LRR Newsletter 2011-2

8/7/2019 LRR Newsletter 2011-2

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300 Day Hill Road Windsor, CT 06095 www.limra.com/compliance Issue 2011-2 Bimonthly

LIMRA Regulatory Review ADVANTAGE IN AREGULATORY WORLDBroker-Dealer

Investment Adviser

Insurance

Research

Whats Next in Broker-DealerCompensation Transparency?

United States

(This article is the second in a series

on compensation disclosures. The

first, titled An Emerging Trend:

Increased Producer Compensation

Transparency, can be found at:

http://www.limra.com/newsletters/

LRR/LRR_Newsletter_2010-6c.pdf.)

FINRA published a concept proposal

requesting comment last October

(see http://www.finra.org/web/

groups/industry/@ip/@reg/@notice/documents/notices/p122361.pdf).

This proposed rule would require

firms, at or prior to commencing a

business relationship with a retail

customer, to provide a written

statement that describes the types of

accounts and services they provide.

Firms would also be required to

disclose any conflicts associated

with such services. Although a new

standard of care or fiduciary standardfor broker-dealers is not yet in effect,

this new disclosure rule would figure

prominently in such an environment

and the disclosure would certainly

accomplish much of what might

be required under such a standard.

It is useful then to examine how

firms should react to this proposal

and begin the task of creating an

inventory of potential conflicts that

would be disclosed at the onset of any

client relationship.

All firms pay and receive

compensation this is not news.

They all provide, as would any sales

organization, incentives to managers,

producers, and third-party firms with

which they do business to grow sales,

increase revenue, attract more clients,

and provide good service. Clientsunderstand this at a basic level;

but, what clients understand less is

that firms may be paid in multiple

ways, or paid more for selling some

products over others, or paid under

complex formulas that even some of

the recipients dont fully understand

until all the variables are known. The

concern here is that some of these

practices present the real possibility

of conflicts of interest. In FINRAsview these conflicts, if known, might

change what the client ultimately

decides to buy or even from which

firm or representative they chose to

buy it. The problem is how to explain

the conflicts. They may or may not be

familiar constructs or concepts that

are easily described in terms clients

would understand.

This complimentary newsletter

addresses current regulatoryconcerns around the world and

provides broker-dealers, investment

advisers, and insurance companies

with tips and suggestions for

meeting regulatory obligations.

IN THIS ISSUE

United States

Whats Next in Broker-DealerCompensation Transparency?

FINRA Says to Report

Non-Securities Complaints Know Your Customer: How a

New Generation of SoftwareHelps Advisors to Identify theRight Solutions for Retirees

ERISA Compliance: AnOverview of New Challengesand Opportunities

Life Settlements: HowLong Should Investors WaitBefore Purchasing LifeInsurance Policies?

April 2011


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LIMRA SPOTLIGHT

2 www.limra.com/compliance 2011, LL Global, Inc.

SEMINAR

Social Media for Financial ServicesAugust 2426, 2011Cambridge, MAThis seminar will help your company take itssocial media eorts to the next level whilemeeting regulatory requirements. Presentationsand panel discussions by industry leadersand social media experts, plus specialbreakout sessions, will optimize your learningexperience. To learn more and register, pleasevisit us online. http://www.limra.com/Events/eventdetail.aspx?id=1074

NOTABLE

Help Producers to Leverage Social Mediaand Stay in ComplianceLIMRA and Socialware have teamed to

create Insights: Advisor Series, an always-current curriculum that helps producers growsales and protects your frm. Coursesalready available include Social Media 101,Compliance Basics, LinkedIn, Twitter, andFacebook. For more inormation, please contactMeggan Tuveson at [email protected].

Cost-Effectively Meet the NAICs Suitabilityin Annuity Transactions Model RegulationLIMRAs new AnnuityXT training program andCompliance Suitability Survey can help you

to: (1) ensure that producers complete basicsuitability and product-specifc annuity trainingbeore recommending an annuity product;(2) monitor sales; and (3) share fndings withdistribution partners. For more inormation orto see a demo o the new AnnuityXT trainingsystem, please contact Meggan Tuveson at860-285-7859 or [email protected].

The real challenge, then, is not what to disclose anyone can

compile a comprehensive, detailed legal document that is so lengthy

no one reads it, (today most of us call that a prospectus) but

how to do it. The objective is to explain it in sufficient detail so the

client understands the products, why they are being recommended,

and their impact on the client. The goal is to do so in a manner that

makes sense to consumers and gives them enough information to

compare firms and decide if the advice or recommendation is truly

impartial. This is an aggressive goal for a brief written document. Infact, FINRA suggests that firms consider new ways including, where

appropriate, web-based tools to provide easy ways for clients and

prospective clients to drill down and find the disclosure that is most

likely to interest them or which best explains how it may impact their

individual dealings with the firm or representative.

The good news here is the regulator is not saying they already have a

view of what the right way to do this might be, or that the myriad

ways compensation and revenue can flow, for very legitimate reasons,

are all necessarily bad. FINRA is not painting all revenue or com-

pensation as improper, but instead asks the firm to expose to clients

how the compensation may impact the firm or representative so thatclients are making decisions in full awareness of who benefits, and

how. FINRA is looking for firms to help them figure out the right

combination of how to capture investors attention up front; how to

provide the needed detail; and how to use brief but effective point-

of-sale disclosures to remind customers of the questions they should

ask their advisor or firm before they act on a recommendation. The

resulting document or website would begin a discussion with clients;

one that differs significantly different from any earlier discussions. So,

how can firms prepare for this new era of disclosure while also under-

standing what might be needed under a fiduciary standard of care?

A first step is to create an inventory or grid of the firms activities.Then, for each activity, identify the sources of revenue. Revenue

might be categorized by product or service, types of compensation,

commission, stock options, reward or recognition incentive plans,

benefit programs, and producer support programs that may be tied to

compensation or product sales, or volumes of sales of certain types of

assets or products.

Ask the following questions about how your firm provides solutions

to clients, and consider each element of compensation to determine

how this might impact what gets sold.

1. Does our compensation promote recommending one product

over another or one group of products or asset classes more

than another?

2. Do we limit the sale of some products either due to lack of a

selling agreement or for competitive reasons? Firms may not

offer all products of a certain class or type and that it or its

affiliates may be the sponsor or originator of certain products

or proprietary products. A firm may, in some cases, also act as a

distributor or placement or sales agent for a fee from the issuer or

sponsor of the product.

