Document ID: SEC-2008-0795-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2008-06-10T04:00Z

[Federal Register: June 10, 2008 (Volume 73, Number 112)]
[Notices]               
[Page 32771-32775]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr10jn08-89]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57920; File No. SR-FINRA-2008-019]

 
Self-Regulatory Organizations: Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Proposed Rule Change Relating to 
Sales Practice Standards and Supervisory Requirements for Transactions 
in Deferred Variable Annuities

June 4, 2008.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'' or ``SEA'') \1\ and Rule 19b-4 thereunder,\2\ notice 
is hereby given that on May 21, 2008, Financial Industry Regulatory 
Authority, Inc. (``FINRA'') (f/k/a National Association of Securities 
Dealers, Inc. (``NASD'')) filed with the Securities and Exchange 
Commission (``SEC'' or ``Commission'') the proposed rule change as 
described

[[Page 32772]]

in Items I, II, and III below, which Items have been prepared 
substantially by FINRA. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing to amend certain provisions of NASD Rule 
2821.\3\ Below is the text of the proposed rule change. Proposed new 
language is italicized; proposed deletions are in brackets.
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    \3\ On March 17, 2008, FINRA filed a separate proposed rule 
change, which became effective upon filing, to delay the effective 
date of paragraphs (c) and (d) of NASD Rule 2821 until 180 days 
following the Commission's approval or rejection of this substantive 
proposed rule change. See FINRA Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change to Delay the Effective Date of 
Certain FINRA Rule Changes Approved in SR-NASD-2004-183, Securities 
Exchange Act Release No. 57769 (May 2, 2008), 73 FR 26176 (May 8, 
2008) (SR-FINRA-2008-015). Paragraphs (a), (b), and (e) of NASD Rule 
2821, as approved in SR-NASD-2004-183, became effective as 
originally scheduled on May 5, 2008.
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* * * * *
2821. Members' Responsibilities Regarding Deferred Variable Annuities
    (a) General Considerations
    (1) Application
    This Rule applies to recommended [the] purchases [or] and exchanges 
of [a] deferred variable annuit[y]ies and recommended initial [the] 
subaccount allocations. This Rule does not apply to reallocations [of] 
among subaccounts made or to funds paid after the initial purchase or 
exchange of a deferred variable annuity. This Rule also does not apply 
to deferred variable annuity transactions made in connection with any 
tax-qualified, employer-sponsored retirement or benefit plan that 
either is defined as a ``qualified plan'' under Section 3(a)(12)(C) of 
the [Securities] Exchange Act [of 1934] or meets the requirements of 
Internal Revenue Code Sections 403(b), 457(b), or 457(f), unless, in 
the case of any such plan, a member or person associated with a member 
makes recommendations to an individual plan participant regarding a 
deferred variable annuity, in which case the Rule would apply as to the 
individual plan participant to whom the member or person associated 
with the member makes such recommendations.
    (2) No change.
    (3) No change.
    (b) Recommendation Requirements
    (1) No member or person associated with a member shall recommend to 
any customer the purchase or exchange of a deferred variable annuity 
unless such member or person associated with a member has a reasonable 
basis to believe
    (A) that the transaction is suitable in accordance with Rule 2310 
and, in particular, that there is a reasonable basis to believe that
    (i) No change.
    (ii) No change.
    (iii) the particular deferred variable annuity as a whole, the 
underlying subaccounts to which funds are allocated at the time of the 
purchase or exchange of the deferred variable annuity, and riders and 
similar product enhancements, if any, are suitable (and, in the case of 
an exchange, the transaction as a whole also is suitable) for the 
particular customer based on the information required by [sub]paragraph 
(b)(2) of this Rule; and
    (B) in the case of an exchange of a deferred variable annuity, the 
exchange also is consistent with the suitability determination required 
by [sub]paragraph (b)(1)(A) of this Rule, taking into consideration 
whether
    (i) No change.
    (ii) No change.
    (iii) the customer['s account] has had another deferred variable 
annuity exchange within the preceding 36 months.
    The determinations required by this paragraph shall be documented 
and signed by the associated person recommending the transaction.
    (2) No change.
    (3) Promptly after receiving information necessary to prepare a 
complete and correct application package for a deferred variable 
annuity, a person associated with a member who recommends the deferred 
variable annuity shall transmit the complete and correct application 
package to an office of supervisory jurisdiction of the member.
    (c) Principal Review and Approval
    Prior to transmitting a customer's application for a deferred 
variable annuity to the issuing insurance company for processing, but 
no later than seven business days after [the customer signs the 
application] an office of supervisory jurisdiction of the member 
receives a complete and correct application package, a registered 
principal shall review and determine whether he or she approves of the 
recommended purchase or exchange of the deferred variable annuity.
    [Subject to the exception in this paragraph, and treating all 
transactions as if they have been recommended for purposes of this 
principal review, a] A registered principal shall approve the 
recommended transaction only if he or she [the registered principal] 
has determined that there is a reasonable basis to believe that the 
transaction would be suitable based on the factors delineated in 
paragraph (b) of this Rule. [Notwithstanding the foregoing, a 
registered principal may authorize the processing of the transaction if 
the registered principal determines that the transaction was not 
recommended and that the customer, after being informed of the reason 
why the registered principal has not approved the transaction, affirms 
that he or she wants to proceed with the purchase or exchange of the 
deferred variable annuity.]
    The determinations required by this paragraph shall be documented 
and signed by the registered principal who reviewed and then 
approved[,] or rejected[, or authorized] the transaction.
    (d) No change.
    (e) Training
    Members shall develop and document specific training policies or 
programs reasonably designed to ensure that associated persons who 
effect and registered principals who review transactions in deferred 
variable annuities comply with the requirements of this Rule and that 
they understand the material features of deferred variable annuities, 
including those described in [sub]paragraph (b)(1)(A)(i) of this Rule.

