The Rules Are Changing!

Transcription

1 The Fiduciary Debate: How Will It Affect How YOU Do Business? Presented to NAIFA-St. Louis CE Day by John L. Olsen, CLU, ChFC, AEP President: Olsen Financial Group April, 2011 The Rules Are Changing!..and they haven t t stopped changing! The Main Issue: Standard of Care Two regimes Suitability Historically, applied to insurance agents and registered representatives ( brokers( brokers ) Fiduciary Historically, applied to investment advisers

2 What is Suitability? Rules-based,, rather than Principles- based. Rules-based standards a series of rules, specifying what will, or will not, meet the prescribed standards. Principles-based standards general principles, relying upon interpretation and judgment of those to whom they apply Pros and Cons of Rules-Based vs. Principles-Based standards Rules-Based PRO Easier to audit for compliance purposes and may produce more consistent behaviors (because everybody knows the rules) Easier to understand (?) CON Lack of flexibility with regard to changing conditions and products Frequently, easier to abuse, by use of loopholes that meet literal wordings but violate spirit of rules. Pros and Cons of Rules-Based vs. Principles-Based standards Principles-Based PRO Flexible, with regard to changing conditions and products. Should be easier to maintain. Sometimes perceived as more appropriate to a profession CON Because they rely upon individual interpretation, more difficult to audit. May produce inconsistent interpretations or uneven enforcement.

3 What is Suitability? Rules-Based, rather than Principlesbased Largely a matter of State law if no securities are involved. NAIC - Life Insurance And Annuities Suitability Model Regulation (2002) Does not define suitability with any precision. What it does say is this (1) Insurance producers shall have reasonable discretion to determine what information is relevant or necessary for any specific insurance transaction. The information that is considered relevant may vary based on the type of product and nature of the transaction. and.. (2) A rebuttable presumption that a recommendation was a suitable recommendation is created if the insurer or insurance producer can demonstrate: Collection and consideration of relevant information; Conformance with an insurer s s guidelines and procedures, prior to making a recommendation; and That the insurance transaction assisted the consumer in meeting the consumer s s insurable needs or financial objectives.

4 NAIC Suitability In Annuity Transactions Model Regulation March, 2010 Identified 12 concerns that must be addressed prior to the recommendation of any annuity. 12 Concerns that must be addressed 1. Age 2. Annual Income 3. Financial Situation and needs, including the financial resources used for the funding of the annuity 4. Financial experience 5. Financial objectives 6. Intended use of the annuity 7. Financial time horizon 8. Existing assets, including investment and life insurance holdings 9. Liquidity needs 10. Liquid Net Worth 11. Risk tolerance 12. Tax status NAIC Suitability In Annuity Transactions Model Regulation March, 2010 (Cont d) Same 12 factors as were stated in NASD Rule 2821 (FINRA Rule 2330) Many states have adopted these 12 factors in their insurance statutes Are these factors relevant only in determining the suitability of annuity recommendations? No. They will affect everyone here!

5 Dodd-Frank Sect. 989J (a) The SEC shall treat as an exempt security any insurance or endowment policy or annuity contract (1) The value of which does not vary according to the performance of a separate account (2) That (A) Satisfies the nonforfeiture or similar requirements of the applicable state at the time of issue OR (B) In the absence of such requirements, satisfies the Model Standard Nonforfeiture Law for Life Insurance or the Model Standard Nonforfeiture Law for Individual Deferred Annuities or any successor model law as published by the NAIC AND - Dodd-Frank Sect. 989J (3) that is issued (A) on and after June 16, 2013, in a State, or issued by an insurance company that is domiciled in a State, that (i) adopts rules that govern suitability requirements in the sale of an insurance or endowment policy or annuity contract which meet or exceed the minimum requirements established by the Suitability in Annuity Transactions adopted by the NAIC in March, 2010 and (ii) adopts rules that meet or exceed the minimum requirements of any successor modifications to the model regulations within 5 years of their adoption by the NAIC or Dodd-Frank Sect. 989J (B) by an insurance company that adopts and implements policies on a nationwide basis for the sale of any insurance or endowment policy or annuity contract that meet or exceed the NAIC Suitability in Annuity Transactions Model Regulation and any successor thereto. What does this mean? TODAY - ALL sales of ANY insurance or annuity contract MUST meet existing State suitability requirements no change AND STARTING ON JUNE 16, 2013 ALL insurance or annuity contracts sold in ANY state MAY be deemed securities unless the State of issue has adopted suitability requirements AT LEAST AS STRONG as those in the NAIC Suitability in Annuity Transactions Model Reg and any modifications thereto within five years of the NAIC s adoption of such modifications OR they re issued by an insurer that has adopted those rules.

