SEC Adopts Rule 151A

[djs]

I'm starting to think that Cox did us a favor. He passed a reulation so flawed, it it likely to be overturned in court, which will futher establish that FIA's are not securities and limiting future SEC action.

You're dreaming. Don't count on this getting overturned, no matter how flawed it may be. The financial sector is up for a power grab, and the bigger the government entity, the more likely they are to grab on and not let go.

I don't necessarily agree with the ruling, but I wouldn't count on it getting overturned. Fight it if you want, but plan on it sticking around.

Dan

 

[Charpress]

The Reagan years pendulum has now swung way the hell the other direction to more government intervention and regulation. Cox is history regardless of what you think of him and the next 8 years are going to be the Big Government Years.

You would normally take comfort in the idea that the pendulum will go the other way eventually. Unfortunately, I think it will be too late.

 

[patch36]

I cant see it being overturned either. Those of us serious about the products and the business will adapt, whether it is to the new products or licensing, we have a year or two to get it together.

 

[padthaiforlunch]

Commissioner Paredes outlines the arguments that will be used to fight this. I think the most effective argument to overturn this ruling is the "more likely than not" test.



[FONT=Verdana,Arial,Helvetica]Speech by SEC Commissioner:
Opening Remarks and Dissent Regarding Final Rule 151A
Indexed Annuities and Certain Other Insurance Contracts[/FONT]

[FONT=Verdana,Arial,Helvetica]by[/FONT]

[FONT=Verdana,Arial,Helvetica]Commissioner Troy A. Paredes[/FONT]

[FONT=Verdana,Arial,Helvetica]U.S. Securities and Exchange Commission[/FONT]

[FONT=Verdana,Arial,Helvetica]Open Meeting of the Securities & Exchange Commission
Washington, D.C.
December 17, 2008[/FONT]

[FONT=Verdana,Arial,Helvetica]Thank you, Chairman Cox.[/FONT]
[FONT=Verdana,Arial,Helvetica]I believe that proposed Rule 151A addressing indexed annuities is rooted in good intentions. For instance, at the time the rule was proposed, the Commission watched a television clip from Dateline NBC that described individuals who may have been misled by seemingly unscrupulous sales practices into buying these products. Part of our tripartite mission at the SEC is to protect investors, so there is a natural tendency to want to act when we hear stories like this.[/FONT]
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[FONT=Verdana,Arial,Helvetica]However, our jurisdiction is limited; and thus our authority to act is circumscribed. Rule 151A is about this very question: the proper scope of our statutory authority.[/FONT]
[FONT=Verdana,Arial,Helvetica][/FONT]
[FONT=Verdana,Arial,Helvetica]In our effort to protect investors, we cannot extend our reach past the statutory stopping point. Section 3(a)(8) of the Securities Act of 1933 ('33 Act) provides a list of securities that are exempt from the '33 Act and thus, by design of the statute, fall beyond the Commission's reach. The Section 3(a)(8) exemption includes, in relevant part, "[a]ny insurance or endowment policy or annuity contract or optional annuity contract, issued by a corporation subject to the supervision of the insurance commissioner . . . of any State or Territory of the United States or the District of Columbia." I am not persuaded that Rule 151A represents merely an attempt to provide clarification to the scope of exempted securities falling within Section 3(a)(8). Instead, by defining indexed annuities in the manner done in Rule 151A, I believe the SEC will be entering into a realm that Congress prohibited us from entering. Therefore, I cannot vote in favor of the rule and respectfully dissent.[/FONT]
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[FONT=Verdana,Arial,Helvetica]Rule 151A takes some annuity products (indexed annuities), which otherwise may be covered by the statutory exemption in Section 3(a)(8), and removes them from the exemption, thus placing them within the Commission's jurisdiction to regulate. If the Commission's Rule 151A analysis is wrong — which is to say that indexed annuities do fall within Section 3(a)(8) — then the SEC has exceeded its authority by seeking to regulate them. In other words, the effect of Rule 151A would be to confer additional authority upon the SEC when these products, in fact, are entitled to the Section 3(a)(8) exemption.[/FONT]

