NASD Rule 2820
NASD Rule 2821
SEA Rule 15c3-1
SEA Rule 15c3-3
Regulatory Notice 07-53
Deferred Variable Annuities
On April 15, 2009, the SEC approved amendments to NASD Rule 2821 governing purchases and exchanges of deferred variable annuities.1 Among other things, the amendments:
The rule text is set forth in Attachment A and is effective February 8, 2010.
Questions regarding this Notice should be directed to:
Background & Discussion
NASD Rule 2821 establishes sales practice standards regarding purchases and exchanges of deferred variable annuities.2 The rule addresses four main areas of concern. First, the rule has requirements governing broker recommendations, including suitability and disclosure obligations. Second, it includes various principal review and approval obligations. Third, the rule requires member firms to establish and maintain supervisory procedures reasonably designed to achieve compliance with the standards set forth in the rule. Fourth, the rule has a training component.
The recommendation and training sections currently are effective.3 The effective dates of the principal review and supervisory procedures sections were stayed to give the SEC time to consider amendments that FINRA filed after careful consideration of public comments.4 On April 15, 2009, the SEC approved those amendments, which become effective on February 8, 2010.5 As described in more detail below, the amendments, among other things, limit the rule's application to recommended transactions, change the triggering event that begins the principal review period, and clarify various other issues through new supplementary material to the rule.
Limiting Application of the Rule to Recommended Transactions
Prior to the amendments, paragraph (c) of NASD Rule 2821 would have required principals to treat "all transactions as if they have been recommended for purposes of this principal review." After carefully considering the public comments, FINRA proposed, and the SEC approved, limiting the rule's application to recommended transactions. This approach is consistent with that taken by FINRA's general suitability rule, NASD Rule 2310.6 Moreover, because the vast majority of purchases and exchanges of deferred variable annuities are recommended by brokers, the rule will cover most transactions. FINRA emphasizes that firms must implement reasonable measures to detect and correct instances of recommended transactions that brokers mischaracterize as non-recommended. Where the transaction truly is initiated by the customer and not recommended by the broker, there generally is less concern regarding potential or actual conflicts of interest and less need for heightened sales-practice requirements. This change also promotes competition by allowing a wide variety of business models to exist, including those premised on keeping costs low by, in part, eliminating the need for a sales force and large numbers of principals.
Modifying the Starting Point for the Seven-Business-Day Review Period
Under the earlier version of paragraph (c) of NASD Rule 2821, principals were required to review and determine whether to reject or approve a deferred variable annuity transaction no later than seven business days after the customer signed the application. Based on the public comments, FINRA proposed, and the SEC approved, modifying the beginning of the period within which the principal must review and determine whether to approve or reject the application. Pursuant to the amendments, the period will begin to run not from the date of the customer's signature but from the date when a firm's office of supervisory jurisdiction (OSJ) receives a complete and correct copy of an application.7 To help ensure that the process remains efficient from the beginning, the amendments also require the associated person who recommended the annuity to promptly transmit the complete and correct application package to the OSJ.8 FINRA emphasizes, however, that the time begins to run when any OSJ at the firm receives the complete and correct application. A firm does not get to pick which OSJ starts the clock.
Clarifying Issues Through Supplementary Material
The supplementary material examines issues that were raised by multiple groups and that potentially could have a significant impact on how firms sell or process deferred variable annuities. The supplementary material makes clear, for instance, that firms generally allowed to handle and carry customer funds under SEA Rules 15c3-1 and 15c3-3 are not prohibited by NASD Rule 2821 from depositing funds for a deferred variable annuity prior to principal approval.
FINRA also reconsidered the question of whether firms could forward funds to insurance companies for deposit in the companies' "suspense accounts" prior to principal approval. FINRA has modified its earlier position rejecting such a process, discussed in Regulatory Notice 07-53 (Nov. 2007), and now will allow such action under certain conditions, including, inter alia, that the insurance company segregate the funds in a manner equivalent to that required of a member firm under SEA Rule 15c3-3.
In addition, the supplementary material discusses:
1 See Exchange Act Release No. 59772 (April 15, 2009), 74 FR 18419 (April 22, 2009) (Order Approving File No. SR-FINRA-2008-019) (Approval Order).
2 In general, a variable annuity is a contract between an investor and an insurance company, whereby the insurance company promises to make periodic payments to the contract owner or beneficiary, starting immediately (an immediate variable annuity) or at some future time (a deferred variable annuity). See Joint SEC and NASD Staff Report on Broker-Dealer Sales of Variable Insurance Products (June 2004) (Joint Report), available at www.sec.gov/news/studies/secnasdvip.pdf.
3 Paragraphs (a), (b), and (e) of NASD Rule 2821, as approved in SR-NASD-2004-183, became effective on May 5, 2008.
4 On April 17, 2008, FINRA filed a proposed rule change, which became effective upon filing, to delay the effective date of paragraphs (c) and (d) of NASD Rule 2821 until after the SEC's approval or disapproval of a substantive proposed rule change. See Exchange Act Release No. 57769 (May 2, 2008), 73 FR 26176 (May 8, 2008) (Notice of Filing and Immediate Effectiveness of File No. SR-FINRA-2008-015).
5 See Approval Order, supra note 1.
7 As FINRA and the SEC previously have noted, "Many broker-dealers are subject to lower net capital requirements under SEA Rule 15c3-1 and are exempt from the requirement to establish and fund a customer reserve account under SEA Rule 15c3-3 because they do not carry customer funds or securities." See Exchange Act Release No. 56376 (Sept. 7, 2007), 72 FR 52400 (Sept. 13, 2007) (Order Granting Exemption to Broker-Dealers from Requirements in SEA Rules 15c3-1 and 15c3-3 to Promptly Transmit Customer Checks).
