[Federal Register: June 10, 2008 (Volume 73, Number 112)]
[Notices]
[Page 32771-32775]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr10jn08-89]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-57920; File No. SR-FINRA-2008-019]
Self-Regulatory Organizations: Financial Industry Regulatory
Authority, Inc.; Notice of Filing of Proposed Rule Change Relating to
Sales Practice Standards and Supervisory Requirements for Transactions
in Deferred Variable Annuities
June 4, 2008.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Exchange Act'' or ``SEA'') \1\ and Rule 19b-4 thereunder,\2\ notice
is hereby given that on May 21, 2008, Financial Industry Regulatory
Authority, Inc. (``FINRA'') (f/k/a National Association of Securities
Dealers, Inc. (``NASD'')) filed with the Securities and Exchange
Commission (``SEC'' or ``Commission'') the proposed rule change as
described
[[Page 32772]]
in Items I, II, and III below, which Items have been prepared
substantially by FINRA. The Commission is publishing this notice to
solicit comments on the proposed rule change from interested persons.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
FINRA is proposing to amend certain provisions of NASD Rule
2821.\3\ Below is the text of the proposed rule change. Proposed new
language is italicized; proposed deletions are in brackets.
---------------------------------------------------------------------------
\3\ On March 17, 2008, FINRA filed a separate proposed rule
change, which became effective upon filing, to delay the effective
date of paragraphs (c) and (d) of NASD Rule 2821 until 180 days
following the Commission's approval or rejection of this substantive
proposed rule change. See FINRA Notice of Filing and Immediate
Effectiveness of Proposed Rule Change to Delay the Effective Date of
Certain FINRA Rule Changes Approved in SR-NASD-2004-183, Securities
Exchange Act Release No. 57769 (May 2, 2008), 73 FR 26176 (May 8,
2008) (SR-FINRA-2008-015). Paragraphs (a), (b), and (e) of NASD Rule
2821, as approved in SR-NASD-2004-183, became effective as
originally scheduled on May 5, 2008.
---------------------------------------------------------------------------
* * * * *
2821. Members' Responsibilities Regarding Deferred Variable Annuities
(a) General Considerations
(1) Application
This Rule applies to recommended [the] purchases [or] and exchanges
of [a] deferred variable annuit[y]ies and recommended initial [the]
subaccount allocations. This Rule does not apply to reallocations [of]
among 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.
(2) No change.
(3) No change.
(b) Recommendation Requirements
(1) No member or person associated with a member shall recommend to
any customer the purchase or exchange of a deferred variable annuity
unless such member or person associated with a member has a reasonable
basis to believe
(A) that the transaction is suitable in accordance with Rule 2310
and, in particular, that there is a reasonable basis to believe that
(i) No change.
(ii) No change.
(iii) the particular deferred variable annuity as a whole, the
underlying subaccounts to which funds are allocated at the time of the
purchase or exchange of the deferred variable annuity, and riders and
similar product enhancements, if any, are suitable (and, in the case of
an exchange, the transaction as a whole also is suitable) for the
particular customer based on the information required by [sub]paragraph
(b)(2) of this Rule; and
(B) in the case of an exchange of a deferred variable annuity, the
exchange also is consistent with the suitability determination required
by [sub]paragraph (b)(1)(A) of this Rule, taking into consideration
whether
(i) No change.
(ii) No change.
(iii) the customer['s account] has had another deferred variable
annuity exchange within the preceding 36 months.
The determinations required by this paragraph shall be documented
and signed by the associated person recommending the transaction.
(2) No change.
(3) Promptly after receiving information necessary to prepare a
complete and correct application package for a deferred variable
annuity, a person associated with a member who recommends the deferred
variable annuity shall transmit the complete and correct application
package to an office of supervisory jurisdiction of the member.
(c) Principal Review and Approval
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 [the customer signs the
application] 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.
[Subject to the exception in this paragraph, and treating all
transactions as if they have been recommended for purposes of this
principal review, a] A registered principal shall approve the
recommended transaction only if he or she [the registered principal]
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. [Notwithstanding the foregoing, a
registered principal may authorize the processing of the transaction if
the registered principal determines that the transaction was not
recommended and that the customer, after being informed of the reason
why the registered principal has not approved the transaction, affirms
that he or she wants to proceed with the purchase or exchange of the
deferred variable annuity.]
The determinations required by this paragraph shall be documented
and signed by the registered principal who reviewed and then
approved[,] or rejected[, or authorized] the transaction.
