Chapter 1

NAIC Model Law Development Process

The National Association of Insurance Commissioners (NAIC) model law development process helps provide uniformity while balancing the needs of insurers operating in multiple jurisdictions with the unique nature of state judicial, legislative and regulatory frameworks. While the value of a state‑based regulatory system from a consumer protection perspective is the ability to tailor state laws and regulations to meet the needs of resident consumers, there is recognition that there are some areas where uniformity and consistency across state borders is beneficial to all. It is primarily through the states’ adoption of NAIC model laws and regulations that the legal framework for insurance regulation has been largely harmonized throughout all of the states.

The criterion for development of a model law or regulation involves a two‑pronged test. First, the subject matter of the model law or regulation must call for a minimum national standard or require uniformity among the states. The second part of the test is the NAIC members must be committed to dedicating significant regulator and NAIC staff resources to educating, communicating and supporting the adoption of the model law or regulation. When a committee, task force or working group decides to address an issue that does not meet the two‑prong test, it may develop a “guideline” instead. A guideline is simply an insurance regulatory best practice and can be used by the states as the basis for a law, regulation or bulletin.[1]

NAIC Annuities/Variable Contracts Model Regulation

A searchable index of the NAIC’s model laws, regulations, guidelines and other resources can be accessed on the NAIC website. For purposes of this course, we are concentrating on the latest developments in Suitability and Best Interest regulation. However, readers may find the following Model Laws informative and may wish to explore them as well on their own.

Model #235, Interest-Indexed Annuity Contracts Model Regulation – This model regulation establishes the initial filing requirements for interest-indexed annuity contracts. It also contains additional filing requirements, valuation requirements, and a Statement of Actuarial Opinion for Interest-Indexed Annuity Contracts. This regulation applies only to individual annuity contracts. This regulation currently addresses only the indexing of interest credits.

Model #240, Charitable Gift Annuities Model Act – This model act defines charitable gift annuities and contains requirements related to certificate of authority requirements, surplus and reserve standards, investments, examinations, annual reports and disclosure.

Model #241, Charitable Gift Annuities Exemption Model Act – This model act specifies that annuities that qualify as charitable gift annuities do not constitute engaging in the business of insurance.

Model #245, Annuity Disclosure Model Regulation – This model regulation provides standards for the disclosure of information about annuity contracts in order to protect consumers and foster consumer education.

Model #250, Variable Annuity Model Regulation – This model regulation specifies the qualifications required of insurers to offer, and agents to sell, variable annuities. It also stipulates the manner in which variable benefits are to be calculated and how separate account categories are to be maintained.

Model #255, Modified Guaranteed Annuity Regulation – This model regulation provides rules for modified guaranteed annuities. It establishes the qualifications of agents and insurers; the required contract form and provisions; and the manner in which separate account assets are to be maintained and reported.

Model #260, Variable Contract Model Law – This model law establishes guidelines for variable contracts. It includes requirements pertaining to contract statements and licensing, and clarifies the powers of the commissioner with respect to variable contracts.

Model #270, Variable Life Insurance Model Regulation – This model regulation establishes parameters for the issuance of variable life insurance. It outlines insurer qualifications, insurance policy requirements, reserve liabilities, separate accounts; information furnished to applicants, reports to policyholders, foreign companies and agent qualifications.

Model #278, Model Regulation on the Use of Senior-Specific Certifications and Professional Designations in the State of Life Insurance and Annuities – The purpose of this model regulation is to set forth standards to protect consumers from misleading and fraudulent marketing practices with respect to the use of senior‑specific certifications and professional designations in the solicitation, sale or purchase of, or advice made in connection with, a life insurance or annuity product.

AND…

Model #275, Suitability in Annuity Transactions Model Regulation – This model regulation sets forth standards and procedures for recommendations to consumers that result in transactions involving annuity products so that the insurance needs and financial objectives of consumers at the time of the transaction are appropriately addressed.

Model #275, aka, “Suitability” model, has been updated to reflect a new Best Interest Standard. In 2019, the NAIC Annuity Suitability (A) Working Group completed the updates, which began in November 2017.

The “Best Interest Standard” refers to the ethical requirement that people who care for others will do so in good faith, placing their assessment of that person’s best interests above their own.

