Document ID: SEC-2006-0824-0001
Agency: sec
Document Type: Notice
Title: Self-regulatory organizations; proposed rule changes: National Association of Securities Dealers, Inc.
Posted Date: 2006-06-28T04:00Z

[Federal Register: June 28, 2006 (Volume 71, Number 124)]
[Notices]               
[Page 36840-36847]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr28jn06-131]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54023; File No. SR-NASD-2004-183]

 
Self-Regulatory Organizations: National Association of Securities 
Dealers, Inc.; Notice of Filing Amendment No. 2 to Proposed Rule 
Relating to Sales Practice Standards and Supervisory Requirements for 
Transactions in Deferred Variable Annuities

June 21, 2006.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on December 14, 2004, NASD filed with the Securities and Exchange 
Commission (``SEC'' or ``Commission''), the proposed rule. NASD filed 
amendment No. 1 on July 8, 2005, which replaced and superseded the text 
of the original rule filing. The proposed rule, as amended by Amendment 
No. 1, was published for comment in the Federal Register on July 21, 
2005.\3\ The Commission received approximately 1500 comments on the 
proposal.\4\ NASD filed Amendment No. 2 on May 4, 2006, which addressed 
the comments and proposed responsive amendments. Amendment No. 2 is 
described in Items I, II and III below, which Items have been prepared 
by NASD. The Commission is publishing this notice to solicit comments 
on Amendment No. 2 to the proposed rule from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Exchange Act. Re. No. 52046A (July 19, 2005); 70 FR 
42126 (July 21, 2005) (SR-NASD-2004-183).
    \4\ Approximately 1300 of these comments were virtually 
identical.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule

    NASD is proposing a new rule, NASD Rule 2821, that would set forth 
recommendation requirements (including a suitability obligation), 
principal review and approval requirements, and supervisory and 
training requirements tailored specifically to transactions in deferred 
variable annuities. Below is the amended text of the proposed rule.
* * * * *
2821. Members' Responsibilities Regarding Deferred Variable Annuities
(a) General Considerations
(1) Application
    This Rule applies to the purchase or exchange of a deferred 
variable annuity and the subaccount allocations. This Rule does not 
apply to reallocations of 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 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 makes such 
recommendations.
(2) Creation, Storage and Transmission of Documents
    For purposes of this Rule, documents may be created, stored and 
transmitted in electronic or paper form, and signatures may be 
evidenced in electronic or other written form.
(3) Definitions
    For purposes of this Rule, the term ``registered principal'' shall 
mean a person registered as a General Securities Sales Supervisor 
(Series 9/10), a General Securities Principal (Series 24) or an 
Investment Company Products/Variable Contracts Principal (Series 26), 
as applicable.
(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 ember has a reasonable 
basis to believe that.
    (A) The customer has been informed of the material features of a 
deferred variable annuity, such as the potential surrender period and 
surrender charge; potential tax penalty if the customer sells or 
redeems the deferred variable annuity before he or she reaches the age 
of 59\1/2\; mortality and expense fees; investment advisory fees; 
potential charges for and features of riders; the insurance and 
investment components of a deferred variable annuity; and market risk;
    (B) The customer would benefit from the unique features of a 
deferred variable annuity (e.g., tax-deferred growth, annuitization or 
a death benefit); and
    (C) 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 ont he information required by paragraph 
(b)(2) of this Rule.
    These determinations shall be documented and signed by the 
associated person recommending the transaction.
    (2) Prior to recommending the purchase or exchange of a deferred 
variable annuity, a member or person associated with a member shall 
make reasonable efforts to obtain, at a minimum, information concerning 
the customer's age, annual income, financial situation and needs, 
investment experience, investment objectives, intended use of the 
deferred variable annuity, investment time horizon, existing investment 
and life insurance holdings, liquidity needs, liquid net worth, risk 
tolerance, tax status and such other information used or considered to 
be reasonable by the member or person associated with the member in 
making recommendations to customers.
(c) Principal Review and Approval
    (1) No later than two business days following the date when a 
member or person associated with a member transmits a customer's 
application for a deferred variable annuity to the issuing insurance 
company for processing and irrespective of whether the transaction has 
been recommended, a registered principal shall review and determine 
whether he or she approves of the purchase or exchange of the deferred 
variable annuity. In reviewing the

[[Page 36841]]

purchase or exchange of a deferred variable annuity, the registered 
principal shall consider.
    (A) The extent to which the customer would benefit from the unique 
features of a deferred variable annuity (e.g., tax-deferred growth, 
annunciation or a death benefit);
    (B) The extent to which the customer's age or liquidity needs make 
the investment inappropriate;
    (C) The extent to which the amount of money invested would result 
in an undue concentration in a deferred variable annuity or deferred 
variable annuities in the context of the customer's overall investment 
portfolio; and
    (D) If the transaction involves an exchange of a deferred variable 
annuity, the extent to which (i) the customer would incur a surrender 
charge, be subject to the commencement of a new surrender period, lose 
death or existing benefits, or be subject to increased fees or charges 
(such as mortality and expense fees, investment advisory fees and 
charges for riders and similar product enhancements), (ii) the customer 
would benefit from any potential product enhancements and improvements, 
and (iii) the customer's account has had another deferred variable 
annuity exchange within the preceding 36 months.
    These considerations shall be documented and signed by the 
registered principal who reviewed and approved the transaction.
    (2) When a member or a person associated with a member has 
recommended the purchase or exchange of a deferred variable annuity, a 
registered principal, taking into account the underlying supporting 
documentation described in paragraph (b)(2) of this Rule, shall review, 
determine whether to approve and, if approved, sign the suitability 
determination document required by paragraph (b)(1) of this Rule no 
later than two business days following the date when the member or 
person associated with the member transmits the customer's application 
for a deferred variable annuity contract to the issuing insurance 
company for processing.
(d) Supervisory Procedures
    In addition to the general supervisory and recordkeeping 
requirements of Rules 3010, 3012, 3013 and 3110, a member must 
establish and maintain specific written supervisory procedures 
reasonably designed to achieve compliance with the standards set forth 
in this Rule. In particular, the member must implement procedures to 
screen the transaction and require a registered principal to consider 
those items enumerated in paragraph (c) of this Rule, as well as 
whether the associated person effecting the transaction has a 
particularly high rate of effecting deferred variable annuity 
exchanges.
(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 paragraph (b)(1)(A) of this Rule.
* * * * *