Supplementary Material:

    .01 Under Rule 2821, a member that is permitted to maintain 
customer funds under SEA Rules 15c3-1 and 15c3-3 may, prior to the 
member's principal approval of the deferred variable annuity, deposit 
and maintain customer funds for a deferred variable annuity in an 
account that meets the requirements of SEA Rule 15c3-3.
    .02 If a customer provides a member that is permitted to hold 
customer funds with a lump sum or single check made payable to the 
member (as opposed to being made payable to the insurance company) and 
requests that a portion of the funds be applied to the purchase of a 
deferred variable annuity and the rest of the funds be applied to other 
types of products, Rule 2821 would not prohibit the member from 
promptly applying those portions designated for purchasing products 
other than a deferred variable annuity to such use. A member that is 
not permitted to hold customer funds can comply with such requests only 
through its clearing firm that will maintain customer funds for the 
intended deferred variable annuity purchase in an account that meets 
the requirements of SEA Rule 15c3-3. In such circumstances, the checks 
would need to be made payable to the clearing firm.

[[Page 32773]]

    .03 Rule 2821 does not prohibit a member from forwarding a check 
made payable to the insurance company or, if the member is fully 
subject to SEA Rule 15c3-3, transferring funds for the purchase of a 
deferred variable annuity to the insurance company prior to the 
member's principal approval of the deferred variable annuity, as long 
as the member fulfills the following requirements: (1) the member must 
disclose to the customer the proposed transfer or series of transfers 
of the funds and (2) the member must enter into a written agreement 
with the insurance company under which the insurance company agrees to 
(a) segregate the member's customers' funds in a bank in an account 
equivalent to the deposit of those funds by a member into a ``Special 
Account for the Exclusive Benefit of Customers'' (set up as described 
in SEA Rules 15c3-3(k)(2)(i) and 15c3-3(f)) to ensure that the 
customers' funds will not be subject to any right, charge, security 
interest, lien, or claim of any kind in favor of the member, insurance 
company, or bank where the insurance company deposits such funds or any 
creditor thereof or person claiming through them and hold those funds 
either as cash or any instrument that a broker or dealer may deposit in 
its Special Reserve Account for the Exclusive Benefit of Customers, (b) 
not issue the variable annuity contract prior to the member's principal 
approval, and (c) promptly to return the funds to each customer at the 
customer's request prior to the member's principal approval or upon the 
member's rejection of the application.
    .04 A member is not prohibited from forwarding a check provided by 
the customer for the purpose of purchasing a deferred variable annuity 
and made payable to an IRA custodian for the benefit of the customer 
(or, if the member is fully subject to SEA Rule 15c3-3, funds) to the 
IRA custodian prior to the member's principal approval of the deferred 
variable annuity transaction, as long as the member enters into a 
written agreement with the IRA custodian under which the IRA custodian 
agrees (a) to forward the funds to the insurance company to complete 
the purchase of the deferred variable annuity contract only after it 
has been informed that the member's principal has approved the 
transaction and (b), if the principal rejects the transaction, to 
inform the customer, seek immediate instructions from the customer 
regarding alternative disposition of the funds (e.g., asking whether 
the customer wants to transfer the funds to another IRA custodian, 
purchase a different investment, or provide other instructions), and 
promptly implement the customer's instructions.
    .05 Rule 2821 requires that the member or person associated with a 
