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Variable Annuities &Variable Life Insurance

Regulation

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Variable Annuities &Variable Life Insurance

Regulation

Second Edition

VOLUME 1

Edited byClifford E. Kirsch

Incorporating Release #10October 2017

#208975

Practising Law InstituteNew York City

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This work is designed to provide practical and usefulinformation on the subject matter covered. However, it issold with the understanding that neither the publishernor the author is engaged in rendering legal, accounting,or other professional services. If legal advice or otherexpert assistance is required, the services of a competentprofessional should be sought.

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Printed in the United States of America. No part of this publication may bereproduced, stored in a retrieval system, or transmitted in any form by anymeans, electronic, mechanical, photocopying, recording, or otherwise,without the prior written consent of Practising Law Institute.

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For My Family, With Love

About the Editor

Clifford E. Kirsch (editor; author of chapters 11, 13, 14, 16, 18, 19, 20and 22; and co-author of chapters 1, 8, and 12) is a partner withEversheds Sutherland, New York City. Prior to this, he was VicePresident and Senior Corporate Counsel at the Prudential InsuranceCompany of America. From 1985 to 1994, Mr. Kirsch was on the Staffof the U.S. Securities and Exchange Commission, Division ofInvestment Management, in Washington, D.C. At the SEC, he heldseveral positions, including Assistant Director in the Office of InsuranceProducts, and was a recipient of the Manuel F. Cohen Younger LawyerAward.

Mr. Kirsch teaches at the University of Pennsylvania Law School, andpreviously taught at Georgetown University Law Center. He serves aschair for two annual American Law Institute/American Bar AssociationCourse Offerings: Investment Management Regulation and InvestmentAdviser Regulation. He also is Chairman of the NASD’s VariableInsurance Products Committee.

Mr. Kirsch has written on various topics relating to investmentcompanies, investment advisers, and the securities activities ofinsurance companies and banks. His publications include: MutualFund Regulation, Third Edition (Practising Law Institute 2011); Broker-Dealer Regulation, Second Edition (Practising Law Institute 2011);Financial Product Fundamentals, Second Edition (PractisingLaw Institute 2012); Investment Adviser Regulation, Third Edition(Practising Law Institute 2011); The Financial Services Revolution:Understanding the Changing Roles of Banks, Mutual Funds andInsurance Companies (Irwin 1996); Regulation and Distribution ofVariable Insurance Products (Aspen 1999); and Investment Manage-ment Regulation (Carolina Academic Press 1998), a law schoolcasebook.

(Variable Prods. Reg., Rel. #10, 10/17) ix

About the Contributors

John T. Adney (Chapter 4) is a partner at Davis & Harman LLP,practicing primarily in the areas of taxation and insurance law. Since1977, he has engaged in an insurance product taxation advisory,ruling, and audit practice, covering universal life insurance, variablelife insurance, group-term life insurance, COLI, fixed and variableannuities, and long-term care insurance. During the same period, hehas engaged in extensive advisory, ruling, and audit work relating toinsurance company taxation. In addition, since 1981, Mr. Adney hasbeen involved in legislative representation of insurance companies ontax matters relating to those companies and their products, includingthe enactment or revision of Internal Revenue Code sections 72, 101(f),101(g), 801–08, 846, 1035, 7702, 7702A, and 7702B. In 1985, hehelped organize Davis & Harman, serving as the firm’s first managingpartner.

Mr. Adney received his B.A., summa cum laude, from MillikinUniversity in 1972 and his J.D. from Yale Law School in 1975. Heserved as a law clerk for the Trial Division of the U.S. Court of Claimsin 1975 and 1976, and then clerked for Judge Marion T. Bennett of theU.S. Court of Claims in 1976 and 1977.

Cynthia J. Borrelli (Chapter 8A) is a partner at Bressler, Amery &Ross, PC and directs the firm’s Insurance Law practice group. Herpractice also includes participation in the firm’s Executive Compensa-tion & Employee Benefits and Labor and Employment practice groups.Her insurance practice is dedicated primarily to matters affectingcorporate regulatory and enforcement aspects of insurance law. Thescope of her practice comprises a broad range of client engagementsrelating to property-casualty and life, annuity and health, managedcare, disability insurance, and reinsurance matters. She works closelywith attorneys in the firm’s Taxation, Executive Compensation &Employee Benefits, and Workers’ Compensation practice groups onissues relating to employee benefits and executive compensation,ERISA welfare benefit plans (including insurance funding mechan-isms for health and pension plans and plan design), agent disputes,workers’ compensation benefits, and related issues. She also chairsthe firm’s Diversity Committee.

Ms. Borrelli has published and lectured on insurance-related topicsfrequently before national organizations. She is an active participant inNational Association of Insurance Commissioners matters. She has

(Variable Prods. Reg., Rel. #10, 10/17) xi

served as Chair of the Public Regulation of Insurance Law Committeeof the Tort and Insurance Practice Section of the American BarAssociation, and as a Vice-Chair of the Life Insurance Law Committee.Ms. Borrelli remains active on both Committees.

Ms. Borrelli serves on the Board of Directors of the Federationof Regulatory Counsel. She is a former Legal Committee memberof the National Organization of Life and Health Insurance GuarantyAssociations, a current member of the Legal Committee of theNational Conference of Insurance Guaranty Funds, a member ofthe Federation of Defense and Corporate Counsel, the New Jersey StateBar Association Diversity Committee, the Association of ProfessionalInsurance Women and the New Jersey Chapter of Risk InsuranceManagement Society.

David N. Brown (Chapter 25) is a Senior Counsel in the Washington,D.C. office of Covington & Burling LLP, where his practice involvesvarious aspects of corporate and securities law. He has advised lifeinsurance companies, general agencies, and producer groups regardingthe federal securities laws as they relate to variable products.Mr. Brown has also advised private equity fund sponsors regardingthe formation of funds and the application of federal securities laws totheir operations. He has focused recently on privately placed variablelife insurance. Mr. Brown received his bachelor ’s degree from CornellUniversity and his J.D. from the University of Chicago. He is amember of the Bar of the District of Columbia and the American BarAssociation.

Kerry Shannon Burke (Chapter 25) is a partner in the Washington,D.C. office of Covington & Burling LLP in the corporate andsecurities practice areas. The focus of Ms. Burke’s practice is oncapital markets and securities transactions. She has a broad rangeof experience representing companies, underwriters, and otherinstitutional investors in private and public debt and equity financings.Ms. Burke also regularly advises on general corporate and federalsecurities law matters. Specifically, Ms. Burke has provided assistanceon issues related to registered and unregistered investment advisersand registered broker-dealers, including on various status questionsand ongoing compliance matters.

Paul G. Cellupica (Chapter 26) is the Managing Director and GeneralCounsel, Securities Law, of TIAA. He was formerly the Chief Counselfor Securities Products and Regulation in the Law Department ofMetLife, Inc., where he was responsible for legal issues involvingMetLife’s registered variable insurance products, broker-dealers,mutual funds, and SEC and NASD regulatory inquiries. Prior tojoining MetLife at the end of 2004, Mr. Cellupica served at the U.S.

VARIABLE ANNUITIES & VARIABLE LIFE INSURANCE REGULATION

xii

Securities and Exchange Commission in a number of capacities in theDivision of Investment Management and the Division of Enforcement.From 2001 to 2004, he was Assistant Director in the Office ofDisclosure Regulation in the Division of Investment Management,where he and his staff were responsible for drafting rules relating toinvestment company disclosure. While at the SEC, he received theMartha Platt Award for his work in the Division of InvestmentManagement, and the Law and Policy Award as part of the ProxyReview Task Force. Mr. Cellupica is a frequent speaker on issuesinvolving mutual funds and variable insurance products. He has a B.A.from Harvard College and a J.D. from Harvard Law School, and was alaw clerk for Judge David Nelson of the U.S. Court of Appeals for theSixth Circuit.

Richard T. Choi (Chapter 21) is a partner at Carlton Fields JordenBurt, P.A. As a member of the firm’s variable insurance products/investment company group, he advises life insurance companies,mutual funds, broker-dealers, and investment advisers regardingvarious aspects of federal securities and income tax law matters, aswell as state insurance and securities law matters. Mr. Choi haspublished articles and is a frequent speaker on federal securities andNASD issues relating to the use of electronic media to market variableinsurance products. He earned his bachelor ’s degree at the Universityof Chicago and his law degree at the University of Virginia School ofLaw. Mr. Choi is a member of the Virginia Bar, the Bar of the District ofColumbia, and the American Bar Association. He serves on theRegulatory Affairs Committee of the National Association for VariableAnnuities.

Elizabeth A. Diffley (Chapter 17) is a partner in the Corporate &Securities Practice Group of Drinker Biddle & Reath LLP. Ms. Diffleyconcentrates her practice in securities law compliance, mergers andacquisitions, banking and corporate finance transactions, and corpo-rate governance. She joined Drinker Biddle from Sullivan & Cromwellin Paris, where her practice primarily involved cross-border securitiesofferings and compliance with U.S. securities laws and reportingobligations. Ms. Diffley earned her J.D., magna cum laude, from theUniversity of Pennsylvania, where she was an articles editor ofthe Law Review. She received her bachelor ’s degree, summa cumlaude, in economics from the Wharton School of the University ofPennsylvania.

Jack Ewing (Chapter 12) is Vice President and Corporate Counsel withthe Prudential Insurance Company of America, where he concentrateson product development, compliance, and distribution issues fortraditional and variable life insurance and annuity products. Prior to

(Variable Prods. Reg., Rel. #10, 10/17) xiii


joining Prudential, Mr. Ewing was an associate in the Philadelphiaoffice of the Dechert law firm, where he specialized in ERISA, tax, andsecurities law issues of employee benefit plans and executivecompensation. He received his B.S. from Rutgers University and hisJ.D., with highest honors, from Rutgers School of Law–Newark.

Wendell M. Faria (Chapter 3) is Of Counsel to Paul Hastings LLP. Heconcentrates his practice in the area of investment management,particularly on matters involving the regulation of investmentcompanies and investment advisers under the federal securities laws,and in the offering of equity-oriented insurance contracts. Mr. Fariawas formerly with the U.S. Securities and Exchange Commission inWashington, D.C., in the SEC ’s Division of Investment Management.He served as the Deputy Chief and as the Acting Chief of the Division’sOffice of Insurance Products, responsible for the regulation of certainequity-oriented insurance contracts (such as variable annuities,variable life policies, modified guaranteed annuities, and guaranteedinvestment contracts). He frequently speaks at conferences dealingwith investment management issues, and is an Adjunct Professor ofLaw at Georgetown University Law Center, where he teaches securitieslaw.

Evan Giller (Chapter 27) is Of Counsel to Boutwell Fay, LLP, a law firmspecializing in employee benefits and ERISA. Mr. Giller ’s practicefocuses on issues relating to the employee benefit plans of tax-exemptorganizations and governments, including 403(b) plans, 457 plans,qualified plans, and fiduciary issues. His practice also includes advisingon the design and regulation of investment products for retirementplans. Prior to his current position, Mr. Giller was a founding mem-ber of the firm of Giller & Calhoun, LLC. He also spent over twentyyears at TIAA-CREF, where he served as Vice President and GeneralCounsel, Institutional Client Services, and managed the Pension LawUnit. Mr. Giller is a member of the New York City Bar Association,where he is currently serving on the Committee on Employee Benefitsand Executive Compensation. He received his J.D. from the StateUniversity of New York at Buffalo Law School.

Gary E. Jenkins (Chapter 3A) is currently Deputy General Counsel forthe Insurance Solutions business of Voya Financial, which includes itsindividual life and group insurance business lines. Mr. Jenkins has hada long career in the financial services industry, providing legal adviceregarding the development, sale, and administration of institutionaland retail products/services across investment management, banking,and insurance industries, with a focus on managing regulatory, legis-lative, and compliance risks. Prior to joining Voya Financial, he servedas General Counsel of CitiStreet LLC, a joint venture of State Street

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Bank and Trust Company and Citigroup, providing recordkeeping ser-vices for defined contribution, defined benefit, and health and welfareplans. Before CitiStreet, he held the position of Division Counsel forState Street Bank and Trust Company ’s 401(k) recordkeeping business.Mr. Jenkins has a broad background and knowledge of ERISA, federalsecurities laws, and state insurance laws. During his career, he hasworked closely with various federal and state regulators on mattersrelevant to the banking, investment management, retirement, andinsurance industries. Mr. Jenkins is a graduate of Columbia College,earned his law degree from Washington University School of Law, andholds a Master ’s in Taxation from the University of Miami.

Weiyen “Ann” Jonas (Chapter 27) is a Vice President and AssociateGeneral Counsel at Fidelity Investments. Ms. Jonas advises on legalmatters affecting the retirement plans of tax-exempt and governmentalemployers, including 401(k), 403(b), and 457 plans, under the Inter-nal Revenue Code, ERISA, and other federal and state laws. Ms. Jonasgraduated cum laude from Harvard Law School and received her B.S.in business administration from Georgetown University, graduatingmagna cum laude. Ms. Jonas previously practiced employee benefitslaw at Goodwin Procter LLC, and was employed as a tax accountantand CPA for Price Waterhouse, prior to law school. She frequentlypresents at conferences, and has taught ERISA and Employee BenefitsLaw at Suffolk University Law School in Boston. Ms. Jonas is amember of the Texas and Massachusetts bars.

Dodie Kent (Chapter 1) is a partner at Eversheds Sutherland. Withmore than 20 years of experience as corporate counsel in the financialservices industry, Ms. Kent advises on product design, marketing, andadministrative issues as they relate to variable and fixed life insuranceand annuity products. She also has particular experience counselingon related regulatory compliance and enforcement issues. Ms. Kentfocuses on many novel and complex insurer initiatives, including thede-risking of legacy product offerings; the design and regulation ofindex-linked investments; issues related to the use of volatilitymanagement; and the simplification of variable annuity disclosure.Ms. Kent’s in-depth knowledge of these topics—particularly variablelife and annuity insurance regulations and issues—makes her asought-after speaker at industry conferences. Her years as corporatecounsel provide her with a practical, results-oriented understanding ofinsurance companies’ internal processes and competing businessinputs related to product development, distribution and administra-tion. Ms. Kent joined Eversheds Sutherland (US) from one of theworld’s leading insurance and asset management groups, where sheserved as Vice President, Lead Director and Associate General Counsel

(Variable Prods. Reg., Rel. #10, 10/17) xv


in the Insurance Practice Group of its U.S. holdings. There, she servedas the company ’s principal legal securities advisor regarding itsvariable and fixed life and annuity product lines. Ms. Kent wasrecognized by The Legal 500 United States in the area of insurance:non-contentious (2016). She received her B.A. from GettysburgCollege and her J.D. from New York Law School.

Michael Kmiecik (Chapter 24) is currently Vice President ofCompliance at the Prudential Insurance Company in Newark, NewJersey. Prior to joining Prudential, he was associate counsel at New YorkLife Insurance Company. Mr. Kmiecik graduated from SUNY BuffaloLaw School in 1979.