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

    In its filing with the Commission, NASD included statements 
concerning the purpose of and basis for the proposed rule and discussed 
the comments it received on the proposed rule. The text of these 
statements may be examined at the places specified in Item IV below. 
NASD 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

1. Purpose
a. Background
    On December 14, 2004, NASD filed with the Commission proposed Rule 
2821 (SR-NASD-2004-183). NASD filed with the Commission Amendment No. 1 
to the proposed rule on July 8, 2005. The Commission published the 
proposed rule, as amended by Amendment No. 1, in the Federal Register 
on July 21, 2005.\5\ The comment period closed on September 19, 2005. 
Based on comments received in response to the publication of the 
proposed rule in the Federal Register, NASD filed Amendment No. 2 to 
SR-NASD-2004-183 to address the comments and to make certain changes to 
the proposed rule as discussed herein.
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    \5\ See supra note 3.
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b. Proposed Rule
    As described in the original and amended rule filings, NASD is 
proposing new NASD Rule 2821, which would impose specific sales 
practice standards and supervisory requirements on members for 
transactions in deferred variable annuities.\6\ In general, NASD's 
guidelines on deferred variable annuity transactions, developed with 
substantial input from industry participants and published in Notice to 
Members 99-35, served as the basis for the proposed rule.
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    \6\ A variable annuity, in general, is a cotnract between an 
investor and an insurance company whereby the insurance company 
promises to make periodic payments to the contract owner or 
beneficiary, starting immediately (an immediate variable annuity) or 
at some future time (a deferred variable annuity). See Joint SEC and 
NASD Staff Report on Broker-Dealer Sales of Variable Insurance 
Products (June 2004) (``Joint Report''); NASD Notice to Members 99-
35 (May 1999). The proposed rule focuses exclusively on transactions 
in deferred variable annuities. NASD recognizes that transactions 
involving immediate variable annuities have begun to increase 
recently, and NASD will continue to monitor sales practices relating 
to these products. Currently, however, deferred variable annuities 
make up the majority of variable annuity transactions. Moreover, to 
date, most of the problems associated with transactions in variable 
annuities that NASD has uncovered involve the purchase or exchange 
of deferred variable annuities.
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    The proposed rule would apply to the purchase or exchange of a 
deferred variable annuity and the initial subaccount allocations.\7\ 
The proposed rule would not apply to reallocations of subaccounts or to 
funds paid after the initial purchase or exchange of a

[[Page 36842]]

deferred variable annuity. However, other NASD rules would continue to 
apply. For instance, NASD's suitability rule, Rule 2310, would continue 
to apply to any recommendations to reallocate subaccounts.\8\
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    \7\ NASD notes that the proposed rule focuses on customer 
purchases and exchanges of deferred variable annuities, areas that, 
to date, have given rise to many of the problems NASD has uncovered. 
The proposed rule would thus cover a standalone purchase of a 
deferred variable annuity and an exchange of one deferred variable 
annuity for another for another deferred variable annuity. For 
purposes of the proposed rule, an ``exchange'' of a product other 
than a deferred variable annuity (such as a fixed annuity) for a 
deferred variable annuity would be covered by the proposed rule as a 
``purchase.'' The proposed rule would not cover customer sales of 
deferred variable annuities, including the sale of a deferred 
variable annuity in connection with an ``exchange'' of a deferred 
variable annuity for another product (such as a fixed annuity). 
However, recommendations of customer sales of deferred variable 
annuities are fully and adequately covered by Rule 2310, NASD's 
general suitability rule. Rule 2310 requires that, when recommending 
that a customer purchase, sell or exchange a security, an associated 
person determine whether the recommendation is suitable for the 
customer. In general, deferred variable annuities are suitable only 
as long-term investments and are inappropriate short-term trading 
vehicles. As part of any analysis under Rule 2310 regarding the 
suitability of a recommendation that a customer sell a deferred 
variable annuity, the associated person must consider significant 
tax consequences, surrender charges and loss of death or other 
benefits. As NASD emphasized in a Regulatory & Compliance Alert in 
2002, entitled ``Reminder--Suitablity of Variable Annuity Sales,'' 
members and their associated persons ``must keep in mind that the 
suitability rule applies to any recommendation to sell a variable 
annuity regardless of the use of the proceeds, including situations 
where the member recommends using the proceeds to purchase an 
unregistered product such as an equity-indexed annuity. Any 
recommendation to sell the variable annuity must be based upon the 
financial situation, objectives and needs of the particular 
investor.''
    \8\ Indeed, except to the extent that specific provisions in the 
proposed rule would govern, or unless the context otherwise 
requires, the provisions of the by-laws and rules and all other 
interpretations and policies of the NASD Board of Governors would be 
applicable to transactions in deferred variable annuities.
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    The proposed rule also would not apply to sales of deferred 
variable annuities to certain tax-qualified, employer-sponsored 
retirement or benefit plans. It would, however, apply if a member makes 
recommendations to individual plan participants regarding a deferred 
variable annuity.\9\ In addition, the rule would apply to the purchase 
or exchange of deferred variable annuities to fund individual 
retirement accounts (IRAs). In part, NASD determined not to exclude 
IRAs from the scope of the proposed rule because, unlike transactions 
for tax-qualified, employer-sponsored retirement or benefit plans, 
investors funding IRAs are not limited to the options provided by a 
plan.\10\
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    \9\ In other words, the proposed rule would apply as to the 
individual plan participants to whom the member makes 
recommendations, but would not apply as to the plan sponsor, trustee 
or custodian regarding the plan-level selection of investment 
vehicles and options for such plans.
    \10\ NASD notes as well that a deferred variable annuity 
purchased to fund an IRA does not provide any additional tax 
deferred treatment of earnings beyond the treatment provided by the 
IRA itself. Accordingly, where a customer is purchasing a deferred 
variable annuity to fund an IRA, firms must ensure that the deferred 
variable annuity's features other than tax deferral make the 
purchase of the deferred variable annuity for the IRA appropriate.
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    The proposed rule has four main provisions: (1) Requirements 
governing recommendations, including a suitability obligation, 
specifically tailored to deferred variable annuity transactions; \11\ 
(2) principal review and approval obligations; \12\ (3) a specific 
requirement for members to establish and maintain written supervisory 
procedures reasonable designed to achieve compliance with the standards 
set forth in the proposed rule; \13\ and (4) a targeted training 
requirement for members' associated persons, including their registered 
principals.\14\
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    \11\ See Proposed Rule 2821(b).
    \12\ See Proposed Rule 2821(c).
    \13\ See Proposed Rule 2821(d).
    \14\ See Proposed Rule 2821(e).
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    NASD will announce the effective date of the proposed rule in a 
Notice to Members to be published no later than 60 days following 
Commission approval. The effective date will be 180 days following 
publication of the Notice to Members announcing Commission approval.
c. Comments on the Proposed Rule
    The Commission received nearly 1500 comment letters in response to 
the publication of the proposed rule in the Federal Register. These 
comments are available on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml
). A summary of the comments and NASD's 