CONTACT USTo subscribe to LIMRA Regulatory Review or read

previous issues, please visit us online.

To suggest article topics or request article reprints:

Stephen [email protected]

http://www.linkedin.com/in/stephenselby

Follow LIMRA Compliance and Regulatory Services

on Twitter at http://twitter.com/limra_crs.

For more information about LIMRAs services:

LIMRA Compliance and Regulatory Services300 Day Hill Road, Windsor, CT 06095

Phone: 877-843-2641Email: [email protected] site: www.limra.com/compliance
mailto:[email protected]?subject=Insights:%20Advisor%20Seriesmailto:[email protected]?subject=Insights:%20Advisor%20Seriesmailto:[email protected]?subject=Insights:%20Advisor%20Seriesmailto:[email protected]?subject=AnnuityXThttp://www.limra.com/Compliance/LRR.aspxmailto:[email protected]://www.linkedin.com/in/stephenselbyhttp://twitter.com/LIMRA_CRSmailto:[email protected]://www.limra.com/compliancemailto:[email protected]?subject=Insights:%20Advisor%20Serieshttp://www.limra.com/compliancemailto:[email protected]://twitter.com/LIMRA_CRShttp://www.linkedin.com/in/stephenselbymailto:[email protected]://www.limra.com/Compliance/LRR.aspxmailto:[email protected]?subject=AnnuityXT


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www.limra.com/compliance 2011, LL Global, Inc. 3

3. Are similar products available to the same client

through this producer, and are there products for

which we dont offer this incentive or compensation

to producers?

4. Is this compensation commonly paid by all firms,

and well understood by clients and prospects

(e.g., commissions on load mutual funds versus

marketing expense reimbursements tied to a

predetermined formula that can vary by produceror from year to year)?

5. Is our firm paid more by some providers than

others and does that impact the degree to which

those products are sold or promoted by the firm?

(e.g. shelf space, research, marketing support,

incentive meetings, expense reimbursements or that

the universe of research covered may be limited

or influenced by the issuers with which the firm

maintains relationship or the securities for which the

firm acts as a market maker or otherwise engages in

proprietary trading)6. Do we receive payments or other benefits for

referring clients to third parties (cash, revenue

sharing, commissions)?

7. Do we receive payments or other benefits for referring

clients to third parties (cash, revenue sharing,

commissions, equipment, research or non-research)?

8. In what capacity do we act on certain transactions

(broker, agent, advisor, market maker, in a

principal capacity)?

9. What fees are charged or offset on some products thatmight influence the recommendation of one product

over another (brokerage account fees, advisory fees,

ticket charges, transaction fees)?

Based on what you find in the above process, begin to

evaluate other issues that may be present. This will help

identify gaps, and where more robust disclosure might

be needed; or, in some cases even a re-evaluation of the

arrangement to reduce or eliminate possible conflicts.

1. Do our disclosures outline all the products we offer

and those we dont offer, and why?

2. Is there ongoing compensation that is lost (orincreased) by the recommendation of some products

over others (12b-1 fees, asset trails, advisory fees,

renewal commissions, and retained business

quality incentives)?

3. Do producers/advisory representatives earn credit

toward health or pension benefits on some products

and not others?

4. Is this compensation already clearly described in our

current disclosures?

5. Do our current disclosures have any gaps in what

they describe compared with all the possible

compensation, and do they clearly explain

possible conflicts?

6. For those identified gaps, ask how the arrangement

might be equalized across all products so that no

client is disadvantaged or no producer/representativeis unduly incented to recommend one product

over another.

This exercise will not only help you to prepare for what is

headed your way under a fiduciary regimen, but also will

be a valuable tool if this new proposed FINRA rule comes

into being. In addition, this process will give you an idea

of how future customers will perceive your firm within

the marketplace should the rule come into effect.

By Larry Niland, Senior Regulatory Consultant, LIMRA; and

former CCO of the John Hancock Financial Network. Pleasecontact Larry at [email protected] if you have any questions about

this article.

If you need to evaluate your firms compensation programs or

disclosures, LIMRA can help you identify opportunities or revise

compensation arrangements to reduce or eliminate possible conflicts.

For more information, contact Meggan Tufveson at 860-285-7859 or

[email protected].
http://www.limra.com/compliancemailto:[email protected]:[email protected]:[email protected]://www.limra.com/compliance


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FINRA Says to Report Non-SecuritiesComplaints

Rule 4530 Effective July 1, 2011

On July 1, 2011, NASD Rule 3070, which requires elec-

tronic reporting to FINRA of certain events such as

customer complaints, will be replaced by FINRA Rule

4530. The new Rule has gathered recent criticism becausethe words should have are found in three different

sections. Protecting a firm from enforcement actions

is difficult when the rules use subjective words such as

should or reasonable. However, the attention given to

the should have clauses has overshadowed several other

changes which will have a significant impact on broker-

dealer operations and supervisory procedures. This rule

will be especially complex for firms whose representatives

hold outside business activities (OBAs).

One of those changes will require firms to report all

written complaints. Firms have been required to reportwritten complaints involving securities-related activities

for years; but now they will have to report any written

complaint received from a customer of the firm. In some

cases, the complaint will have to be reported even if the

complainant never opened an account. Not only will

complaints from customers concerning a fixed annuity

or investment advisory account have to be reported, but

complaints about a representatives accounting practice,

mortgage business, property & casualty business, etc.

Notice to Members 96-85 has been an important source

of guidance for reporting customer complaints; but asof July 1, 2011 some sections of that notice will no longer

be applicable: question #6 and the corresponding answer

will become obsolete. Question #6 asks if broker-dealers

are required to include in their quarterly statistical

reports . . . customer complaints regarding the sale of

insurance-related non-securities products (e.g., fixed

insurance products)? The FINRA answer was No . . .

members should not report complaints that relate to non-

securities activities (such as fixed insurance products).

Until now, firms have only been required to report non-

securities complaints when there was an allegation oftheft, certain misappropriations, or forgery, but that will

soon change. The first quarterly reporting requirement

under the new rule will be October 15, 2011.

