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FINRA and Indexed Annuities

Does FINRA have jurisdiction to require arbitration involving the sale of an indexed annuity?

Judith A. Hasenauer, 07/07/2011

Have a comment, insight, or burning opinion on this article? Make your feelings known in the comments section at the end of the article.

Prior to 1980, very few securities brokers sold life insurance products. Also, few traditional insurance agents sold any form of securities except for the proprietary variable annuities offered by the life insurance companies that were their principal providers of life insurance products.

In the early 1980s, large mutual fund companies entered the variable annuity business with proprietary variable annuities. These products were offered in partnership with life insurers and utilized the exclusive investment options provided by the mutual fund companies. Marketing responsibility for these products was usually exclusively in the control of the mutual fund company, and the wholesalers for these companies pushed sales through the same broker-dealers where they promoted their mutual fund sales. This "crossover" between the life insurance industry and the securities industry also morphed into the banking industry, so that today life insurance agents sell stocks and bonds, stock brokers and bankers sell annuities and life insurance products, and it is increasingly difficult to ascertain where one industry ends and another begins--at least insofar as products are concerned.

Almost immediately after this crossover began, there arose a concern over which regulators and which tribunals had jurisdiction over the sellers of the various products that were sold under the crossover. FINRA (then known as the NASD) had jurisdiction over sales of securities, including variable annuities. They did not have control over sales of life insurance products other than variable annuities. State insurance regulators had jurisdiction over sales of all life insurance products, including variable annuities. The question arose, what is the responsibility of securities regulators over malfeasance of a registered representative of a broker when selling a life insurance product? Likewise, what is the responsibility of insurance regulators over malfeasance of an insurance agent when selling securities?

It seemed clear that any form of major malfeasance--particularly one involving moral turpitude--should cause any regulator involved in the sales of financial products to step in and determine whether such a person should be relieved of the license to sell any type of financial product. Yet, during the early days of the crossover, each set of regulators seemed to believe that they had jurisdiction only over the sale of the specific products that they were delegated the responsibility to regulate. In cases of embezzlement, virtually all regulators would attempt to de-license a malefactor. Yet, it was less likely that any such action would take place with less blatant types of malfeasance, such as failure to disclose or suitability violations.

It is far more likely today for the separate regulators to look into any charges of malfeasance of a salesperson subject to their jurisdiction, regardless of the product sold. Yet, there is one area where we are beginning to see a new form of crossover--the area of FINRA arbitrations involving the suitability of exchanges of variable annuities for indexed annuities. A number of FINRA arbitrations have taken place and others are pending that involve a registered representative of a broker-dealer recommending an exchange of a variable annuity for an indexed annuity. Does FINRA have jurisdiction to require arbitration involving the sale of an indexed annuity? At the present time, indexed annuities are not required to be registered as securities. The SEC has attempted to classify certain types of indexed annuities as securities, but the attempt was thwarted in the courts and later, in the last round of regulatory "reforms," Congress exempted indexed annuities from the jurisdiction of the federal securities regulators.

So, if someone demands a FINRA arbitration action against a registered representative of a broker-dealer and against the broker-dealer where the transaction that causes the complaint involves an indexed annuity, does FINRA have jurisdiction?

It seems pretty clear that FINRA has jurisdiction over both sides of a securities transaction. This includes both the sale of a security to a consumer and the sale of a security by a consumer. Therefore, a registered representative who recommends the exchange of a variable annuity for an indexed annuity is subject to FINRA jurisdiction since the exchange of a variable annuity is, essentially, the sale of a security by the owner. Thus, even though it is questionable if FINRA has jurisdiction over the sale of the indexed annuity, they can question the suitability of the recommendation for the disposition of the variable annuity. This, through the back door, brings into question the recommendation for the purchase of the indexed annuity.

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