Daniel W. Krane (Chapter 17) is a partner in the Corporate andSecurities Group of Drinker Biddle & Reath LLP. Mr. Krane advisesinsurance and financial services clients on corporate, transactional andregulatory matters, business formations, mergers and acquisitions,holding company transactions, reinsurance, product design anddistribution, regulatory examinations, compliance, internal investiga-tions, and delinquency proceedings. He has particular experienceadvising insurance companies and their affiliates, including broker-dealers, agencies, advisors and mutual funds, in connection withstructuring compliance programs and related investigations. Mr. Kranegraduated from the Pennsylvania State University in 1981 and fromDickinson School of Law in 1985, where he was elected to the Order ofthe Barristers and served as an editor of the Dickinson Journal ofInternational Law. He is a member of numerous bar associations andtrade groups, and has presented before NAIC working groups onvarious topics. Recently, Mr. Krane has served as an Adjunct FacultyMember at the Rutgers School of Law–Newark for an advancedinsurance course. He has been active on committees and task forcesinvolved with drafting insurance, financial services, and healthcarelaws, and frequently writes and lectures on these topics.

Susan S. Krawczyk (Chapter 15) is a partner in the Washington, D.C.office of Eversheds Sutherland, where her practice focuses on federaland state regulation of insurance, financial, and investment products.She counsels insurers, mutual fund sponsors, banks, and financialproduct distributors in developing products, establishing distributionand marketing arrangements, and implementing appropriate compli-ance systems and procedures. She works closely with insurers as wellas distributors in structuring and negotiating joint venture andmarketing arrangements for insurance products and insurance productfunds. She also advises clients on wrap fee programs, financialplanning programs, and networking arrangements for banks and

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insurance agencies. Ms. Krawczyk represents clients before theSecurities and Exchange Commission and the National Associationof Securities Dealers, Inc. She is a member of and serves on severalindustry committees focusing on sales and marketing practices.Ms. Krawczyk is a member of the District of Columbia Bar and theVirginia State Bar. She received a J.D. degree from George WashingtonUniversity National Law Center in 1984.

Ben Marzouk (Chapter 18) is an associate in the Washington, D.C.office of Eversheds Sutherland. Mr. Marzouk is a financial servicesattorney who advises broker-dealers and investment advisers on theirregulatory compliance matters with the U.S. Securities and ExchangeCommission (SEC) and the Financial Industry Regulatory Authority(FINRA), as well as state rules and regulations. Before joining EvershedsSutherland as an associate, Mr. Marzouk participated in the firm’sSummer Associate Program in 2010 where he assisted primarily withfinancial services matters. He previously worked as an analyst for aglobal consulting firm where he analyzed testing documents as part of alarge-scale SAP implementation for the United States Army ’s financialbranch. Mr. Marzouk is admitted to the Virginia State Bar. His work issupervised by District of Columbia bar members. He received his B.A.,magna cum laude, from the College of William and Mary, and his J.D.from the University of Virginia School of Law, where he served asPresident of the William Minor Lile Moot Court Board, and on theEditorial Board of The Virginia Journal of Social Policy & the Law.

Michael J. Mazza (Chapter 8), Assistant General Counsel in the LawDepartment of The Northwestern Mutual Life Insurance Company, isresponsible for legal issues involving Northwestern Mutual’s variableinsurance products. His responsibilities include filing registrationstatements with the SEC and advising on issues related to variableannuity and variable life insurance product development, administra-tion, distribution, and compliance. Prior to joining NorthwesternMutual in 2003, Mr. Mazza clerked for the Honorable John L. Coffey ofthe United States Court of Appeals for the Seventh Circuit and workedin private practice in the areas of estate planning and employeebenefits. Mr. Mazza graduated summa cum laude in 1999 from theMarquette University Law School, where he served as Editor-in-Chiefof the Marquette Law Review, and where he now teaches a class oninvestment company and investment adviser regulation as an AdjunctAssociate Professor of Law.

Joseph F. McKeever, III (Chapter 4) is a partner at Davis & HarmanLLP, practicing primarily in the areas of taxation and insurance law.Mr. McKeever represents life insurance companies throughout North

(Variable Prods. Reg., Rel. #10, 10/17) xvii


America, advising these companies on a wide variety of federal incometax issues, including issues associated with the design, developmentand marketing of annuities and life insurance contracts. He alsorepresents companies on tax controversies in both Internal RevenueService administrative proceedings and in the federal courts.Mr. McKeever has an extensive practice in the IRS National Officewith respect to requests for private letter rulings, requests for technicaladvice, and other miscellaneous proceedings. In addition, he repre-sents many life insurance companies in legislative matters.

Mr. McKeever graduated with a B.A. in history from GeorgeWashington University in 1972. He obtained his law degree (withhigh honors) from George Washington University in 1978, where hewas elected to the Order of the Coif. During 1978–79, he served aslaw clerk to Trial Judge Harry Wood at the United States Court ofClaims, and during 1979–80, he was law clerk to former Chief JudgeWilson Cowen of the United States Court of Appeals for the FederalCircuit.

Christopher E. Palmer (Chapters 6 & 10) is a partner in the law firm ofGoodwin Procter LLP. He is the leader of the Business Law Departmentin Goodwin Procter ’s Washington, D.C. office, and is a member of theFinancial Services Group. Mr. Palmer focuses his practice on securities,investment management and insurance matters. He represents mutualfunds, investment advisers, insurance companies, and broker-dealers onthe development, regulatory approval, sale, and administration of avariety of investment products, including mutual funds and variable andfixed life insurance and annuity contracts. He also represents mutualfund independent directors, and advises companies on securities lawmatters, including reporting and corporate governance matters. Inaddition, he also represents companies in financial services litigation, inSEC inspections and enforcement actions, and before state insurancedepartments. Mr. Palmer was a partner at Shea & Gardner prior to itscombination with Goodwin Procter in 2004. After graduating magnacum laude from the Georgetown University Law Center in 1986, heserved as a Court Law Clerk for the U.S. Court of Appeals for theDistrict of Columbia Circuit.

Christopher S. Petito (Chapter 2) is Of Counsel in the Washington,D.C. office of Willkie Farr & Gallagher LLP. Mr. Petito concentrates ininvestment company, investment adviser, and broker-dealer federaland state securities law matters. His practice includes all aspects of thedesign, organization, and registration of investment companies andrelated insurance products, as well as providing regulatory counseling.Mr. Petito has also represented regulated entities before federal andstate securities regulators in connection with exemptive applications,


xviii

no-action requests, and regulatory examinations, investigations, andenforcement proceedings.

William A. Schmidt (Chapter 5) is a partner in the Washington, D.C.office of K&L Gates LLP. He works in the areas of institutionalinvesting and employee benefits, with particular emphasis on fiduciaryresponsibility matters under the Employee Retirement IncomeSecurity Act of 1974. Mr. Schmidt advises major financial institutions,including banks, insurance companies, registered investment advisersand large employee benefit plans about ERISA restrictions relating toplan investments and to fee arrangements for investment managementand plan administrative services. He was formerly Counsel forRegulation in the Plan Benefits Security Division of the Office of theSolicitor of the U.S. Department of Labor, where he was responsible forproviding legal advice with respect to the Department’s regulatory,interpretive, and legislative activities under ERISA. Mr. Schmidt servesas an Adjunct Professor of Law at Georgetown University Law Center.

Holly H. Smith (Chapter 23) is a partner at Eversheds Sutherland inthe Washington, D.C. office. Prior to becoming associated withEversheds Sutherland, she was an Associate Director in the SEC ’sDivision of Market Regulation, where she participated in writing andoverseeing the implementation of rules governing the U.S. equity andoptions markets. While at the SEC, Ms. Smith also served as legalcounsel to Commissioner Mary L. Schapiro. She is also a former legalcounsel of the Internal Review Department at the National Associa-tion of Securities Dealers, Inc. Ms. Smith devotes her practice tocounseling clients on compliance with the Securities ExchangeAct of 1934 and the rules of the NASD and other self-regulatoryorganizations.

C. Christopher Sprague (Chapters 7 & 9) has been Vice President andCorporate Counsel with Prudential Insurance Company since 1994.At Prudential, he specializes in compliance, product development, anddistribution issues for variable life, variable annuities, and mutualfunds. Mr. Sprague also deals with investment adviser and broker/dealerissues for one of Prudential’s broker-dealers. Prior to 1994, Mr. Spraguewas Senior Counsel in the SEC’s Division of Investment Management,where he worked on a variety of issues under the Investment CompanyAct and the Investment Advisers Act. Mr. Sprague has spoken at anumber of industry conferences concerning variable insurance products,including ALI-ABA, the Securities Industry Association, and theNational Association for Variable Annuities. He is a graduate of YaleUniversity and New York University Law School.


(Variable Prods. Reg., Rel. #10, 10/17) xix

Kristina M. Zanotti (chapter 5) is a partner in the Washington, D.C.office of K&L Gates LLP in the investment management practicegroup, concentrating in the ERISA Fiduciary and Derivatives practiceareas. In the ERISA Fiduciary practice area, Ms. Zanotti has substan-tial experience advising clients regarding fiduciary responsibilitymatters under ERISA. Ms. Zanotti assists investment advisers, banksand trust companies, fund complexes, and other financial institutions,in navigating ERISA’s prohibited transaction restrictions and exemp-tions. Ms. Zanotti co-authors chapters on ERISA in two corporate andsecurities law treatises for the Practicing Law Institute and also teachesa class on ERISA for the D.C. Bar. In the Derivatives area, Ms. Zanottirepresents financial services clients in connection with swap and otherderivatives transactions and in negotiating master agreements,including ISDAs, Master Repurchase Agreements, Master SecuritiesForward Transaction Agreements, futures agreements, cleared deriva-tives documentation, and related agreements.

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Table of Chapters

VOLUME 1

PART I:OVERVIEW OF THE REGULATORY FRAMEWORK

Chapter 1 An Introduction to Variable Insurance Products

Chapter 2 Status of Insurance Products Under theSecurities Act of 1933

Chapter 3 Status of Insurance Companies and InsuranceCompany Separate Accounts Under theInvestment Company Act

Chapter 3A Regulation of Variable Insurance ProductsUnder the Investment Company Act of 1940

Chapter 4 Tax Treatment of Variable Contracts

Chapter 5 ERISA Issues

PART II:PRODUCT DESIGN AND APPROVALS

Chapter 6 Variable Insurance Product Design

Chapter 7 The Funding Vehicle

Chapter 8 SEC Registration

Chapter 8A State Contract Issues

PART III:PRODUCT ADMINISTRATION

Chapter 9 Issues Related to Product Administration

Chapter 10 Redemption Fee Rule

(Variable Prods. Reg., Rel. #10, 10/17) xxi

Chapter 11 Separate Account Compliance Programs

Chapter 12 Insurer Exchange Programs

PART IV:PRODUCT DISTRIBUTION

Chapter 13 SEC Regulation of Product Distribution

Chapter 14 State Securities Regulation of ProductDistribution

VOLUME 2

Chapter 15 FINRA Regulation of Product Distribution

Chapter 16 Suitability

Chapter 17 Replacement of Insurance Products

Chapter 18 Broker-Dealer and Adviser Uniform Standardof Care

PART V:MARKETING MATERIAL

Chapter 19 Advertising

Chapter 20 Variable Life Insurance Illustrations

Chapter 21 Marketing on the Internet

PART VI:REGULATORY EXAMINATIONS

Chapter 22 SEC Insurance Product Exams

Chapter 23 FINRA Examination and Disciplinary Programs

Chapter 24 State Insurance Department Market ConductExaminations


xxii

PART VII:SPECIAL TOPICS

Chapter 25 Private Placement Variable Life Insurance

Chapter 26 Asset Allocation Programs and Funds of Fundsin Variable Insurance Products

Chapter 27 Variable Annuities in Retirement Plans

(Variable Prods. Reg., Rel. #10, 10/17) xxiii

Table of Chapters

(Variable Prods. Reg., Rel. #10, 10/17)

Table of Contents

VOLUME 1

About the Editor ...............................................................................ix

About the Contributors ...................................................................xi

Table of Chapters...........................................................................xxi

PART I:OVERVIEW OF THE REGULATORY FRAMEWORK

Chapter 1 An Introduction to Variable InsuranceProductsClifford E. Kirsch & Dodie Kent

§ 1:1 Background—Variable Annuities and Variable LifeInsurance ........................................................................ 1-3

§ 1:2 Variable Annuities in Today ’s Marketplace..................... 1-3§ 1:2.1 Generally.................................................................. 1-3§ 1:2.2 Variable Annuities in the Retail Marketplace........... 1-4

[A] Generally.................................................................. 1-4[B] Insurance and Other Guarantee Features ................ 1-5[C] Current Product-Related Developments................... 1-9[C][1] Recent Regulatory-Driven Product

Developments .................................................... 1-10[D] Variable Annuity Share Classes.............................. 1-11[E] Unique Investment Features .................................. 1-13

§ 1:2.3 Annuities Sold in the Retirement Marketplace...... 1-14§ 1:3 Variable Life Insurance in Today ’s Marketplace............ 1-14

§ 1:3.1 Generally................................................................ 1-14§ 1:3.2 Variable Life Insurance in the Retail Marketplace..... 1-15§ 1:3.3 Life Insurance Sold to Individuals Through

Employers and Associations .................................. 1-16§ 1:3.4 Life Insurance Sold to Businesses (Corporate

Owned Life Insurance) ........................................... 1-16

xxv

§ 1:4 Legal Structure and Changes ........................................ 1-17§ 1:5 Regulatory Treatment of Variable Products................... 1-19

§ 1:5.1 Generally................................................................ 1-19§ 1:5.2 Product Design and Approval ................................ 1-20

[A] State Insurance Requirements RegardingProduct Design and Approval ................................ 1-20

[B] Federal Securities Laws Regarding ProductDesign and Approval.............................................. 1-21

[B][1] Background ........................................................ 1-21[B][2] Private Offering Exception ................................. 1-23[B][3] Retirement Plan Exemption............................... 1-23[C] State Securities Laws.............................................. 1-23

§ 1:5.3 Product Administration ......................................... 1-24§ 1:5.4 Product Distribution .............................................. 1-26

[A] Background ............................................................ 1-26[B] FINRA Regulation.................................................. 1-27[B][1] Generally ........................................................... 1-27[B][2] Requirements Governing the Suitability of

Variable Annuity Transactions........................... 1-28[B][2][a] NASD’s Suitability Rule Applying to

Recommended Transactions—FINRARule 2111........................................................ 1-28

[B][2][b] Guidance Concerning Variable AnnuityExchanges........................................................ 1-29

[B][3] Controls Over Marketing Material: Review,Content, and Filing Requirements..................... 1-30

[B][4] Requirement to Adopt and Implement aSupervisory System Over Sales Activity............. 1-31

[B][4][a] Written Supervisory Procedures....................... 1-31[B][4][b] Chain of Supervision....................................... 1-31[B][4][c] Approval of Transactions................................. 1-31[B][4][d] Approval of Correspondence ........................... 1-31[B][4][e] Annual Compliance Meetings with

Representatives................................................ 1-31[B][4][f] Office Designations......................................... 1-32[B][4][g] Inspections ...................................................... 1-32[B][4][h] “Outside” Activities of a Representative.......... 1-32[B][4][i] Continuing Education Requirements .............. 1-32[B][5] Requirement to Establish an Effective

Compliance Program ......................................... 1-33[B][6] Controls Over Compensation............................ 1-33[B][7] Examinations and Enforcement......................... 1-33[C] Group Variable Annuities—Regulation Under

FINRA Rules .......................................................... 1-35§ 1:5.5 Marketing............................................................... 1-35

[A] Generally................................................................ 1-35


xxvi

[B] SEC Rules............................................................... 1-36[C] FINRA Rules .......................................................... 1-37

§ 1:6 The Structure of This Book.......................................... 1-37

Chapter 2 Status of Insurance Products Under theSecurities Act of 1933Christopher S. Petito

§ 2:1 Overview......................................................................... 2-2§ 2:2 Section 3(a)(8): Exclusion for “Non-Securities” .............. 2-4

§ 2:2.1 The Statute .............................................................. 2-4§ 2:2.2 Supreme Court Cases .............................................. 2-5

[A] SEC v. VALIC ........................................................... 2-5[B] SEC v. United Benefit .............................................. 2-7

§ 2:2.3 Rule 151 Safe Harbor............................................. 2-11§ 2:2.4 Lower Court Cases Interpreting Section 3(a)(8)

and Rule 151.......................................................... 2-13[A] Olpin v. Ideal National Insurance Co. ................... 2-13[B] Peoria Union Stockyards Co. v. Pennsylvania

Mutual Life Insurance Co. ..................................... 2-15[C] Otto v. VALIC ......................................................... 2-15[D] Associates in Adolescent Psychiatry, S.C. v.