FINRAs intention to expand the reporting requirement

for complaints was announced with Rule Filing

SR-FINRA-2010-034 which states on page 23 . . . if a

member has engaged, or has sought to engage, in secu-

rities activities with a person, then any written com-

plaint from that person is reportable under the proposed

rule, regardless of whether it relates to non-securities

products. On July 1, 2011 the requirement will change

from reporting only securities-related complaints, to

reporting any complaint. Fortunately, the final rule does

allow some reporting exemptions if the person was

solicited but did not become a customer.

The best source for information on the new Rule is found

in Regulatory Notice 11-06. In some cases the filing

requirement applies only when the complaint involvesa person who is or was a customer. In this situation a

customer is defined as a person with whom . . . a membe

has engaged in securities activities. In other cases the

requirement to file a complaint applies even to those who

were solicited by the firm but never became customers.

That definition includes a person with whom . . . a

member . . . has sought to engage in securities activities.

Supplementary Material .08 provides more details on

the differences. Complaints from those with whom the

member has engaged or sought to engage in securities

activities involving allegations of theft, misappropriationof funds or securities, or forgery must be reported within

30 days after the firm knows or should have known of the

complaint. Most other complaints must be filed quarterly.

Another important change is found at 4530(a)(1)(G).

Although similar to the wording in Rule 3070(a)(7)

and (8), the new Rule also applies to insurance and

other financial services and transactions. The specific

wording is, financial-related insurance civil litigation

or arbitration; and, relates to the provision of financial

services or relates to a financial transaction. The

requirement to report in this section does not includeproperty & casualty related matters. It does, however,

include fixed and indexed annuities among other

transactions. As with the old Rule, the filing is normally

required when a payment of $15,000 or more has been

determined. But a new twist has been added; the calcula-

tion must include attorneys fees and interest if that is part

of the payment. This will complicate negotiations for

claims that are near the $15,000 minimum.

Action is required. The definition of a reportable

complaint has changed and firms will need to train

compliance staff, supervisors, and reps to ensure that

they understand the new requirements. Procedures will

need to be developed in order to collect and timely report

non-securities related complaints. It will be especially

important that registered representatives understand their

obligation to report non-securities-related complaints to

their compliance department. The firm is responsible for

reporting complaints either within 30 days or after the

end of a quarter. The 30-day requirement applies even to

a person who never opened an account at the firm and


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the clock starts ticking when the firm knows or should

have known of the complaint.

One suggestion would be to update the annual

questionnaire. It is a common practice for firms to

require registered representatives to submit an annual

certification of outside business activity questionnaire.

The annual questionnaire could include more questions

about complaints. Questions designed to capture the reps

understanding of the new rules would be especially useful.Requiring representatives to certify that they understand

that even non-securities-related complaints must be

promptly reported to compliance would help protect

firms from the should have known clauses. Promptly

means in a time frame sufficient for compliance to receive

the information, investigate if necessary, and submit the

report in a timely manner. Requiring all complaints to be

forwarded promptly will give the compliance department

time to determine if the complaint needs to be filed at all,

within 30 days, or at the end of the quarter. The require-

ment to file certain events within 10 days will no longerapply once Rule 3070 expires.

Changes to branch office inspection procedures could

also be considered. The inspection would provide a good

opportunity to explore the level of understanding of the

new complaint requirements and to ask some probing

questions. But how deep the firm should dig into the

representatives OBAs is a complicated question.

Those responsible for submitting the electronic report

will also need some training. The name of the reporting

application will change from Disclosure Events andComplaints to Rule 4530 Application. The drop-down

menus will also change. A list of the new menus can be

found in a footnote to Regulatory Notice 11-10. The new

menus are more descriptive than the current ones and it

should be easier to identify the appropriate filing category.

When developing the procedures, firms will have a

number of issues to consider. Will the firm have access to

complaints containing confidential client information?

For example, the AICPA Code of Conduct prohibits a

member from disclosing any confidential client infor-

mation without the specific consent of the client.Under what conditions would the firm investigate the

complaint and what are the record retention requirements?

Rule 4530(d) requires reporting customer complaints in

such detail as FINRA shall specify. There is no mention of

investigation, response, or record retention in Rule 4530.

NASD Rule 3110(d) and (e) still regulate the requirements

of the complaint file. Those Rules will be replaced by

FINRA Rule 4513 at some point in the future. Section

(b) of the approved Rule reads in part, For purposes

of this Rule, customer complaint means any grievance

by a customer . . . in connection with the solicitation

or execution of any transaction or the disposition of

securities or funds of that customer.

Here is an example of the need for training. Any

complaint received from a customer must be reported.

If the complaint is from a prospective customer it must

be reported only if the complaint involves securities-

related activities or allegations of theft, misappropriation,or forgery. Records for the complaint file will only be

required if the complaint is securities-related and from

customers the definition of which has not changed.

A final complication in complying with 4530(d) is that

the report is due after the end of the quarter in which

customer complaints are received by the member. A non-

securities-related complaint from a customer received by

an accounting firm involving an accountant/registered

rep will likely be deemed to have been received by the

member when the accountant/registered rep becomes

aware of the complaint.

In order to comply with Rule 4530 firms will need to

develop new procedures and implement additional

training to collect and report non-securities-related

complaints, litigation, arbitrations, and claims. Many

decisions will need to be made before the July 1st

deadline; and, as is often the case with rules in this

industry, the procedures will necessarily evolve over time.

By Victor A. Shier, LIMRA Regulatory Services Consultant

Know Your Customer: How a NewGeneration of Software Helps Advisors toIdentify the Right Solutions for Retirees

Supports compliance with FINRA rules that go intoeffect October 2011

The need to know your customer is critical to every

advisor-client relationship, and is the foundation for any

recommendation or strategy that an advisor proposes.This need to understand the essential facts concerning

every customer is the key to delivering the right solutions

to clients, and is mandated under new FINRA rules which

will take effect on October 7, 2011.

Although the new FINRA rules are based in part on

former NASD and NYSE provisions, they expand on these

prior rules in important ways. The new rules underscore

the need to use reasonable diligence in gathering the

essential facts concerning a customer, and require that this
http://www.limra.com/compliancehttp://www.limra.com/compliance


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undertaking occur at the beginning of a client-advisor

relationship. This can be difficult if a new (or existing

client) is about to retire. Typically, most clients approach

retirement with an accumulation mindset for years

they have been saving and investing to build up their

retirement nest egg. They are frequently unprepared

to address the financial risks they will need to manage,

or to evaluate the alternatives for ensuring that they

have a retirement income that meets their needs andlifestyle goals. And, before an advisor can recommend

an investment strategy, the new FINRA Suitability Rule

2111 requires that he or she understand the customers

age, financial situation and needs, investments, tax

status, investment objectives, investment experience,

investment time horizon, liquidity needs, risk tolerance,

and any other information the customer may disclose.

