Financial services professionals need to get in line with the times.
For those of you who consider yourselves to be technologically challenged, the title of this article may cause some panic. We regularly come across people in the financial-services industry who have chosen to defer entry into the electronic age or who have abdicated responsibility for installing technology in their day-to-day activities to someone within their organization. We have all heard the jokes about those who have to rely on their children or grandchildren to hook up their computers, iPods, stereos, and the like. Unfortunately, those who are technologically challenged will very shortly be called upon to move into the 21st century.
It has been at least 15 years since the SEC has required electronic filing of registration statements and similar documents on its "EDGAR" system. Many sectors of the financial-services industry have used electronic delivery of prospectuses, reports, confirmations, and the like. More and more consumers routinely use electronic communications for their purchases, transactions with their brokers, and for their banking. Great numbers of financial advisors routinely communicate with their clients electronically. Yet, there are still a large number of financial advisors who still avoid electronic communications, and the various regulators have yet to require electronic filing of reports by investment advisors.
The variable annuity industry, through its trade association, NAVA, has taken a leadership role in establishing procedures and standards for the origination and maintenance of variable annuities on an electronic basis. This initiative by NAVA is known as the "STP Project." STP stands for "straight-through processing," and was initially conceived as a method to complete an entire annuity purchase transaction electronically--from point of sale through issuance of the annuity contract.
Electronic origination and processing of annuities seems simple enough in the contemplation but, in actuality is a much more complex procedure than it would seem. For example, there are numerous different insurers and numerous different distribution organizations, each with its different procedures, nomenclature and different corporate culture. Added to these levels of complexity are the different regulatory requirements of the SEC, FINRA, and state insurance regulators. Therefore, before any sort of universal electronic procedures can be implemented, standards have to be adopted that will enable a commonality of nomenclature, product features, and operating standards that each insurer and each distribution organization can implement to ensure that all parties are "on the same page." Even such elements as the use of an electronic signature--permitted by federal law since the Clinton administration--are not universally accepted within the financial services industry. In fact, "electronic signature" is not even universally defined within the industry.
Variable annuities pose an unusual challenge to this process, not only because they are regulated by so many diverse regulatory bodies, but because they are also regulated, insofar as suitability and supervisory standards are concerned by special rules that apply only to this type of product. Likewise, unlike stocks, bonds and mutual funds, annuities have many diverse product features that vary from insurer to insurer and which require a wide diversity of electronic options if technology is to work.
Design of an STP program for an entire industry is a challenge, not just with technology, but also with obtaining consensus from among the various participants within the industry. Manufacturers of financial products, clearing organizations, brokerage firms and insurance agencies and brokers all have to provide input and have to come to some form of consensus about product and processing standards, electronic signatures, electronic protocols for transmission of funds and delivery of legal documents. All of these elements have to conform to some minimum standards if chaos is to be avoided. Obviously, there are financial repercussions to the participants resulting from the decisions that are made and these can affect acceptance of common standards.
Recent years have seen a growth in the use of the investment advisory process, not only with stocks and bonds, but also with mutual funds and with all types of insurance products (not just with annuities). Yet, large numbers of investment advisors--whether registered under the Investment Advisers Act of 1940 or as state registered advisors, have not yet adapted to technology. In a speech in 2008, the director of the division of investment management of the SEC, Buddy Donahue, stated that the SEC has under active study rulemaking to "restructure" the recordkeeping regime of investment advisors. We have not yet seen any proposed rules, but it is obvious that better electronic recordkeeping and communications are essential. The use of an electronic filing system for SEC documents was by no means an easy task for the entire securities industry to adopt. There were numerous delays and missteps along the way. Yet, it has functioned successfully now for well over a decade and it seems difficult to recall a time when we prepared SEC filings with "scissors and gluepot" as was the standard when I started in this business nearly 40 years ago.
Likewise, a standardized electronic system for the origination and maintenance of customer and firm records for investment advisors and the entire financial services industry is inevitable. The main question is not if, but when? This also presents the question to all of us: will we adapt, or be left behind. If our experience with the implementation of the EDGAR electronic filing system is any guide, the implementation of electronic record keeping, reporting and communication will require commitment at the highest levels of each organization involved. When EDGAR first mandated electronic filings with the SEC, a number of firms tried to implement the system and failed. Even today, many law firms, mutual fund managers, and others use outside services to complete their EDGAR filings for them. While outside services may be helpful in the implementation of an STP program, the day-to-day operation will likely require in-house capability.
We do not believe it is wise or practical to wait until the SEC or other regulatory bodies mandate electronic recordkeeping to begin the development of the capability to comply. Instead, every investment advisor, every insurer, every mutual fund manager and every financial planner should be actively engaged in the understanding of the process and should be participating with the industry groups charged with the responsibility for designing and implementing the program.