Home Life Insurance Co. ....................................... 2-17[E] Berent v. Kemper Corp........................................... 2-18[F] Malone v. Addison Insurance Marketing, Inc. ........ 2-18

§ 2:2.5 Vacated Rule 151A Proposal................................... 2-19§ 2:2.6 Section 989J of the Dodd-Frank Act ...................... 2-22

§ 2:3 Section 3(a)(2): Exemption for Contracts FundingQualified Plans ............................................................. 2-24

§ 2:4 Section 4(2): Exemption for Private Offerings .............. 2-25§ 2:5 The Securities Act—Status of Annuity Contracts ........ 2-25

§ 2:5.1 Traditional Fixed Annuities ................................... 2-25§ 2:5.2 Excess Interest Annuity Contracts......................... 2-26

[A] Nature of the Issuer ............................................... 2-27[B] Investment Risks Retained .................................... 2-27[B][1] Link to Separate Account Performance.............. 2-27[B][2] Guarantee of Non-forfeiture Rates .................... 2-28[B][3] Market Value Adjustments ................................ 2-29[B][4] Frequency of Declaration of Excess Rates.......... 2-31[C] Marketing............................................................... 2-31[D] Mortality Risks Assumed....................................... 2-33

§ 2:5.3 Indexed Annuities .................................................. 2-34[A] Nature of the Issuer ............................................... 2-37[B] Investment Risks Retained .................................... 2-37[B][1] Link to Separate Account Performance.............. 2-38


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xxvii

[B][2] Guarantee of Non-forfeiture Rates .................... 2-38[B][3] Market Value Adjustments ................................ 2-39[B][4] Frequency of Declaration of Index-Based

Credits ............................................................... 2-39[C] Marketing............................................................... 2-40[D] Mortality Risks Assumed....................................... 2-41[E] State Regulation ..................................................... 2-41

§ 2:5.4 Variable Annuities.................................................. 2-42§ 2:6 The Securities Act—Status of Life Insurance

Contracts ...................................................................... 2-43§ 2:6.1 Traditional Term Life Insurance Contracts ............ 2-43§ 2:6.2 Whole Life Insurance Contracts ............................ 2-43§ 2:6.3 Universal Life Insurance Contracts ....................... 2-44§ 2:6.4 Indexed Universal Life Insurance Contracts .......... 2-44§ 2:6.5 Variable Universal and Variable Whole Life

Insurance Contracts............................................... 2-45

Chapter 3 Status of Insurance Companies andInsurance Company Separate AccountsUnder the Investment Company ActWendell M. Faria

§ 3:1 Introduction.................................................................... 3-2§ 3:2 What Is an Investment Company?................................. 3-4

§ 3:2.1 Section 3(a)(1)(A): The Orthodox InvestmentCompany ................................................................. 3-4

[A] Meaning of “Issuer”................................................. 3-5[B] Meaning of “Engaged Primarily” ............................. 3-7

§ 3:2.2 Section 3(a)(1)(B): The Face-Amount CertificateCompany ................................................................. 3-7

§ 3:2.3 Section 3(a)(1)(C): The Inadvertent InvestmentCompany ................................................................. 3-8

§ 3:2.4 Exclusions for Certain Holding Companies............. 3-9[A] Sections 3(b)(1) and 3(b)(2) ...................................... 3-9[A][1] Meaning of “Engaged Primarily” for

Purposes of Section 3(b)..................................... 3-10[B] Section 3(c)(6) ........................................................ 3-12

§ 3:2.5 Section 3(b)(3) ........................................................ 3-12§ 3:2.6 Exclusions for Various Other Companies .............. 3-13

§ 3:3 Status on Insurance Companies—Definitions ............. 3-13§ 3:3.1 Insurance Company............................................... 3-13§ 3:3.2 Meaning of “Primary and Predominant Business

Activity” .................................................................. 3-13[A] Foreign Insurance Companies................................ 3-15


xxviii


§ 3:4 Status of Variable Annuity Separate Accounts.............. 3-16§ 3:4.1 History ................................................................... 3-16

[A] The Prudential Decision ........................................ 3-16[B] Difficulties with the Prudential Decision:

The Legal Identity of the Separate Account........... 3-17[C] Difficulties with the Prudential Decision:

Regulation As Periodic Payment PlansUnder the Investment Company Act..................... 3-19

§ 3:4.2 Current Regulation of Variable AnnuitySeparate Accounts.................................................. 3-20

[A] Investment Company Classification...................... 3-21[A][1] Open-End Management Companies.................. 3-22[A][2] Unit Investment Trusts ..................................... 3-22[A][2][a] Registration of Variable Annuity

Separate Accounts Organized AsUnit Investment Trusts................................... 3-25

[B] Rules Applying to Regulation of VariableAnnuity Separate Accounts.................................... 3-25

[B][1] Rule 11a-2 ......................................................... 3-26[B][2] Rule 14a-2 ......................................................... 3-26[B][3] Rules 15a-3, 16a-1, 32a-2.................................. 3-27[B][4] Rule 22d-2 ......................................................... 3-27[B][5] Rule 22e-1.......................................................... 3-28[C] Exemptive Relief Applicable to Variable

Annuities ............................................................... 3-28[C][1] Section 26(b) Relief ............................................ 3-29

§ 3:5 Status of Variable Life Insurance SeparateAccounts ....................................................................... 3-29

§ 3:5.1 History ................................................................... 3-29§ 3:5.2 Regulation of Variable Life Insurance Company

Separate Accounts ....................................................3-31[A] Rule 6e-2 ................................................................ 3-31[B] Rule 6e-3(T) ........................................................... 3-34[C] Exemptive Relief—Mixed and Shared Funding

Relief ...................................................................... 3-34§ 3:6 Other Separate Accounts .............................................. 3-39

Chapter 3A Regulation of Variable Insurance ProductsUnder the Investment Company Act of 1940Gary E. Jenkins

§ 3A:1 Introduction..................................................................3A-2§ 3A:2 Conceptual Framework Under the Investment

Company Act................................................................3A-4§ 3A:2.1 Generally................................................................3A-4

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xxix

§ 3A:2.2 Separate Accounts Under State andFederal Law..............................................................3A-5

§ 3A:2.3 Variable Contracts Separate Accounts AsInvestment Companies and UITs ........................3A-12

§ 3A:2.4 UITs Under Investment Company ActSection 12(d)1(E)—Contract Holder Votingand Underlying Funds .........................................3A-14

§ 3A:3 Variable Insurance Contracts and the InvestmentCompany Act..............................................................3A-16

§ 3A:3.1 Classification of Investment Companies .............3A-16[A] Open- and Closed-End Funds—Diversified

and Non-Diversified Funds ..................................3A-16§ 3A:3.2 Registration of the Variable Separate Account

and the Variable Contract Offering ......................3A-17[A] Overview ..............................................................3A-17[B] Underlying Funds—Form N-1A...........................3A-19[C] Variable Contracts—Forms N-4 and N-6.............3A-22[D] Prospectus Updates ..............................................3A-24

§ 3A:3.3 Organizational and Governance Requirements.....3A-25[A] Overview ..............................................................3A-25[B] Initial Funding .....................................................3A-25[C] Custody................................................................3A-26[D] Election and Requirements of Board of

Directors—Underlying Funds ..............................3A-27[E] Approval of Advisory Fees ....................................3A-31[F] Capital Structure—Senior Securities and

Preferential Rights................................................3A-34§ 3A:3.4 Affiliated Transactions/

Fiduciary Responsibility.........................................3A-36[A] Overview ..............................................................3A-36[B] Principal Transactions..........................................3A-38[C] Joint Transactions ................................................3A-39[D] Agency Transactions ............................................3A-39[E] Fiduciary Responsibility .......................................3A-40[F] Reasonableness Standard .....................................3A-42[G] Fund Selection and Substitution..........................3A-44[H] Insurer Disclosure Liability..................................3A-44

§ 3A:3.5 Valuation, Redemptions, Exchanges,and Distribution ..................................................3A-45

[A] Valuation and the Forward Pricing Rule...............3A-45[B] Redemptions ........................................................3A-47[C] Exchanges.............................................................3A-48[D] Distribution .........................................................3A-50

§ 3A:3.6 Administrative Considerations ............................3A-53[A] Reporting..............................................................3A-53[B] Recordkeeping ......................................................3A-55


xxx

[C] Independent Accountant......................................3A-56[D] Compliance Programs..........................................3A-57

§ 3A:3.7 Other Considerations for Variable InsuranceContracts .............................................................3A-58

[A] Insurance Dedicated Funds—DiversificationRequirements of Section 817(h) ...........................3A-58

[B] Mixed and Shared Funding ..................................3A-60[C] Summary Prospectus............................................3A-62

§ 3A:4 Conclusion .................................................................3A-66

Chapter 4 Tax Treatment of Variable ContractsJohn T. Adney & Joseph F. McKeever, III

§ 4:1 Introduction.................................................................... 4-2§ 4:2 Tax Definition of “Variable Contract” ............................ 4-2§ 4:3 Contractholder Tax Treatment........................................ 4-4

§ 4:3.1 General Contractholder Tax Rules ........................... 4-4[A] Life Insurance Contracts.......................................... 4-4[B] Annuity Contracts ................................................. 4-11[C] Modified Endowment Contracts ............................ 4-25[D] Long-Term Care Insurance Combination

Products ................................................................. 4-26§ 4:3.2 Special Contractholder Tax Rules Applicable to

Variable Contracts.................................................. 4-27[A] Diversification Rules (I.R.C. § 817(h)) ................... 4-28[A][1] General Diversification Test .............................. 4-29[A][2] Safe Harbor Test ................................................ 4-29[A][3] Alternative Test for Variable Life Contracts ....... 4-30[A][4] Rules of Application........................................... 4-30

Figure 4-1 Unacceptable Structure ...................................... 4-35Figure 4-2 Acceptable Structure........................................... 4-36

[A][5] Consequences of Nondiversification.................. 4-36[B] Investor Control..................................................... 4-37

§ 4:4 Insurance Company Tax Treatment ............................. 4-41

Appendix 4A Selected Sections of the Internal RevenueCode and Treasury Regulations.................. App. 4A-1

Appendix 4B Treasury Regulation § 1.817-5 ................... App. 4B-1

Chapter 5 ERISA IssuesWilliam A. Schmidt & Kristina M. Zanotti

§ 5:1 Introduction.................................................................... 5-2§ 5:2 ERISA ............................................................................. 5-2

§ 5:2.1 Which Programs Are Covered.................................. 5-3


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§ 5:2.2 Exclusions from Coverage: Governmental andChurch Plans ........................................................... 5-7

§ 5:3 Implications of ERISA Coverage..................................... 5-8§ 5:4 Reporting and Disclosure.............................................. 5-10

§ 5:4.1 Overview and Schedule A ...................................... 5-10§ 5:4.2 Schedule C ............................................................. 5-12§ 5:4.3 Service Provider Disclosures Under ERISA

§ 408(b)(2).............................................................. 5-14§ 5:4.4 Participant-Level Disclosures ................................. 5-15

§ 5:5 Fiduciary Responsibilities ............................................. 5-16§ 5:5.1 Overview ................................................................ 5-16§ 5:5.2 Fiduciary Status and Plan Assets ........................... 5-16§ 5:5.3 The “Plan Assets” Issue......................................... 5-20

§ 5:6 Application of the Fiduciary Responsibility Rules toVariable Annuity Contracts .......................................... 5-23

§ 5:7 Prohibited Transaction Restrictions .............................. 5-24§ 5:8 The Best Interest Contract Exemption......................... 5-30§ 5:9 Statutory Exemption for Investment Advice................. 5-31

§ 5:9.1 General Requirements for Computer Models ........ 5-32§ 5:9.2 Authorization, Disclosure, and Other

Requirements ......................................................... 5-34§ 5:9.3 Relief for Plan Sponsors ......................................... 5-36

§ 5:10 Conclusion ................................................................... 5-36

PART II:PRODUCT DESIGN AND APPROVALS

Chapter 6 Variable Insurance Product DesignChristopher E. Palmer

§ 6:1 Overview......................................................................... 6-2§ 6:2 Federal Regulatory Framework........................................ 6-4

§ 6:2.1 Pre-1996 Federal Regulation .................................... 6-4§ 6:2.2 The Reasonableness Standard.................................. 6-5§ 6:2.3 Unused Rulemaking Authority ................................ 6-6§ 6:2.4 Mechanics of the Reasonableness Representation....... 6-7

[A] Location and Language of ReasonablenessRepresentation ......................................................... 6-7

[B] Supporting Memorandum........................................ 6-7§ 6:2.5 Legislative History ................................................... 6-8§ 6:2.6 SEC Staff Guidance.................................................. 6-9§ 6:2.7 Factors to Consider in Assessing Reasonableness ....... 6-9

[A] “Services Rendered”................................................ 6-10[B] “Expenses Expected to Be Incurred”....................... 6-10


xxxii

[C] “Risks Assumed”.................................................... 6-10[D] Aggregate Charges Within Range of Industry

Practice................................................................... 6-11[E] Reasonable Profit.................................................... 6-11[F] Innovation.............................................................. 6-12[G] General Economic Factors and Industry Trends ..... 6-12[H] Other Regulatory Requirements ............................. 6-12[I] Pre-NSMIA Standards............................................ 6-13[J] Other Considerations............................................. 6-13

