Regulators Focus on Complex Alternatives


The Financial Industry Regulatory Authority (FINRA), as well as the SEC and state regulators, have announced that they are concerned about broker/adviser sales practices involving alternative investments including variable annuities and equity-indexed annuities. They have the distribution of these complex products on their radar screens.  On January 11, 2013, FINRA sent a letter to its member firms disclosing its plans to focus on these sales practices this year. See Variable Annuities and Equity-Indexed Annuities.

FINRA’s letter noted that brokers/advisers who sell complex or high-yield products often do not fully understand the associated risks and so are not in a position to explain them to customers even if they wanted to.  FINRA apparently wants to see evidence of improvement in brokers’ product-specific knowledge, including the market risk, credit risk and liquidity risk associated with variable annuities.

FINRA may also be requiring an increased level of supervision over sales of variable annuities. Last year, FINRA published Regulatory Notice 12-03, which had to do with the requirement of heightened supervision for sales of complex products (“What Happens If Annuities Are Considered ‘Complex?,’” by Linda Koco, InsuranceNewsNet Magazine). A recent report by the influential International Organization of Securities Commissions (IOSCO) suggested that U.S. regulators will treat variable annuities as complex products requiring stricter suitability standards.

In its January letter, FINRA reportedly admonished members that “long holding periods in conjunction with significant surrender charges can make [variable annuities] unsuitable for investors who have near-term liquidity needs” and that “high fees and expenses” have a negative impact on performance and invite “switching,” a form of churning.  Such warnings by FINRA shine a light on the impact of broker/adviser compensation upon recommendations and sales of variable annuities.

FINRA says it will be scrutinizing variable product sales for suitability (including customer’s risk tolerance and liquidity needs), broker product-specific knowledge, due diligence, risk disclosures, presentation of investment alternatives with fewer risks and lower commissions, and the impact of broker compensation on all of the above.  Expect more enforcement actions to be filed by FINRA in these areas.

Page Perry is an Atlanta-based law firm with over 150 years of collective experience maintaining integrity in the investment markets and protecting investor rights.