response is set forth below.
    While some commenters expressed support for the proposed rule,\15\ 
most opposed it.\16\ Reasons for their opposition varied. Several 
commenters stated that the proposal should be withdrawn, viewing it as 
unnecessary and arguing that NASD has not demonstrated a need for 
it.\17\ While NASD disagreed with the suggestion that there must be 
demonstrable harm before it can engage in rulemaking, in its response 
to comments it also noted the numerous Notices to Members, Regulatory & 
Compliance Alerts and Investor Alerts that it has issued regarding 
deferred variable annuities. NASD also noted that notwithstanding those 
efforts, a recent joint review with the Commission, NASD examinations 
and NASD enforcement actions indicate NASD's prior efforts have not 
been sufficiently effective at curbing problems in this area.
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    \15\ See, e.g., North American Securities Administrators 
Association (``NASAA''), Patricia D. Struck, President and Wisconsin 
Securities Administrator (9/20/05); Pace Investor Rights Project 
(``Pace''), Barbara Black, Director (9/19/05); and Public Investors 
Arbitration Bar Association (``PIABA''), Rosemary J. Shockman, 
President (9/9/05).
    \16\ See, e.g., America Council of Life Insurers (``ACLI''), 
Carl B. Wilkerson, Vice President & Chief Counsel (9/19/05); 
Committee of Annuity Insurers (``CAI''), W. Thomas Conner and Eric 
A. Arnold, Sutherland Asbill & Brennan LLP (9/19/05), National 
Association for Variable Annuities (``NAVA''), Michael P. DeGeorge, 
General Counsel (9/19/05); Securities Industry Association 
(``SIA''), Ira D. Hammerman, Senior Vice President and General 
Counsel (9/19/05); T. Rowe Price Investment Securities, Inc. (``T. 
Rowe Price''), Henry H. Hopkins, Darrell N. Braman and Sara 
McCafferty (9/19/05); and Wachovia Securities, LLC (``Wachovia''), 
Ronald C. Long, Senior Vice President (9/19/05).
    \17\ See, e.g., ACLI; CAI; NAVA; and SIA.
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i. Comments on Proposed Rule 2821(a)(1)--Application
    Numerous commenters argued that the rule should not apply to tax-
qualified, employer-sponsored retirement or benefit plans. One 
commenter believed, however, that the rule should apply to those plans 
in which the plan sponsor, trustee, or custodian is either 
``unsophisticated'' or primarily relied on the recommendation of the 
member.\18\ NASD disagreed. In its response to comments, NASD stated 
that the rule should not apply to plan-level decisions. In NASD's view, 
the factors that can be important to understanding the appropriateness 
of a recommendation to a sponsor, trustee or custodian of a qualified 
retirement or benefit plan can be distinct from those that are 
important regarding the determination of the appropriateness of a 
recommendation to a retirement-plan participant.
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    \18\ NASAA.
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    One commenter suggested that, in addition to transactions in 
connection with ``qualified plans'' as defined in Section 3(a)(12)(C) 
of the Act and plans that meet the requirements of Internal Revenue 
Code Sections 403(b) and 457(b), the rule should not apply to 
transactions with plans that meet the requirements of Section 457(f) of 
the Internal Revenue Code, unless the member makes a recommendation to 
an individual plan participant.\19\ NASD agreed and proposes to exclude 
transactions in connection with these plans from the rule. Another 
commenter argued that the rule should not apply to transactions with 
individual plan participants if the only funding vehicle for a tax-
qualified employer sponsored plan is a deferred variable annuity.\20\ 
NASD disagreed and in its response to comments stated that the proposed 
rule would apply if a registered representative recommends the deferred 
variable annuity in the plan to an individual plan participant. It 
noted, however, that only communications constituting a 
``recommendation'' would trigger application of the rule.
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    \19\ NAVA.
    \20\ Lincoln Investment Planning (``Lincoln''), Deirdre B. 
Koerick, Vice President (9/19/05).
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    A number of commenters asked NASD to clarify that the rule would 
not apply to premiums paid into a deferred variable annuity after the 
initial purchase and to subsequent purchase payments.\21\ As it noted 
in its response to comments, NASD has modified the proposed rule to 
specify that it ``does not apply * * * to funds paid after the initial 
purchase or exchange.''
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    \21\ CAI; Massachusetts Mutual Life Insurance Company (``Mass 
Mutual''); Jennifer B. Sheehan, Assistant Vice President and Counsel 
(9/19/05); NAVA; and Northwestern Mutual Investment Services 
(``NMIS''), Daniel A. Riedl, Senior Vice President and Chief 
Operating Officer (9/16/05).
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    One commenter asserted that the NASD has no basis for excluding an 
investor's reallocation of his or her subaccounts from the scope of the 
proposed rule.\22\ This commenter believed that specific attention 
should be paid to the broker's obligation to oversee and reallocate 
sub-accounts