§ 6:2.8 Underlying Fund Fees and Charges ....................... 6-13§ 6:2.9 Litigation Involving the Reasonableness

Standard................................................................. 6-15§ 6:2.10 Specific Contracts Fees and Charges...................... 6-15

[A] Mortality and Expense Risk Charges ..................... 6-16[B] Administrative Charges.......................................... 6-16[C] Cost of Insurance Charges..................................... 6-16[D] Sales Charges ......................................................... 6-17[E] DAC Taxes ............................................................. 6-17

§ 6:2.11 Required Liquidity Determination ......................... 6-18§ 6:3 Variable Annuity Product Design.................................. 6-19

§ 6:3.1 Overview ................................................................ 6-19§ 6:3.2 Specific Design Features......................................... 6-20

[A] Death Benefits........................................................ 6-20[B] Payout Options ...................................................... 6-21[C] Living Benefits........................................................ 6-22[D] Long-Term Care Benefits........................................ 6-23[E] Sales Charges ......................................................... 6-23[F] Purchases and Redemptions................................... 6-23[G] Partial Withdrawals................................................ 6-24[H] Nonforfeiture Law.................................................. 6-24[I] Free Look Period..................................................... 6-25[J] Other State Law Features....................................... 6-25

§ 6:4 Variable Life Product Design......................................... 6-25§ 6:4.1 Overview ................................................................ 6-25§ 6:4.2 Specific Design Features......................................... 6-27

[A] Minimum Death Benefits and Grace Periods ........ 6-27[B] Purchases and Redemptions................................... 6-28[C] Partial Withdrawals................................................ 6-29[D] Mandatory Policy Provisions.................................. 6-29[D][1] Mandatory Disclosure ....................................... 6-29[D][2] Contestability Provisions ................................... 6-30[D][3] Free Look Period ................................................ 6-30[D][4] Other Mandatory Provisions ............................. 6-30


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Chapter 7 The Funding VehicleC. Christopher Sprague

§ 7:1 Regulation Under the Investment Company Act ........... 7-2§ 7:2 Unique Federal Tax Status of Underlying

Mutual Funds ................................................................. 7-3§ 7:3 Mixed and Shared Funding............................................. 7-4§ 7:4 Rule 12b-1 Plans........................................................... 7-10§ 7:5 Participation Agreements.............................................. 7-12

§ 7:5.1 Purchases and Redemptions .................................. 7-12§ 7:5.2 Prospectuses and Sales Literature .......................... 7-13§ 7:5.3 Mixed and Shared Funding Provisions................... 7-13§ 7:5.4 Other Typical Provisions ........................................ 7-13

§ 7:6 Substitution of Underlying Funds Held by UITAccounts ....................................................................... 7-14

§ 7:6.1 Section 26(c) Applications ..................................... 7-15§ 7:7 Mutual Fund Redemption Fees..................................... 7-19§ 7:8 Rule 22e-3: Exemption for Liquidation of Money

Market Funds ............................................................... 7-22§ 7:9 Special Exemptions for Underlying Funds.................... 7-25§ 7:10 Fund Summary Prospectus ........................................... 7-27§ 7:11 State Regulation of Underlying Funds .......................... 7-29

Chapter 8 SEC RegistrationClifford E. Kirsch & Michael J. Mazza

§ 8:1 Introduction.................................................................... 8-2§ 8:2 Drafting Considerations ................................................. 8-3

§ 8:2.1 Requirement That Prospectuses Be Written inPlain English ............................................................ 8-3

§ 8:2.2 SEC Staff Insurance Products IndustryComment Letters..................................................... 8-5

§ 8:3 Mechanics of the Registration Process for NewProducts .......................................................................... 8-5

§ 8:3.1 Filing the Initial Registration Statement.................. 8-5§ 8:3.2 Staff Review Process................................................. 8-6§ 8:3.3 Going Effective......................................................... 8-6§ 8:3.4 Registration Fees ...................................................... 8-7

§ 8:4 Prospectus Delivery and Updating Requirements........... 8-7§ 8:4.1 Requirement to Keep Prospectus Current ................ 8-8§ 8:4.2 Delivery of Updated Prospectus ............................... 8-8§ 8:4.3 Discontinued Contracts ........................................... 8-9

[A] Generally.................................................................. 8-9[B] Group Contracts .................................................... 8-10


xxxiv


§ 8:4.4 Delivery of One Prospectus to Investors WhoShare an Address—Householding .......................... 8-10

§ 8:4.5 Electronic Delivery of Prospectuses........................ 8-12§ 8:5 Mechanics of Updating the Prospectus......................... 8-12

§ 8:5.1 Post-Effective Amendments ................................... 8-13[A] Generally................................................................ 8-13[B] Text of Rule 485..................................................... 8-15

§ 8:5.2 Stickers................................................................... 8-20[A] Generally................................................................ 8-20[B] Text of Rule 497..................................................... 8-21

§ 8:5.3 The Yearly Update Season ..................................... 8-22§ 8:6 Forms N-3 and N-4—Registration Forms for

Variable Annuities......................................................... 8-22§ 8:6.1 Form N-4 Requirements ........................................ 8-23

§ 8:7 The Variable Annuity Profile ........................................ 8-35§ 8:8 Form N-6—Registration Form for Variable Life

Insurance ...................................................................... 8-36§ 8:8.1 Form N-6 Requirements ........................................ 8-37

§ 8:9 Form N-1A—Registration Form for UnderlyingFunds ............................................................................ 8-48

§ 8:9.1 Delivery of Fund Prospectus .................................. 8-48§ 8:10 Registering a Marketing Value Adjustment Contract ......8-49

§ 8:10.1 Generally................................................................ 8-49§ 8:10.2 MVA Contracts and Exchange Act Reporting ........ 8-49

§ 8:11 Special Topics ............................................................... 8-50§ 8:11.1 Marketing Prior to an Effective Registration

Statement............................................................... 8-50[A] Legal Framework .................................................... 8-50[A][1] Permissible Marketing Activity During the

Waiting Period.................................................... 8-51[A][1][a] Oral Offers ...................................................... 8-52[A][1][b] Written Offers ................................................. 8-52

§ 8:11.2 Rule 38a-1 and the Registration Process................ 8-54

Appendix 8A Form N-4 ................................................... App. 8A-1

Appendix 8B Form N-6 ................................................... App. 8B-1

Appendix 8C Industry Comment Letters.........................App. 8C-1

Appendix 8D Form N-4 Registration Statement DueDiligence Grid ............................................App. 8D-1

Chapter 8A State Contract IssuesCynthia J. Borrelli

§ 8A:1 Regulation of Variable Products ....................................8A-2§ 8A:2 State Standards for Contracts on a Variable Basis ........8A-2

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§ 8A:3 Alternatives to 50-State Filing and Approval................ 8A-4§ 8A:3.1 Certification Filings on a State-by-State Basis ....... 8A-4

[A] “Unique Product Features or Design” .................... 8A-4[B] The “Certification Memo” ..................................... 8A-5[C] Regulatory Acknowledgement ................................ 8A-6

§ 8A:3.2 Interstate Product Regulation Compact ................. 8A-6[A] The Compact ......................................................... 8A-6[B] Variable Compact Products .................................... 8A-8[C] IIPRC Procedures ................................................. 8A-11[D] Compact Benefits................................................. 8A-11[E] Noted Compact Product Exceptions .................... 8A-12[F] Compact Product Uniformity .............................. 8A-12

§ 8A:4 Unique Products ......................................................... 8A-13§ 8A:4.1 Innovative Variable Products Developed

Post-1996 Amendments to theInvestment Company Act of 1940....................... 8A-13

[A] Regulatory Issues Associated withNew Product Designs........................................... 8A-14

[B] Disclosure Requirements Under GLBs................. 8A-15[C] Reserve Liabilities for Guaranteed Minimum

Death Benefit (GMDB) Riders ............................. 8A-16§ 8A:4.2 Synthetic Guaranteed Investment

Contract (GIC) Forms.......................................... 8A-18§ 8A:5 Practical Tips for Policy Form Filing .......................... 8A-19§ 8A:6 Conclusion ................................................................. 8A-21

Appendix 8A-A Summary of Five-Year Review Commentsand PSC Recommendations For UniformStandards in Phases 2, 3, and 4 of theFive-Year Review ..................................... App. 8A-A-1

PART III:PRODUCT ADMINISTRATION

Chapter 9 Issues Related to Product AdministrationC. Christopher Sprague

§ 9:1 Introduction.....................................................................9-1§ 9:2 Variable Annuity Processing Issues..................................9-2

§ 9:2.1 Two-Day/Five-Day Rule.............................................9-2§ 9:3 Group Variable Annuities ................................................9-4

§ 9:3.1 Principal Mutual No-Action Letter ...........................9-5§ 9:4 Variable Life Processing Issues .........................................9-6§ 9:5 Processing of Premium Payments by

the Insurer .......................................................................9-8


xxxvi

§ 9:6 Allocation of Premiums During the Free LookPeriod.............................................................................. 9-9

§ 9:7 Impact of Underlying Fund Redemption Fees .............. 9-11

Chapter 10 Redemption Fee RuleChristopher E. Palmer

§ 10:1 Overview....................................................................... 10-1§ 10:2 Administrative History ................................................. 10-2

§ 10:2.1 Proposal ................................................................. 10-2§ 10:2.2 Adoption ................................................................ 10-2§ 10:2.3 Amendments.......................................................... 10-3§ 10:2.4 Compliance Date ................................................... 10-3§ 10:2.5 Funds Covered by the Rule .................................... 10-4

§ 10:3 Redemption Fee ............................................................ 10-5§ 10:3.1 Board Determination ............................................. 10-5§ 10:3.2 Features of Any Redemption Fee............................ 10-6§ 10:3.3 Factors for Board Consideration ............................ 10-9

§ 10:4 Shareholder Information Agreements......................... 10-10§ 10:5 Industry Standardization Efforts ................................. 10-14§ 10:6 Implementation of Shareholder Agreement

Requirement ............................................................... 10-15§ 10:7 Variable Insurance Products Funds ............................. 10-18§ 10:8 Conclusion ................................................................. 10-21

Chapter 11 Separate Account Compliance ProgramsClifford E. Kirsch

§ 11:1 Background ................................................................... 11-1§ 11:1.1 Text of Rule 38a-1.................................................. 11-2§ 11:1.2 Coverage ................................................................ 11-5

§ 11:2 Adoption and Implementation of Written Policiesand Procedures.............................................................. 11-5

§ 11:2.1 Required Scope of Written Policies andProcedures.............................................................. 11-6

§ 11:2.2 Oversight of Service Providers’ Policies andProcedures.............................................................. 11-7

§ 11:3 Approval of Written Policies and Procedures ................ 11-8§ 11:4 Annual Review.............................................................. 11-9§ 11:5 Chief Compliance Officer ............................................. 11-9§ 11:6 Record Keeping ........................................................... 11-10§ 11:7 Special Issues Related to Variable Products................. 11-11

§ 11:7.1 Satisfying the Oversight ResponsibilityProvisions............................................................. 11-11


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§ 11:7.2 Determining Who Is a Service Provider............... 11-11§ 11:7.3 Living with a Separate Account

Compliance Program ........................................... 11-12§ 11:8 SEC Enforcement Activity Related to Compliance

Program Deficiencies .................................................. 11-13

Chapter 12 Insurer Exchange ProgramsClifford E. Kirsch & Jack Ewing

§ 12:1 Introduction.................................................................. 12-3§ 12:2 Text of Relevant Provisions........................................... 12-3

§ 12:2.1 Section 11—Offers to Exchange Securities ............ 12-3§ 12:2.2 Rule 11a-2—Offers of Exchange by Certain

Registered Separate Accounts or Others theTerms of Which Do Not Require PriorCommission Approval ........................................... 12-4

§ 12:3 Section 11 of the Investment Company Act ................ 12-7§ 12:3.1 Overview ................................................................ 12-7§ 12:3.2 Coverage of Section 11 .......................................... 12-8

[A] Exchange of Investment CompanySecurity for Another InvestmentCompany Security.................................................. 12-8

[A][1] Reallocation of Sub-Account Assets................... 12-8[A][2] Section 11 Coverage Summary.......................... 12-9[B] Internal Versus External Exchange Offers .............. 12-9[C] Covered Parties: Separate Account;

Principal Underwriters ......................................... 12-10[D] Timing of Exchanges............................................ 12-11

§ 12:3.3 Exceptions to Section 11...................................... 12-12[A] Treatment of Retail Transactions:

“The Retail Exception”......................................... 12-12[B] Rule 11a-2............................................................ 12-14[B][1] Conditions of Rule 11a-2—Variable Life

Insurance Contracts ........................................ 12-15[B][2] Conditions of Rule 11a-2—Variable

Annuity Contracts ........................................... 12-15[B][3] Conditions of Rule 11a-2-Reallocation

of Sub-Account Assets ..................................... 12-17[C] Exemptive Orders................................................. 12-17[C][1] Hartford Life Insurance Company—New

Contingent Deferred Sales Charge................... 12-19§ 12:4 Insurance Law Considerations ................................... 12-20

§ 12:4.1 State Regulation of Policy Replacements.............. 12-21[A] NAIC Model Unfair Trade Practices Act ............. 12-21


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[B] NAIC Replacement of Life Insurance andAnnuities Model Regulation ................................ 12-22

[B][1] Exceptions for Certain Exchange Offers .......... 12-23§ 12:4.2 Relationship to Section 11 Exchange Offers.......... 12-23

[A] Comparison of Section 11 with StateInsurance Rules.................................................... 12-23

PART IV:PRODUCT DISTRIBUTION

Chapter 13 SEC Regulation of Product DistributionClifford E. Kirsch

§ 13:1 Introduction.................................................................. 13-2§ 13:2 Broker-Dealer Registration............................................ 13-3

§ 13:2.1 Registration of an Insurance Company/Insurance Company Subsidiary—Exchange ActRelease No. 8389 ................................................... 13-4

§ 13:2.2 Registration of an Insurance Agency...................... 13-5§ 13:3 Record-Keeping Requirements ...................................... 13-6

§ 13:3.1 Required Records.................................................... 13-6§ 13:3.2 Preservation of Records ........................................ 13-14

[A] Time Period.......................................................... 13-14[B] Location ............................................................... 13-14[C] Requirements to Maintain Records at

an Office .............................................................. 13-15§ 13:3.3 Insurance Company Subsidiary Registered

As a Broker-Dealer ............................................... 13-16§ 13:4 Financial Reporting..................................................... 13-17

§ 13:4.1 Financial Statements............................................ 13-17§ 13:4.2 FOCUS Reports ................................................... 13-17

§ 13:5 Net Capital Requirements .......................................... 13-17§ 13:5.1 Required Level of Net Capital .............................. 13-18§ 13:5.2 Restrictions on Withdrawals of Equity Capital .... 13-19

§ 13:6 Customer Protection Rule .......................................... 13-19§ 13:7 SIPC Membership....................................................... 13-20§ 13:8 Payment of Commissions........................................... 13-20

