The crossover in recent years among entities distributing financial products has created confusion among applicable regulatory schemes.
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Long before FINRA was FINRA--when it was still the NASD--its rules required registered representatives of broker-dealers to report "outside employment" to their broker-dealers. For the early years of this requirement, the definition of "outside employment" was fairly easy to understand. In those days, broker-dealers were either "wire-houses" with large numbers of captive registered representatives or were regional broker-dealers where a significant number of salespeople were more likely to be financial planners as well as sellers of securities.
The last two decades have seen a large change-over among different types of distributors of financial products. Banks now sell securities and insurance, and the vast majority of FINRA-registered representatives also possess insurance licenses. Indeed, for many registered representatives, sales of annuities--both variable and fixed--are a major source of their income.
At one time the image of an "insurance agent" conjured up a picture of a person licensed and appointed only to sell the products of his specific insurer. Such an "agent" might occasionally "broker" a life insurance product issued by an insurer other than his primary company, but usually only because his or her primary insurer did not offer a product a client needed for a particular purpose. This "crossover" among the various types of entities distributing financial products has created confusion among the various regulatory schemes that apply to financial products. The rules applicable to insurance agents imposed by state insurance regulators are different from the rules that apply to sellers of securities by FINRA and the SEC. The reporting requirements for "outside employment" of registered representatives of broker-dealers who sell insurance products continues to confuse many people who are either required to comply with the rule or who have the responsibility to enforce the rule.
Traditionally, when a person with a license to sell life insurance products wanted to sell a policy of an insurer that was different from her primary company, all that was required was to secure an "appointment" as an agent of the new insurer. This required a filing by the new insurer with the state insurance regulator of the state where the transaction was to take place.
Public records might inform the agent's primary company of the appointment by the new insurer, but agents had no regulatory requirement to report the appointment or the insurance transaction to anyone. The advent of variable annuities--which are insurance products for state purposes, but securities for federal purposes, brought broker-dealers into the arena with new requirements applicable to the transactions. It is pretty clear that the sale of a variable annuity must be placed through a registered representative's broker-dealer. For broker-dealer purposes, a variable annuity is an investment company security just like a mutual fund. However, when it comes to sales of more traditional life insurance products, either life insurance policies or fixed annuities, the situation is less clear.
If a registered representative of a broker-dealer sells traditional life insurance products and is not placing the transaction through her broker-dealer, this transaction constitutes "outside employment" that must be reported to her broker-dealer. A broker-dealer has the right, but not the obligation to prohibit its registered representatives from undertaking any type of "outside employment" because the broker-dealer has the power to terminate registrations. Thus, a broker-dealer could require all insurance transactions to be placed through the broker-dealer (as is currently the case with many broker-dealers for sales of indexed annuities), or could prohibit a registered representative from selling insurance products at all. The registered representative always has the right to shift his registration to a broker-dealer that will permit the type of "outside employment" desired. However, a broker-dealer can control the activities of its registered representatives with respect to any employment undertaken.
The open question is what has to be reported by a registered representative who sells traditional life insurance products that are not "securities." Certainly, a registered representative must report to the broker-dealer that she is selling insurance products. This probably also extends to reporting the insurers with which the registered representative is appointed. What is not clear is whether this reporting requirement extends to each individual transaction of such a registered representative.
We have written in the past about the "jurisdiction creep" whereby FINRA arbitrations seem to be trending toward assuming jurisdiction over activities of registered representatives and their broker-dealers involving transactions other than traditional securities sales. This results in the possibility of a broker-dealer to be liable for actions of its registered representatives for all types of financial transactions, not just for sales of what are clearly understood to be "securities." As a result, a broker-dealer has an interest in whatever financial activities one of its registered representatives undertakes. This interest is difficult to maintain if the broker-dealer has only a general report that the registered representative sells traditional insurance products for a particular insurer.
FINRA has not, at yet, given any guidance on what the degree of reporting of "outside employment" must be. This is particularly important when it comes to financial planners who are more involved in the uses of life insurance for business and estate planning than it is for the traditional registered representative of a wire-house. Should compliance personnel of a broker-dealer require reporting of each life insurance transaction, or is a report that the registered representative is an appointed agent of a particular insurer enough? There is no clear regulatory answer to this question, but in view of the litigious society in which we live, broker-dealers should at least have a clear policy regarding this question.
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