In most cases, this all changes when a client retires, and

the advisor as well as the firm they represent are bound

by new regulations, and the strictures of ethical conduct,

to understand and document the changing investment

profile of each customer.

If the customer does not yet have a clearly defined picture

of their goals for retirement, an understanding of how

long retirement is likely to last, or how their expenses or

tax situation may change, creating an investment profile

for that client will be particularly challenging. In advisor

focus groups conducted by LIMRA, advisors express

frustration over the inability of clients to articulate their

goals for retirement (or in the case of spouses, to agree

on goals), and the time involved in educating clients

regarding the risks of outliving assets, managing health-care costs, keeping pace with inflation, and optimizing

Social Security and Medicare benefits. Pre-retirees over

age 55 hold over $16 trillion dollars in assets, and advisors

are witnessing a significant redeployment of retirement

savings as in excess of $1 billion dollars moves from

employer-sponsored defined contribution plans to IRA

rollover accounts every business day. With that much

retirement money in motion, it is essential that advisors

and their firms understand the new FINRA rules and

apply them correctly.

What if there was a way for existing or prospectiveclients, about to retire, to frame their thinking about

lifestyle goals, their preferences for retirement residence,

and the timing of retirement? What if clients could

educate themselves about the new financial risks and

challenges that retirement will bring, and rank them

in order of priority? What if clients could do all this

while conveying to an advisor how they plan to pay

for basic and discretionary retirement expenses, and

indicating their level of confidence in achieving their

goals, and which financial management strategies they

would like to consider? If that were possible, it would

certainly make it easier for advisors to conclude that

their recommendations were based (as new FINRA Rule

2111 requires) on an investor profile developed through

reasonable due diligence. The new rule recognizes that

not every factor regarding a customers investment profile

will be relevant to every recommendation, but because the

listed factors that comprise an investor profile are oftencrucial to recommending strategies to soon-to-be-retired

and other customers, it would be prudent for advisors

and their firms to document, with specificity, what they

believe is relevant. Certainly the when, where, and how

attitudes that a customer has toward retirement would

seem highly relevant to any recommendation an advisor

might make.

To help clients and their advisors make the transition to

retirement together, LIMRA, in partnership with Impact

Technology Group, Inc. has developed an engaging and

educational software application that creates a SummaryProfile which is completed before any recommendations

are made. While it is very informative for the client,

and very useful for the advisor, the application also

provides documentation of goals and concerns, and of

strategies the client is interested in learning more about.

Its colorful graphics and intuitive functionality make it

easy-to-use, and it can be completed in about 20 minutes.

Unlike planning tools that require the input of financial

data, and assumptions about long-term rates of return

and inflation, the new software helps clients prepare

for their meeting with an advisor so that the solutionswhich are ultimately proposed are the right ones for

theirretirement. This is a new generation of software

application for financial services it doesnt provide

the answers, but it makes sure that the clients, and their

advisors, are asking all the right questions.

For information regarding new FINRA Know-Your-

Customer and Suitability Rules, see Regulatory Notice

11-02, which can be viewed on www.limra.com/

retirement.

By Paul S. Henry, LIMRA Managing Director of Retirement Clients

and Products, and formerly a Registered Principal with MML

Investor Services, Inc., a MassMutual subsidiary.
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solutions to support plan sponsors, plan participants,

and IRAs.

Proposed Expansion of the Definition of FiduciaryUnder ERISA and the Code

The DOL has the authority to make rules affecting

ERISA and certain aspects of the Code. In October 2010,

it issued a proposal to redefine the term investment

advice, which is the most common way for an adviserto trigger fiduciary status, and expand the activities

that may give rise to prohibited transactions. The

proposed standard is much easier to meet, and registered

investment advisers (RIAs) are singled out and have

unique status. For example, if individualized to the

needs of the client, even one-time advice may now be

fiduciary advice. The revised definition would also make

recommendations concerning investment managers a

fiduciary act.

While changes to ERISA will no doubt present challenges,

most firms have already begun to identify and remediatecompliance gaps as part of their 408(b)(2) preparedness

strategies (see below). It will be important to anticipate

and evaluate the effect of the proposed expansion of

fiduciary status even though not final. The impact on IRA

business, however, may not be as clear given the fact that

many firms have not invested the same resources toward

IRA-related compliance initiatives.

The DOL has both rulemaking and enforcement

authority over ERISA, but enforcement of the prohibited

transactions under the Code (applicable to IRAs) lies

solely with Treasury. To date, Treasury has not madeexamination of IRA service providers a priority; however,

the creation of the Consumer Financial Protection

Bureau under Dodd-Frank is expected to change that.

Firms should therefore not only begin preparing for

the proposed changes but also should examine their

compliance with existing rules to ensure that prohibited

transactions are detected and prevented under the status

quo (investment advice in brokerage accounts with

variable commissions and 12bs, failing to offset 12bs

against fees in advisory accounts, etc.).

Plan-Level Fee Disclosure Under ERISA 408(b)(2)

While the expansion of fiduciary status remains a

proposal at this time, the fee disclosure regulation has

been finalized and will become effective January 1, 2012.

The regulation requires service providers to provide

written disclosures setting forth: (1) all services to be

provided to the plan and/or its participants; (2) any and

all direct and/or indirect compensation received by the

service provider (and affiliates); and (3) a statement

ERISA Compliance: An Overview of NewChallenges and OpportunitiesSweeping reforms introduced this year by the DOL will

pose significant challenges for insurance companies,

broker-dealers (BDs), agents, and financial advisers that

provide services to qualified retirement plans, including

individual retirement plans (IRAs). The risks will be

particularly acute for those considered to be providingfiduciary services, as it is a prohibited transaction under

the Employee Retirement Income Security Act (ERISA)

and the Internal Revenue Code (Code) to use the

authority that makes one a fiduciary to cause him/herself

(or an affiliate) to receive additional compensation.