§ 13:8.1 Payment of Commissions to Captive Agents ...... 13-20§ 13:8.2 Payment of Commissions to an Insurance

Agency.................................................................. 13-21§ 13:9 Compensation Practices ............................................. 13-21§ 13:10 Confirmation Requirements ....................................... 13-22

§ 13:10.1 Immediate Confirmation Requirements:Rule 10b-10(a)...................................................... 13-23


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§ 13:10.2 Quarterly Confirmation Requirements:Rule 10b-10(b)...................................................... 13-24

§ 13:10.3 SEC Exemptive Authority .................................... 13-25§ 13:10.4 Special Considerations Applicable to

Variable Products.................................................. 13-26§ 13:11 Settlement of Transactions ......................................... 13-26§ 13:12 Duty to Supervise ....................................................... 13-27

§ 13:12.1 Who Is Subject to Sanctions for Failingto Supervise? ........................................................ 13-28

[A] Who Is a Supervisor? ........................................... 13-28[A][1] Personnel in the Management Chain.............. 13-29[A][2] Compliance and Legal Personnel..................... 13-29

§ 13:12.2 Discharging Supervisory Responsibility ............... 13-30[A] Designing and Implementing Adequate

Procedures ............................................................ 13-30[B] Meaningful Follow-Up ......................................... 13-31

§ 13:13 Duty to Supervise Remote Offices .............................. 13-32§ 13:14 Investment Advisory Activity ..................................... 13-34

§ 13:14.1 Definition of an Investment Adviser ................... 13-35[A] “Engaging in the Business” .................................. 13-36[B] Providing “Advisory” Services Concerning

Securities.............................................................. 13-37[C] Advice or Reports Provided for

“Compensation”................................................... 13-38§ 13:14.2 Broker-Dealer Exclusion from the Advisers

Act ....................................................................... 13-38[A] The Nature of the Exclusion................................ 13-39[B] Availability of the Exclusion to Registered

Representatives..................................................... 13-41[C] Conducting Advisory Activity Outside the

Exclusion.............................................................. 13-42[D] Proposed SEC Rulemaking................................... 13-42

Chapter 14 State Securities Regulation of ProductDistributionClifford E. Kirsch

§ 14:1 Introduction.................................................................. 14-1§ 14:2 State Securities Jurisdiction over the Sale of Variable

Products ......................................................................... 14-2§ 14:2.1 Variable Product Notice Filings .............................. 14-3§ 14:2.2 2002 Uniform Securities Act ................................. 14-3

§ 14:3 State Securities Regulation of the Sale of MutualFund and Other Securities Products ............................. 14-4

§ 14:4 Registration Issues ........................................................ 14-4


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§ 14:4.1 Firm ....................................................................... 14-4§ 14:4.2 Branch Offices........................................................ 14-4§ 14:4.3 Personnel................................................................ 14-5

§ 14:5 Substantive Regulation ................................................. 14-6§ 14:6 Record-Keeping Requirements and Inspections ............ 14-6

VOLUME 2

Table of Chapters............................................................................vii

Chapter 15 FINRA Regulation of Product DistributionSusan S. Krawczyk

§ 15:1 Introduction.................................................................. 15-8§ 15:1.1 Origin of the NASD............................................... 15-9

[A] Industry Interest in a Self-RegulatoryOrganization .......................................................... 15-9

[B] Legislation Authorizing National SecuritiesAssociations ........................................................... 15-9

[C] NASD Registration As a National SecuritiesAssociation........................................................... 15-10

[D] Subsequent Amendments to theMaloney Act......................................................... 15-10

§ 15:1.2 Rules Governing FINRA As a NationalSecurities Association .......................................... 15-11

[A] Powers and Duties ............................................... 15-11[B] SEC Oversight of Self-Regulatory

Organizations....................................................... 15-11[B][1] SEC Approval of Rules and Rule Changes ....... 15-12[B][2] SEC Examinations of SROs............................. 15-13[B][3] SEC Review of Disciplinary Actions and

Other Determinations ..................................... 15-13§ 15:1.3 FINRA Operational Structure .............................. 15-14

[A] Original Structure ................................................ 15-14[B] Re-Examination of the NASD’s Structure ........... 15-15[B][1] Rudman Report................................................ 15-15[B][2] Justice Department Settlement........................ 15-16[B][3] SEC Consent Order and Section 21(a)

Report .............................................................. 15-16[C] Plan of Allocation—1996 to 2002 ....................... 15-17[D] Divisional Structure ............................................. 15-20[E] FINRA: Consolidation of the NASD and

Certain NYSE Operations .................................... 15-21

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§ 15:1.4 FINRA Rule Material and Guidance.................... 15-22[A] FINRA By-Laws.................................................... 15-22[B] NASD Rules......................................................... 15-23[C] Interpretive Material ............................................ 15-24[D] Other Guidance ................................................... 15-24[D][1] Interpretive Letters and Exemptions................ 15-24[D][2] Notices to Members and Regulatory

Notices............................................................. 15-25[D][3] NASD Regulatory & Compliance Alert ........... 15-25[D][4] Other FINRA Publications............................... 15-26[D][5] FINRA Website ................................................ 15-26

§ 15:1.5 Other Functions Performed by FINRA ................ 15-26[A] Central Registration Depository (CRD)

System and Investment AdviserRegistration Depository........................................ 15-27

[B] Review of Investment Company AdvertisingMaterial................................................................ 15-28

[C] Continuing Education Program ........................... 15-28[D] Investor Education ............................................... 15-29[E] Arbitration and Mediation ................................... 15-30

§ 15:2 Historical Overview of FINRA Regulation ofBroker-Dealers Selling Variable Contracts................... 15-30

§ 15:2.1 Early NASD Regulation of Members SellingVariable Contracts................................................ 15-30

[A] Voluntary Membership ........................................ 15-31[B] Establishment of the Variable Contracts

Committee ........................................................... 15-32[C] Variable Contracts Rule........................................ 15-32[D] Examination Requirements.................................. 15-34[E] Dealing with Non-Members ................................ 15-35

§ 15:2.2 Later Developments ............................................. 15-36[A] Mandatory Membership Requirement ................. 15-36[B] Regulation of Member Activity in

Qualified Contracts.............................................. 15-37[C] Defined Variable Annuities Rule .......................... 15-38

§ 15:3 FINRA Membership ................................................... 15-39§ 15:3.1 Applying for Membership .................................... 15-40

[A] Membership Application...................................... 15-40[B] Designation of Executive Representative.............. 15-41[C] Designation of Offices.......................................... 15-41[D] Minimum Number of Principals ......................... 15-42[E] Limits on Member Names and

Organizational Forms .......................................... 15-43[F] Additional Registrations....................................... 15-44


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§ 15:3.2 FINRA Membership Admission Process .............. 15-45[A] District Office Review .......................................... 15-45[B] Membership Interview ......................................... 15-45[C] Standards for Admission...................................... 15-46[D] Restrictions and Conditions ................................ 15-46[E] Membership Agreement....................................... 15-46[F] Appeal Process ..................................................... 15-47

§ 15:3.3 Impact of Other Business Activities..................... 15-48[A] Mutual Fund Sales ............................................... 15-49[B] Retail Brokerage Activities ................................... 15-49[C] Retail Investment Advisory Operations and

Financial Planning Services.................................. 15-50[D] Mutual Fund Investment Advisory Operations..... 15-51[E] Insurance Products............................................... 15-51[F] Certificates of Deposit and Other Bank

Products ............................................................... 15-52[G] Activities in Foreign Jurisdictions ........................ 15-53[H] 529 Plans ............................................................. 15-54

§ 15:3.4 Subsequent Filings and Changes Relating toMembership or Permissible Operations ............... 15-54

[A] Changes in Form BD ........................................... 15-55[B] Changes in Member Name or Executive

Representative ...................................................... 15-55[C] Changes in Office Locations or Supervisors......... 15-55[D] Changes in Restrictions ....................................... 15-55[E] Changes in Ownership, Control, or

Operations ........................................................... 15-56[F] Changes in Status Under the Customer

Protection Rule..................................................... 15-57[G] Business Continuity Plans ................................... 15-58

§ 15:3.5 Termination of Membership ................................ 15-58§ 15:4 Registration of Principals and Representatives ........... 15-59

§ 15:4.1 Registration Requirements ................................... 15-59[A] Definition of “Associated Person” ........................ 15-59[B] Definition of “Principal” ...................................... 15-60[C] Definition of “Representative” ............................. 15-60[D] Definition of “Engaged in the Investment

Banking or Securities Business” ........................... 15-61[E] Exemptions .......................................................... 15-62[E][1] Clerical Employees........................................... 15-62[E][2] Directors and Corporate Officers..................... 15-63[E][3] Home Office and Service Center

Employees........................................................ 15-64[E][4] Foreign Finders ................................................ 15-65


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§ 15:4.2 Qualification and Registration Process ................ 15-65[A] FINRA Qualification Requirements ..................... 15-65[B] Examinations and Categories of Registration........ 15-66[C] Application and Approval .................................... 15-68[D] Other Registration Issues..................................... 15-68[D][1] Minimum Number of Principals ..................... 15-68[D][2] Change in Principal Status .............................. 15-69[D][3] Registration Renewals...................................... 15-69

§ 15:4.3 Background Investigation and HiringPractices ............................................................... 15-69

[A] Duty to Review Form U-4 and Form U-5History ................................................................. 15-70

[B] Best Hiring Practices ............................................ 15-70[C] Non-Registered Persons........................................ 15-71

§ 15:4.4 Employment Issues .............................................. 15-72[A] Employee Versus Independent Contractor ........... 15-72[B] Associated Person Agreements............................. 15-73[C] Dual Registration ................................................. 15-73[D] FINRA Arbitration Procedures ............................. 15-73

§ 15:4.5 Continuing Obligations and RequirementsApplicable to Registered Persons.......................... 15-74

[A] Duties and Obligations ........................................ 15-74[B] Reporting Obligations .......................................... 15-75[C] Continuing Education Requirements................... 15-75[C][1] Regulatory Element.......................................... 15-75[C][2] Firm Element................................................... 15-77[D] Disclosures to Associated Persons ....................... 15-79

§ 15:4.6 Termination of Registration ................................. 15-79§ 15:4.7 Transferring Registration from One Member

to Another............................................................ 15-80§ 15:5 Overview of Supervision Requirements ...................... 15-80

§ 15:5.1 The Supervision Rule........................................... 15-80[A] Written Supervisory Procedures ........................... 15-81[B] Chain of Supervision ........................................... 15-82[B][1] Qualified Supervisors....................................... 15-83[B][2] Principal/Representative Ratios........................ 15-84[B][3] Compliance Officers ........................................ 15-85[C] Approval of Transactions ..................................... 15-85[D] Approval of Correspondence ................................ 15-86[E] Internal Inspections ............................................. 15-88[F] Annual Compliance Meetings with

Representatives..................................................... 15-89§ 15:5.2 Office Designations.............................................. 15-91

[A] Office of Supervisory Jurisdiction......................... 15-92[B] Branch Office ....................................................... 15-93


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[C] Non-Branch Locations ......................................... 15-93[D] Proposed Amendments to Branch Office

Definition............................................................. 15-95§ 15:5.3 Use of Compliance Manuals and Other

Procedures............................................................ 15-95[A] Manuals ............................................................... 15-95[B] Exception and Activity Reports ............................ 15-96[C] Compliance Audits and Other Sampling

Techniques ........................................................... 15-97§ 15:5.4 Outside Activities................................................. 15-97

[A] Dual Registration ................................................. 15-98[B] Accounts with Other Institutions ........................ 15-98[C] Other Activities.................................................... 15-99[C][1] Private Securities Transaction........................ 15-100[C][2] Outside Business Activities ........................... 15-101[C][3] Applicability to Investment Adviser

Activities........................................................ 15-101[C][4] Applicability to Viaticals and Life

Settlements .................................................... 15-102[C][5] Applicability to Promissory Notes and

Other Instruments......................................... 15-103§ 15:5.5 Special Supervisory Situations ........................... 15-103

[A] Guidance for Supervision of RemoteLocations............................................................ 15-103

[B] Guidance for Supervision of CertainRegistered Persons.............................................. 15-104

[B][1] Identifying Problem Representatives.............. 15-105[B][2] Guidelines...................................................... 15-105[C] Guidance for Telemarketing Activities ............... 15-106

§ 15:5.6 Anti-Money Laundering CompliancePrograms ............................................................ 15-107

[A] Customer Identification Requirements .............. 15-109§ 15:5.7 Supervisory Controls.......................................... 15-109§ 15:5.8 CEO Certification and Designation of Chief

Compliance Officer ............................................ 15-110§ 15:5.9 Outsourcing ....................................................... 15-110

§ 15:6 Sales and Advertising Practices................................. 15-111§ 15:6.1 Variable Contracts Rule...................................... 15-111

[A] Distribution and Selling Agreements ................. 15-111[B] Compliance with Pricing Rule ........................... 15-111[C] Sales Charges ..................................................... 15-112[D] Sales Compensation........................................... 15-112[E] Comparison with the Investment Company

Rule .................................................................... 15-112[F] Proposed Amendments ...................................... 15-113


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§ 15:6.2 The Deferred Variable Annuities Rule ............... 15-113§ 15:6.3 The Suitability Rule ........................................... 15-116

[A] Recommendation ............................................... 15-116[B] Customer Profile ................................................ 15-117[C] Institutional Investors........................................ 15-119[D] Guidance for Variable Contracts ........................ 15-120[E] Know-Your-Customer Rule ................................. 15-123

§ 15:6.4 Advertising and Customer Communications ..... 15-124[A] Rules Governing Communications.................... 15-124[B] Review, Approval, and Record-Keeping

Requirements ..................................................... 15-125[B][1] Advertisements and Sales Literature.............. 15-125[B][1][a] Research Reports and Reprints.................... 15-125[B][1][b] Seminars and Radio Talk Shows ................. 15-126[B][1][c] Correspondence........................................... 15-126[B][1][d] Institutional Sales Materials ....................... 15-127[B][1][e] Electronic Communications........................ 15-127[B][2] Internal Review and Approval Procedures....... 15-128[B][3] FINRA Filing and Approval Requirements

for Investment Company Material ................ 15-129[B][3][a] What Is Investment Company Material? ..... 15-130[B][3][b] Timing of Filing .......................................... 15-130[B][3][c] Record-Keeping Requirements..................... 15-131[C] Variable Contract Guidelines ............................. 15-131[C][1] Variable Annuity Tax Deferral

Illustrations ................................................... 15-132[C][2] Personalized Variable Life Hypothetical

Illustrations ................................................... 15-132[C][3] Fund Performance.......................................... 15-133[D] Other Content Standards for

Communications ............................................... 15-133[D][1] General Fairness and Balance Standards ....... 15-134[D][2] Rankings Disclosure ...................................... 15-134[D][3] Dollar Cost Averaging and Other

