Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Friday, April 17, 2009

FINRA Waters Down Supervisory Review of Deferred Variable Annuities

On May 21, 2008, FINRA filed with the SEC a proposed rule change to amend certain provisions of NASD Rule 2821 (Sales Practice Standards and Supervisory Requirements for Transactions in Deferred Variable Annuities).  The Rule, as originally adopted, required supervisory review of all deferred variable annuities, and a determination of suitability, whether or not the transaction was recommended by the broker.  After a comment period and revisions by FINRA, the SEC declared the proposed rule change effective.  A significant change is that a suitability determination would only be required for recommended transactions.  As explained in the adopting release:

Paragraph (c) of NASD Rule 2821 requires principals to treat all transactions as if they have been recommended for purposes of the rule. Following the Commission’s approval of the rule, however, several commenters asked that the Commission and FINRA reconsider this approach. As FINRA stated in the notice, some commenters asserted that applying the rule to non-recommended transactions would have unintended and harmful consequences. In particular, these commenters claimed that applying the rule to non-recommended transactions would effectively force out of the deferred variable annuities business some firms that offer low priced products, but that do not make recommendations or pay transaction-based compensation. In addition, commenters stated that, absent a recommendation, a customer should be free to invest in a deferred variable annuity without interference or second guessing from a broker-dealer.  In response, FINRA proposed to limit the rule’s application to recommended transactions. In the notice, FINRA explained that limiting the rule to recommended transactions would be consistent with the approach taken in its general suitability rule, Rule 2310. FINRA also stated that this change would not detract from the effectiveness of Rule 2821 because at firms that permit registered representatives to make recommendations concerning deferred variable annuities, the vast majority of purchases and exchanges of deferred variable annuities are recommended. FINRA offered further support for the rule change by stating that non-recommended transactions pose fewer concerns regarding conflicts of interest and less of a need for heightened sales-practice requirements. FINRA also indicated that 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. Finally, FINRA stated that attempts by registered representatives to mischaracterize transactions as non-recommended would be mitigated by the requirement that firms implement reasonable measures to detect and correct circumstances when brokers mischaracterize recommended transactions as non-recommended.

Two commenters representing retail investors -- PIABA and the Cornell Securities Arbitration Clinic -- disagreed with the proposed change and argued that registered representatives could falsely assert that an unsuitable transaction was not recommended.  While FINRA acknowledged the concern, it responded that it would be mitigated by the requirement that broker-dealers implement reasonable measures to detect and correct circumstances in which transactions can be mischaracterized.

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