Disclosure & Agent Responsibilities
Comparison of Florida’s and FINRA’s Suitability Requirements
While the intent and scope of FINRA's Rules is similar to Florida law, it is important to note some significant differences:
No Age Restrictions. One of the key differences between Florida's suitability requirements and FINRA Rule 2821 is that Florida law applies only to "senior consumers" (i.e., those age 65 or older). Rule 2821 applies to all purchasers of variable annuities regardless of their age.
Reasonable Basis. FINRA Rule 2821 relies on a subjective standard — what the registered representative "reasonably believes" to be suitable. As we discussed earlier, Florida regulators found that standard to be vague and difficult to enforce. Florida's updated suitability regulations are now based on a review of objective criteria.
Deferred Variable Contracts. As we've noted throughout this course, variable annuities are subject to dual regulation -- as insurance and securities. That is not the case for fixed annuities (including indexed annuities), which are solely insurance products. As a securities regulator, FINRA's rules extend only to variable annuity transactions. It is useful to note that this rule specifically applies to deferred variable contracts, not variable contracts purchased for immediate annuitization. The rule is concerned with variable annuities as an investment (accumulation) vehicle, not as a means to distribute periodic income.
Purchase and Exchange. The detailed determination of suitability required under Rule 2821 applies only to the "purchase or exchange" of deferred variable contracts. That language seems relatively straightforward — but in application it is not so clear-cut. This rule does not apply to recommendations to sell or liquidate a variable annuity, although the general suitability rule (Rule 2310) does. According to a FINRA regulatory memorandum, the general suitability rule “applies to any recommendation to sell a variable annuity regardless of the use of the proceeds, including situations where the member recommends using the proceeds to purchase an unregistered product such as an equity-indexed annuity. Any recommendation to sell the variable annuity must be based upon the financial situation, objectives and needs of the particular investor” — but the written determination and principal review required under Rule 2821 does not apply. FINRA takes the position that an exchange of a variable annuity for a fixed contract is to be treated as a simple liquidation. Likewise, the exchange of a fixed contract for a variable one is treated as a simple purchase. While such switches constitute "replacement" under state law, they are not treated as an "exchange" for purposes of Rule 2821.
Exchanges within 3 years. A registered representative must determine whether the customer has effected another exchange at the broker-dealer at which he or she is performing the review and must make reasonable efforts to ascertain whether the customer has effected an exchange at any other broker-dealer(s) within the preceding 36 months. State law requires agents to make additional inquiries when an exchange is being recommended by the agent, but it does not require agents to delve into past transactions.
Principal Review. A registered representative who recommends the purchase or exchange of a deferred variable annuity must document and sign the determinations of suitability. This signed document must provide reviewing principals with enough information to adequately assess whether the registered representative has complied with the requirements of Rule 2821. Principals have seven business days to review the application and the rep's determination of suitability. As a result, this can cause a delay in client fund's being invested in the selected subaccounts. The review process may also complicate a broker-dealer's compliance with other requirements: such as custody of funds and prompt execution of orders. [Principals should be aware of the narrow exceptions carved out of these rules to allow for the 7-day review period.] Florida's suitability law does not impose this additional level of review, nor does it require approval by the agent's supervisor prior to each individual transaction. Issuers (or third parties) will review agent compliance after-the-fact, but prior review is not required under state law. [As noted above, the 7-day period is not currently being enforced while FINRA considers adjusting that timeframe.]
Paperwork. Rule 2821 requires a written determination of suitability by the registered representative. That form is submitted, with the application, to a principal of the firm. If the principal declines approval because he or she deems the recommendation unsuitable, the principal can still permit the purchase or exchange under limited circumstances: if the transaction was not recommended by a registered rep, or if the principal explains the reasons the transaction is unsuitable and the client chooses to proceed with the transaction anyway. In either case, the principal must document his or her actions in writing. It is the broker-dealer's (i.e. firm's) responsibility to maintain records of the rep's recommendation and the principal's decision. If the principal approves the transaction, the application must be forwarded to the annuity company within 7 business days. State law, by comparison, requires the agent and the issuing company (or third parties) to retain documents related to the agent’s recommendation. Agents must submit a completed copy of customer questionnaires to the issuing company within 10 days of the application -- and, in addition, provide a copy to the client with (or before) delivery of the contract documents. Rule 2821 does not contain any requirement for client disclosure of the suitability determination.
Initial Asset Allocation. State law governing the recommendations on fixed annuity transactions does not deal with the underlying investments within the contract. That is because the assets backing fixed contracts are held in the company's general account, and the contractholder has no control over those investments. The purpose of a variable annuity is to provide the contractholder with control over the investments that support the contract — and the separate investment subaccounts are an integral part of the variable annuity product. Rule 2821 requires registered representatives to determine whether the initial asset allocation among the contract's subaccounts is suitable for the client. The initial asset allocation will be subject to review, and approval, by the firm's principal. This is not true of subsequent reallocations within the contract. Registered representatives should take care that any future reallocations are suitable (under the general suitability rule), but those reallocations need not follow the procedures in Rule 2821.
Exemption for qualified plans. In general, state and FINRA rules on the sales of annuities to retirement plans are similar. Sales to employer-provided plans are exempt from the written suitability requirements; Individual Retirement Accounts are not. (The exemption under Rule 2821 applies to contracts sold to the employer for benefit of the employees as a group. If an annuity is recommended to individual plan participants, the written suitability determination is required)