Periodic Investment Plans ............................. 15-135[D][4] Testimonials .................................................. 15-135[D][5] References to Tax-Advantaged Status............. 15-135[D][6] Comparisons.................................................. 15-136[D][7] Use of Index Returns..................................... 15-136[E] Specific Disclosures Required............................. 15-136[E][1] Member Name............................................... 15-136[E][1][a] Business Cards and Stationery.................... 15-137[E][1][b] Use of Logos................................................ 15-138[E][2] Date of First Use ........................................... 15-138[E][3] Bank Disclosure............................................. 15-138


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§ 15:6.5 Other Business Conduct and Sales PracticeRules .................................................................. 15-139

[A] Sales Presentations............................................. 15-139[B] Cold Calling and Telemarketing Practices ......... 15-141[C] Bank Broker-Dealer Rule .................................... 15-142[D] General Standards of Business Conduct ............ 15-143

§ 15:7 Compensation .......................................................... 15-145§ 15:7.1 Rules Specifically Applicable to Variable

Contract Compensation Arrangements ............. 15-145[A] Current Rules..................................................... 15-145[A][1] Dealing Only with Members ......................... 15-145[A][2] Limits on Sales Charges ................................ 15-145[A][3] Refunds and Commission-Netting Practices... 15-146[A][4] Regulation of Cash and Non-Cash

Compensation ............................................... 15-146[A][4][a] Associated Person Receipt of

Compensation............................................. 15-148[A][4][b] Prohibition on Non-Cash Compensation .... 15-149[A][4][c] Record-Keeping Requirements..................... 15-151[A][4][d] Applicability to Exempted Securities........... 15-152[B] Proposed Rule Changes...................................... 15-152

§ 15:7.2 General Rules Governing Compensation........... 15-152[A] Payments to Non-Members ............................... 15-152[B] Payments to Associated Persons ........................ 15-153[C] Payments to Another Member ’s Associated

Person ................................................................ 15-153[D] Payments to Former Registered Persons............. 15-155[E] Assignments by Associated Persons................... 15-155[F] Referral Fees and Transaction-Based

Compensation.................................................... 15-156[G] Payments to Customers ..................................... 15-157

§ 15:7.3 Sales Practices Issues InvolvingCompensation Arrangements ............................ 15-157

[A] Guidance Concerning Mutual Fund SalesPractices ............................................................. 15-158

[B] Tully Committee................................................ 15-158[C] FINRA Study on Compensation ........................ 15-159

§ 15:8 Customer Accounts and Complaints ....................... 15-160§ 15:8.1 Establishment and Maintenance of

Customer Accounts ........................................... 15-160[A] Customer Accounts and Files ............................ 15-160[B] Customer Agreements ....................................... 15-162[C] Acceptance of Accounts ..................................... 15-162[D] Approval of Transactions and

Correspondence.................................................. 15-163


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[E] Release of Confidential Information .................. 15-163[F] Customer Account Transfer ............................... 15-164

§ 15:8.2 Customer Complaints ....................................... 15-165[A] Resolution of Customer Complaints ................. 15-165[B] Settlement Agreements ...................................... 15-165[C] Reporting Requirements..................................... 15-165

§ 15:8.3 Handling Customer Funds, Applications,and Requests ...................................................... 15-166

§ 15:8.4 Customer Disclosures and Provision ofInformation........................................................ 15-167

[A] Confirmations.................................................... 15-168[B] Control Relationship.......................................... 15-168[C] Notice of Public Disclosure Program ................. 15-168[D] Customer Account Statements .......................... 15-169[E] Other Information for Customers...................... 15-169

§ 15:9 FINRA Record-Making, Record-Keeping, andReporting Requirements ........................................... 15-170

§ 15:9.1 FINRA Record-Making and Record-KeepingRequirements ..................................................... 15-170

[A] SEC Records....................................................... 15-170[B] Customer Account Records................................ 15-171[C] Transaction Records ........................................... 15-171[D] Correspondence Files ......................................... 15-171[E] Advertising Files................................................. 15-172[F] Due Diligence Files ............................................ 15-172[G] Customer Complaint Files................................. 15-172[H] Do-Not-Call Lists .............................................. 15-172[I] Associated Person Files ...................................... 15-173[J] Training, Supervision, and Continuing

Education Files................................................... 15-173[K] Foreign Finders and Other Compensation

Payments............................................................ 15-174[L] Outside Activities Records ................................. 15-174[M] FINRA Manual .................................................. 15-174[N] Application Materials and Bad Acts................... 15-174[O] Reports and Filings ............................................ 15-174

§ 15:9.2 Reporting Requirements..................................... 15-174[A] Bad Act Reporting Requirements ....................... 15-175[B] Quarterly Complaints Reporting

Requirements ..................................................... 15-176[C] Changes in Form BD or Membership

Application Information .................................... 15-176[D] Annual Assessment Reports and

Renewal Fees ...................................................... 15-176


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[E] Form U-4 and Form U-5 Filings........................ 15-177[F] Registered Person Reporting Requirements ......... 15-177

§ 15:10 Citations for NASD Rules ........................................ 15-177

Chapter 16 SuitabilityClifford E. Kirsch

§ 16:1 Background ................................................................... 16-3§ 16:2 FINRA Regulatory Framework...................................... 16-3

§ 16:2.1 General Rules Applying to All Securities ............... 16-3[A] The Suitability Rule ............................................... 16-3[A][1] Text of New Suitability Rule—FINRA

Rule 2111 (Suitability) (Effective July 9,2012—Replaced NASD Rule 2310) ................... 16-3

[A][2] Overview of FINRA’s General Suitability Rule.... 16-7[A][2][a] Old NASD Conduct Rule 2310....................... 16-7[A][2][b] FINRA Rule 2111 (Suitability) ........................ 16-7[A][2][b][i] Recommendations to Customers................. 16-8[A][2][b][ii] What Are Investment Strategies?............... 16-10[A][2][b][iii] Reasonable-Basis; Customer-Specific;

Quantitative Suitability ............................. 16-11[A][2][b][iv] Customer ’s Investment Profile .................. 16-11[A][2][b][v] Institutional Investors ............................... 16-12[A][2][c] FINRA Rule 2090 (Know Your Customer)

(Effective July 9, 2012) .................................. 16-13[A][3] General Interpretative Questions Regarding

the Application of FINRA’s General SuitabilityRule to Variable Products ................................. 16-14

[A][3][a] Duty Runs to FINRA Members .................... 16-15[A][3][b] Duty Runs to Transactions Involving a

“Recommendation” ....................................... 16-15[A][3][c] Application of the Suitability Rule to

Third-Party Sales........................................... 16-15[B] Other Relevant FINRA General Rules.................. 16-17[B][1] Supervisory Systems ........................................ 16-17[B][2] Customer Account Requirements.................... 16-17

§ 16:2.2 FINRA Rulemaking and Related GuidanceSpecific to Variable Product Sales......................... 16-17

[A] Reminder That Sales of Variable ContractsAre Subject to FINRA SuitabilityRequirements: 1996 ............................................. 16-18

[B] Sale of Variable Annuities: 1999 .......................... 16-18[C] Sale of Variable Life Insurance: 2000 ................... 16-19


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[D] Replacement of Annuities’ Impact on ContractValue and Death Benefit—Regulatory &Compliance Alert: 2002;Notice to Members 05-50.................................... 16-20

[E] Application of Suitability Rule to TransactionsWhere Registered Product Is Sold to PurchaseUnregistered Product—Regulatory & ComplianceAlert: 2002; Notice to Members 05-50................ 16-20

[F] SEC/NASD Joint Report: 2004 ............................ 16-20[G] FINRA Rule 2330—Supervision and Suitability

of Annuity Transactions ........................................ 16-21[G][1] Text of FINRA Rule 2330 ................................ 16-22[G][2] Coverage .......................................................... 16-27[G][3] Recommendation Requirements ...................... 16-28[G][4] Principal Review and Approval ........................ 16-29[G][4][a] Prompt Transmittal Requirement ................. 16-29[G][5] Supervisory Procedures and Training............... 16-30

§ 16:2.3 Recent Enforcement and ExaminationFocus on Variable Products .................................. 16-31

[A] Recent Enforcement Cases................................... 16-31[B] Exam Initiatives ................................................... 16-33[B][1] FINRA’s Variable Annuity Database Proposal..... 16-33[B][2] Focus on Guarantees ....................................... 16-33[B][3] SEC ReTIRE Initiative ..................................... 16-33[B][4] “L” Shares......................................................... 16-35

§ 16:3 SEC Regulatory Framework ........................................ 16-35§ 16:3.1 Anti-Fraud Provisions .......................................... 16-35§ 16:3.2 Broker-Dealer Books and Records Rule ................ 16-35

§ 16:4 State Regulatory Framework ....................................... 16-35§ 16:4.1 NAIC Model Variable Life Insurance Regulation...... 16-36§ 16:4.2 NAIC Suitability in Annuity Transactions

Model Regulation................................................. 16-36[A] Customer Information......................................... 16-37[B] Supervisory Program ............................................ 16-37[C] Records................................................................. 16-37

§ 16:4.3 2010 Amendments .............................................. 16-37§ 16:4.4 Insurer Supervisory Programs .............................. 16-38§ 16:4.5 State Adoption of the Annuity Model Regulation .... 16-39

Chapter 17 Replacement of Insurance ProductsDaniel W. Krane & Elizabeth A. Diffley

§ 17:1 Introduction.................................................................. 17-3§ 17:2 Background ................................................................... 17-5

§ 17:2.1 Definition of a Replacement .................................. 17-5


l

§ 17:2.2 Early Regulation of Replacements .......................... 17-7[A] State Regulation ..................................................... 17-7[B] Federal Regulation.................................................. 17-9

§ 17:2.3 Bonus Annuities .................................................. 17-11§ 17:2.4 Recent Developments .......................................... 17-12

§ 17:3 Federal Regulation of Replacements ........................... 17-17§ 17:3.1 Suitability............................................................. 17-17§ 17:3.2 Duty of Fair Dealing ............................................ 17-22§ 17:3.3 Disclosure ............................................................ 17-23§ 17:3.4 Supervision .......................................................... 17-25

§ 17:4 State Regulation.......................................................... 17-29§ 17:4.1 State Replacement Regulation.............................. 17-29

[A] NAIC Model Regulations..................................... 17-29[A][1] Life Insurance and Annuities Replacement

Model Regulation............................................. 17-30[A][1][a] Scope and Application................................... 17-32[A][1][b] Duties of Producers....................................... 17-33[A][1][c] Duties of Insurers That Use Producers......... 17-34[A][1][d] Duties of Replacing Insurers That Use

Producers....................................................... 17-36[A][1][e] Duties of the Existing Insurer ....................... 17-37[A][1][f] Duties of Insurers with Respect to Direct

Response Solicitations................................... 17-38[A][1][g] Violations and Penalties................................ 17-38[B] Suitability in Annuity Transactions Model

Regulation ............................................................ 17-40[B][1] Scope and Application ..................................... 17-41[B][2] Suitability ........................................................ 17-42[B][3] Supervision ...................................................... 17-44[B][4] Insurance Producer Training............................ 17-45[B][5] Compliance; Mitigation; Penalties................... 17-46[B][6] State Reaction to the Suitability in Annuity

Transactions Model ......................................... 17-46[C] Model Unfair Trade Practices Act ........................ 17-47

§ 17:4.2 State Statutes and Regulations............................. 17-49[A] New York State Insurance Department

Regulation 60....................................................... 17-49[A][1] Scope and Application ..................................... 17-51[A][2] Duties of Producers ......................................... 17-53[A][3] Duties of All Insurers ...................................... 17-54[A][4] Duties of Replacing Insurers............................ 17-55[A][5] Existing Insurers .............................................. 17-56[A][6] Prohibited Acts ................................................ 17-57[A][7] Market Conduct Exams and Disciplinary

Action .............................................................. 17-58


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[B] California ............................................................. 17-61[C] Florida .................................................................. 17-65[D] Illinois.................................................................. 17-67[E] Pennsylvania ........................................................ 17-68

§ 17:4.3 State Securities Laws............................................ 17-69

Chapter 18 Broker-Dealer and Adviser Uniform Standard ofCareClifford E. Kirsch & Ben Marzouk

§ 18:1 Introduction.................................................................. 18-2§ 18:2 Current Legal Framework ............................................. 18-2

§ 18:2.1 Current Framework for Standard of Care .............. 18-2§ 18:2.2 Duty of Fair Dealing (the “Shingle Theory”) ......... 18-4§ 18:2.3 Duty to Observe Just and Equitable Principles of

Trade ...................................................................... 18-5§ 18:2.4 Situations Where Broker-Dealers Are Bound by

Fiduciary Duty ....................................................... 18-7[A] Discretionary Accounts.......................................... 18-7[B] Certain Relationships of Trust ............................... 18-8[C] Dual Registrants .................................................... 18-8[D] Muni-Advisors........................................................ 18-9[E] ERISA Fiduciaries................................................... 18-9

§ 18:3 Chronology—Regulatory Response to Convergence ofBroker-Dealer and Advisory Services............................ 18-10

§ 18:4 Treatment of Broker-Dealers Under theAdvisers Act .............................................................. 18-13

§ 18:4.1 Generally.............................................................. 18-13§ 18:4.2 RAND Report ...................................................... 18-13

§ 18:5 Harmonizing the Broker-Dealer and InvestmentAdviser Standard of Care ............................................ 18-14

§ 18:6 Legislative Proposals ................................................... 18-15§ 18:6.1 Investor Protection Act of 2009........................... 18-15§ 18:6.2 House Proposal .................................................... 18-16§ 18:6.3 Senate Banking Committee Proposal................... 18-17§ 18:6.4 Dodd-Frank Wall Street Reform and

Consumer Protection Act of 2010 ....................... 18-17[A] The SEC Study..................................................... 18-19[B] SEC’s Request for Cost/Benefit Data ................... 18-23[B][1] Assumptions About a Possible Uniform

Fiduciary Standard ............................................ 18-24[B][2] Possible Uniform Fiduciary Standard .............. 18-25[B][3] Possible Alternatives to a Uniform Standard .... 18-26[B][4] Key Industry Concerns .................................... 18-26


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[B][5] Information About Changes Made inResponse to 2007 Wrap Fee AccountRule Case......................................................... 18-27

[B][6] Information About Further RegulatoryHarmonization ................................................ 18-27

§ 18:7 Practical Implications to Consider ............................. 18-28§ 18:8 SEC Activity: 2013–2016............................................ 18-29§ 18:9 Other Initiatives ......................................................... 18-30

§ 18:9.1 Department of Labor ’s Fiduciary Duty Rule........ 18-30§ 18:9.2 The GAO’s Financial Planner Study.................... 18-32

PART V:MARKETING MATERIAL

Chapter 19 AdvertisingClifford E. Kirsch

§ 19:1 Overview....................................................................... 19-3§ 19:2 Content Requirements.................................................. 19-4

§ 19:2.1 SEC Content Requirements ................................... 19-4[A] Background ............................................................ 19-5[B] Permissible Types of Marketing Material ............... 19-5[B][1] Advertisements .................................................. 19-6[B][1][a] Omitting Prospectuses: Rule 482

Advertisements................................................ 19-6[B][1][b] Generic Advertisements .................................. 19-7[B][2] Supplemental Sales Literature ........................... 19-7[C] Standards ............................................................... 19-8