member consider whether the customer has had another deferred variable 
annuity exchange within the preceding 36 months. Under this provision, 
a member or person associated with a member must determine whether the 
customer has had such an exchange at the member and must make 
reasonable efforts to ascertain whether the customer has had an 
exchange at any other broker-dealer within the preceding 36 months. An 
inquiry to the customer as to whether the customer has had an exchange 
at another broker-dealer within 36 months would constitute a 
``reasonable effort'' in this context. Members shall document in 
writing both the nature of the inquiry and the response from the 
customer.
    .06 Rule 2821 requires principal review and approval ``[p]rior to 
transmitting a customer's application for a deferred variable annuity 
to the issuing insurance company for processing* * * .'' In 
circumstances where an insurance company and its affiliated broker-
dealer share office space and/or employees who carry out both the 
principal review and the issuance process, FINRA will consider the 
application ``transmitted'' to the insurance company only when the 
broker-dealer's principal, acting as such, has approved the 
transaction, provided that the affiliated broker-dealer and the 
insurance company have agreed that the insurance company will not issue 
the contract prior to principal approval by the broker-dealer.
    07 Rule 2821 does not prohibit using the information required for 
principal review and approval in the issuance process, provided that 
the broker-dealer and the insurance company have agreed that the 
insurance company will not issue the contract prior to principal 
approval by the broker-dealer. For instance, the rule does not prohibit 
a broker-dealer from inputting information used as part of its 
suitability review into a shared database (irrespective of the media 
used for that database, i.e., paper or electronic) that the insurance 
company uses for the issuance process, provided that the broker-dealer 
and the insurance company have agreed that the insurance company will 
not issue the contract prior to principal approval by the broker-
dealer.
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. FINRA has prepared summaries, set forth in sections A, 
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    FINRA is proposing to amend NASD Rule 2821 to modify the rule's 
scope and the timing of principal review. FINRA also is proposing to 
clarify various issues that commenters have raised through a 
``Supplementary Material'' section following the rule text. Reasons for 
these changes are discussed below.
Limit Application of the Rule To Recommended Transactions
    As approved by the Commission, NASD Rule 2821(c) requires 
principals to treat ``all transactions as if they have been recommended 
for purposes of this principal review.'' Following the Commission's 
approval of the rule, however, numerous commenters asked the SEC and 
FINRA to reconsider this approach. Some of the commenters asserted that 
applying the rule to non-recommended transactions would have the 
unintended and harmful consequence of essentially forcing some firms 
that offer low-priced alternatives and do not allow recommendations or 
use transaction-based compensation out of the deferred variable 
annuities business. Still other commenters believed that, absent a 
recommendation, a customer should be completely free to invest in a 
deferred variable annuity without interference or second guessing from 
a broker-dealer.
    After further reflection, FINRA is proposing to limit the rule's 
application to recommended transactions. This approach is consistent 
with that taken by FINRA's general suitability rule, Rule 2310. This 
change, moreover, should not detract from the effectiveness of Rule 
NASD 2821 in providing additional protection to investors in deferred 
variable annuities. For instance, brokers recommend the vast majority 
of purchases and exchanges of