[[Page 36843]]

because brokers do not pay attention or fail to follow-up on a 
customer's subaccount investments, often allowing these accounts to 
flounder in unsuitable investments. NASD declined to take this 
suggestion, but noted that NASD Rule 2310 continues to apply to a 
customer's subaccount investments.
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    \22\ PIABA.
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    Another commenter stated that the rule should also apply to the 
sale of immediate variable annuities.\23\ In response, NASD stated that 
the majority of variable annuity transactions currently are in deferred 
variable annuities, and that most of the problems NASD has uncovered 
have been associated with the purchase or exchange of deferred variable 
annuities. However, NASD also stated that it will continue to monitor 
sales practices relating to immediate variable annuities.
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    \23\ NASAA.
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ii. Comments on Proposed rule 2821(b)--Recommendation Requirements
(a) General Comments
    Several commenters urged NASD to eliminate the specific suitability 
requirements from paragraph (b) of the proposed rule.\24\ Some 
commenters asserted that deferred variable annuities are too varied and 
complex to mandate specific criteria for determining suitability.\25\ 
Others stated that NASD would need to clarify the level of knowledge 
that would be sufficient to support a registered representative's 
``reasonable basis'' for believing the standards of paragraph (b) have 
been met with respect to a particular customer.\26\
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    \24\ See, e.g., Association for Advanced Life Underwriting/
National Association of Insurance and Financial Advisers (``AALU/
NAIFA''), Gary A. Sanders, Senior Counsel (9/19/05); ACLI; 
Intersecurities, Inc. (``Intersecurities''), Thomas R. Moriarty, 
President (9/16/05); NAVA; SIA; and World Group Securities, Inc. 
(``World Group''); Leesa M. Easley, Chief Legal Officer (9/8/05).
    \25\ HD Vest Financial Services (``HD Vest''), Roger C. Ochs, 
President (9/20/05); Investment Company Institute (``ICI''), Frances 
M. Stadler, Deputy Senior Counsel (9/19/06); and T. Rowe Price.
    \26\ Associated Securities Corporation (``Associated 
Securities''), Denise M. Evans, General Counsel (9/19/05); Lincoln; 
and Pacific Select Distributors, Inc. (``Pacific Distributers''), 
John L. Dixon, President (9/16/05).
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(b) Comments on Proposed Rule 2821(b)(1)(A)--Deferred Variable 
Annuity's Material Features
    The rule, as originally proposed, would have required members to 
have a reasonable basis to believe that the customer has been informed 
of the material features of a specific deferred variable annuity before 
recommending it. Commenters criticized this provision, arguing that it 
would amount to a de facto requirement to provide written disclosure to 
customers \27\ Commenters asserted that this disclosure along with the 
other disclosures already provided to investors in deferred variable 
annuities would be redundant and would overwhelm investors.\28\
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    \27\ See, e.g., American Bankers Insurance Association/ABA 
Securities Association (``ABIA/ABASA''), Beth L. Climo, Executive 
Director (9/20/06); ACLI; A.G. Edwards & Sons, Inc. (``A.G. 
Edwards''), Thomas M. Vacovino, Vice President (9/20/05); HD Vest; 
ING; Intersecurities; NAVA; SIA; and Wachovia.
    \28\ AALU/NAIFA; ACLI; Intersecurities; NAVA; SIA; and World 
Group. Commenters pointed out that investors already receive a 
prospectus and state-mandated disclosures and may in the future 
receive an SEC-mandated point of sale disclosure form.
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    A few commenters supported a mandatory plain English summary and an 
industry-wide or product specific Q&A that would answer basic questions 
about fees, taxes, liquidity and other issues.\29\ While one commenter 
requested that NASD wait and consider the proposed rule after the 
Commission acts on its ``point of sale'' rule proposal.\30\ another 
stated that the ``point of sale'' disclosure form would not be a 
substitute for a ``plain English'' risk disclosure.\31\
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    \29\ MWA Financial Services (``MWA''), Pamela S. Fritz, Chief 