§ 19:2.2 FINRA Content Requirements............................... 19-8[A] FINRA Communication Categories ....................... 19-9[A][1] Retail Communications................................... 19-10[A][2] Institutional Communications ........................ 19-10[A][2][a] Internal Communications............................. 19-11[A][2][b] “Reason to Believe” Standard ........................ 19-11[A][3] Correspondence ............................................... 19-12[A][3][a] Prior Definition of Correspondence .............. 19-12[B] Requirements As to Content ............................... 19-13[B][1] General Content Standards Applicable to

All Communications with the Public.............. 19-13[B][2] Predictions and Projections.............................. 19-14[B][3] Bond Fund Volatility Ratings........................... 19-14[B][4] Testimonials .................................................... 19-15[B][5] Use and Disclosure of Member ’s Name.......... 19-15


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[B][6] Comparisons.................................................... 19-17[B][7] Performance Figures ........................................ 19-17[B][8] Tax ................................................................... 19-18[B][8][a] Tax-Deferral Illustrations .............................. 19-18[B][9] Specific Content Standards Applicable to

Variable Life and Variable Annuity Products ..... 19-19§ 19:2.3 State Content Requirements ................................ 19-21

[A] Applicability: Definition of Advertising ............... 19-21[B] Requirements As to Content ............................... 19-22[B][1] General Standards ........................................... 19-22[B][2] Specific Disclosure Requirements .................... 19-22[B][3] Identity of Insurer and Policies........................ 19-23

§ 19:3 Internal Review and Recordkeeping Procedures.......... 19-24§ 19:3.1 SEC Internal Review Requirements ..................... 19-24§ 19:3.2 FINRA Internal Review and Recordkeeping

Requirements ....................................................... 19-24[A] Institutional Sales Material.................................. 19-24[B] Correspondence.................................................... 19-25[C] Material Used by Intermediary Firms.................. 19-25[D] Other Exceptions: Market Letters, Online Posts,

and Administrative Communications.................. 19-26§ 19:3.3 State Internal Review and Recordkeeping

Requirements ....................................................... 19-26§ 19:4 Filing Requirements.................................................... 19-27

§ 19:4.1 Requirements to File Sales Material withthe SEC................................................................ 19-27

§ 19:4.2 FINRA Filing Requirements................................. 19-27[A] FINRA Review Procedure ..................................... 19-27[B] Exceptions to the Filing Requirements ................ 19-28[B][1] Retail Communications................................... 19-28[B][1][a] Generic Fund Communications.................... 19-28[B][1][b] Backup Material for Investment Company

Performance Rankings and Comparisons ..... 19-28[B][1][c] Investment Analysis Tools ............................ 19-28[B][1][d] Bond Fund Volatility Ratings ........................ 19-29[B][2] Institutional Sales Material and

Correspondence ............................................... 19-29[B][2][a] For “Internal Use Only” ............................... 19-29[B][3] Prospectuses..................................................... 19-30[B][4] Updates of Previously Filed Material ............... 19-30[B][5] Unregistered Group Variable Annuities ........... 19-30[B][6] Advisory Services ............................................. 19-31[B][7] Listing of Available Securities .......................... 19-31[B][8] Traditional Products ........................................ 19-31


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[B][9] Extemporaneous Statements at Seminars........ 19-32[B][10] Independently Prepared Reprints ..................... 19-32[B][11] Online Communications................................. 19-32[B][12] Templates......................................................... 19-32

§ 19:4.3 State Filing Requirements .................................... 19-33§ 19:5 Specific Types of Variable Products Sales Literature ..... 19-33

§ 19:5.1 Performance Advertising ...................................... 19-33[A] Variable Annuity Performance Advertising........... 19-34[A][1] Fund Performance Pre-Dating the

Fund’s Inclusion in a Variable Product ............ 19-34[A][2] Related Performance ........................................ 19-35[A][2][a] Inclusion of Related Performance

Information in a Prospectus.......................... 19-36[A][2][b] Inclusion of Related Performance in

Advertising and Sales Literature.................... 19-37[A][2][b][i] Related Performance Distributed to

Institutional Investors ............................... 19-38[A][3] FINRA Guidance: Back-Tested Index

Performance/Institutional Communication..... 19-40[B] Variable Life Performance..................................... 19-40

§ 19:5.2 Variable Annuity Tax-Deferral Illustrations ......... 19-43§ 19:5.3 Investment Analysis Tools ................................... 19-44§ 19:5.4 Hypothetical Illustration of Mathematical

Principles ............................................................. 19-45§ 19:5.5 Customized Hypothetical Investment

Planning Illustrations .......................................... 19-45§ 19:5.6 Interactive Computer Software Programs

That Compare Variable Annuities toMutual Funds ...................................................... 19-45

§ 19:5.7 Foreign Language Marketing Material ................. 19-46§ 19:5.8 Bonus Annuity Products ...................................... 19-47§ 19:5.9 Variable Annuity Illustrations .............................. 19-47

[A] Background .......................................................... 19-48[B] FINRA’s Current Position .................................... 19-50

§ 19:5.10 Dollar Cost Averaging Programs.......................... 19-51§ 19:5.11 Rankings .............................................................. 19-52

§ 19:6 Recent Developments Related to FINRA’sVariable Product Advertising Rules ............................. 19-53

§ 19:6.1 Variable Product Advertising Rule Filing.............. 19-53[A] Regulatory Notice 08-39 ...................................... 19-53[B] Current Status ..................................................... 19-54

§ 19:6.2 FINRA Retrospective Rule Review ....................... 19-54§ 19:6.3 Customized Hypothetical Investment

Planning Illustrations .......................................... 19-54


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Chapter 20 Variable Life Insurance IllustrationsClifford E. Kirsch

§ 20:1 Overview....................................................................... 20-2§ 20:1.1 The Different Types of Illustrations....................... 20-2

[A] Non-Personalized Illustrations............................... 20-2[B] Personalized Illustrations ....................................... 20-2[B][1] The Basic Illustration ........................................ 20-3[B][2] The Conceptual Illustration .............................. 20-3

§ 20:2 Overview of the Regulatory Structure ........................... 20-3§ 20:2.1 The SEC Framework.............................................. 20-3§ 20:2.2 The FINRA Framework ......................................... 20-3

[A] Filing Requirement................................................. 20-4§ 20:2.3 The State Framework............................................. 20-4

§ 20:3 Regulation of the Underlying Assumptions.................. 20-4§ 20:3.1 Cash Flow: Premium Payments, Loans,

and Withdrawals .................................................... 20-5§ 20:3.2 Charges .................................................................. 20-6

[A] Contract Charges ................................................... 20-6[B] Fund Charges ......................................................... 20-6[B][1] Fund-Specific Illustrations ................................. 20-7

§ 20:3.3 Investment Returns ............................................... 20-8[A] Prospectus Illustrations.......................................... 20-8[A][1] Historical Illustrations....................................... 20-9[B] Personalized Illustrations ....................................... 20-9[B][1] Historical Illustrations..................................... 20-10

§ 20:4 Required Disclosures .................................................. 20-10§ 20:5 Requirement to Use an Illustration............................ 20-11§ 20:6 Special Topics ............................................................. 20-11

§ 20:6.1 Internal Rate of Returns ...................................... 20-11§ 20:6.2 Comparisons........................................................ 20-12

Chapter 21 Marketing on the InternetRichard T. Choi

§ 21:1 Introduction.................................................................. 21-4§ 21:2 SEC Pronouncements ................................................... 21-5

§ 21:2.1 SEC Analytical Framework .................................... 21-5[A] Basic Premise ......................................................... 21-5[B] Procedural Considerations ..................................... 21-6[B][1] Consent ............................................................. 21-6[B][1][a] SEC Requirements for Consents ..................... 21-7[B][1][a][i] E-SIGN Consent Requirements ................... 21-7[B][1][a][ii] Telephonic Consent ................................... 21-10[B][1][a][iii] Rule 160 .................................................... 21-10


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[B][1][b] Negative Consents ........................................ 21-11[B][1][c] Third-Party Reliance...................................... 21-13[B][2] Notice .............................................................. 21-13[B][3] Access .............................................................. 21-15[B][4] Evidence of Delivery ........................................ 21-16[C] Clarification of the “Envelope Theory”................ 21-16[D] Responsibility for Hyperlinked Information on

Websites ............................................................... 21-17[D][1] Entanglement and Adoption Theories............. 21-18[D][1][a] Context of Hyperlink .................................... 21-18[D][1][b] Risk of Confusion ......................................... 21-19[D][1][c] Presentation of Hyperlinked Information ..... 21-20[D][2] Anti-Fraud Liability for Hyperlinked

Information ..................................................... 21-20[E] Access to Historical Information ......................... 21-22[F] Summary Information ......................................... 21-23[G] Interactive Website Features................................. 21-23[H] Disclosure Controls and Procedures .................... 21-24[I] Access Equals Delivery Model.............................. 21-24[J] Notice and Access Model..................................... 21-25

§ 21:2.2 SEC Regulation .................................................... 21-26[A] Advertisements..................................................... 21-26[A][1] Types of Advertisements .................................. 21-26[A][2] Legends ............................................................ 21-27[B] Sales Literature..................................................... 21-27[B][1] Prospectus Delivery Requirement .................... 21-27[B][2] Mixed Media.................................................... 21-28[B][3] Unsolicited Materials ...................................... 21-29[B][4] Applications..................................................... 21-29[C] Prospectuses ......................................................... 21-30[C][1] General Requirements ..................................... 21-30[C][1][a] Format of Prospectus..................................... 21-30[C][1][b] Internet Legend ............................................. 21-30[C][2] Preliminary Prospectuses ................................. 21-31[C][3] Definitive Prospectuses.................................... 21-32[C][4] Summary Prospectuses .................................... 21-32[C][4][a] Layered Disclosure Approach ........................ 21-33[C][4][b] Industry Proposal .......................................... 21-33[C][5] Updates and Amendments .............................. 21-33[C][6] Information Incorporated by

Reference into Prospectus ................................ 21-34[D] Reports and Proxies.............................................. 21-34[E] Revised Materials ................................................. 21-34[F] Single Document Delivery or “Householding” ..... 21-34


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[G] Electronic “Road Shows”...................................... 21-36[H] Private Offerings .................................................. 21-37[H][1] Lamp Technologies, Inc. .................................. 21-39[H][1][a] Nature of Website.......................................... 21-39[H][1][b] Procedural Safeguards.................................... 21-39[H][2] IPONET........................................................... 21-40[H][2][a] Nature of Website.......................................... 21-40[H][2][b] Procedural Safeguards.................................... 21-40[I] Third-Party Service Providers ............................... 21-41[I][1] Broker/Dealer Status ........................................ 21-41[I][1][a] Charles Schwab & Co., Inc........................... 21-41[I][1][b] Angel Capital Electronic Network ................ 21-42[I][1][c] Progressive Technology, Inc. .......................... 21-44[I][1][d] Oil-N-Gas ..................................................... 21-44[I][2] Responsibility for Third-Party Content ........... 21-45[J] Use of Electronic Means in Issuer ’s Discretion .... 21-46[K] Plain English ........................................................ 21-47

§ 21:2.3 Use of Social Media ............................................. 21-47[A] 2012 SEC Actions................................................ 21-47[A][1] Investor Alert: Social Media and

Investing—Avoiding Fraud............................... 21-47[A][2] Investor Bulletin: Social Media and

Investing—Understanding Your Accounts ....... 21-48[A][3] National Examination Risk Alert:

Investment Adviser Use of Social Media ......... 21-49[A][4] Order Instituting Proceedings: In the Matter

of Anthony Fields, CPA d/b/a AnthonyFields & Associates and d/b/a PlatinumSecurities Brokers (“Fields”) ............................. 21-53

[B] SEC Social Media Sweep...................................... 21-53§ 21:3 FINRA Pronouncements............................................. 21-56

§ 21:3.1 Overview .............................................................. 21-56§ 21:3.2 Suitability............................................................. 21-57

[A] Possible Higher Duty Where InternetInvolved................................................................. 21-57

[B] Special Care for Widely DisseminatedCommunications ................................................. 21-58

§ 21:3.3 Supervision .......................................................... 21-58[A] Supervisory Procedures Must Cover

Online Activities .................................................. 21-58[B] Supervisory Procedures for Incoming and

Outgoing Correspondence.................................... 21-59[B][1] Specific Provisions ........................................... 21-59[B][2] Record Retention ............................................. 21-60


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§ 21:3.4 Communications with the Public........................ 21-60[A] Websites ............................................................... 21-60[B] Hyperlinks............................................................ 21-61[B][1] Ongoing Hyperlinks to Internet Sites.............. 21-61[B][2] Hyperlinks to Educational Material................. 21-62[B][3] Hyperlinks to a Home Page ............................. 21-63[C] Use of Social Media ............................................. 21-63[C][1] Recordkeeping.................................................. 21-63[C][2] Suitability ........................................................ 21-65[C][3] Supervision ...................................................... 21-65[C][4] Types of Interactive Electronic Forums............ 21-67[C][5] Third-Party Posts, Links, and Content ............ 21-68[C][6] Personal Communications and

Other Devices .................................................. 21-70[D] FINRA Disciplinary Actions ................................ 21-70[D][1] Failure to Supervise ......................................... 21-71[D][2] Failure to Comply with Advertising

Requirements, Including RegisteredPrincipal Approval ........................................... 21-73

[D][3] False, Misleading, or Inadequate Disclosures.... 21-76[D][4] Failure to Safeguard Customer Information ..... 21-77

§ 21:4 Conclusion ................................................................. 21-78

PART VI:REGULATORY EXAMINATIONS

Chapter 22 SEC Insurance Product ExamsClifford E. Kirsch

§ 22:1 Introduction.................................................................. 22-2§ 22:2 History of the Variable Products Inspection Program..... 22-3

§ 22:2.1 Background ............................................................ 22-3§ 22:2.2 Office of Compliance Inspections and

Examinations ......................................................... 22-4§ 22:2.3 SEC and FINRA Joint Variable Product

Examinations ......................................................... 22-5§ 22:2.4 SEC, FINRA, and NASAA Free Lunch Seminar

Sweep Examinations .............................................. 22-9§ 22:3 OCIE Variable Products Inspection Focus .................. 22-10§ 22:4 The Mechanics of Variable Products Inspections ....... 22-13

§ 22:4.1 Inspection Site ..................................................... 22-14[A] Home Office Versus Off-Site ................................ 22-14


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[B] Third-Party Service Provider ................................ 22-15[C] Sales Office........................................................... 22-15

§ 22:4.2 Frequency of Variable Product Inspections........... 22-15§ 22:4.3 Inspection Targets ................................................ 22-16§ 22:4.4 Notice Period ....................................................... 22-17§ 22:4.5 Requests for Documentation ............................... 22-17

[A] Phase I Request for Information for VariableProduct Sponsors ................................................. 22-18

[A][1] Customer Transactions.................................... 22-18[A][2] Replacement Transactions ............................... 22-19[A][3] Financed Transactions ..................................... 22-20[B] Phase II Request for Information for Variable