(d) No change.
(e) Training
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:
.01 Under Rule 2821, a member that is permitted to maintain
customer funds under SEA Rules 15c3-1 and 15c3-3 may, prior to the
member's principal approval of the deferred variable annuity, deposit
and maintain customer funds for a deferred variable annuity in an
account that meets the requirements of SEA Rule 15c3-3.
.02 If a customer provides a member that is permitted to hold
customer funds with a lump sum or single check made payable to the
member (as opposed to being made payable to the insurance company) and
requests that a portion of the funds be applied to the purchase of a
deferred variable annuity and the rest of the funds be applied to other
types of products, Rule 2821 would not prohibit the member from
promptly applying those portions designated for purchasing products
other than a deferred variable annuity to such use. A member that is
not permitted to hold customer funds can comply with such requests only
through its clearing firm that will maintain customer funds for the
intended deferred variable annuity purchase in an account that meets
the requirements of SEA Rule 15c3-3. In such circumstances, the checks
would need to be made payable to the clearing firm.
[[Page 32773]]
.03 Rule 2821 does not prohibit a member from forwarding a check
made payable to the insurance company or, if the member is fully
subject to SEA Rule 15c3-3, transferring funds for the purchase of a
deferred variable annuity to the insurance company prior to the
member's principal approval of the deferred variable annuity, as long
as the member fulfills the following requirements: (1) the member must
disclose to the customer the proposed transfer or series of transfers
of the funds and (2) the member must enter into a written agreement
with the insurance company under which the insurance company agrees to
(a) segregate the member's customers' funds in a bank in an account
equivalent to the deposit of those funds by a member into a ``Special
Account for the Exclusive Benefit of Customers'' (set up as described
in SEA Rules 15c3-3(k)(2)(i) and 15c3-3(f)) to ensure that the
customers' funds will not be subject to any right, charge, security
interest, lien, or claim of any kind in favor of the member, insurance
company, or bank where the insurance company deposits such funds or any
creditor thereof or person claiming through them and hold those funds
either as cash or any instrument that a broker or dealer may deposit in
its Special Reserve Account for the Exclusive Benefit of Customers, (b)
not issue the variable annuity contract prior to the member's principal
approval, and (c) promptly to return the funds to each customer at the
customer's request prior to the member's principal approval or upon the
member's rejection of the application.
.04 A member is not prohibited from forwarding a check provided by
the customer for the purpose of purchasing a deferred variable annuity
and made payable to an IRA custodian for the benefit of the customer
(or, if the member is fully subject to SEA Rule 15c3-3, funds) to the
IRA custodian prior to the member's principal approval of the deferred
variable annuity transaction, as long as the member enters into a
written agreement with the IRA custodian under which the IRA custodian
agrees (a) to forward the funds to the insurance company to complete
the purchase of the deferred variable annuity contract only after it
has been informed that the member's principal has approved the
transaction and (b), if the principal rejects the transaction, to
inform the customer, seek immediate instructions from the customer
regarding alternative disposition of the funds (e.g., asking whether
the customer wants to transfer the funds to another IRA custodian,
purchase a different investment, or provide other instructions), and
promptly implement the customer's instructions.
.05 Rule 2821 requires that the member or person associated with a
member consider whether the customer has had another deferred variable
annuity exchange within the preceding 36 months. Under this provision,
a member or person associated with a member must determine whether the
customer has had such an exchange at the member and must make
reasonable efforts to ascertain whether the customer has had an
exchange at any other broker-dealer within the preceding 36 months. An
inquiry to the customer as to whether the customer has had an exchange
at another broker-dealer within 36 months would constitute a
``reasonable effort'' in this context. Members shall document in
writing both the nature of the inquiry and the response from the
customer.
.06 Rule 2821 requires principal review and approval ``[p]rior to
transmitting a customer's application for a deferred variable annuity
to the issuing insurance company for processing* * * .'' In
circumstances where an insurance company and its affiliated broker-
dealer share office space and/or employees who carry out both the
principal review and the issuance process, FINRA will consider the
application ``transmitted'' to the insurance company only when the
broker-dealer's principal, acting as such, has approved the
transaction, provided that the affiliated broker-dealer and the
insurance company have agreed that the insurance company will not issue
the contract prior to principal approval by the broker-dealer.