Compliance Officer (3/18/05); NASAA; and Pace.l
    \30\ National Planning Holdings, Inc. (``National Planning''), 
M. Shawn Dreffein, President and Chief Executive Officer (9/9/05). 
For details regarding the Commission's point of sale rule proposal, 
see, Securities Exchange Act Release No. 49148, (January 29, 2004), 
69 FR 6438 (February 10, 2004) and Securities Exchange Act Release 
No. 51274 (Feb. 28, 2005), 70 FR 10521 (March 1, 2005). Securities 
Exchange Act Release No. 51274 (Feb. 28, 2005), 70 FR 10521 (March 
1, 2005) (``Supplemental Release'').
    \31\ Pace.
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    Some commenters opined that the rule would be more effective if it 
required a registered representative to direct the customer to the 
variable annuity synopsis, fee table and risk disclosure in the 
prospectus.\32\ Others argued that if NASD and the Commission believe 
that the prospectus is inadequate, the solution would be to revise the 
prospectus rather than to require additional disclosures.\33\
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    \32\ ABIA./ABASA; ACLI; A.G. Edwards; HD Vest; ING; NAVA; SIA; 
Wachovia; and World Group.
    \33\ ACLI and World Group.
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    While noting in its response to comments that numerous commenters 
sought to eliminate this provision, NASD modified it to no longer 
require product-specific disclosure. As revised, the proposed rule 
would require a registered representative to have a reasonable belief 
that the customers has been informed of the material features of 
deferred variable annuities in general. NASD cautioned, however, that 
this modification would not mean that a firm and its associated person 
may ignore product-specific features. It noted that the firm and its 
associated person must be capable of discussing the specific features 
of the deferred variable annuity under consideration, and must know 
these features in order to adequately perform a suitability analysis.
    The proposed rule would have required a registered representative 
to document and sign the determinations that he or she has made 
pursuant to the proposed rule's recommendation requirements. Some 
commenters criticized this requirement, noting that neither the rule 
nor the release described what the documentation should look like or 
how detailed it should be.\34\ Another commenter supported this 
requirement, opining that it would serve the dual purpose of creating a 
regulatory paper trail and reminding NASD members of the serious 
analytical undertaking involved in recommending a deferred variable 
annuity.\35\ After considering the comments, NASD has determined to 
retain the requirement.
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    \34\ See, e.g., ACLI; HD Vest; ING; NAVA; and SIA.
    \35\ Pace.
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(c) Comments on Proposed Rule 2821(b)(1)(B)--Long-Term Investment 
Objective
    The rule, as originally proposed, would have required members 
recommending a deferred variable annuity to have a reasonable belief 
that the customers had a long-term investment objective. Commenters 
asserted that an investor's time horizon does not have to be long-term 
in all circumstances for a deferred variable annuity to be suitable, 
noting that some deferred variable annuities have features that can 
benefit a customer regardless of age and potential for a long term 
investment.\36\ Some commenters stated that an investor's time horizon 
should be one factor in a suitability analysis, but that a deferred 
variable annuity should not be deemed per se unsuitable based on that 
factor alone.\37\
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    \36\ A.G. Edwards; CAI; Fintegra Financial Solutions 
(``Fintegra''), Kenneth M. Cherrier, Chief Compliance Officer (8/11/
05); HD Vest; ING; Intersecurities; Lincoln; NMIS; NAVA; New York 
Life Insurance and Annuity Corporation (``NY Life''), John R. Meyer, 
Senior Vice President (9/19/05); SIA; United Planners Financial 
Services of America (``United Planners), Julie Gebert, Vice 
President and Chief Compliance Officer (9/19/06); and World Group.''
    \37\ Fintegra; Financial Services Institute (``FSI''), Dale E. 
Brown, Executive Director (9/19/05); Great American Advisors 
(``Great American''), Shawn M. Mihal, Chief Compliance Officer (9/
19/05); HD Vest; MWA; NMIS; National Planning; Pacific Select; 
United Planners; and World Group.