Product Sponsors ................................................. 22-20[B][1] Legal, Back-Office Administration, and

Customer Transaction Files............................. 22-21[B][2] Accounting Documents ................................... 22-22[B][3] Market Conduct and Sales Practices ............... 22-22[B][4] Rule 38a-1 Program Documentation ............... 22-24[C] Request for Information for Broker-Dealers

That Solicit Variable Products.............................. 22-24[C][1] Financial and Corporate Books and Records..... 22-24[C][2] Sales Practice Information Request.................. 22-25[C][3] Variable Annuity Information Request ............ 22-26

§ 22:4.6 Duration of Inspection......................................... 22-27§ 22:4.7 Inspection Follow-Up........................................... 22-27

[A] Evaluation and Reporting Components ............... 22-27[B] Deficiency Letter and Response to Inspection

Findings ............................................................... 22-28§ 22:5 An In-Depth Look at Variable Product Back-Office

(Administration) Inspections ...................................... 22-28§ 22:5.1 Opening Interview/Outline of Review Points ....... 22-28§ 22:5.2 Compliance Policies and Procedures and

Designated CCO Manuals ................................... 22-34§ 22:5.3 Transaction Processing and “As of” Pricing ......... 22-34§ 22:5.4 NAV and AUV Computations.............................. 22-36§ 22:5.5 Walk-Through ...................................................... 22-37

§ 22:6 An In-Depth Look at Variable Product MarketConduct and Sales Practice Inspections ..................... 22-39

§ 22:6.1 General ................................................................ 22-39§ 22:6.2 Supervisory and Market Conduct Compliance

Procedures Manual .............................................. 22-40§ 22:6.3 Supervisory and Compliance Systems ................. 22-40§ 22:6.4 Sales Office Activity ............................................. 22-41§ 22:6.5 Sales Office Component ...................................... 22-41

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§ 22:6.6 Opening Interview/Outline of Review Points ....... 22-42§ 22:6.7 Request for Documentation ................................. 22-46

§ 22:7 Frequently Cited Exam Deficiencies ........................... 22-47§ 22:8 Conclusion ................................................................. 22-47

Appendix 22A Examination Request List ........................ App. 22A-1

Chapter 23 FINRA Examination and Disciplinary ProgramsHolly H. Smith

§ 23:1 Introduction.................................................................. 23-2§ 23:1.1 Statutory Authority ................................................ 23-3

[A] Examination Authority Granted toSelf-Regulatory Organizations ................................ 23-3

[B] Allocation of Regulatory ResponsibilityAmong SROs ......................................................... 23-3

[C] Scope of FINRA Examination Authority................ 23-4§ 23:1.2 Types of Examinations ........................................... 23-5

[A] Cycle Exams........................................................... 23-5[A][1] Conduct of the Exam......................................... 23-7[B] Cause Exams........................................................ 23-10[C] Branch Exams ...................................................... 23-10[D] Market Regulation Exams.................................... 23-11[E] Sweep Exams........................................................ 23-11[F] New Member Exams............................................ 23-11[G] Letter Exams ........................................................ 23-12[H] Advertising Spot-Check Exams ............................ 23-12[I] Product-Based Exams ........................................... 23-12[J] SEC Quality Exams.............................................. 23-13

§ 23:1.3 Rights and Responsibilities Vis-à-Vis Membersand FINRA........................................................... 23-13

[A] FINRA Right to Information and Inspection....... 23-13[B] Duty to Comply................................................... 23-13

§ 23:2 FINRA Disciplinary Program...................................... 23-14§ 23:2.1 Generally.............................................................. 23-14§ 23:2.2 Disciplinary Program ........................................... 23-15

[A] Delegation of Responsibility to FINRA................ 23-15[B] Enforcement Department Investigation ............... 23-17[C] Authorization of Proceedings ............................... 23-18[D] Hearings............................................................... 23-18[E] Issuance and Review of Decisions ....................... 23-20

§ 23:2.3 Resolution of Disciplinary Proceedings................ 23-21§ 23:2.4 Sanctions.............................................................. 23-21§ 23:2.5 SEC Review.......................................................... 23-22§ 23:2.6 Statutory Disqualifications .................................. 23-23§ 23:2.7 Conclusion........................................................... 23-23

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Chapter 24 State Insurance Department Market ConductExaminationsMichael Kmiecik

§ 24:1 Overview....................................................................... 24-1§ 24:1.1 Statutory Authority ................................................ 24-2§ 24:1.2 National Association of Insurance

Commissioners (NAIC) ......................................... 24-2§ 24:2 The Mechanics of the Examination ............................. 24-3

§ 24:2.1 Types of Examinations ........................................... 24-3§ 24:2.2 Areas Reviewed ...................................................... 24-4

§ 24:3 Conduct of Examinations ............................................. 24-6§ 24:3.1 The “Call Letter” ................................................... 24-6§ 24:3.2 Examination Technique ......................................... 24-7§ 24:3.3 Books and Records ................................................. 24-7§ 24:3.4 Confidentiality ....................................................... 24-7

§ 24:4 Examination Report...................................................... 24-8§ 24:5 Challenges and Reform Efforts ..................................... 24-9

PART VII:SPECIAL TOPICS

Chapter 25 Private Placement Variable Life InsuranceDavid N. Brown & Kerry Shannon Burke

§ 25:1 Introduction.................................................................. 25-3§ 25:1.1 Structure ................................................................ 25-4§ 25:1.2 Insurance Regulation ............................................. 25-4§ 25:1.3 Tax Treatment........................................................ 25-5§ 25:1.4 Fees and Charges ................................................... 25-5§ 25:1.5 Distribution ........................................................... 25-6

§ 25:2 Regulatory Treatment of PPVLI Products ..................... 25-6§ 25:3 The Securities Act of 1933 ........................................... 25-8

§ 25:3.1 Exemptions ............................................................ 25-8§ 25:3.2 Rule 506 Offerings ................................................. 25-9

[A] Accredited Investors ............................................... 25-9[A][1] Natural Persons ............................................... 25-10[A][2] Corporations, Limited Liability Companies,

Partnerships, and Business Trusts ................... 25-13[A][3] Common Law and Similar Trusts ................... 25-14[A][4] Employee Benefit Plans—Rule 501(a)(1).......... 25-15[A][5] “Formed for the Specific Purpose” ................... 25-16

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[B] Regulation D—Conditions................................... 25-18[B][1] Integration ....................................................... 25-18[B][2] Information ..................................................... 25-19[B][2][a] Offerings to Accredited Investors .................. 25-20[B][2][b] Offerings to Non-Accredited Investors .......... 25-20[B][2][c] Offerings to Both Accredited and

Non-Accredited Investors .............................. 25-21[B][2][d] Disclosures Generally.................................... 25-22[B][3] Manner of Offering.......................................... 25-22[B][4] Resale Restrictions ........................................... 25-25[B][5] Notice of Offering ............................................ 25-25[C] Rule 506(b)—Specific Terms ................................ 25-26[D] Rule 506(c)—Reasonable Verification................... 25-28[E] Rule 506(d)—Bad Actor Disqualification ............. 25-29

§ 25:3.3 State Securities Law Registration and Filing ........ 25-32§ 25:4 Investment Company Act of 1940 ............................. 25-33

§ 25:4.1 Exclusions Under the Investment Company Act.... 25-33[A] Section 3(c)(1) Separate Accounts ........................ 25-33[A][1] “Look-Through” Provisions ............................. 25-35[A][2] Anti-Circumvention Principles........................ 25-38[A][3] Integration ....................................................... 25-40[A][4] Estates and Donees.......................................... 25-42[A][5] General Considerations ................................... 25-42[B] Section 3(c)(7) Separate Accounts ........................ 25-42[B][1] Qualified Purchasers ........................................ 25-43[B][1][a] Natural Persons............................................. 25-45[B][1][b] Corporations, Partnerships, and

Other Entities................................................ 25-45[B][1][c] Common Law and Similar Trusts................. 25-47[B][1][d] Pension Plans and IRAs ................................ 25-48[B][2] “Formed for the Specific Purpose” ................... 25-49[B][3] Estates and Donees.......................................... 25-49[B][4] Anti-Circumvention Principles........................ 25-50[B][5] Integration ....................................................... 25-50[B][6] Investments ..................................................... 25-50[C] Section 12(d)(1)—Anti-Pyramiding ...................... 25-51

§ 25:4.2 Fees and Expenses................................................ 25-51§ 25:5 Securities Exchange Act of 1934................................. 25-51

§ 25:5.1 Section 12(g) Registration .................................... 25-51§ 25:5.2 Antifraud Provisions ............................................ 25-52

§ 25:6 Commodity Exchange Act .......................................... 25-52§ 25:7 Tax Considerations ..................................................... 25-53

§ 25:7.1 Diversification...................................................... 25-53§ 25:7.2 Investor Control................................................... 25-54

(Variable Prods. Reg., Rel. #10, 10/17) lxiii

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§ 25:8 Insurance Agencies and Other Distributors ............... 25-55§ 25:8.1 Broker-Dealer Registration ................................... 25-55§ 25:8.2 FINRA Regulation................................................ 25-56§ 25:8.3 Investment Adviser Registration .......................... 25-57§ 25:8.4 Commodity Trading Advisor Regulation.............. 25-58

§ 25:9 Funding Vehicles......................................................... 25-59

Chapter 26 Asset Allocation Programs and Funds ofFunds in Variable Insurance ProductsPaul G. Cellupica

§ 26:1 Introduction.................................................................. 26-2§ 26:2 Asset Allocation Programs............................................ 26-2

§ 26:2.1 Background ............................................................ 26-2§ 26:2.2 SEC Staff Guidance on Asset Allocation

Programs in Variable Products ............................... 26-4[A] Generally................................................................ 26-4[B] Investment Company Act Issues ........................... 26-5[C] Investment Advisers Act Issues ............................. 26-6

§ 26:2.3 Implementation Issues Under the SEC ’sGuidance................................................................ 26-7

[A] Selection of Investment Adviser for Program......... 26-7[B] Role of Broker-Dealer ............................................. 26-9[C] Updates to Static Asset Allocation Models .......... 26-10[D] Notice Required by Opt-Out Programs................ 26-10

§ 26:2.4 ERISA Concerns Regarding Selection ofMutual Funds in Asset Allocation Programs ....... 26-11

§ 26:3 Funds of Funds ........................................................... 26-16§ 26:3.1 Generally.............................................................. 26-16§ 26:3.2 Statutory Restrictions and Exceptions

Under Section 12 of the InvestmentCompany Act ....................................................... 26-17

§ 26:3.3 SEC Exemptive Relief for Funds of Funds inVariable Products.................................................. 26-19

[A] Generally.............................................................. 26-19[B] Compliance with Section 17(e) ............................ 26-22[C] Mixed and Shared Funding Issues ....................... 26-25

§ 26:3.4 Funds of Funds Exemptive Rules ......................... 26-26[A] Generally.............................................................. 26-26[B] Rule 12d1-1 (Money Market Fund Cash

Sweep Arrangements)........................................... 26-27[C] Rule 12d1-2 (Expanded Investment in

Other Types of Issuers for AffiliatedFunds of Funds) ................................................... 26-28

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§ 26:3.5 Disclosure Requirements for Funds ofFunds in Variable Products................................... 26-29

§ 26:3.6 Proposed Rules Regarding Funds Investingin ETFs ................................................................ 26-30

§ 26:3.7 Use of Target-Date Funds in VariableAnnuities ............................................................. 26-31

Chapter 27 Variable Annuities in Retirement PlansEvan Giller & Weiyen “Ann” Jonas

§ 27:1 Introduction.................................................................. 27-2§ 27:2 Regulatory Environment ............................................... 27-3

§ 27:2.1 Internal Revenue Code........................................... 27-3§ 27:2.2 ERISA..................................................................... 27-4§ 27:2.3 Federal Securities Laws .......................................... 27-5§ 27:2.4 State Laws.............................................................. 27-6

§ 27:3 Overview of Retirement Plans ...................................... 27-7§ 27:3.1 Defined Contribution Plans Compared to

Defined Benefit Plans............................................. 27-7§ 27:3.2 Trust Requirement ................................................. 27-8

§ 27:4 Defined Contribution Plan Types ................................. 27-8§ 27:4.1 Qualified Plans Under Code Section 401(a)

(Including 401(k) Plans)......................................... 27-9§ 27:4.2 Section 403(a) Annuity Plans .............................. 27-10§ 27:4.3 Section 403(b) Plans ............................................ 27-10§ 27:4.4 Section 457(b) Plans ............................................ 27-12§ 27:4.5 Variable Annuity Contract Designs for

Retirement Plans.................................................. 27-13[A] Deferred Annuities............................................... 27-13[B] Immediate Annuities ........................................... 27-14[C] Individual and Group Annuity Contracts............ 27-14[D] Allocated and Unallocated Group Annuity

Contracts ............................................................. 27-16[E] Forms of Distributions from Retirement Plans..... 27-17[F] Spousal Rights Requirements............................... 27-18[G] Specific Defined Contribution Plan Provisions .... 27-19[G][1] Required Distribution Requirements ............... 27-20[G][2] Contribution Limitations ................................ 27-20[G][3] Right to a Direct Rollover................................ 27-20[G][4] Distribution Restrictions ................................. 27-20[G][5] Distributions Without Consent....................... 27-22[G][6] Hardship Distributions.................................... 27-22[G][7] Loans ............................................................... 27-23[G][8] No Assignment................................................ 27-24[G][9] Vesting ............................................................. 27-24

(Variable Prods. Reg., Rel. #10, 10/17) lxv

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[H] Specific Requirements for 403(b) Plans................ 27-24[H][1] Nonforfeitability .............................................. 27-24[H][2] Limitations on Elective Deferrals .................... 27-25[H][3] Nontransferability............................................ 27-25[H][4] Rollover Distributions...................................... 27-25[H][5] Limitation on Incidental Benefits .................... 27-25

§ 27:5 Enrollment Processes.................................................. 27-25§ 27:6 Other Issues Relating to the Use of Annuities in

Retirement Plans ........................................................ 27-27§ 27:6.1 Selecting an Annuity Provider ............................. 27-27§ 27:6.2 Qualified Longevity Annuity Contracts ............... 27-29§ 27:6.3 Participant Disclosures Related to Variable

Annuity Contracts ............................................... 27-31§ 27:6.4 Use of Deferred Annuities in Target Date

Funds ................................................................... 27-37

Appendix 27A 29 C.F.R. § 2550.404a-5—FiduciaryRequirements for Disclosure inParticipant-Directed Individual AccountPlans......................................................... App. 27A-1

Appendix 27B 29 C.F.R. § 2550.404c-1—ERISASection 404(c) Plans ................................. App. 27B-1

Appendix 27C SEC No-Action Letter(October 26, 2011) ...................................App. 27C-1

Appendix 27D SEC No-Action Letter(February 18, 2015) ..................................App. 27D-1

Appendix A Statutory Material ..................................... App. A-1

Table of Authorities ......................................................................T-1

Index................................................................................................. I-1

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