NEW YORK - NASD has begun a significant push to regulate broker-dealers' sales of insurance-oriented financial services products though the Securities and Exchange Commission has not yet approved specific new or amended rules giving it the power to do so.
According to industry observers, the brokerage industry's self-regulating organization soon will release a notice to members that focuses on equity-indexed annuities, fixed annuities that are regulated by the states as insurance products.
Neither the SEC nor the courts define equity-indexed annuities as securities. Therefore, they technically fall outside the reach of Washington-based NASD, observers said.
The NASD notice to members might focus on the suitability of equity-indexed annuities, said one industry lawyer, who has had recent discussion with the association's staff and asked not to be identified. "NASD is trying to scare members into not selling it," the lawyer said.
If the SEC approves NASD rules at a later date regarding equity-indexed annuities, broker-dealers could face questioning over registered representatives' sales practices, observers said. The self-regulator "gave the impression that it could attack equity-indexed annuities under suitability rules," according to the lawyer.
Equity-indexed annuities, which allow investors theoretically to participate in the equity market with downside protection, have been a hot product. Of late, NASD officials have been particularly wary of any investment product that has been a big seller.
And brokers and advisers lately have been aggressively selling equity-indexed annuities and other products that combine elements of insurance and stocks, with sales of such annuities reaching $23.4 billion last year, according to Advantage Compendium Ltd., a research company in St. Louis. That's an increase of 67% from the level a year earlier. They accounted for 30% of total fixed-annuity sales last year.
Equity-indexed annuities are extremely complex products, observers said, with commissions of between 4% and 12%. The industry average is 8.1%, according to Advance Compendium research.
Only three of the 130 equity-indexed annuities on the market are registered as securities, Advantage Compendium reported.
NASD tipped its hand in May to extending its reach into fixed-insurance products such as equity-indexed annuities when Mary L. Schapiro, vice chairman and president of regulatory policy and oversight, drew attention to the association's concern.
Unclear legal distinction
In a speech in Chicago at NASD's spring conference that focused on retirement savings and investment products such as equity-indexed annuities, she said: "The legal distinction between a security and insurance is not always clear, and it is very difficult to determine whether a particular equity-indexed annuity is a security or form of insurance."
Ms. Schapiro said: "These firms are taking a risk. What if the equity-indexed annuity is in fact a security? Then the firm has a 'selling away' problem that it has not adequately policed.
"I urge you to consider whether your reps should be selling any unregistered equity-indexed annuity without being fully supervised by your firm."
In her speech, she also listed tenants-in-common exchanges, and viatical and life settlements, as financial products that firms might regard as non-securities. "NASD considers all of these products to be securities subject to firm supervision," Ms. Schapiro said.
And along with increased oversight of insurance products that are not defined as securities, NASD has been toughening its oversight of sales practices on products such as variable annuities, which combine insurance and equities (InvestmentNews, June 13).
In May, NASD told 10 of its broker-dealer members that it was scrutinizing the common industry practice of variable annuity companies' offering extra commissions to firms and reps for selling their products. Such bonuses are known as "commission specials."
NASD recently has been pressing its broker-dealer members for sales practices regarding life insurance products. Last Wednesday, NASD said it had fined independent-contractor broker-dealer Hornor Townsend & Kent Inc. $325,000 for violations including having sales contests rewarding sales of proprietary variable life and variable annuity products.
The firm, which has 1,200 affiliated reps, is owned by Penn Mutual Life Insurance Co. of Horsham, Pa. The sales contests, which included weekend trips to New York, New Orleans and Las Vegas, as well as vouchers that could be traded for entertainment, ended in 2003.
"Since then, Horner Townsend & Kent reviewed procedures and processes, and made changes to focus on the client," said Pat Beauchamp, a company spokeswoman.