Prohibited transactions, therefore, may arise where an

adviser provides investment advice to a plan sponsor, plan

participant, or account holder/beneficiary of an IRA that

results in additional receipt of commissions, 12b-1 fees,

revenue sharing payments, or investment management

fees for affiliated products/funds. The new regulationswill require firms to disclose all indirect and direct

compensation earned from qualified plans, which will

among other things be used to populate newly required

detail on participant statements, and the Department of

Labor (DOL) recently proposed expanding the nature and

scope of activities that would give rise to fiduciary status

under ERISA and the Code.

In addition to new and changing regulatory requirements,

Phyllis Borzi, Assistant Secretary of Labor, has vowed to

implement a strong, vigorous, comprehensive enforce-

ment policy. Indeed, the DOL has already increased itsenforcement staff significantly, and examination of ERISA

plan service providers jumped markedly in 2009 and

2010. The agency is also sharing information and

actively cooperating with the Securities and Exchange

Commission (SEC) in examinations designed to detect

and prevent prohibited conflicts of interest among

retirement plan service providers.

The convergence of new regulations, increasing

enforcement, and ongoing ERISA litigation, could lead

to significant exposure for firms that have not helped

their advisers prepare for and adapt to these challenges.Particularly at risk are those that distribute proprietary

or affiliated funds through agents and advisers. Proactive

firms that develop and deploy thoughtful responses will

not only mitigate fiduciary risk but also will be well-

positioned to retain and attract advisers seeking to stay

competitive in the qualified plan and IRA marketplace.

This article provides an overview of the changes to come

and describes how firms can mitigate fiduciary risk by

developing competitive and compliant non-fiduciary


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acknowledging any of the services that are reasonably

expected to give rise to fiduciary status. This disclosure

alone presents a number of challenges to insurance-

affiliated firms.

For example, ERISA requires plan sponsors to manage

the plans investments prudently. If they do not possess

the requisite investment-related expertise, they are

required to hire it. Many plan sponsors, therefore,

look to their advisers for assistance with the selectionand monitoring of the plans designated investment

alternatives (DIAs). If the adviser provides individualized

investment advice, then a prohibited transaction may

occur if he/she (or his/her affiliate) receives unlevel

compensation (commissions, 12bs, revenue sharing, etc.)

or if the DIAs include proprietary or affiliate sub-advised

funds. The written disclosure will operate to provide a

roadmap for plan fiduciaries, regulators, and would-be

plaintiffs. Affected firms should deploy adequate resources

to educate their advisers of this risk (ERISA imposes

personal liability on fiduciaries) and arm them withthe necessary tools to service their clients in a

compliant manner.

Competitive forces are also at play, as advisers who

may have provided more holistic support in the past

(e.g., plan- and/or participant-level investment advice,

model portfolio allocations) may now find themselves

constrained by home office policies and disclosures

generated by supervising firms, and will be forced to

defend or redefine their value proposition in light of any

perceived or actual reduction in services. Again, advisers

will be looking to their home office for the requiredresources and support.

Participant-Level Fee Disclosure Under ERISA404(a)(5)

The DOL issued its above-referenced Plan Fee Disclosure

Regulation as part of a three-part initiative aimed at

facilitating the exchange of information among service

providers and plan sponsors, plan sponsors and the DOL

(via Schedule C of Form 5500) and plan participants. In

October 2010, it published its final Participant Disclosure

Regulation under ERISA 404(a)(5) requiring plansponsors to provide each participant, or beneficiary, with

two categories of information:

(1) Plan-related information, including general plan

information, administrative expense information, and

individual expense information; and

(2) Investment-related information including

performance data, benchmarking information,

fee and expense information, Internet access to

investment-related information, and a glossary

to assist participants with investment-related

terminology.

Both categories of disclosures must be presented to the

plan participant prior to the participants first direction

of investments, and annually thereafter. Further, thenew rule requires that this information be provided in a

comparative format such as a chart or similar comparative

format, and the information must be provided in plain

language the average participant can understand. (See

the Model Comparative Chart presented in the appendix

to Fiduciary Requirements for Disclosure in Participant-

Directed Individual Account Plans; Final Rule).

While nothing affirmative is required on the part of plan

service providers under the Participant Disclosure

Regulation (service providers are required to disclose

sufficient information under 408(b)(2) to allow plan

sponsors to meet their requirements under 404(a)(5)),

recent surveys indicate that the majority of plan partici-

pants currently believe that their plans are free or that

the plan sponsor pays most or all of the plan expenses.

Consequently, advisers will need to be prepared to defend

their value to participants who will now see the fees paid

from their investments to the broker-dealer, adviser, or

both. Firms should begin to support their advisers in this

regard and provide them with materials to assist plan

sponsors track and manage participant inquiries

concerning services and fees.

Mitigating Risk and Adding Value Through Non-Fiduciary Support

As discussed, given the challenges presented by fiduciary

status, firms should begin evaluating the support provided

to advisers for non-fiduciary services. For example, firms

should consider developing more robust investment edu-

cation programs that their advisers can implement as part

of a retirement readiness approach for participants by

using tools such as gap analysis; this process of tracking

participant success measurements is a way to demonstratethe value of an advisers non-fiduciary support. If he/she

can demonstrate an increase in participation and contri-

butions year over year, plan sponsors will be better able to

verify and document the value of the advisers services.
http://webapps.dol.gov/FederalRegister/PdfDisplay.aspx?DocId=24323http://webapps.dol.gov/FederalRegister/PdfDisplay.aspx?DocId=24323http://webapps.dol.gov/FederalRegister/PdfDisplay.aspx?DocId=24323http://webapps.dol.gov/FederalRegister/PdfDisplay.aspx?DocId=24323http://webapps.dol.gov/FederalRegister/PdfDisplay.aspx?DocId=24323


9/13


Another way that supervising firms can assist agents and

advisers in adding value through non-fiduciary services is

by educating advisers and plan sponsors on their respon-

sibilities arising out of new DOL regulations. For example,

plan sponsors may not have the time or inclination to

stay abreast of the new requirements to assess the com-

pleteness and reasonableness of disclosures presented by

the plans other service providers (recordkeepers, TPAs,

investment advisers, etc.). By assisting the plan fiduciariesin establishing and maintaining procedures to evaluate

their service arrangements, agents and advisers can not

only add additional value but also can insert themselves

in that process and thereby help ensure that there is an

ongoing need for their services. Many advisers report

recent successes with prospecting new plans by offering

disclosure management services to plan sponsors. As such,

firms that are the first to build and to market their plan

sponsor education materials for their advisers will be at

a strategic advantage over other firms who lack adviser

resources in this area.