NAIC Suitability in Annuity Transactions Model Regulation

Since 2003, state insurance regulators have overseen the sale of annuities to ensure products sold to consumers are suitable for them, based on a review of their needs. Model #275 (Suitability model) sets forth standards and procedures for recommending annuity products to consumers to ensure their insurance and financial objectives are appropriately addressed. In revising the Suitability model, the NAIC intends to provide clear, enhanced standards for annuity sales so that consumers understand the products they are purchasing, are made aware of any potential conflicts, and are assured that those selling the products do not place their financial interests above consumers’ interests. Since the model’s original adoption, the standards have been updated for consistency with those issued by the Financial Industry Regulatory Authority (FINRA), which will be addressed later in this course material.

The following sections cover the current status of the NAIC Suitability in Annuity Transactions Model Regulation. This Model Regulation can be viewed as a template to be used in drafting the law to be passed at the state level. In several sections there are blanks where reference to state laws will be inserted and/or choice will be made by state legislators.

While all sections of this Model Regulation are important, Section 6 contains the duties of the insurer and producer under this regulation and should be reviewed carefully.

Annuity Suitability and Best Interest Standard

The revisions to Model #275 clarify that all recommendations by agents and insurers must be in the best interest of the consumer and that agents and carriers may not place their financial interest ahead of the consumers’ interest in making a recommendation. The model now requires agents and carriers to act with “reasonable diligence, care and skill” in making recommendations. The revisions also include enhancements to the current model’s supervision system to assist in compliance.

The enhanced Model Regulation includes a new best interest standard of care that producers and insurers can meet if they satisfy four requirements:

1.    a Care Obligation;

2.    a Disclosure Obligation;

3.    a Material Conflict of Interest Obligation; and

4.    a Documentation Obligation.

Appendices A, B, and C have also been revised.

·         Appendix A. Insurance Agent (Producer) Disclosure For Annuities

·         Appendix B. Consumer Refusal to Provide Information

·         Appendix C. Consumer Decision to Purchase an Annuity Not Based on a Recommendation

The final rule takes effect on June 30, 2020. Following is the revised version, which was adopted on December 30, 2019, showing all revisions in the normal underline and strikethrough method.[2]

Purpose of the Suitability Model Act

Though the title “Purpose” of Section 1 remains the same, the big change here is to set forth a requirement for producers (the definition of which is amended under Section 5.L.) to act in the best interest of the consumer. The 2010 MDL 275 Purpose section address insurers only. Additionally, now insurers are required to establish and maintain a system to supervise recommendations. Finally, “appropriately” has been changed to “effectively.”

Section 1. Purpose. Subsection A. The purpose of this regulation is to require producers, as defined in this regulation, to act in the best interest of the consumer when making a recommendation of an annuity and to require insurers to establish and maintain a system to supervise recommendations and to set forth standards and procedures for recommendations to consumers that result in a transaction involving annuity products so that the insurance needs and financial objectives of consumers at the time of the transaction are appropriately effectively addressed.

Subsection A (above) states what the purpose of this regulation is; Subsection B states what it is not and expands on the current disclaimer (that a violation of the regulation should not create or imply a private cause of action) to add that a best interest standard should not be construed to treat producers as fiduciaries.

Section 1. Purpose. Subsection B. Nothing herein shall be construed to create or imply a private cause of action for a violation of this regulation or to subject a producer to civil liability under the best interest standard of care outlined in Section 6 of this regulation or under standards governing the conduct of a fiduciary or a fiduciary relationship.

Drafting Note:  The language of Subsection B comes from the NAIC Unfair Trade Practices Act. If a state has adopted different language, it should be substituted for Subsection B.

Drafting Note:  Section 989J of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd‑Frank Act”) specifically refers to this model regulation as the “Suitability in Annuity Transactions Model Regulation.” Section 989J of the Dodd‑Frank Act confirmed this exemption of certain annuities from the Securities Act of 1933 and confirmed state regulatory authority. This regulation is a successor regulation that exceeds the requirements of the 2010 model regulation.

Note that this drafting note was included to ensure that this model regulation would remain compliant under the safe harbor provisions included in Dodd‑Frank. For indexed annuities to remain free from securities regulation, the terms of Dodd‑Frank require states (or insurers on a nationwide basis) to adopt the NAIC.