Although some of these firms receive checks from customers made payable to third parties, the SEC does not deem a firm to be carrying customer funds if it "promptly transmits" the checks to third parties. The SEC has interpreted "promptly transmits" to mean that "such transmission or delivery is made no later than noon of the next business day after receipt of such funds or securities." Id. at 52400. In conjunction with its approval of Rule 2821, the SEC provided an exemption to the "promptly transmits" requirement as long as, among other things, the "principal has reviewed and determined whether he or she approves of the purchase or exchange of the deferred variable annuity within seven business days in accordance with the rule." Id. at 52401. In its order approving the recent amendments, the SEC explained that the exemption order continues to apply, notwithstanding the new starting point for the principal review period under NASD Rule 2821. See Approval Order, supra note 1, at 18422 n.37.
NASD rules also could have conflicted with the seven-business-day period. NASD Rule 2330, for instance, generally prohibits improper use of customer funds, and NASD Rule 2820 specifically requires firms to "transmit promptly" the application and purchase payment for a variable annuity contract to the issuing insurance company. Because of this potential conflict, FINRA provided an exemption similar to that provided by the SEC. FINRA stated that a firm may hold an application for a deferred variable annuity and a customer's non-negotiated check payable to an insurance company for up to seven business days without violating either NASD Rule 2330 or 2820 if the reason for the hold is to allow completion of principal review of the transaction pursuant to NASD Rule 2821. As with the SEC's exemption order, FINRA's exemption continues to apply even though the triggering event for the principal review period has changed via the recently approved amendments. (FINRA has proposed to adopt NASD Rule 2330 as FINRA Rule 2150 in the Consolidated FINRA Rulebook—see SR-FINRA-2009-014 (filed March 24, 2009)—and to adopt NASD Rule 2820 as FINRA Rule 2320 in the consolidated FINRA rulebook—see Exchange Act Release No. 59762 (April 14, 2009), 74 FR 18269 (April 21, 2009) (Notice of Filing File No. SR-FINRA-2009-023)).
8 However, the provision, amended paragraph (b)(3) of NASD Rule 2821, would not preclude the customer from transmitting the complete and correct application package to the OSJ. For instance, there may be occasions where the application package is technically complete and correct but the customer wants to review the purchase or exchange further at home and then send the application to the OSJ. Proceeding in such a manner is not inconsistent with the proposed provision.
Text of Amended Rule
New language is underlined; deletions are in brackets.
(Paragraphs (a), (b), and (e) of Rule 2821 currently are effective. New paragraphs (c) and (d) and the supplementary material, as well as amendments to paragraphs (a), (b), and (e), are effective February 8, 2010.)
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2821. Members' Responsibilities Regarding Deferred Variable Annuities
This Rule applies to recommended [the] purchases [or] and exchanges of [a] deferred variable annuity[y]ies and recommended initial [the] subaccount allocations. This Rule does not apply to reallocations among [of] subaccounts made or to funds paid after the initial purchase or exchange of a deferred variable annuity. This Rule also does not apply to deferred variable annuity transactions made in connection with any tax-qualified, employer-sponsored retirement or benefit plan that either is defined as a "qualified plan" under Section 3(a)(12)(C) of the [Securities] Exchange Act [of 1934] or meets the requirements of Internal Revenue Code Sections 403(b), 457(b), or 457(f), unless, in the case of any such plan, a member or person associated with a member makes recommendations to an individual plan participant regarding a deferred variable annuity, in which case the Rule would apply as to the individual plan participant to whom the member or person associated with the member makes such recommendations.
For purposes of this Rule, documents may be created, stored, and transmitted in electronic or paper form, and signatures may be evidenced in electronic or other written form.
For purposes of this Rule, the term "registered principal" shall mean a person registered as a General Securities Sales Supervisor (Series 9/10), a General Securities Principal (Series 24) or an Investment Company Products/Variable Contracts Principal (Series 26), as applicable.
The determinations required by this paragraph shall be documented and signed by the associated person recommending the transaction.
Prior to transmitting a customer's application for a deferred variable annuity to the issuing insurance company for processing, but no later than seven business days after an office of supervisory jurisdiction of the member receives a complete and correct application package, a registered principal shall review and determine whether he or she approves of the recommended purchase or exchange of the deferred variable annuity.
A registered principal shall approve the recommended transaction only if he or she has determined that there is a reasonable basis to believe that the transaction would be suitable based on the factors delineated in paragraph (b) of this Rule.
The determinations required by this paragraph shall be documented and signed by the registered principal who reviewed and then approved or rejected the transaction.
In addition to the general supervisory and recordkeeping requirements of Rules 3010, 3012, 3013, and 3110, a member must establish and maintain specific written supervisory procedures reasonably designed to achieve compliance with the standards set forth in this Rule. The member also must (1) implement surveillance procedures to determine if any of the member's associated persons have rates of effecting deferred variable annuity exchanges that raise for review whether such rates of exchanges evidence conduct inconsistent with the applicable provisions of this Rule, other applicable NASD rules, or the federal securities laws ("inappropriate exchanges") and (2) have policies and procedures reasonably designed to implement corrective measures to address inappropriate exchanges and the conduct of associated persons who engage in inappropriate exchanges.
Members shall develop and document specific training policies or programs reasonably designed to ensure that associated persons who effect and registered principals who review transactions in deferred variable annuities comply with the requirements of this Rule and that they understand the material features of deferred variable annuities, including those described in [sub]paragraph (b)(1)(A)(i) of this Rule.
• • • Supplementary Material: ---------
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