Document ID: SEC-2021-0277-0001
Agency: sec
Document Type: Notice
Title: Applications: Statement on Insurance Product Fund Substitution
Posted Date: 2021-02-26T05:00Z

[Federal Register Volume 86, Number 37 (Friday, February 26, 2021)]
[Notices]
[Pages 11813-11815]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2021-03989]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. IC-34199]

Commission Statement on Insurance Product Fund Substitution 
Applications

February 23, 2021.
AGENCY: Securities and Exchange Commission.

ACTION: Commission statement.

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    The Commission is issuing a statement regarding applications for 
orders approving the substitution of certain securities pursuant to 
section 26(c) of the Investment Company Act of 1940, as amended, (the 
``Act'') (and

[[Page 11814]]

related orders of exemption pursuant to section 17(b) of the Act from 
section 17(a) of the Act). The statement sets forth the Commission's 
position that the substitution by an insurance company of registered 
open-end investment companies used as investment options for variable 
life insurance policies or variable annuity contracts will not provide 
a basis for enforcement action under section 26(c) of the Act (and 
section 17(a) of the Act for in-kind substitutions) if the insurance 
company does not obtain an order under section 26(c) (and section 
17(b)) so long as the terms and conditions of the proposed substitution 
are substantially similar to those approved by a prior order for a 
substitution under section 26(c) (and section 17(b)) obtained by the 
insurance company since January 1, 2004.

DATES: The Commission's statement is effective upon publication in the 
Federal Register.

FOR FURTHER INFORMATION CONTACT: Jennifer O. Palmer, Senior Counsel, 
David J. Marcinkus, Branch Chief, Nadya B. Roytblat, Assistant Chief 
Counsel, or Daniele Marchesani, Assistant Chief Counsel, at (202) 551-
6825 (Chief Counsel's Office, Division of Investment Management).

SUPPLEMENTARY INFORMATION: Variable insurance contracts (variable 
annuities and variable life insurance policies) are issued by insurance 
companies and typically have a two-tier structure. The top tier is a 
separate account of the insurance company, registered under the Act as 
a unit investment trust (``UIT''). The separate account, in turn, has 
subaccounts that invest in numerous (sometimes hundreds of) underlying 
mutual funds (open-end investment companies registered under the Act) 
and exchange-traded funds (collectively, ``Investment Options''). 
Contract holders typically allocate their assets across these various 
Investment Options available through the separate account. Under the 
contracts, the insurance company typically reserves the right, subject 
to compliance with applicable laws, to substitute Investment Options 
with other Investment Options after appropriate notice. The contracts 
also typically permit the insurance company to limit the manner in 
which a contract owner may allocate purchase payments to the 
subaccounts that invest in an Investment Option.\1\ Insurance companies 
have offered separate account UITs with numerous Investment Options 
with the expectation and understanding that they would have the ability 
to make changes among the Investment Options in appropriate 
circumstances.
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    \1\ In addition to registering with the Commission as an 
investment company under the Act, each separate account registers 
its securities under the Securities Act of 1933. In doing so, each 
separate account files a registration statement with the Commission 
that includes a prospectus describing the Contracts offered by the 
separate account and a copy of the form of such contracts.
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    Section 26(c) of the Act prohibits a depositor or trustee of a UIT 
that invests in the securities of a single issuer from substituting the 
securities of another issuer without the approval of the Commission.\2\ 
Section 26(c) provides that such approval shall be granted by order of 
the Commission if the evidence establishes that the substitution is 
consistent with the protection of investors and the purposes fairly 
intended by the policy and provisions of the Act. Congress' concern 
underlying section 26(c) related to the lack of recourse and 
potentially additional fees experienced by investors in a single-
security UIT in the case of a substitution.\3\ Legislative history 
suggests that when Congress enacted the substitution order requirement 
in section 26(c) in 1970, it intended to limit the requirement to those 
UITs whose investors' economic exposure was limited to the single 
underlying security being substituted.\4\
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    \2\ Section 26(c) states: ``It shall be unlawful for any 
depositor or trustee of a registered unit investment trust holding 
the security of a single issuer to substitute another security for 
such security unless the Commission shall have approved such 
substitution. The Commission shall issue an order approving such 
substitution if the evidence establishes that it is consistent with 
the protection of investors and the purposes fairly intended by the 
policy and provisions of this title.'' 15 U.S.C. 80a-26(c).
    \3\ In amending section 26 to require Commission approval of 
substitutions, Congress stated: ``The proposed amendment recognizes 
that in the case of the unit investment trust holding the securities 
of a single issuer notification to shareholders does not provide 
adequate protection since the only relief available to shareholders, 
if dissatisfied, would be to redeem their shares. A shareholder who 
redeems and reinvests the proceeds in another unit investment trust 
or in an open-end company would under most circumstances be subject 
to a new sales load. The proposed amendment would close this gap in 
shareholder protection by providing for [Commission] approval of the 
substitution. The [Commission] would be required to issue an order 
approving the substitution if it finds the substitution consistent 
with the protection of investors and the purposes fairly intended by 
the policy and provisions of the Act.'' S. Rep. No. 184, 91st Cong., 
1st Sess. 41 (1969), reprinted in 1970 U.S.C.C.A.N. 4897, 4936 
(``Senate Report'').
    \4\ In 1966, the Commission recommended requiring Commission 
approval for any proposed substitution, regardless of the number of 
underlying issuers. See Report of the Securities and Exchange 
Commission on the Public Policy Implications of Investment Company 
Growth, H.R. Rep. No. 2337, 89th Cong. 2d Sess. 337 (1966) (stating 
``the Commission recommends that section 26 be amended to require 
that proposed substitutions may not occur without Commission 
approval''). Congress, however, amended section 26 with reference to 
single-security UITs only. At the time Congress enacted section 
26(c), most UITs invested all of their assets in a single security 
and issued ``periodic payment plan certificates,'' which in return 
for fixed monthly payments over a period of years provided the 
purchaser with an interest in, but not direct ownership of, an 
underlying investment company's shares. These single-security UITs 
``serve[d] merely as a mechanism for buying investment company 
shares on an installment payment basis.'' Id. at 38. Although UITs 
holding a variety of securities were popular in the early 1930s, by 
the time section 26(c) was enacted, their importance had dwindled. 
Both types of UITs seldom made changes to their underlying 
securities and were viewed as fixed portfolios. See id. at 38. In 
1982, in response to a commenter, the Commission stated in a release 
that it had determined not to reexamine at that time its position 
that section 26(c) of the Act requires Commission approval for a 
substitution of securities in any subaccount of a registered 
separate account. See Inv. Co. Act Rel. No. 12678 (Sep. 21, 1982) at 
5.
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    In the past four decades, nearly 200 substitution applications 
under section 26(c) by insurance companies sponsoring variable annuity 
and variable life insurance products that offer multiple Investment 
Options have been approved by the Commission.\5\ In so doing, the 
Commission has come to require terms and conditions that focus on key 
investor protections designed to address the concerns expressed in the 
legislative history of Section 26(c). These conditions include, among 
others, disclosure notifying affected contract owners at least 30 days 
in advance of the substitution; a requirement that each substitute fund 
have substantially similar investment objectives, principal investment 
strategies, and principal risks to the fund it is replacing; and a cap 
on total operating expenses of the substitute fund, such that they will 
not exceed those of the fund it is replacing for at least two years. 
The terms and conditions of substitution applications approved by the 
Commission under section 26(c) have been substantially similar to one 
another for at least the past 17 years.\6\
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    \5\ A number of such orders also included relief pursuant to 
section 17(b) of the Act from section 17(a)(1) and (2) of the Act to 
the extent necessary to permit the substitutions to be carried out 
by redeeming shares issued by each target fund in-kind and using the 
securities distributed as redemption proceeds to purchase shares 
issued by the applicable destination funds, at the respective net 
asset values of the funds. Section 17(a)(1) of the Act, in relevant 
part, prohibits any affiliated person of a registered investment 
company, or an affiliated person of such person, acting as 
principal, knowingly from selling any security or other property to 
such registered investment company. Section 17(a)(2) of the Act, in 
relevant part, prohibits any affiliated person of a registered 
investment company, or an affiliated person of such person, acting 
as principal, knowingly from purchasing any security or other 
property from such registered investment company. ``Affiliated 
person'' is defined in section 2(a)(3) of the Act.
    \6\ Pursuant to the Congressional Review Act, the Office of 
Information and Regulatory Affairs has designated this policy 
statement as not a ``major rule,'' as defined by 5 U.S.C. 804(2). 
See 5 U.S.C. 801 et seq.

