The staff at the Securities and Exchange Commission (“SEC”) Division of Trading and Markets (the “Staff”) recently issued a no-action letter1 to three trade associations clarifying its position on traditional insurance networking arrangements between insurance agencies and broker-dealers for the distribution of variable products. The April 23, 2013, letter (“2013 No-Action Letter”) both:
- Affirmed that such arrangements are allowed even in those states that no longer prohibit a broker-dealer from becoming directly licensed as an insurance agency; and
- Extended to insurance agencies the explicit right to make, on a purely ministerial basis, “transaction-based payments” (i.e. commissions, bonuses, etc.) on the sale of variable products.
Variable insurance products (i.e. variable annuities and variable life policies) are dually regulated as insurance products and securities. In the past, the Staff has issued a number of no-action letters that permitted insurance agencies to enter into insurance networking arrangements with registered broker-dealers for the offer and sale of variable insurance products without the insurance agencies registering as broker-dealers under Section 15(b) of the Securities Exchange Act of 1934 (“Exchange Act”). Such insurance networking arrangements, and the subsequent no-action letters, were originally a response to a quirk in state and federal regulatory schemes which prohibited broker-dealers from receiving commissions from the sale of the variable products unless they were licensed as insurance agencies, while at the same time prohibiting broker-dealers from receiving such licenses. Finally, in 1995, the Staff issued a no-action letter to First of America Brokerage Service, Inc. (the “First of America Letter”), which contained a comprehensive description of insurance networking arrangements which would not trigger enforcement under the Exchange Act. As such, the majority of insurance networking arrangements have followed the model set forth in the First of America Letter. No-action letters issued after the First of America Letter were intended to address novel situations. The most widely cited letters following the First of America Letter were two letters issued to M Financial Holdings, Inc. (“M Financial”).2
M Financial Revocation Letter
On May 8, 2006, the Staff revoked the two previous no-action letters issued to M Financial involving insurance networking arrangements (the “Revocation Letter”). While the majority of the Revocation Letter focused on facts specific to M Financial’s situation, the Revocation Letter also included language that suggested that the First of America Letter:
- (1) only permitted insurance networking arrangements where broker-dealers were prohibited by state law from also obtaining an insurance agency license; and
- (2) prohibited insurance agencies (as opposed to the broker-dealer) from making transaction-based payments to dual representatives.
As noted by the trade associations in their request for the 2013 No-Action Letter, the industry had generally not taken this view of the First of America Letter and, in fact, the majority of states now allow a broker-dealer to directly obtain an insurance agency license. As such, the trade associations argued, if the First of America Letter was interpreted in such a limiting fashion, nearly all of the existing insurance networking arrangements would need to be unwound and the broker-dealers would need to go through the costly process of obtaining insurance agency licenses or vice a versa (i.e. the agencies would need to become broker-dealers). Furthermore, the trade associations argued that transaction based payments made by insurance agencies on variable products, where such payments are directed and controlled by the broker-dealer, should be allowed consistent with an already existing exception when such payments are made by the insurance companies themselves (sometimes referred to as the “paymaster” exception).
2013 No-Action Letter
- State Law Issue
Specifically, the trade associations requested that the Staff not recommend action to the SEC under Section 15(a) of the Exchange Act against insurance agencies if they are parties to, or enter into, insurance networking arrangements with registered broker-dealers without the agencies themselves registering as broker-dealers under Section 15(b) of the Exchange Act. In making such a request, the trade associations laid out a number of representations regarding the insurance networking arrangements which are generally consistent with the First of America Letter, including requiring:
- That insurance agency personnel involved in the marketing and sale of variable products become associated with a broker-dealer, as registered representatives (such personnel are often referred to as “dual representatives”);
- That dual representatives be properly registered and qualified under FINRA rules and licensed as insurance producers;
- That broker-dealers have the responsibility for supervising and controlling the employees who sell insurance securities through the insurance agency and conducting regular compliance reviews of the insurance agency’s variable product activities;
- That broker-dealers maintain books and records developed in connection with the sales of the variable products; and
- That an insurance agency may not be the payee of any customer funds intended for the purchase of a variable product.
Based on these and other representations (which can be found in complete detail in the 2013 No Action Letter), the Staff concluded that it would not recommend enforcement action for such activity. Importantly, as noted in footnote 7 to the 2013 No-Action Letter, despite much discussion between the trade associations and Staff about the issue, the 2013 No Action Letter makes clear that there is no requirement for an affiliation between the insurance agency and the broker-dealer, other than the existence of the dual representatives and the insurance networking arrangement.
- Insurance Agency Payment Issue
The 2013 No-Action Letter also states that, consistent with the Staff’s prior rulings regarding payments made directly by insurance companies, insurance agencies may make certain transaction-based payments related to the sale of variable products directly to their dual representatives. However, such payments must be:
- Made on a purely ministerial basis pursuant to instructions from the registered broker-dealer without any exercise of discretion by the insurance agency over the amount of payments;
- Made to persons registered with and under the supervision and control of the registered broker-dealer; and
- Made “on behalf of” the registered broker-dealer.
Furthermore, the registered broker-dealer must assume full responsibility for the securities activities of persons in connection with the sale of variable products, including responsibility for training, supervision and control.
The 2013 No-Action Letter represents a long awaited assurance that the majority of the existing insurance networking arrangements are compliant with the Exchange Act and that insurance agencies may make transaction based payments when doing so in a purely ministerial fashion. The 2013 No-Action Letter should provide needed stability to an industry that has faced regulatory uncertainty over these issues for the past seven years.