Approval By SEC of FINRA VA Rule

Executive Summary
The SEC granted approval to FINRA’s proposed changes to NASD Rule 2821 pertaining to sales practices and supervision for transactions in deferred variable annuities (VA). On May 5, 2008, Rule 2821 became partially effective. With the new SEC approval, the remainder of the rule will now become effective 240 days after FINRA publishes the regulatory notice announcing the SEC approval.

The new SEC approval to NASD Rule 2821 will include new procedures on principal review and approval, new supervisory procedures and a supplementary materials section. Because of the substantial industry comment that was received on these changes, a number of changes to the original proposed Rule were made.

Originally, registered principals would have been required to treat all VA transactions as though they were recommended by the firm to the client. FINRA received a lot of comment from the industry indicating that this would force discount firms out of the VA business because they do not make recommendations. In the final rule, FINRA is requiring firms to implement measures to detect and correct instances when brokers mischaracterize recommended transactions as non-recommended.

Also modified from the original rule is the requirement that all transactions be reviewed and approved by a principal. Initially, this would have been required to have been completed prior to transmission of a customer’s VA application to the insurance company, and within seven business days after the application is signed by the client.

It was determined that the 7-day period may not allow enough time for a thorough principal review, especially when the original customer application needed further clarification or was lacking information. The Rule now states that the 7-day period will begin on the date when the firm’s office of supervisory jurisdiction (OSJ) received a complete and correct copy of the application. The associated person who recommended the VA will need to promptly transmit the complete application package to the OSJ to ensure no applications are delayed in branch offices. Firms may forward funds to an insurance company for deposit in the insurance company’s suspense account pending completion of the principal review, as long as certain conditions are met, including requiring that the insurance company segregate the funds.

New Compliance Considerations
With the new rule come new implications for firms on their VA sales practices. Some key areas for consideration include:

Whether the firm has a process to “stop-the-clock” for applications that are considered incomplete and whether these applications are identified as such when first received;
Assessing if they have any representatives with a high portion of VA applications that are considered incomplete – and if there is a valid reason for this;
Implementing a means by which any exceptions to the 7-day approval will be communicated to the proper principal and expedited;
With respect to exchanges with the firm, determine if an automated process can identify if the client has had prior exchanges and if this is flagged for the principal independently of the representative;
For exchanges outside the firm, firms should consider a standardized process where representatives ask for and retain this information;
Review the documentation of the processes where representatives identify any previous VA exchanges the client may had made;
Identify if funds are sent on to an insurance company before approval, and determine how the firm can monitor if the insurance company is complying with the required segregation conditions;
When a firm allows its reps to do both recommended and non-recommended VA transaction, the firm should consider what measures can identify whether the transaction is properly classified;
Firm’s should have a surveillance process that will measure the time period when the customer application is first received to when it is approved by a principal – as well as the timely distribution from the branch to the OSJ for principal approval.

Variable annuities have been a key area of focus for FINRA exams and will continue to be. Examiners will continue to monitor the sale and supervision of VAs, the recommendations made to any senior investors to purchase or redeem VAs, the rationale where a VA is exchanged for another annuity, and exchanges based on the financial condition of the insurance company.

Regulatory Compliance will be happy to assist you with this rule change, making certain that your Written Supervisory Procedures are updated. Do not hesitate to contact your compliance professional at Regulatory Compliance (603-434-3594) for further clarification on how these changes might impact your operations.

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