Scope of the Suitability Model Act

Some of the changes here are cleanup, but untethering recommendation from “that results in the purchase…” expands the scope of the regulation to ALL recommendations, even where no purchase is made or consummated. Regulators understood this and wanted this regulation to apply to the activities involved in making a recommendation without regard to whether a purchase is made.

Section 2. Scope. This regulation shall apply to any sale or recommendation to purchase, exchange or replace of an annuity made to a consumer by an insurance producer, or an insurer where no producer is involved, that results in the purchase, exchange or replacement recommended.

Conferred Authority

No change to this section other than the drafting note.

Section 3. Authority. This regulation is issued under the authority of [insert reference to state enabling legislation].

Drafting Note:  States may wish to use the Unfair Trade Practices Act as enabling legislation or may pass a law with specific authority to adopt this regulation.

Exemptions to the Suitability Model Act

Changes to this section are clean up, separating as new Subsections C and D litigation/dispute resolution settlements or assumptions of liabilities and formal prepaid funeral contracts as unique exempted types of transactions, rather than lumping them under contracts generally related to the funding of pension and benefit plans.

Section 4. Exemptions. Unless otherwise specifically included, this regulation shall not apply to recommendations involving:

A. Direct response solicitations by insurers where there is no recommendation based on information collected from the consumer pursuant to this regulation;

B. Contracts used to fund:

(1) An employee pension or welfare benefit plan that is covered by the Employee Retirement and Income Security Act (ERISA);

(2) A plan described by sections 401(a), 401(k), 403(b), 408(k) or 408(p) of the Internal Revenue Code (IRC), as amended, if established or maintained by an employer;

(3) A government or church plan defined in section 414 of the IRC, a government or church welfare benefit plan, or a deferred compensation plan of a state or local government or tax exempt organization under section 457 of the IRC;

(4) A nonqualified deferred compensation arrangement established or maintained by an employer or plan sponsor;

C.(5) Settlements of or assumptions of liabilities associated with personal injury litigation or any dispute or claim resolution process; or

D.(6) Formal prepaid funeral contracts.

Definitions Used in the Context of the Suitability Model Act

Subsection A contains no change in the definition of “annuity.” Subsection B contains a new definition, “cash compensation,” and Subsection C, “consumer profile information” replaces the old suitability information. (3) “Financial situation and needs” now adds the language, “including debts and other obligations.” Also, the “financial resources used to fund the annuity” is now split off as its own separate element. (5) “Insurance Needs” is a new element. (8) “Old” is modified to say as the “New.” (9) “Existing assets or financial products, including investment, annuity and life insurance holdings.” (12) (Old 11‑ Risk Tolerance) adds “including but not limited to, willingness to accept nonguaranteed elements in the annuity.” NOTE that the term “nonguaranteed elements” is itself newly defined here as Sec. 5.K. (H) “Intermediary” is a new definition. The only other time that the word/term “intermediary” is actually used in the amended regulation is under the definition of “cash compensation.” (I.1) “Material conflict of interest” is a new definition. Of note, (I.2) states that a material conflict of interest does not include cash compensation or non‑cash compensation. (J) “Non‑cash compensation” and (K) “Nonguaranteed elements” are new definitions. (L) The 2010 version included a definition for an “insurer and for an insurance producer”—and then throughout the regulation it repeatedly said, “an insurance producer, or insurer where no producer is involved…” This simplifies and cleans that up. “Entity” now encompasses an insurer—but could also mean a marketing organization or intermediary, if it is required to be licensed. (M.1) “…intended to result or does result…” circles back to the expanded application in Section 2. Scope, in applying the regulation to “any sale or recommendation of an annuity.” However, the new language in M.2. narrows the interpretive breadth of the foregoing by exempting from the definition of a recommendation general communications, customer service and administrative activities, and educational support and activities related to annuity sales. Section (N) contains no substantive change. (I) “Suitability information” has been redefined through “Consumer profile information” (C). (O) “SEC” is a new definition. The Drafting Note contains no changes.

Section 5. Definitions. A. “Annuity” means an annuity that is an insurance product under State law that is individually solicited, whether the product is classified as an individual or group annuity.