Plan advisers, given the proper training and support

materials, may also benefit from offering to assist

sponsors to manage the inquiries that will likely come

from participants once the new disclosures are reported

on their statements. Advisers, who are often the most

knowledgeable on concepts such as share classes, expense

ratios, etc., can serve as the first line of defense for

sponsors. Many routine inquiries can be resolved by

demonstrating the prudence of the sponsors selection

and monitoring processes and that the plan would not

exist but for the support provided by and the fees paidto the plans service providers. At a minimum, plan

sponsors will value the advisers foresight, preparedness,

and willingness to run interference on their behalf by

providing information and explanations designed to

resolve informal and/or routine participant inquiries.

Firms should also consider providing training and

materials to help their advisers educate plan sponsors on

procedures to track and manage participant inquiries.

Plan participants that do not receive adequate, timely,

or complete responses to their questions may turn to

the DOL for assistance. The DOL Enforcement Manualprovides that [c]omplaints may be specific or non-

specific, written or oral . . . [and] when appropriate, a par-

ticipant complaint may be transferred as an investigative

lead to the enforcement unit. Plan sponsors often rely

on their adviser to ensure that the plan is maintained in

a compliant manner. Indeed, most plan sponsors do not

have the time or the inclination to stay abreast of their

requirements and have failed to establish procedures to

mitigate the likelihood of participant complaints. A visit

from the DOLs enforcement division will, at a minimum,

operate as a distraction from the sponsors business and

will not reflect well on the plan adviser. Moreover, service

provider examinations often arise from plan audits

triggered by participant complaints. By educating andassisting plan sponsors in establishing procedures for

logging, resolving, and/or escalating participant inquiries,

forward-looking advisers and their firms can mitigate the

risk that a participant inquiry or request for information

will lead to a formal DOL complaint.

Lastly, given the increase in plan audits (from both the

DOL and IRS), firms should provide their advisers with

the tools needed to aid plan sponsors in developing an

exam-ready approach to compliance. For example,

many firms have created web-based systems for their

advisers that allow for the collecting and storing operativedocuments and information. If these files are maintained

in real time, plan fiduciaries can respond more accurately

and timely to requests from examiners. The fact that the

documents are complete and easily accessible will, in

and of itself, demonstrate a high degree of prudence on

the part of the plan sponsors and help to streamline the

examination process.

Although only a sampling of non-fiduciary services were

described above, there are many ways that firms can assist

their advisers by providing non-fiduciary, value-added

tools. Firms that are the first to move and implementthese resources will possess a compliance and competitive

advantage and can use these resources for adviser

recruiting and retention.

By Jason C. Roberts, Esq., AIFA, Founder and CEO

Pension Resource Institute, LLC. The firm works with insurance

companies, broker-dealers, registered investment advisers,

investment managers, recordkeepers, and third-party administrators

to develop and deploy sustainable and profitable solutions in the

qualified plan marketplace. For more information, visit

www.pension-resources.com.
http://www.limra.com/compliancehttp://pension-resources.com/http://pension-resources.com/http://www.limra.com/compliance


10/13


Life Settlements: How Long ShouldInvestors Wait Before Purchasing LifeInsurance Policies?In the United States, a market has developed for

institutional investors to purchase life insurance policies

that insure the lives of U.S. residents residing in various

states. Many investors correctly understand that stranger-

originated life insurance (STOLI)1 is prohibited by most

U.S. states; and, accordingly, seek to ensure that they do

not purchase any life insurance policies that were issued

in violation of a states STOLI prohibition. However, some

investors believe that if they purchase STOLI policies,

an insurer that issued such a policy cannot contest the

policys validity upon the passage of two years from the

date the policy was originally issued. Unfortunately,

depending on a number of factors, those investors

could be wrong.

Because insurance in the United States is primarilyregulated on a state-by-state basis, determining whether

(and when) an issuing insurer may contest the validity

of a life insurance policy requires a review of (i) the laws

of the state in which the sale of the policy originally

occurred; and (ii) the laws of the state where the owner

resides at the time the policy is settled (i.e., sold by the

life insurance policys owner to a third-party provider).

State insurance statutes and regulations, as well as relevant

administrative and judicial decisions, all of which vary

from state to state, would need to be reviewed to make

any such determination.

The following provides a brief overview of the issues

that will need to be reviewed before investing in a policy

(e.g., contestable periods, STOLI, insurable interest, and

life settlement waiting periods), as well as a review of the

current situation in New York.

The Contestable Period

The insurance laws of most states provide that the validity

of an individual life insurance policy is not contestable

by the issuing insurer after the policy has been in force

during the life of the insured for a specified period fromits date of issue. Generally, the time period during which

a life insurer may contest the validity of the policy (i.e.,

the contestable period) is two years. The prohibition

against an insurer contesting the validity of a life

insurance policy after the expiration of the contestable

period is based on the notion that it would be unfair

to allow the policyowner to pay premiums indefinitely

while assuming that benefits are available, only to have

the policy declared void because of a defect existing when

the policy was issued.2 This prohibition forces the insurer

to investigate the validity of the policy at a time when

evidence that could support the policyowners position is

likely to still be available.

In some states, the expiration of the contestable period

may serve as an absolute bar to an insurers challenge

to the validity of a life insurance policy. In other states,

an insurer may challenge the validity of a life insurance

policy if, for example, there was no insurable interestin the insured life at the time the policy was purchased

from the insurer, even after the contestable period has

expired.3 Because an insurable interest is required to

create a validly existing life insurance policy, it is reasoned

that if no such insurable interest existed at the time the

policy was issued, the policy is void ab initio (i.e., void

from its inception). Moreover, if the contestable period

requires that the policy be in force during the life of

the insured for a period of two years, and there was no

insurable interest at the time the policy was originally

purchased, then it cannot be said that the policy was everin force. Accordingly, in such states, the expiration of the

contestable period should not operate to create a validly

existing policy where one never existed.

STOLI and Insurable Interest

Because an issuing insurer might be able to contest the

validity of a life insurance policy after the expiration

of the contestable period based on a lack of insurable

interest at the policys inception, the investors should

understand the relationship between STOLI policies and

insurable interest.Although some states do not have an explicit STOLI

prohibition, the insurance laws of all states prohibit the

procurement of life insurance policies by those not

_____

1The National Conference of Insurance Legislators Life Settlements ModelAct (the NCOIL Model Act) defines Stranger-Originated Life Insurance asa practice or plan to initiate a life insurance policy for the benefit of a thirdparty investor who, at the time of policy origination, has no insurable interestin the insured.