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[[Page 11815]]

Commission Statement

    Based on the Commission's administrative experience with 
substitution orders, we are stating our position that the substitution 
by an insurance company of registered open-end investment companies 
used as Investment Options for variable life insurance policies or 
variable annuity contracts will not provide a basis for an enforcement 
action if the insurance company does not obtain an order from the 
Commission under section 26(c) (and section 17(b) for certain 
substitutions) so long as the terms and conditions of the proposed 
substitution are substantially similar to those approved by a prior 
order for a substitution pursuant to section 26(c) obtained by the 
insurance company since January 1, 2004.\7\
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    \7\ Our position also extends to any related relief under 
section 17(b) of the Act from section 17(a) that the insurance 
company might have received to conduct the substitutions in-kind.
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    When making the sort of substitution discussed in this Commission 
statement, the insurance company should submit correspondence 
accompanying its disclosure of the upcoming substitution made via a 
prospectus supplement filed with the Commission pursuant to Rule 497 
under the 1933 Act. Such correspondence should: (1) Indicate that the 
substitution is of the type discussed in this Commission statement; (2) 
identify the prior order with terms and conditions substantially 
similar to those in the substitution; (3) confirm that the substitution 
is consistent with the terms and conditions of the identified prior 
order; and (4) explain why each existing fund and corresponding 
replacement fund are substantially similar, including a comparison of 
the investment objectives, strategies and risks of each existing fund 
and its corresponding replacement fund.
    Any insurance company that has not obtained an order under section 
26(c) for a substitution since January 1, 2004 will need to apply for 
one, and any insurance company that prefers to receive such an order is 
able to continue to apply for one.\8\ We believe that this approach 
would continue to preserve the investor protections that have been 
afforded as part of the review of substitutions under section 26(c), 
while allowing for a more efficient process of substitutions in the 
variable insurance products context. We also believe that this approach 
would lessen the regulatory burden associated with insurance company 
substitutions, while remaining consistent with previous Substitution 
Orders that were designed to address the concerns reflected in the 
legislative history of section 26(c) of the Act.
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    \8\ An insurance company that has not obtained such an order 
since January 1, 2004, but may have acquired another insurance 
company that did, may not rely on the acquiree's order under the 
Commission's position; an insurance company that had obtained such 
an order and also may have acquired another insurance company that 
also had obtained such an order, must look exclusively to the terms 
and conditions of the acquiror's order for purposes of the 
Commission's position.

    By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2021-03989 Filed 2-25-21; 8:45 am]
BILLING CODE 8011-01-P