[FONT=Verdana,Arial,Helvetica]The Supreme Court has twice construed the scope of Section 3(a)(8) for annuity contracts in the VALIC and United Benefit cases.1 I believe the approach embraced by Rule 151A conflicts with these Supreme Court cases. Although neither VALIC nor United Benefit deals with indexed annuities directly, the cases nevertheless are instructive in evaluating whether such a product falls within the Section 3(a)(8) exemption. And despite the adopting release's efforts to discount its holding, at least one federal court applying VALIC and United Benefit has held that an indexed annuity falls within the statutory exemption of Section 3(a)(8).2[/FONT]
[FONT=Verdana,Arial,Helvetica][/FONT]
[FONT=Verdana,Arial,Helvetica]When fixing the contours of Section 3(a)(8), the relevant features of the product at hand should be considered to determine whether the product falls outside the Section 3(a)(8) exemption. Rule 151A places singular focus on investment risk without adequately considering another key factor — namely, the manner in which an indexed annuity is marketed.[/FONT]
[FONT=Verdana,Arial,Helvetica][/FONT]
[FONT=Verdana,Arial,Helvetica]Moreover, I believe that Rule 151A misconceptualizes investment risk for purposes of Section 3(a)(8). The extent to which the purchaser of an indexed annuity bears investment risk is a key determinant of whether such a product is subject to the Commission's jurisdiction. Rule 151A denies an indexed annuity the Section 3(a)(8) exemption when it is "more likely than not" that, because of the performance of the linked securities index, amounts payable to the purchaser of the annuity contract will exceed the amounts the insurer guarantees the purchaser. This approach to investment risk gives short shrift to the guarantees that are a hallmark of indexed annuities. In other words, the central insurance component of the product eludes the Rule 151A test. More to the point, Rule 151A in effect treats the possibility of upside, beyond the guarantee of principal and the guaranteed minimum rate of return the purchaser enjoys, as investment risk under Section 3(a)(8). I believe that it is more appropriate to emphasize the extent of downside risk — that is, the extent to which an investor is subject to a risk of loss — in determining the scope of Section 3(a)(8). When investment risk is properly conceived of in terms of the risk of loss, it becomes apparent why indexed annuities may fall within Section 3(a)(8) and thus beyond this agency's reach, contrary to Rule 151A.[/FONT]

[FONT=Verdana,Arial,Helvetica]Not only does Rule 151A seem to deviate from the approach taken by courts, including the Supreme Court, but it also appears to depart from prior positions taken by the Commission. For example, in an amicus brief filed with the Supreme Court in the Otto case,3 the Commission asserted that the Section 3(a)(8) exemption applies when an insurance company, regulated by the state, assumes a "sufficient" share of investment risk and there is a corresponding decrease in the risk to the purchaser, such as where the purchaser benefits from certain guarantees. Yet Rule 151A denies the Section 3(a)(8) exemption to an indexed annuity issued by a state-regulated insurance company that bears substantial risk under the annuity contract by guaranteeing principal and a minimum return.[/FONT]
[FONT=Verdana,Arial,Helvetica][/FONT]
[FONT=Verdana,Arial,Helvetica]In addition, Rule 151A seems to diverge from the analysis embedded in Rule 151. Rule 151 establishes a true safe harbor under Section 3(a)(8) and provides that a variety of factors should be considered, such as marketing techniques and the availability of guarantees. The Rule 151 adopting release even indicates that the rule allows for certain "indexed excess interest features" without the product falling outside the safe harbor.[/FONT]
[FONT=Verdana,Arial,Helvetica][/FONT]

 

[padthaiforlunch]

[FONT=Verdana,Arial,Helvetica]An even more critical difference between Rule 151 and Rule 151A is the effect of failing to meet the requirements under the rule. If a product does not meet the requirements of Rule 151, there is no safe harbor, but the product nevertheless may fall within Section 3(a)(8) and thus be an exempted security. But if a product does not pass muster under the Rule 151A "more likely than not" test, then the product is deemed to fall outside Section 3(a)(8) and thus is under the SEC's jurisdiction. In essence, while Rule 151 provides a safe harbor, Rule 151A takes away the Section 3(a)(8) statutory exemption.[/FONT]

[FONT=Verdana,Arial,Helvetica]I am not aware of another instance in the federal securities laws where a "more likely than not" test is employed, and for good reason. A "more likely than not" test does not provide insurers with proper notice of whether their products fall within the federal securities laws or not. If an insurer applies the test in good faith and gets it wrong, the insurer nonetheless risks being subject to liability under Section 5 of the Securities Act, even if the insurer had no intent to run afoul of the federal securities laws. In addition, under the "more likely than not" test, the availability of the Section 3(a)(8) exemption turns on the insurer's own analysis. Accordingly, it is at least conceivable that the same product could receive different Section 3(a)(8) treatment depending on how each respective insurer modeled the likely returns.[/FONT]

[FONT=Verdana,Arial,Helvetica]Further, I am concerned that Rule 151A, as applied, reveals that the "more likely than not" test, despite its purported balance, leads to only one result: the denial of the Section 3(a)(8) exemption. In practice, Rule 151A appears to result in blanket SEC regulation of the entire indexed annuity market. The adopting release indicates that over 300 indexed annuity contracts were offered in 2007 and explains that the Office of Economic Analysis has determined that indexed annuity contracts with typical features would not meet the Rule 151A test. Indeed, the adopting release elsewhere expresses the expectation that almost all indexed annuity contracts will fail the test. If everyone is destined to fail, what is the purpose of a test? Further, there is at least some risk that in sweeping up the index annuity market, the rule may sweep up other insurance products that otherwise should fall within Section 3(a)(8).
[/FONT]
[FONT=Verdana,Arial,Helvetica]The rule has other shortcomings, aside from the legal analysis that underpins it. These include, but are not limited to, the following.[/FONT]