6 Dodd-Frank Sect. 989J What does this section mean? TODAY - ALL sales of ANY insurance or annuity contract MUST meet existing State suitability requirements no change AND STARTING ON JUNE 16, 2013 ALL insurance or annuity contracts sold in ANY state will be deemed securities unless the State of issue has adopted suitability requirements AT LEAST AS STRONG as those in the NAIC Suitability in Annuity Transactions Model Reg and any modifications thereto within five years of the NAIC s adoption of such modifications OR they re issued by an insurer that has adopted those rules. What is the Fiduciary Standard? Not precisely clear (Principles-based) But there are central elements (Committee for the Fiduciary Duty, 2009) Put the client s s best interest first; Act with prudence; that is, with the skill, care, diligence and good judgment of a professional; Do not mislead clients; provide conspicuous, full and fair disclosure of all important facts; Avoid conflicts of interest; Fully disclose and fairly manage, in the client s favor, any unavoidable conflicts. Those are the two regimes in today s Standard of Care debate So, what s s changing?

7 Dodd-Frank Financial Reform Act Section 913 Ordered SEC to do studies 913(g) Authority to Establish A Fiduciary Duty for Brokers and Dealers SEC may rule that standard of conduct for brokers and dealers may be same as that applying to investment advisors Receipt of commissions shall not, in and of itself, be considered a violation of such standard. Dodd-Frank Financial Reform Act (Cont d) IMPLICATIONS Does this mean that anyone who receives commissions cannot be held to a fiduciary standard? It addresses only a a broker or dealer.. Does this offer a free pass to an insurance agent who is neither? Dodd-Frank Financial Reform Act (Cont d) Section 913(g) (cont d) (1) No requirement for continuing duty of care or loyalty to the customer after providing personalized investment advice about securities. (2) The sale of only proprietary or other limited range of products shall not, in and of itself, be considered a violation of [that standard].

8 Dodd-Frank Financial Reform Act (Cont d) IMPLICATIONS Some advocates for a unified fiduciary standard maintain that the standard as applied to portfolio managers should apply to all financial advisors. What are some of the implications of that position? Unified Fiduciary Standard Not everyone manages or makes recommendations regarding clients portfolios on an ongoing basis. Indeed, some of us do planning when we don t t have custody of, manage, or make specific recommendations regarding a client s s investment portfolio. Shouldn t t the rule fit the activities? The Commission may commence a rulemaking, as necessary or appropriate in the public interest and for the protection of retail customers, to address the legal or regulatory standards of care for brokers, dealers, investment advisers, persons associated with brokers or dealers, and persons associated with investment advisers for providing personalized investment advice about securities to such retail customers. Who will be subject to these rules?

9 SEC Staff Report (Jan, 2011) Recommends the establishing of a uniform fiduciary standard for investment advisers and broker-dealers when providing investment advice about securities to retail customers that is consistent with the standard that currently applies to investment advisers. SEC Staff Report Cont d Recommends that the Broker-Dealer exclusion from the definition of Investment Adviser in the Investment Advisers Act of 1940 be retained (that is, that it not be eliminated, as some have advocated). Recommends that the SEC engage in rulemaking and/or issue interpretive guidance to explain what it means to provide personalized investment advice about securities. SEC Staff Report Cont d That definition of investment adviser,, in the 1940 Act, is any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities. What does this mean? Whom does this describe?

10 12 Concerns that must be addressed 1. Age 2. Annual Income 3. Financial Situation and needs, including the financial resources used for the funding of the annuity 4. Financial experience 5. Financial objectives 6. Intended use of the annuity 7. Financial time horizon 8. Existing assets, including investment and life insurance holdings 9. Liquidity needs 10. Liquid Net Worth 11. Risk tolerance 12. Tax status All that said.. When, if ever, will the SEC actually produce the rules that it is authorized to create? Congressional Republicans sent a letter to Mary Schapiro asking her to delay rulemaking. Congressional wrangling over the budget may result in decreased funding of the SEC. Some Congresspersons want to repeal, or at least gut, Dodd-Frank. What might be the responses to these emerging issues From Broker-Dealers? Requiring a single standard of care for all sales, whether broker or advisory Changes in oversight/supervisory policies E&O coverage changes Payout changes Requiring their reps to submit all sales variable or fixed through them What else?