The NCOIL Model Act does not have the force of law; it merely servesas a model for life settlement statutes that have been enacted in variousU.S. states. In addition to the NCOIL Model Act, some U.S. states haveenacted life settlement statutes that are based on the National Association ofInsurance Commissioners Viatical Settlements Model Act (the NAIC ModelAct). Unlike the NCOIL Model Act, the NAIC Model Act does not containa definition of STOLI. Since 2007, approximately 28 states have enactedstatutes that are based on the NCOIL Model Act, the NAIC Model Act,or both.2See New England Mut. Life Ins. Co. v. Caruso, 73 N.Y.2d 74 (1989).3In some states, a life insurer is also permitted to contest the validity of alife insurance policy after the expiration of the contestable period if (i) thepolicy was purchased with the intent to murder the insured, or (ii) the policysmedical examination was taken by an imposter.


11/13


having an insurable interest in the life of the insured at

the time the policy is originally purchased from the life

insurance company.

The definition of insurable interest with respect to life

insurance varies slightly from state to state, but generally

is defined as an interest in the continuation of the life of

the person insured. An individual always has an insurable

interest in his or her own life. In addition, an insurable

interest generally exists where there is (i) a substantialinterest engendered by love and affection (in the case

of persons closely related by blood or by law); or, (ii) a

substantial economic interest in the continued life, health,

or bodily safety of the individual insured. Such insurable

interests are distinguished from an interest that would

arise only by, or would be enhanced in value by, the death,

disablement, or injury of the insured (in the case of

persons not closely related by blood or law).4

In general, investors do not have an insurable interest

in the lives of the individuals insured under the policies

they purchase as investments. In fact, in such a situation,

investors have an interest that would arise upon the

death of the individual insured. Although an individual

is generally permitted to purchase a life insurance policy

insuring his or her own life and then immediately transfer

or assign the policy to a person that does not have an

insurable interest in the life of the insured, several recent

court cases have determined that where an individual pur-

chases a life insurance policy on his or her own life, with

the then present intent to sell or otherwise transfer the

policy to an identified third party, and there is a precon-

ceived agreement or understanding with such identifiedthird-party regarding such sale or transfer, the third party

is, in essence, the real purchaser of the policy. In such a

case, the validity of the policy could be challenged by the

issuing insurer based upon the third partys lack of an

insurable interest in the life of the insured.5

The Two-Year and Five-Year Waiting Periods

Adding confusion to a potential investors understanding

of the two-year period following the issuance of a life

insurance policy are the NCOIL and NAIC Model Acts

so-called two-year and five-year waiting periods forentering into life settlement contracts.

As a means of preventing STOLI, both the NCOIL Model

Act and the NAIC Model Act contain provisions that

prohibit any person from entering into a life settlement

contract for a certain period of time following the issu-

ance of the policy. Specifically, the NCOIL Model Act

prohibits any person from entering into a life settlement

contract at any time prior to, or at the time of, the appli-

cation for, or issuance of, a policy, or during a two-year

period commencing with the date of issuance of the

policy . . . . Similarly, the NAIC Model Act prohibits any

person from entering into a life settlement contract6 at

any time prior to the application or issuance of a policy

which is the subject of [a] viatical settlement contract or

within a five-year period commencing with the date of

issuance of the insurance policy . . . .7

Although neither the NCOIL Model Act nor the NAIC

Model Act explicitly provide for an insurer to invalidatea life insurance policy that is settled before the expiration

of the statutory period prohibiting settlement of a policy,

neither model Act explicitly prohibits an insurer from

doing so. In fact, the NCOIL Model Act explicitly provides

that [n]othing in [the Section providing the two-year

ban] shall prohibit an insurer from exercising its right to

contest the validity of any policy.

In determining which states law applies to any waiting

period for entering into a life settlement contract, both

the NCOIL Model Act and the NAIC Model Act provide

that the residency of the owner of the policy at the

time that the policy is settled is the determining factor.

With respect to state statutes that provide for waiting

periods before entering into life settlement contracts,

approximately 17 states (and the Commonwealth of

Puerto Rico) have enacted a two-year waiting period, two

states have enacted a four-year waiting period, and nine

states have enacted a five-year waiting period.

The Situation in New York

The issue of whether an insurer may contest the validity

of a life insurance policy after the expiration of the con-testable period remains unsettled in New York. In a recent

federal case in the Southern District of New York,8 the

district court determined that under certain conditions, a

life insurer may be permitted to invalidate a life insurance

policy after the expiration of the contestable period,

stating [t]hough a high bar, the incontestability clause

is not sacrosanct. In support of its determination, the

_____

4See, e.g., N.Y. Ins. Law 3205(a) (McKinney 2006).5See First Penn-Pac. Life Ins. Co. v. Evans, 313 F. Appx 633 (2009); SunLife Assurance Co. of Canada v. Paulson, Civil No. 07-3877(DSD/JJG),2008 U.S. Dist. LEXIS 99633 (D. Minn. Dec. 3, 2008).6The NAIC Model Act refers to a life settlement contract as a viaticalsettlement contract.7Both the NCOIL Model Act and the NAIC Model Act also provideexceptions to their respective bans for certain situations that tend to show thatthe insurance policy was settled within the prohibited period for a legitimate(non-STOLI) purpose.8Settlement Funding, LLC v. AXA Equitable Life Ins. Co., No. 09 CV 8685(HB) (S.D.N.Y. Sept. 29, 2010).


12/13


district court cited a February 6, 2002 Opinion of the New

York Insurance Departments Office of General Counsel,

which concluded that whether or not an individual life

insurance policy is contestable after being in force during

the life of the insured for a period of two years from its

date of issue depends on the facts. The district court

also stated that the need to monitor and quell what

appears to be an expanding market for STOLI policies

tips the scales in favor of reviewing otherwise incon-testable life insurance policies where, as here, a substantial

factual record points to an improperly procured policy.