[[Page 32774]]

deferred variable annuities. Thus, the rule would continue to cover 
most transactions. FINRA emphasizes, moreover, that members must 
implement reasonable measures to detect and correct circumstances when 
brokers mischaracterize recommended transactions as non-recommended. 
Where the transaction truly is initiated by the customer and not 
recommended by the broker, there generally is less of a concern 
regarding potential or actual conflicts of interest and less of a need 
for heightened sales practice requirements. In addition, 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.
Modifying the Starting Point for the Seven-Business-Day Review Period
    NASD Rule 2821(c) requires principal review and approval ``[p]rior 
to transmitting a customer's application for a deferred variable 
annuity to the issuing insurance company for processing, but no later 
than seven business days after the customer signs the application.'' A 
number of firms asserted that seven business days beginning from the 
time when the customer signs the application may not allow for a 
thorough principal review in all cases. These firms provided examples 
of situations where a principal might not be able to complete the 
required review within the allotted time, such as when a customer 
inadvertently omits information from the application, when information 
provided by a customer on the application needs clarification, when a 
customer signs the application but does not mail it for several days 
after signature, and when a customer mails the application by regular 
U.S. mail.
    FINRA is proposing to modify the beginning of the period within 
which the principal must review and determine whether to approve or 
reject the application. Under the proposal, the period would begin to 
run not from the date of the customer's signature but from the date 
when the firm's office of supervisory jurisdiction (OSJ) receives a 
complete and correct copy of the application.\4\ This period should be 
sufficient to permit a principal to conduct an appropriate review, 
building in time for readily foreseeable delays, while still 
maintaining a definite period within which the principal must make a 
final decision.
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    \4\ As FINRA and the Commission previously have noted, ``Many 
broker-dealers are subject to lower net capital requirements under 
[Exchange Act] Rule 15c3-1 and are exempt from the requirement to 
establish and fund a customer reserve account under [Exchange Act] 
Rule 15c3-3 because they do not carry customer funds or 
securities.'' SEC Order Granting a Conditional Exemption to Broker-
Dealers from Requirements in Rules 15c3-1 and 15c3-3 under the 
Securities Exchange Act of 1934 to Promptly Transmit Customer Checks 
for the purchase of deferred variable annuity contracts, Securities 
Exchange Act Release No. 56376 (Sept. 7, 2007), 72 FR 52400 (Sept. 
13, 2007). Although some of these firms receive checks from 
customers made payable to third parties, the SEC does not deem a 
firm to be carrying customer funds if it ``promptly transmits'' the 
checks to third parties. The SEC has interpreted ``promptly 
transmits'' to mean that ``such transmission or delivery is made no 
later than noon of the next business day after receipt of such funds 
or securities.'' Id. In conjunction with its approval of NASD Rule 
2821, the Commission provided an exemption to the ``promptly 
transmits'' requirement as long as, among other things, the 
``principal has reviewed and determined whether he or she approves 
of the purchase or exchange of the deferred variable annuity within 
seven business days in accordance with [Rule 2821].'' Id. FINRA 
believes that the Commission's exemption order allows for the 
modification to the event that triggers the review period, discussed 
above.
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    To help ensure that the process remains efficient from the 
beginning, the proposal also would require the associated person who 
recommended the annuity to promptly transmit the complete and correct 
application package to the OSJ. However, that latter provision, 
proposed paragraph (b)(3) of NASD Rule 2821, would not preclude the 
customer from transmitting the complete and correct application package 
to the OSJ. For instance, there may be occasions where the application 
package is technically complete and correct but the customer wants to 
take it home and consider the purchase or exchange some more before 
sending the application to the OSJ. Proceeding in such a manner would 
not be inconsistent with the proposed provision.
Clarification of Issues Through Supplementary Material
    Commenters have raised a number of additional issues requiring 
clarification. A ``Supplementary Material'' section following the 
rule's text examines those issues that were raised by multiple groups 