07 Rule 2821 does not prohibit using the information required for
principal review and approval in the issuance process, provided that
the broker-dealer and the insurance company have agreed that the
insurance company will not issue the contract prior to principal
approval by the broker-dealer. For instance, the rule does not prohibit
a broker-dealer from inputting information used as part of its
suitability review into a shared database (irrespective of the media
used for that database, i.e., paper or electronic) that the insurance
company uses for the issuance process, provided that the broker-dealer
and the insurance company have agreed that the insurance company will
not issue the contract prior to principal approval by the broker-
dealer.
* * * * *
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, FINRA included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. FINRA has prepared summaries, set forth in sections A,
B, and C below, of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
FINRA is proposing to amend NASD Rule 2821 to modify the rule's
scope and the timing of principal review. FINRA also is proposing to
clarify various issues that commenters have raised through a
``Supplementary Material'' section following the rule text. Reasons for
these changes are discussed below.
Limit Application of the Rule To Recommended Transactions
As approved by the Commission, NASD Rule 2821(c) requires
principals to treat ``all transactions as if they have been recommended
for purposes of this principal review.'' Following the Commission's
approval of the rule, however, numerous commenters asked the SEC and
FINRA to reconsider this approach. Some of the commenters asserted that
applying the rule to non-recommended transactions would have the
unintended and harmful consequence of essentially forcing some firms
that offer low-priced alternatives and do not allow recommendations or
use transaction-based compensation out of the deferred variable
annuities business. Still other commenters believed that, absent a
recommendation, a customer should be completely free to invest in a
deferred variable annuity without interference or second guessing from
a broker-dealer.
After further reflection, FINRA is proposing to limit the rule's
application to recommended transactions. This approach is consistent
with that taken by FINRA's general suitability rule, Rule 2310. This
change, moreover, should not detract from the effectiveness of Rule
NASD 2821 in providing additional protection to investors in deferred
variable annuities. For instance, brokers recommend the vast majority
of purchases and exchanges of
[[Page 32774]]
deferred variable annuities. Thus, the rule would continue to cover
most transactions. FINRA emphasizes, moreover, that members must
implement reasonable measures to detect and correct circumstances when
brokers mischaracterize recommended transactions as non-recommended.
Where the transaction truly is initiated by the customer and not
recommended by the broker, there generally is less of a concern
regarding potential or actual conflicts of interest and less of a need
for heightened sales practice requirements. In addition, this change
would promote 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
NASD Rule 2821(c) requires principal review and approval ``[p]rior
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 the customer signs the application.'' A
number of firms asserted that seven business days beginning from the
time when the customer signs the application may not allow for a
thorough principal review in all cases. These firms provided examples
of situations where a principal might not be able to complete the
required review within the allotted time, such as when a customer
inadvertently omits information from the application, when information
provided by a customer on the application needs clarification, when a
customer signs the application but does not mail it for several days
after signature, and when a customer mails the application by regular
U.S. mail.
FINRA is proposing to modify the beginning of the period within
which the principal must review and determine whether to approve or
reject the application. Under the proposal, the period would begin to
run not from the date of the customer's signature but from the date
when the firm's office of supervisory jurisdiction (OSJ) receives a
complete and correct copy of the application.\4\ This period should be
sufficient to permit a principal to conduct an appropriate review,
building in time for readily foreseeable delays, while still
maintaining a definite period within which the principal must make a
final decision.
---------------------------------------------------------------------------
\4\ As FINRA and the Commission previously have noted, ``Many
broker-dealers are subject to lower net capital requirements under
[Exchange Act] Rule 15c3-1 and are exempt from the requirement to
establish and fund a customer reserve account under [Exchange Act]
Rule 15c3-3 because they do not carry customer funds or
securities.'' SEC Order Granting a Conditional Exemption to Broker-
Dealers from Requirements in Rules 15c3-1 and 15c3-3 under the
Securities Exchange Act of 1934 to Promptly Transmit Customer Checks
for the purchase of deferred variable annuity contracts, Securities
Exchange Act Release No. 56376 (Sept. 7, 2007), 72 FR 52400 (Sept.
13, 2007). 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. In conjunction with its approval of NASD Rule
2821, the Commission 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 [Rule 2821].'' Id. FINRA
believes that the Commission's exemption order allows for the
modification to the event that triggers the review period, discussed
above.
---------------------------------------------------------------------------
To help ensure that the process remains efficient from the
beginning, the proposal also would require the associated person who
recommended the annuity to promptly transmit the complete and correct
application package to the OSJ. However, that latter provision,
proposed 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
take it home and consider the purchase or exchange some more before
sending the application to the OSJ. Proceeding in such a manner would
not be inconsistent with the proposed provision.
