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SEC approves rule increasing protection

By: dmc-admin//October 29, 2007//

SEC approves rule increasing protection

By: dmc-admin//October 29, 2007//

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The Securities and Exchange Commission (SEC) recently approved a controversial rule proposal that will add significant protections for investors purchasing or exchanging deferred variable annuities. Deferred variable annuities are life insurance annuity contracts whose value fluctuates over time, and whose income is not received immediately but delayed to a future date.

The deferred variable annuity rule imposes new requirements on financial services firms in four areas. The areas are: suitability; review and approval by a principal of the financial services firm; supervisory and compliance procedures; and training of financial advisers.

Let’s highlight the key features of new Rule 2821 as they relate to suitability. The suitability rule requires financial advisers to have a “reasonable basis” for believing the purchase or exchange of a deferred variable annuity to be suitable. Specifically, in the case of a purchase, the new rule requires that:

(1) the investor has been informed generally about the features of deferred variable annuities (such as surrender charges, taxation, tax penalties and market risk);

(2) the investor will benefit from certain features of the deferred variable annuities (such as tax-deferred growth, annuitization, or death or living benefit); and

(3) the annuity as a whole, the initial sub-account allocations, riders and similar product enhancements (if any) are suitable for the investor.

Likewise, in determining whether an annuity exchange is suitable, financial advisers must take into consideration whether:

(1) the customer will incur a surrender charge, be subject to a new surrender period, lose existing benefits (such as death, living or other contractual benefits), be subject to increased fees or charges (such as mortality and expense fees, investment advisory fees or charges for riders and similar product enhancements);

(2) the customer will benefit from product enhancements and improvements; and

(3) the customer’s account has had another deferred variable annuity exchange within the preceding 36 months.

Second, Rule 2821 requires that, prior to recommending a variable annuity, the financial adviser must make reasonable efforts to obtain a host of personal and financial information related to the investor. At a minimum, the rule requires making reasonable efforts to obtain information concerning the investor’s age, annual income, financial situation and needs, investment experience, investment objectives, investment time horizon, existing assets (including investment and life insurance holdings), liquidity needs, liquid net worth, risk tolerance, and tax status. The rule also requires something unique: the financial adviser must make reasonable efforts to determine the customer’s “intended use of the deferred variable annuity.”

Third, another unique suitability requirement is that the financial adviser document his or her considerations in writing and sign that writing.

Fourth, in the SEC’s release approving Rule 2821, a footnote states that: “The general suitability obligation requires a [financial services firm] to consider its customer’s ability to understand the security being recommended, including changes in the customer’s ability to understand, monitor, and make further decisions regarding securities over time.”

New Rule 2821 also imposes significant requirements relating to the review and approval of deferred variable annuity transactions. First, a principal at the financial services firm must review and approve the purchase or exchange not only in writing but also in advance of the transaction. Moreover, if by this review the principal determines that the transaction is unsuitable — whether or not the financial adviser is recommending the transaction — the transaction cannot be consummated, unless the customer nevertheless affirms that he or she wishes to proceed with the transaction (despite being informed that the financial adviser’s supervisor had not approved the transaction and the reason(s) why).

As one can see, a new, heightened standard of suitability, review and approval exists now to better protect investors purchasing or exchanging deferred variable annuities. That’s welcome news given what securities regulators have identified as “numerous instances of questionable sales practices”!

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