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[[Page 36844]]

    In response to comments, NASD deleted this provision from paragraph 
(b) of the proposed rule and all references to long-term investment 
objectives in paragraph (c) (``Principal Review and Approval'') and 
paragraph (d) (``Supervisory Procedures''). In addition, NASD stated 
that in general, deferred variable annuities are appropriate only for 
customers with long-term investment objectives who intend to take 
advantage of tax-deferred accumulation and annuitization. Although NASD 
recognized that some deferred variable annuities have shorter holding 
periods and smaller surrender fees than traditional deferred variable 
annuities, it stated that a deferred variable annuity is suitable for 
an investor without a long-term investment objective only in rare 
cases. NASD also ``strongly cautioned'' firms to scrutinize any 
deferred variable annuity transaction involving customers without long-
term investment objectives and to carefully document any analysis in 
favor of recommending such a transaction.
(d) Comments on Proposed Rule 2821(b)(1)(C)--Need for the Product as 
Compared With Other Investment Vehicles
    As originally proposed, the rule would have required members to 
have a reasonable belief that the customer had a need for the deferred 
variable annuity as compared with other investment vehicles. Many 
commenters criticized this provision.\38\ Some stated that while 
customers may ``benefit'' from a deferred variable annuity, no customer 
``needs'' one.\39\ Some viewed the standard as subjective and 
overreaching, stating that it would require a determination that a 
deferred variable annuity is the sole, unique investment to satisfy the 
needs of a customer.\40\ Commenters also questioned what other 
investment vehicles would have to be compared with the deferred 
variable annuity \41\ and whether a registered representative would 
have to compare the deferred variable annuity to products that he or 
she is not licensed to sell.\42\
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    \38\ See, e.g., ACLI; CAI; HD Vest; NAVA; Pacific Select; United 
Planners; and World Group.
    \39\ ACLI; CAI; NAVA; and ICI. Some commenters also stated that 
these provisions conflict with NASD's longstanding concerns about 
product comparisons.
    \40\ A.G. Edwards; Intersecurities; NMIS; NY Life; SIA; and 
World Group.
    \41\ ACLI; CAI; ICI; ING; Mass Mutual; and NAVA.
    \42\ Intersecurities and World Group.
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    NASD noted in its response to comments that it did not intend to 
require firms to perform a side-by-side comparison of a deferred 
variable annuity with other investment vehicles or require firms to 
prove that the customer needed the deferred variable annuity to the 
exclusion of all other investments. Instead, NASD intends to require 
firms to analyze whether the customer would benefit from the unique 
features of a deferred variable annuity. To clarify this, NASD 
eliminated the references in the proposed rule to ``need'' and ``as 
compared with other investment vehicles.'' As revised, the rule would 
require a member or associated person to have a reasonable basis to 
believe that ``the customer would benefit from the unique features of a 
deferred variable annuity (e.g., tax-deferred growth, annuitization or 
a death benefit)''.
(e) Comments on proposed Rule 2921(b)(2)--Customer Information
    As originally proposed, the rule would have required members to 
make reasonable efforts to obtain from a customer a variety of 
information, including age, financial situation, liquid net worth and 
intended use of the deferred variable annuity. Some commenters urged 
NASD to delete this provision, stating that NASD Rules 2310 and 3110, 
as well as Rule 17a-3(17)(i)(A) of the Act, should govern the 
information that members are required to gather in making 
recommendations to purchase or exchange deferred variable 
annuities.\43\
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    \43\ National Planning; NAVA; NMIS; and Pacific Select.
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    Commenters also criticized a number of the terms used in this 
provision. Some viewed the terms ``financial situation'' and ``liquid 
net worth'' as vague and redundant.\44\ Others questioned what 
constitutes a legitimate intended use of a deferred variable annuity 
\45\ and whether ``other insurance holdings'' would be limited to life 
insurance or would also encompass automobile and health insurance.\46\ 
One commenter also inquired whether a registered representative must 
look to liquidity needs at the time of the sale or in the future and 
whether investment experience means experience in deferred variable 
annuities or overall investment experience.\47\After considering the 
comments, NASD has determined to retain this paragraph with limited 
revisions.
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    \44\ NAVA and NY Life.
    \45\ Associated Securities and FSI. Another commenter asked if 
these terms were the same as the investment objective. Lincoln.
    \46\ See, e.g., 1717 Capital Management Company and Nationwide 
Securities, Inc. (``1717 Capital''), Lance A. Reihl, President (9/
19/05); AALU/AIFA; ACLI; CAI; NAVA; NMIS; and NY Life.
    \47\ Lincoln.
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iii. Comments on Proposed Rule 2821(c)--Principal Review and Approval
    The rule, as originally proposed, would have required principals to 
review and approve the purchase or exchange of a deferred variable 
annuity before the customer's application was transmitted to the 
issuing insurance company for processing, regardless of whether the 
transaction was recommended.
(a) General Comments
    Several commenters viewed the proposed principal review requirement 
as unduly duplicative of NASD Rule 3110.\48\ Some stated that the 
proposed timing requirement and additional standards for principal 
review would be disruptive for firms that use automated systems to 
approve transactions that meet established criteria,\49\ and one 
suggested requiring manual principal review only when an application 
does not meet a firm's standard criteria.\50\
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    \48\ See, e.g., ACLI; Lincoln; Mass Mutual; NAVA; and SIA.
    \49\ CAI and NAVA.
    \50\ NAVA.
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(b) Comments on Proposed Rule 2821(c)(1)--Timing of Principal Review
    Two commenters supported the proposed provisions relating to the 
timing of principal review, stating that it would ensure that a 
principal would have sufficient time for a complete review while 
providing greater assurances that unsuitable transactions would not be 
consummated.\51\ Numerous commenters, however, objected to the 
principal review deadline.\52\ Some were concerned that members would 
be subject to liability for market changes during the delay for 
supervisory review.\53\ Others stated that the timing deadline would 
require costly reprogramming of broker-dealers' electronic processing 
systems that forward contracts to the insurance company and the 
broker's home office at the same time.\54\
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    \51\ NASAA and PIABA.
    \52\ See, e.g., ACLI; CAI; ING; and NAVA.
    \53\ Associated Securities; Pacific Direct; and United Planners.
    \54\ CAI and NMIS.
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    One commenter stated that the interaction of this provision with 
other Commission and NASD rules could limit a firm's ability to review 
applications thoroughly.\55\ Another stated that time-linking the 
application process with supervisory review would