The district court then allowed a jury to determine, as a

factual issue, whether the insurer was barred from con-

testing the validity of the policy based on the expiration

of the contestable period. Although the jury in this case

thereafter determined that the insurer was so barred, the

insurer is now seeking to have the district court determine

that the policies are invalid as a matter of law.9

In addition, although many investors believe that the

situation in New York was clarified by the November 17,2010 decision of the New York Court of Appeals in

Kramer v. Phoenix Life Insurance Co.,10 because of the

extremely limited scope of the question that was before

the court of appeals, as well as the fact that the case was

decided based on the law that was in effect in New York

in 2005 (which has since been supplemented by a STOLI

prohibition and a two-year waiting period before settling

a life insurance policy), the Kramer decision may be of

limited importance.

The Kramer case involved more than $56 million dollars

in life insurance coverage on the life of Arthur Kramer,a named partner in a New York law firm. According to

the decision, in 2003, Steven Lockwood, the principal of

Lockwood Pension Services, Inc. (Lockwood Pension),

approached Mr. Kramer about participating in a STOLI

transaction. In 2005, the transaction was commenced

when several life insurance policies on Mr. Kramers life

were purchased by two trusts established by Mr. Kramer.

Although both trusts were established by Mr. Kramer and

named his adult children as the trusts beneficiaries, it

was alleged that both trust agreements were prepared by

counsel for Lockwood Pension, neither Mr. Kramer norhis children ever paid premiums on the policies, and the

Kramer children sold their interests in the trusts after the

policies were issued.

After Mr. Kramers death, his widow, Alice Kramer,

instituted a federal court action in New York alleging that

the policies violated New Yorks insurable interest statute

and should therefore be paid to her, as representative

of Mr. Kramers estate (and not to the investors). In

response, the insurers sought a declaratory judgment that

the policies were void and that they were not required to

pay the policies proceeds to anyone at all (i.e., neither to

Alice Kramer nor to the investors).

The federal district court, citing New England Mutual

Life Insurance Co. v. Caruso, determined that the insurers

could not void the policies, as they had been issued more

than two years earlier (and so were incontestable). The

district courts order was then appealed to the SecondCircuit, which granted a petition to have the following

certified question answered by the court of appeals:

Does New York Insurance Law 3205(b)(1) and(b)(2) prohibit an insured from procuring a policy onhis own life and immediately transferring the policy toa person without an insurable interest in the insuredslife, if the insured did not ever intend to provideinsurance protection for a person with an insurableinterest in the insureds life?

The court of appeals answered the question in the

negative and held that New York law permits a personto procure an insurance policy on his or her own life

and immediately transfer it to one without an insurable

interest in that life, even where the policy was obtained for

just such a purpose.

However, the decision expressly did not apply recently

enacted legislation in New York (with an effective date of

May 18, 2010) that, among other things, prohibits anyone

from entering into a valid life settlement contract for

two years following the issuance of a policy (with certain

limited exceptions). In addition, the new legislation

also prohibits STOLI (which is defined in New York,

in relevant part, as any act, practice or arrangement,

at or prior to policy issuance, to initiate or facilitate

the issuance of a policy for the intended benefit of a

person who, at the time of policy origination, has no

insurable interest in the life of the insured under the

laws of this state). The STOLI prohibition became

effective on November 19, 2009. Because the events that

were reviewed by the court of appeals occurred prior to

dates of enactment of New Yorks statutes requiring a

two-year waiting period to elapse before entering into a

life settlement contract and prohibiting STOLI, the newstatutes were not applied to this case.

_____

9The investors argument that it should be granted summary judgment basedon principles of estoppel (i.e., that it relied on the insurers representationsconcerning the validity of the policy) was rejected by the District Court, whichconcluded that this issue should also be decided by the jury. Accordingly,although an insurers representation that a particular policy is in forcemay be helpful to an investor, it does not prevent an insurer from seeking toinvalidate the policy.1015 N.Y.3d 539 (N.Y. 2010).


13/13

Moreover, although the insurers urged the court of

appeals to expand the scope of the certified question and

consider whether the district court properly dismissed

their claims based upon the expiration of the contestable

period, the court of appeals declined to expand the scope

of the certified question. Accordingly, the court of appeals

did not address whether the expiration of the contestable

period should serve to prohibit the insurers from con-

testing the validity of the policies in connection with aSTOLI transaction.

Although it appears that the death benefit in the Kramer

case will likely be paid to the investors, future New York

cases involving the same facts as this New York case, but

involving life insurance policies purchased and/or settled

after enactment of the New Yorks new life settlement

statutes, would be expected to yield different results.

Conclusions

Investors should never assume that it is safe to purchase a

life insurance policy simply because more than two yearshave passed since the policy was issued. Only by reviewing

applicable state laws can investors determine whether an

issuing insurer is permitted to contest the validity of a life

insurance policy. Specifically:

Investors should carefully review the laws of the states

in which the life insurance policies were originally

purchased to determine whether the laws of those

states provide for contestable periods,11 the length of

such contestable periods, and whether any exceptions

exist that would permit the insurer to contest the

validity of a life insurance policy after the expiration ofa contestable period (such as the lack of an insurable

interest at the inception of the policy).

In those states in which there is no contestable period,

the contestable period has not expired, or there is an

exception to the contestable period based on a lack

of insurable interest at the inception of the policy,

investors should be aware of the risk of the issuing

insurers potential to challenge the validity of the

policy based upon a lack of insurable interest at the

policys inception.

In those states in which the validity of the life insurance

policy can no longer be contested by the issuing insur-

ance company (e.g., because of the expiration of the

contestable period in a state that does not have an

insurable interest exception thereto), investors should

be aware of the risk that the benefits payable under

the policy might be required to be paid to the estate of

the deceased insured rather than to the policys benefi-

ciary (i.e., the investor) if, for example, the states lawprovides that policy proceeds obtained in violation of

a states insurable interest requirement must be paid to

the estate of the deceased insured.

Investors should be aware that an insurers representa-

tions concerning the validity of a policy (e.g., that that

policy is in force as of a certain date) does not prevent

an insurer from seeking to invalidate the policy.

Finally, investors should review the laws of the state

where the owner of the policy resides at the time

the policy is settled to determine whether there is a

statutory waiting period for settling a policy, the lengthof any such waiting period, and whether there are any

exceptions that might be applicable.

By Frederic M. Garsson, Associate, Baker & McKenzie LLP.

Mr. Garsson can be reached at 212-626-4701 or

[email protected].

_____

11In those few U.S. states where there is no contestable period, insurersmight be able to challenge the validity of the insurance policy at any time.
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LRR Newsletter 2011-2

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