The ramifications of a branch office redefinition would be numerous for life insurance companies and their agents.
FINRA recently announced that it was going to take a closer look at its rules regarding branch offices. This is but the latest in what has been a longtime and regularly recurring concern that the NASD and now FINRA have about branch offices of broker-dealers.
Prior to the advent of variable annuities, there was little concern about the definition of a "branch office" for traditional broker-dealers. Most stock brokers worked out of easily ascertained central workplaces that had all the accouterments of a stock brokerage firm, complete with ticker boards and large bull pens where the brokers made their phone calls and their trades. When the United States Supreme Court determined that variable annuities were "investment company securities," all insurance agents who wished to sell such products had to become "associated persons" of a broker-dealer. When the variable annuity industry was new, the branch office issue never arose because no life insurance company affiliated broker-dealers were members of the NASD--they were directly regulated by the SEC, which had little concern about where associated persons were housed.
Life insurance agents frequently work from home or from a small individual office in a commercial complex, often far away from the insurance agency where they are officially assigned. As more and more life insurers joined the NASD in the early 1970s, it became more and more difficult for the NASD to come up with an easily applied definition of "branch office."
FINRA rule 3010(g)(2)(A) states that "[a] 'branch office' is any location where one or more associated persons of a member [of FINRA] regularly conducts the business of effecting any transactions in, or inducing or attempting to induce the purchase or sale of any security, or is held out as such…." The rule then proceeds to list a number of exemptions to the definition, most of which are seemingly directed toward the method of operation of a traditional individual insurance agent who operates from his residence.
On several occasions the NASD and FINRA have attempted to eliminate or limit this exemption. This has always resulted in serious push-back by insurers to keep the exemption in place. The ramifications of a change are numerous. The most obvious is monetary. FINRA charges its members fees for each official "branch office." This is a relatively small fee to originally designate a branch office with an even smaller annual renewal fee. Nevertheless, for a large insurer with thousands of appointed agents operating from their residences, the costs of having each such dwelling designated as a "branch office" because an agent selling variable annuities worked from home would be substantial.
Officially designated branch offices also have regulatory and supervisory requirements imposed on them and by a strict interpretation of FINRA rules could require the "branch office" to have a registered principal to supervise the "branch office's" activities. Any marketing executive of an insurance company would treat the requirement of having the bulk of the company's agents become registered principals as the worst sort of nightmare. The supervisory and record-keeping requirements imposed on a formally designated "branch office" are not only probably beyond the capability of most insurance agents, but would also severely curtail such agent's sales activities.
Insurers are also rightfully concerned about potential liability issues. When compliance is entrusted to central supervisory offices with standardized rules, there is some hope of ensuring that the rules are observed and applied on a uniform basis. Thousands of one-person "branch offices" with individual compliance responsibility could result in chaos and increase an insurer's already broad liability for the activities of its sales personnel.
If the exemption from the FINRA branch office rules were to be broadened to require that insurance agents operating from their residences must each be registered as a branch office, the branch offices' rules would probably have to be rewritten to enable broker-dealers to avoid the necessity for each agent becoming a registered principal. There would also have to be some relaxation from the record-keeping and supervision requirements that are currently imposed on officially designated branch offices. There would also have to be some diminution of the fees charged for branch offices if it is to be economically possible for an insurer to register potentially thousands of "branch offices."
The branch office issue has been around since the first insurance company affiliated broker-dealer joined the NASD in 1968 and is likely to continue in the spotlight for the foreseeable future. When the first insurance company joined the NASD, there was considerable sentiment for the creation of a new self-regulatory body to regulate variable annuity broker-dealers. It is highly unlikely that any such an entity could be created in today's regulatory environment. Nevertheless, issues such as the branch office controversy focus on the differences between insurance products that are also "securities" and traditional products sold by traditional stock brokers. This issue becomes particularly difficult as traditional stock brokers sell more and more insurance products and as the lines of distinction within the entire financial-service industry become even more blurred. Those insurance agents and other sellers of variable annuities who complain about current centralized compliance and supervisory practices should carefully consider the alternatives that could result from a change in such practices.
Judith A. Hasenauer is an attorney with the law firm of Blazzard & Hasenauer, P.C. She devotes her practice exclusively to the financial services industry, providing consulting on the development and regulatory clearance of products, compliance issues, distribution issues and related matters, such as advisory activities and industry initiatives