[FONT=Verdana,Arial,Helvetica]First, a range of state insurance laws govern indexed annuities. I am disappointed that the rule and adopting release make an implicit judgment that state insurance regulators are inadequate to regulate these products. Such a judgment is beyond our mandate or our expertise. In any event, Section 3(a)(8) does not call upon the Commission to determine whether state insurance regulators are up to the task; rather, the section exempts annuity contracts subject to state insurance regulation.[/FONT]

[FONT=Verdana,Arial,Helvetica]Second, as a result of Rule 151A, insurers will have to bear various costs and burdens, which, importantly, could disproportionately impact small businesses. Some even have predicted that companies may be forced out of business if Rule 151A is adopted. Such an outcome causes me concern, especially during these difficult economic times. Even when the economy is not strained, such an outcome is disconcerting because it can lead to less competition, ultimately to the detriment of consumers.[/FONT]

[FONT=Verdana,Arial,Helvetica]Third, the Commission received several thousand comment letters since Rule 151A was proposed in June 2008. Consistent with comments we have received, I believe that there are more effective and appropriate ways to address the concerns underlying this rulemaking. One possible alternative to Rule 151A would be amending Rule 151 to establish a more precise safe harbor in light of all the relevant facts and circumstances attendant to indexed annuities and how they are marketed. A more precise safe harbor would provide better clarity and certainty in this area — regulatory goals the Commission has identified — and would preserve the ability of insurers to find an exemption outside the safe harbor by relying directly on Section 3(a)(8) and the cases interpreting it. I believe further exploration of alternative approaches is warranted, as is continued engagement with interested parties, including state regulators.[/FONT]

 

[Mark]

Okay, Okay. Can someone put this in simple terms that I can understand. I'm feeling stupid here. I read all of the new changes and it is not my market. So what does this really mean in simple terms?

Is it that there are more rules and now the agent has to do more or what?

I feel like I should have my lawyer read the new rules and explain it to me. Someone please make it simple to us that don't understand this market.

 

[patch36]

I quote someone who was there, the Pres of the largest Annuity Marketing Group...

[SIZE=+1]

The two-pronged test to disallow exemption under Section 3(a)(8) of the Securities Act of 1933 is slightly modified to assure that traditional, non-indexed annuities remain as non-securities. Nearly every other non-security, fixed indexed annuity on the market today will meet the test of 1) having interest linked to a securities index and 2) having a 50% chance or greater of receiving interest in excess of guarantees. As such, they would be disallowed from using the securities exemption. The SEC anticipates this would mean products of this type would have to be registered by insurance companies with the SEC and only registered representatives could sell them.

The effective date has been extended one additional year from the original proposal to January 12, 2011. It is also apparent that the SEC anticipates a legal challenge to their rule in the near future.
[/SIZE]

 

[padthaiforlunch]

Right. I think the 50% or better test is so ambiguous that it provides the best hope for overturning 151A.

I quote someone who was there, the Pres of the largest Annuity Marketing Group...

[SIZE=+1]

The two-pronged test to disallow exemption under Section 3(a)(8) of the Securities Act of 1933 is slightly modified to assure that traditional, non-indexed annuities remain as non-securities. Nearly every other non-security, fixed indexed annuity on the market today will meet the test of 1) having interest linked to a securities index and 2) having a 50% chance or greater of receiving interest in excess of guarantees. As such, they would be disallowed from using the securities exemption. The SEC anticipates this would mean products of this type would have to be registered by insurance companies with the SEC and only registered representatives could sell them.

The effective date has been extended one additional year from the original proposal to January 12, 2011. It is also apparent that the SEC anticipates a legal challenge to their rule in the near future.
[/SIZE]

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If allowed to stand, it will require anyone selling an FIA or EIUL policy to be securities licensed.

This will lead to less competition by agents and by offerings. Modified EIA's will become less attractive because they will have a smaller upside.

New products will be rich on the income account side, so not all hope is lost.

Okay, Okay. Can someone put this in simple terms that I can understand. I'm feeling stupid here. I read all of the new changes and it is not my market. So what does this really mean in simple terms?

Is it that there are more rules and now the agent has to do more or what?

I feel like I should have my lawyer read the new rules and explain it to me. Someone please make it simple to us that don't understand this market.

 

[patch36]

Unless you have a working knowledge of FIA's, it is really difficult to get a handle on.

Because the vote was so lopsided in favor of regulation, and with the regulatory mood sweeping DC, I imagine it will stand pretty much intact in the end. At this point all we can do is wait to see the new products and how this all shakes out in the future.

 

[Charpress]

What 151A means in simple terms is simple:

If any insurance product mentions, hints at, alludes to, or in any manner brings up the possibility that returns on the product are related to an index, the stock market, a security, a group of securities, or anything remotely connected to whatever the SEC currently regulates, than that product will also be regulated by the SEC -'cuz it is more likely than not that the SEC will want to regulate it.