11 What might be the responses to these emerging issues From IMO s, through which registered reps submit non-securities business? Increase compliance requirements Change their product lines Change their business model Merge with a Broker-Dealer Go out of business What else? What might be the responses to these emerging issues From product manufacturers? Commissions disclosure Changes in products Changes in marketing materials Illustrations / Point of sale materials Changes in agents contracts Authority / duty Compensation What else? How might these changes affect YOUR business model?

12 What you can do now to protect yourself and your clients Examine how you do business How do you represent yourself? What do you say or imply or imply that you do? What titles do you use? What designations do you use? What designations will you acquire? If you wear more than one hat,, how can a consumer tell which hat you re wearing? An Example Not To Follow MO Sec. of State case #AP (Dec. 2010) John Jones is an MO RIA with Jones Advisors. He sold index annuities to seniors at free lunch seminars. He obtained a series 65 license [sic] as a marketing tool for his business and to lend credibility to his EIA recommendations. Seminar invitations described respondent as Your investment advisor representative,, and as a financial educator and advisor In addition to [respondent s] s] Professional Profile, business card, and seminar invitation, [his RIA s] website also touted [his] credentials and experience. The website stated that [his] goal was to be the most comprehensive retirement planner and investment advisor based upon [his] experience, professional judgment and skills. The website also stated that, since 1995, [respondent]has been providing [his] clients with unbiased and independent financial advice.

13 Jones case: Conclusions of Law [Respondent] engaged in dishonest and unethical practices in the securities, investment, and insurance business when he, among other things: failed to conduct a reasonable inquiry into his clients overall portfolio, investment objectives, financial situation and needs, and investment experience; recommended products to clients without reasonable grounds for believing that the products were suitable; misrepresented to his clients and prospective clients the nature of the advisory services being offered or fees to be charged for such services; Jones case: Conclusions of Law Respondent - omitted to state material facts necessary to make the statements made regarding services or fees, in light of the circumstances under which they are made, not misleading; failed to provide a written disclosure to the clients about any material conflicts of interest that could reasonably be expected to impair the rendering of unbiased and objective advice before [respondent] rendered such advice to his clients; or Jones case: Conclusions of Law failed to provide disclosures to his clients detailing the compensation [respondent] would receive through the sale of products he recommended. [Respondent], as a person that advised others for compensation, engaged in an act, practice, or course of business that operated or would operate as a fraud or deceit upon another person by, among other things: using his IAR registration to lend credibility to his annuity recommendations and sales; recommending and selling unsuitable products through which he made substantial commissions after leading his clients to believe that he was acting in their best interest. (c) John interests; L. Olsen, 2011

14 The MO Sec. of State s s news release.. As a registered investment adviser representative in Missouri, [Jones] was required to put his clients interests first and to disclose any conflicts. Instead, his investors were allegedly harmed by being sold products which tied up their money for long periods of time, when other cheaper, less-restrictive products would have better served their investment goals. The penalties Cease and Desist Order Further ordered that Commissioner will determine whether to grant Enforcement Section s s petition for imposition of a civil penalty of up to $10,000 upon each of respondent and his RIA. Further ordered whether to censure and impose civil penalty of up to $50,000 upon respondent. Another horror story Joe Smith sold some mutual funds and variable annuities that the MO Commissioner of Securities determined were unsuitable. He was censured and placed on probation for 2 years, and Prohibited from selling VAs or closed-end end funds to anyone over age 65, and from Selling index annuities Despite the fact that none of the sales in the complaint were of index annuities! [Case No. S-S AP ]

15 So what can you do to protect yourself and your clients? Consider your activities How do you market yourself and what you do? What titles & designations do you claim? If you are a registered representative, are all of your Outside Business Activities disclosed to your Broker- Dealer? Are all those activities covered by E&O insurance? Are you sure of that? Do you perform all of them under one company identity? Are there activities that you should discontinue? So what can you do to protect yourself and your clients? (Cont d) What products do you recommend? If you re shopping for a client, which types of policies do you consider? Are there any types that you do not consider? If so, did you make that clear to your client? If you imply that you do comprehensive planning, do you address Property & Liability coverages? Long Term Care? Disability Income coverage? Debt management strategies? So what can you do to protect yourself and your clients? (Cont d) Confirm client understanding of what you ve presented Client initials point of sale brochure where each benefit and cost is described Client explains back to you how the product works Dealing with surrender charges Disclose commissions For only those products you recommended??? Consider an Engagement Agreement How much help will you get? And from whom?

16 Questions? John L. Olsen, CLU, ChFC, AEP Olsen Financial Group 131 Hollywood Lane Kirkwood, MO (314)