Clarification of Issues Through Supplementary Material
Commenters have raised a number of additional issues requiring
clarification. A ``Supplementary Material'' section following the
rule's text examines those issues that were raised by multiple groups
and that potentially could have a significant impact on how members
sell or process deferred variable annuities. FINRA refuted, for
instance, the misconception that firms generally allowed to handled and
carry customer funds under Exchange Act Rules 15c3-1 and 15c3-3 could
not deposit funds for a deferred variable annuity prior to principal
approval.
FINRA also reconsidered the question of whether members could
forward funds to insurance companies for deposit in the companies'
``suspense accounts'' prior to principal approval. FINRA modified its
earlier position rejecting such a process, discussed in Regulatory
Notice 07-53 (Nov. 2007), and proposed to 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
under Exchange Act Rule 15c3-3.
In addition, the Supplementary Material section discusses
customers' lump sum payments for the purchase of deferred variable
annuities and other products, the forwarding of customer checks or
funds to an IRA custodian prior to principal approval, the timing of
``transmittal'' of the application where an insurance company and its
affiliated broker-dealer share office space and/or employees,
consideration of what constitutes a ``reasonable effort'' to determine
whether a customer has had a recent exchange at another broker-
dealer,\5\ and the permissibility of using information required for
principal review in the contract issuance process. These are all issues
that commenters have raised on multiple occasions and that could
broadly impact how broker-dealers sell, or process transactions in,
deferred variable annuities.
---------------------------------------------------------------------------
\5\ FINRA notes that the proposal also clarifies in NASD Rule
2821(b)(1)(B)(iii) that an analysis of whether the customer has had
another recent exchange includes possible exchanges at other broker-
dealers. The rule currently states that the member must consider
whether ``the customer's account has had another deferred variable
annuity exchange within the preceding 36 months.'' Id. As FINRA
stated in Regulatory Notice 07-53 (Nov. 2007), however, FINRA did
not intend the use of the term ``account'' in that passage to limit
the analysis only to exchanges at the member firm performing the
review at issue. The proposal eliminates the term ``account'' to
make this point even more clear.
---------------------------------------------------------------------------
2. Statutory Basis
FINRA believes that the proposed rule change is consistent with the
provisions of Section 15A(b)(6) of the Exchange Act, \6\ which
requires, among other things, that FINRA rules must be designed to
prevent fraudulent and manipulative acts and practices, to promote just
and equitable principles of trade, and, in general, to protect
investors and the public interest. The rule change will promote
investor protection because it will allow firms to focus on recommended
transactions, which generally have the potential to raise more
significant sales-practice issues than do non-recommended transactions,
and will provide firms with adequate time to perform an appropriately
thorough principal review. It will also provide firms with
[[Page 32775]]
guidance to clarify various issues with respect to the operation of the
rule.
---------------------------------------------------------------------------
\6\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------
B. Self-Regulatory Organization's Statement on Burden on Competition
FINRA does not believe that the proposed rule change will result in
any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Exchange Act.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
Written comments were neither solicited nor received.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) By order approve such proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Exchange Act. Comments may be submitted
by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
Send an e-mail to rule-comments@sec.gov. Please include
File Number SR-FINRA-2008-019 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.
All submissions should refer to File Number SR-FINRA-2008-019. This
file number should be included on the subject line if e-mail is used.
To help the Commission process and review your comments more
efficiently, please use only one method. The Commission will post all
comments on the Commission's Internet Web site (http://www.sec.gov/
rules/sro.shtml). Copies of the submission, all subsequent amendments,
all written statements with respect to the proposed rule change that
are filed with the Commission, and all written communications relating
to the proposed rule change between the Commission and any person,
other than those that may be withheld from the public in accordance
with the provisions of 5 U.S.C. 552, will be available for inspection
and copying in the Commission's Public Reference Room, 100 F Street,
NE., Washington, DC 20549, on official business days between the hours
of 10 a.m. and 3 p.m.. Copies of such filing also will be available for
inspection and copying at the principal office of FINRA. All comments
received will be posted without change; the Commission does not edit
personal identifying information from submissions. You should submit
only information that you wish to make available publicly.
All submissions should refer to File Number SR-FINRA-2008-019 and
should be submitted on or before July 1, 2008.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\7\
---------------------------------------------------------------------------
\7\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------
Florence E. Harmon,
Acting Secretary.
[FR Doc. E8-12948 Filed 6-9-08; 8:45 am]
BILLING CODE 8010-01-P