[[Page 36845]]

impair the goal under the Investment Company Act of 1940's for timely 
processing.\56\ Some commenters stated that a delay in pricing the 
contract would be unfair to investors.\57\
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    \55\ ING.
    \56\ ACLI.
    \57\ ACLI; Pacific Select; and United Planners.
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    Two commenters recommended that NASD require the review to be 
completed prior to the insurance company issuing the contract.\58\ One 
of these commenters noted that while this would require logistical 
coordination between the principal and the issuer, it would allow 
insurers to process applications coextensively with the supervisory 
review, but before the security is issued.\59\ Others recommended 
requiring principals to conduct their review and approval promptly 
after the completion of the contract application and in accordance with 
procedures reasonably designed to ensure that problematic purchases are 
detected and disapproved.\60\
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    \58\ ACLI and NY Life.
    \59\ ACLI.
    \60\ CAI and NMIS.
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    A few commenters stated that the time deadline would not work in 
the context of direct sales, in which an insurance company may not know 
of an applicant's interest in a deferred variable annuity until it 
receives the application.\61\ Another stated that the timing deadline 
would not take into account situations in which the registered 
principal is housed in the insurance company.\62\
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    \61\ CAI; NAVA; and T. Rowe Price.
    \62\ NMIS.
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    A few commenter also stated that their current supervisory 
structure as an Office of Supervisory Jurisdiction would be incapable 
of dealing with the prior approval requirement and they would be forced 
to eliminate this form of supervisory structure.\63\ One commenter 
stated the requirement could overwhelm principals,\64\ and another 
stated that it would require members to allocate two to three times the 
supervisory staff for deferred variable annuities than for any other 
product.\65\
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    \63\ Great American and ING.
    \64\ Wachovia.
    \65\ Associated Securities.
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    NASD responded to commenters' concerns by modifying the timeframe 
for principal review from ``prior to transmitting a customer's 
application for a deferred variable annuity to the issuing insurance 
company'' to ``no later than two business days following the date when 
a member or person associated with a member transmits a customer's 
application for a deferred variable annuity to the issuing insurance 
company for processing.'' It stated that requiring completion of the 
principal review within two business days of the firm's transmittal of 
the application to the insurance company is necessary for the 
protecting of investors and should promote efficiency. It also noted 
that the proposed rule would not preclude firms from using automated 
supervisory systems, or a mix of automated and manual supervisory 
systems, to facilitate compliance with the rule. In addition, NASD 
delineated what, at a minimum, a principal would need to do if his or 
her firm intends to rely on automated supervisory systems to comply 
with the proposed rule. Specifically, a principal would need to (1) 
approve the criteria that the automated supervisory system uses, (2) 
audit and update the system as necessary to ensure compliance with the 
proposed rule, (3) review exception reports that the system creates, 
and (4) remain responsible for each transaction's compliance with the 
proposed rule. Finally, NASD noted that a principal would be 
responsible for any deficiency in the system's criteria that would 
result in the system not being reasonably designed to comply with the 
rule.
    NASD also noted that commenters asked whether the principal review 
would need to start, but not necessarily be completed, by the time 
specified in the rule. In most circumstances, NASD stated that under 
the revised timing requirement for principal review firms would be able 
to determine the appropriateness of the transactions before the 
insurance company issues the contract. In NASD's view, requiring 
completion of the principal review with this time period is necessary 
for the protection of investors. Moreover, it also believes that 
requiring a thorough principal review at the early stages of the 
process also should promote efficiency.
(c) Comments on Proposed Rule 2821(c)(1)--Specific Standard for 
Principal Review
    Commenters objected to the proposed requirements for members to 
establish standards regarding age, liquidity needs and the dollar 
amount involved in the transactions and questioned the need for such 
standards.\66\ While some requested more clarification of appropriate 
standards, others stated that NASD should mandate specific 
standards.\67\ One commenter criticized permitting firms to 
individually set their own standards, stating that firms would defend 
suitability challenges by asserting that the transaction met their own 
standards.\68\ Others expressed concern that without defined standards, 
a firm's suitability decisions would be second guessed and there would 
be inconsistent regulation as different NASD districts establish and 
impose different standards.\69\ One commenter stated that the provision 
would lead principals to emphasize two or three elements of a 
customer's profile rather than considering all of the facts and 
circumstances.\70\
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    \66\ See, e.g., Associated Securities; Dominion Investor 
Services, Inc. (``Dominion''), Kevin P. Takacs, Chief Compliance 
Officer (9/9/05); FSI; Great American; ING; Intersecurities; Pacific 
Select; and United Planners.
    \67\ Associated Securities; Dominion; FSI; Fintegra; Great 
American; MWA; and Wachovia.
    \68\ Pace.
    \69\ See, e.g., ABIA/ABASA; Associated Securities; Dominion; 
FSI; Great American; and ING.
    \70\ Intersecurities.
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    In its response to comments, NASD stated that the particular 
provisions requiring members to establish standards were never intended 
to require the adherence to brightline standards. It noted that the 
establishment of specific thresholds in these instances would 
unnecessarily limit a firm's discretion in establishing procedures that 
adequately address its overall operations. NASD intended for principals 
to consider these factors as part of their facts and circumstances 
review. As a result, NASD deleted the requirement for firms to 
establish standards for age, liquidity needs and dollar amounts.
(d) Comments on Proposed Rule 2821(c)(1)--Non-Recommended Transactions
    Some commenters objected to requiring principal review of 
transactions that are not recommended,\71\ and one noted that the 
information that would be needed for a principal review is not 
currently required to be collected for non-recommended annuity 
transactions.\72\ Another commenter stated that requiring review for 
non-recommended transactions would allow principals to second guess 
investors' decisions.\73\
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    \71\ See, e.g., ICI; NMIS; and T. Rowe Price.
    \72\ T. Rowe Price.
    \73\ ICI and NMIS.
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    NASD disagreed, noting that due to the complexity of the products, 
it is appropriate to require firms to review all deferred variable 
annuity transactions for problematic sales practices. It stated that 
the proposed rule would create requirements to ensure that firms 
perform a consistent, baseline analysis of transactions, irrespective 
of whether the customer purchased the deferred variable annuity as a 
result of an associated person's