and that potentially could have a significant impact on how members 
sell or process deferred variable annuities. FINRA refuted, for 
instance, the misconception that firms generally allowed to handled and 
carry customer funds under Exchange Act Rules 15c3-1 and 15c3-3 could 
not deposit funds for a deferred variable annuity prior to principal 
approval.
    FINRA also reconsidered the question of whether members could 
forward funds to insurance companies for deposit in the companies' 
``suspense accounts'' prior to principal approval. FINRA modified its 
earlier position rejecting such a process, discussed in Regulatory 
Notice 07-53 (Nov. 2007), and proposed to allow such action under 
certain conditions, including, inter alia, that the insurance company 
segregate the funds in a manner equivalent to that required of a member 
under Exchange Act Rule 15c3-3.
    In addition, the Supplementary Material section discusses 
customers' lump sum payments for the purchase of deferred variable 
annuities and other products, the forwarding of customer checks or 
funds to an IRA custodian prior to principal approval, the timing of 
``transmittal'' of the application where an insurance company and its 
affiliated broker-dealer share office space and/or employees, 
consideration of what constitutes a ``reasonable effort'' to determine 
whether a customer has had a recent exchange at another broker-
dealer,\5\ and the permissibility of using information required for 
principal review in the contract issuance process. These are all issues 
that commenters have raised on multiple occasions and that could 
broadly impact how broker-dealers sell, or process transactions in, 
deferred variable annuities.
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    \5\ FINRA notes that the proposal also clarifies in NASD Rule 
2821(b)(1)(B)(iii) that an analysis of whether the customer has had 
another recent exchange includes possible exchanges at other broker-
dealers. The rule currently states that the member must consider 
whether ``the customer's account has had another deferred variable 
annuity exchange within the preceding 36 months.'' Id. As FINRA 
stated in Regulatory Notice 07-53 (Nov. 2007), however, FINRA did 
not intend the use of the term ``account'' in that passage to limit 
the analysis only to exchanges at the member firm performing the 
review at issue. The proposal eliminates the term ``account'' to 
make this point even more clear.
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2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Exchange Act, \6\ which 
requires, among other things, that FINRA rules must be designed to 
prevent fraudulent and manipulative acts and practices, to promote just 
and equitable principles of trade, and, in general, to protect 
investors and the public interest. The rule change will promote 
investor protection because it will allow firms to focus on recommended 
transactions, which generally have the potential to raise more 
significant sales-practice issues than do non-recommended transactions, 
and will provide firms with adequate time to perform an appropriately 
thorough principal review. It will also provide firms with

[[Page 32775]]

guidance to clarify various issues with respect to the operation of the 
rule.
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    \6\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Exchange Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Exchange Act. Comments may be submitted 
by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-FINRA-2008-019 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-FINRA-2008-019. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/
rules/sro.shtml). Copies of the submission, all subsequent amendments, 
all written statements with respect to the proposed rule change that 
are filed with the Commission, and all written communications relating 
to the proposed rule change between the Commission and any person, 
other than those that may be withheld from the public in accordance 
with the provisions of 5 U.S.C. 552, will be available for inspection 
and copying in the Commission's Public Reference Room, 100 F Street, 
NE., Washington, DC 20549, on official business days between the hours 
of 10 a.m. and 3 p.m.. Copies of such filing also will be available for 
inspection and copying at the principal office of FINRA. All comments 
received will be posted without change; the Commission does not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly.
    All submissions should refer to File Number SR-FINRA-2008-019 and 
should be submitted on or before July 1, 2008.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\7\
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    \7\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Acting Secretary.
 [FR Doc. E8-12948 Filed 6-9-08; 8:45 am]

BILLING CODE 8010-01-P