Variable Insurance Products:
Sales Practice Regulation
Todd Cipperman, Esq.
Cipperman & Company
November 11, 2008
Overview
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Suitability
Switching Firms
State Regulation
Sales Literature and Advertising
Indexed Annuities
Non-Cash Compensation
Sales Contests
Recordkeeping
Compliance
Suitability: Rule 2310
 “reasonable grounds”
 Security holdings; financial situation
 “reasonable efforts” to obtain information
– Financial/tax
– Investment objectives
– Other information
 See also SEC Rule 10b-5; 17(a)(2); 10b-10
 State securities statutes
Suitability: What to Consider
 Investment Objectives
– Disclosure of risks
– Investor’s ability to understand
– Influence exerted by broker
– Suitability ≠ Prudence
 Risk Tolerance
– Wealthy ≠ More aggressive
– The case of the poor, risk-seeking customer i.e. what are the consequences
– Potholes: age, concentration, margin, penny stocks
 Investment Costs
– See reverse churning cases
– Class B shares
 Solicited vs. Unsolicited orders
 Compensation and conflicts of interest
 Susan Merrill (FINRA Chief of Enforcement): target audience is people
preparing for retirement without sufficient retirement plans
Variable Annuities: Rule 2821
 Rule applies to purchase/exchange of deferred
variable annuities and subaccount allocations
– Note NTM 97-27: Conduct Rules apply to group variable
contracts
 Rule does not apply
– Reallocations of subaccounts
– Follow-on investments
– Employer-sponsored benefit plans
 No recommendation unless reasonable basis to
believe transaction is suitable
Rule 2821: Suitability
 Customer has been informed of product features
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Surrender period and charges
Tax penalties
Fees and expenses
Insurance and investment components
Market risk
Note: Rep must understand the product
 Customer would benefit from tax deferral, annuitization,
death/living benefits
– Note: Customer need not benefit from all features
 Deferred variable annuity as a whole (including subaccounts
and riders) are suitable
Rule 2821: Exchanges
 Consider negatives:
– Surrender charges
– Loss of existing benefits
– Increased fees/charges
 Customer would benefit from product
enhancements and improvements
 Previous exchange within 36 months
– Must make effort to review exchanges at third
party firms
Rule 2821: Suitability Due Diligence
 Age
 Time horizon
 Annual Income
 Existing assets
 Financial situation
 Liquidity needs
 Investment experience
 Risk tolerance
 Investment objectives
 Tax status
 Intended use
 Other information
Rule 2821: Principal Review
 Before submission; within 7 days
 Reasonable basis that transaction is suitable
 Can follow customer’s express instructions after
informed consent
 Documentation
 Modified Proposal
– Only recommended transactions
– 7 days runs from date OSJ receives application
– Allows firms to forward money to insurance companies
during review
Rule 2821: Procedure
 Document review for Principal
 Written Supervisory Procedures
 Surveillance procedures to detect high rates
or exchanges
 Polices/procedures to punish reps engaged in
high rates of exchanges
 Training programs
 Effective May 5
Variable Life: NTM 00-44
 Suitability
– Need for life insurance
– Ability to assume investment risk
– Can afford premiums
• Establish target ratios
– Older customers
 Document customer information
 Familiarity with product features/clearly explained
– Use case studies
– Product brochures
 Replacements
– Fees, taxes
– Get written consent
 Financing with cash value
 Marketing Materials: don’t over-emphasize investments vs. insurance
Switching Firms: NTM 07-06
 Surrender charges and loads without benefit
– See also “churning”
 Assess suitability
– Surrender charges
– Comparative fees/expenses
 May be the right thing:
– Client Service
• Notify customer that new firm can’t service
– Better product
– Not motivated by compensation
 Bonus variable annuity may not be enough
 Privacy: See In re Next Financial (using customer data
without consent)
State Regulation
 E.g. Regulation 60 of NYS Insurance Department
– Replacement sales of annuity contracts
– Document 2 separate interactions
– Pru fined $9.5 Million in 2004
 National Assn of Insurance Commissioners model
regulation to protect seniors (July 2003)
 Suitability: See In re Cantella (MA suit re structured
products)
 Do-Not-Call Statutes: See In re Morgan Stanley (using
CareerBuilder list)
 What you say can be used against you.