[[Page 36846]]

recommendation, thereby enhancing investor protection for all 
customers.
(e) Comments on Proposed Rule 2821(c)(1)(D)--Rate of Exchanges
    Two commenters criticized the proposed provision that would require 
principals to consider whether the customer's account had a deferred 
variable annuity exchange within the preceding 36 months, stating it 
could signal to registered representatives that exchanges occurring 
more than 36 months apart are appropriate.\74\ One commenter stated 
that, while a firm should generate reports and review a registered 
representative's sales activity for patterns of inappropriate 
replacements as part of its supervisory procedures, it should not be 
required to approve each transaction.\75\ After considering the 
comments, NASD has determined to retain the requirement.
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    \74\ Intersecurities and World Group.
    \75\ Intersecurities.
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iv. Comments on Proposed Rule 2821(d)--Supervisory Procedures
    The rule, as originally proposed, would require members to 
establish and maintain specific written supervisory procedures 
reasonably designed to achieve compliance with the rule. Members would 
be required to implement procedures to screen transactions and require 
registered principals to consider all of the factors enumerated in 
paragraph (c) of the proposed rule. They would also have to consider 
whether the associated person effecting a transaction has a 
particularly high rate of effecting deferred variable annuity 
exchanges.
    One commenter supported requiring registered principals to review 
the total production attributable to variable annuities of associated 
person.\76\ One commenter requested guidance as to what a 
``particularly high rate'' refers to and what must be compared to 
determine it.\77\ After considering the comments, NASD determined to 
retain without modification the provision relating to high rates of 
exchange.
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    \76\ NASAA.
    \77\ Wachovia.
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v. Comments on Proposed Rule 2821(e)--Training
    Most of the commenters that addressed the training provision 
supported it.\78\ However, one commenter questioned the need for a 
specific training requirement and requested clarification regarding 
what additional training is contemplated.\79\ Some suggested that the 
training obligations in the proposed rule could be met through existing 
``Firm Element'' programs.\80\ After considering the comments, NASD 
determined to retain this requirement.
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    \78\ See, e.g., FSI; Great American; Lincoln; Mass Mutual; MWA; 
NAVA; and PIABA.
    \79\ ING.
    \80\ See, e.g., Pacific Select; United Planners; and Wachovia. 
NASD Rule 1120(b) requires each member to establish a training plan 
that identifies certain minimum requirements. Each year the firm 
must prepare a written training plan after an analysis of its 
training needs. Firms must consider certain factors when conducting 
their analyses and in developing their training plans, such as the 
firm's size, organizational structure, scope and type of business 
activities, as well as regulatory developments. This training is 
referred to as the ``Firm Element'' portion of NASD's continuing 
education requirements.
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(f) Comments on the Effective Date of Proposed Rule 2821
    NASD stated that the effective date of the proposal would be 120 
days following publication of its Notice to Members announcing 
Commission approval. Numerous commenters requested more time, from 180 
days \81\ to no less than one year,\82\ to comply with the proposed 
rule. In its response to comments, NASD stated that because some firms 
likely will have to make operational changes, it would be appropriate 
to provide additional time for members to comply with the rule, if 
approved. As a result, NASD stated that the proposed rule's effective 
date would be 180 days following publication of the Notice to Members 
in which it announces Commission approval.
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    \81\ ING and Intersecurities.
    \82\ NAVA, SIA, and World Group.
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2. Statutory Basis
    NASD believes that the proposed rule is consistent with the 
provisions of Section 15A(b)(6) of the Act,\83\ which requires, among 
other things, that NASD rules 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. NASD believes that the proposed rule is consistent 
with the provisions of the Act noted above in that it will enhance 
firms' compliance and supervisory systems and provide more 
comprehensive and targeted protection to investors in deferred variable 
annuities. As such, the proposed rule will decrease the likelihood of 
fraud and manipulative acts, promote just and equitable principles of 
trade and increase investor protection.
---------------------------------------------------------------------------

    \83\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

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

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

    The Commission published proposed rule 2821 (SR-NASD-2004-183) in 
the Federal Register on July 21, 2005. The comment period closed on 
September 19, 2005. The Commission received nearly 1500 comment letters 
in response to the Federal Register publication of the SR-NASD-2004-
183. The comment letters and NASD's response to them are discussed in 
section II above.

III. Date of Effectiveness of the Proposed Rule 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 (1) 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, or
    (B) Institute proceedings to determine whether the proposed rule 
should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 2, including whether the proposed 
rule is consistent with the Act.\84\ We also invite interested persons 
to discuss how, if at all, the proposed rule's timing requirement for 
principal review would impact member firms' ability to efficiently 
review deferred variable annuity transactions. What changes, if any, 
would member firms need to make to their supervisory procedures and 
systems in order to comply with the proposed rule's timing requirement 
for principal review? If changes would be necessary, we invite 
interested persons to discuss how current supervisory procedures and 
systems operate and why those procedures and systems would not 
accommodate the proposed rule's timing requirement for principal 
review.
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    \84\ The Commission will consider the comments we previously 
received. Commenters may reiterate or cross-reference previously 
submitted comments.
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    Comments may be submitted by any of the following methods:

[[Page 36847]]

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 -NASD-2004-183 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.
    All submissions should refer to File Number SR-NASD-2004-183. 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 that are filed 
with the Commission, and all written communications relating to the 
proposed rule 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 
Commisison's Public Reference Room. Copies of such filing also will be 
available for inspection and copying at the principal office of NASD.
    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-NASD-2004-183 
and should be submitted on or before July 19, 2006.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\85\
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    \85\ 17 CFR 200.30-3(a)(12).
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 J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 06-5730 Filed 6-27-06; 8:45 am]

BILLING CODE 8010-01-M