– See Betz vs. Trainer Wortham: tolling statute of
limitations for re-assuring clients
Sales Literature & Advertising
(IM-2210-2 and NtM 08-39)
 NtM 08-39: Aggregate and clear guidance summarizing past interpretations
 Can’t imply that VA is a mutual fund or is a short-term, liquid investment
 Full disclosure on Riders and Guarantees
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Can’t exaggerate ins. co.’s financial strength
Explain costs and features
Note that Rider is optional
 Performance rules same as mutual funds
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1, 5, and 10 year performance
Compare to index
Impact of fees, expenses, etc.
“Past performance is no guarantee of future results.”
 Can show predecessor and combined historical performance so long as limits on
performance are fully described
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When investment option became available
No significant changes to investment objectives
 Illustrations
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Must show 0% and no more than 10%
Must use real tax rates when showing benefits of tax deferral and compounding
Show deduction of charges
Indexed Annuities
 SEC proposal to treat Indexed Annuities as
securities
– Primary risk of return on the purchaser
 Effect
– Licensing of Reps.
– Disclosure, antifraud, sales practices
 Comments pending
Non-Cash Compensation: Rule 2820
 No paying or receiving gifts > $100
 Occasional Meals/sporting events/entertainment: can’t raise question of
“propriety”
– But see IM 3060 requiring specific policies and procedures to include dollar
limits, prohibitions on quid pro quos
 Business development tools permitted
– Lead lists
– Software
 Reimbursement of travel expenses for sales
 Training and education meetings
 Logo gifts ok
 Personal gifts (e.g. wedding gifts) ok
 Recordkeeping requirements
 Sales Contests
Non-Cash Compensation: Training
and Education Meetings
 Paid by “Offeror”
 Home office permission
 No sales targets
– Can recognize performance in selecting attendees
 Appropriate location: no golf resorts
 No payment for spouse expenses, unless within firm
 Can play golf; just can’t pay for it
Sales Contests: Total Production and
Equal Weighting
 Total production of all variable contracts distributed
– Can include non-insurance products
– Can’t separate out variable products into multiple
contests
– Can’t have single product contests
– Can limit to a division or department
– Can apply to proprietary funds or one contract, if that’s
all firm sells
 Equal weighting of credit
 No limits on award
 Can contribute to third party’s sales program
Recordkeeping
Numerous Rules (e.g., NASD Rule 2210 (Sales Materials), 3010 (Supervisory
Records), 3060 (Non-cash compensation), 3110 (General Books and Records)
– SEC Rules 17a-3 and 17a-4
– Electronic storage must be non-rewriteable, non-erasable format, aka WORM
("Write Once, Read Many”)
– All communications related to your securities business, “even those cute little
instant messages”
Financial records, shareholder account ledgers, agreements, board meeting minutes,
brokerage reports
May be different time requirements for each type of record
SEC access upon request
Third party service providers may hold records
Advisers Act requirements (generally 5 years)
Compound Effect: Most other violations are accompanied by (and possibly
sparked by) one or more recordkeeping violations!
Compliance
Firm must adopt and implement policies and
procedures reasonably designed to prevent violations
of the securities laws
Consult your policies and procedures manual
–Written supervisory procedures
–Desk procedures
–Compliance manual
Consult your legal and compliance department(s)
Final Thoughts
 Regulatory attention to variable insurance products
 Treating Reps as fiduciaries
 Exam priority
 Higher standard of care with unsophisticated clients
– Seniors
– Military personnel
 Clear Rules
More certainty
Fewer problems
Cipperman & Company is a unique law firm devoted exclusively to the investment
management industry. Our lawyers have spent their careers in the investment
management industry, including significant experience at major industry players. Our
shared heritage and experience make our lawyers unique and creative industry partners
who can give you practical, real-world advice for making informed business decisions
and controlling your legal risk. We have worked on a wide range of transactional and
regulatory matters, but we concentrate on three core areas - Distribution, Technology
and Fund Formation:
Distribution: Broker-Dealer Regulatory Matters, Dealer, Solicitation, and Referral
Agreements, Asset-Gathering Strategies and Structures, Wrap Programs, Marketing
Materials
Technology: Licensors and Licensees, Installed and ASP, Portfolio Management
Systems, Trading Utilities and Platforms, Compliance Tools
Fund Formation: Hedge Funds, Fund-of-Funds, Institutional Products, ETFs, Variable
Insurance Products, Cash Sweep Vehicles
150 S. Warner Road, Suite 140, King of Prussia, PA 19406, 610.687.5320, tcipperman@cipperman.com, www.cipperman.com