B. “Cash compensation” means any discount, concession, fee, service fee, commission, sales charge, loan, override, or cash benefit received by a producer in connection with the recommendation or sale of an annuity from an insurer, intermediary, or directly from the consumer.

C. “Consumer profile information” means information that is reasonably appropriate to determine whether a recommendation addresses the consumer’s financial situation, insurance needs and financial objectives, including, at a minimum, the following:

(1) Age;

(2) Annual income;

(3) Financial situation and needs, including debts and other obligations;

(4) Financial experience;

(5) Insurance needs;

(6) Financial objectives;

(7) Intended use of the annuity;

(8) Financial time horizon;

(9) Existing assets or financial products, including investment, annuity and insurance holdings;

(1) Liquidity needs;

(11) Liquid net worth;

(12) risk tolerance, including but not limited to, willingness to accept nonguaranteed elements in the annuity;

(13) Financial resources used to fund the annuity; and

(14) Tax status.

B.D. “Continuing education credit” or “CE credit” means one continuing education credit as defined in [insert reference in State law or regulations governing producer continuing education course approval].

C.E. “Continuing education provider” or “CE provider” means an individual or entity that is approved to offer continuing education courses pursuant to [insert reference in State law or regulations governing producer continuing education course approval].

D.F. “FINRA” means the Financial Industry Regulatory Authority or a succeeding agency.

E.G. “Insurer” means a company required to be licensed under the laws of this state to provide insurance products, including annuities.

F. “Insurance producer” means a person required to be licensed under the laws of this state to sell, solicit or negotiate insurance, including annuities.

H. “Intermediary” means an entity contracted directly with an insurer or with another entity contracted with an insurer to facilitate the sale of the insurer’s annuities by producers.

I. (1) “Material conflict of interest” means a financial interest of the producer in the sale of an annuity that a reasonable person would expect to influence the impartiality of a recommendation.

(2) “Material conflict of interest” does not include cash compensation or non-cash compensation.

J. “Non-cash compensation” means any form of compensation that is not cash compensation, including, but not limited to, health insurance, office rent, office support and retirement benefits.

K. “Nonguaranteed elements” means the premiums, credit interest rates (including any bonus), benefits, values, dividends, non-interest based credits, charges or elements of formulas used to determine any of these that are subject to company discretion and are not guaranteed at issue. An element is considered nonguaranteed if any of the underlying nonguaranteed elements are used in its calculation.

L. “Producer” means a person or entity required to be licensed under the laws of this state to sell, solicit or negotiate insurance, including annuities. For purposes of this regulation, “producer” includes an insurer where no producer is involved.

GM. (1) “Recommendation” means advice provided by an insurance a producer, or an insurer where no producer is involved, to an individual consumer that was intended to result or does result results in a purchase, an exchange or a replacement of an annuity in accordance with that advice.

(2) Recommendation does not include general communication to the public, generalized customer services assistance or administrative support, general educational information and tools, prospectuses, or other product and sales material.

HN. “Replacement” means a transaction in which a new policy or contract annuity is to be purchased, and it is known or should be known to the proposing producer, or to the proposing insurer if there is nowhether or not a producer is involved, that by reason of the transaction, an existing annuity or other insurance policy or contract has been or is to be any of the following:

(1) Lapsed, forfeited, surrendered or partially surrendered, assigned to the replacing insurer or otherwise terminated;

(2) Converted to reduced paid-up insurance, continued as extended term insurance, or otherwise reduced in value by the use of nonforfeiture benefits or other policy values;

(3) Amended so as to effect either a reduction in benefits or in the term for which coverage would otherwise remain in force or for which benefits would be paid;

(4) Reissued with any reduction in cash value; or

(5) Used in a financed purchase.

I. “Suitability information” means information that is reasonably appropriate to determine the suitability of a recommendation, including the following:

(1) Age;

(2) Annual income;

(3) Financial situation and needs, including the financial resources used for the funding of the annuity;

(4) Financial experience;

(5) Financial objectives;

(6) Intended use of the annuity;

(7) Financial time horizon;

(8) Existing assets, including investment and life insurance holdings;

(9) Liquidity needs;

(10) Liquid net worth;

(11) Risk tolerance; and

(12) Tax status.

O. “SEC” means the United States Securities and Exchange Commission.

Drafting Note:  The definition of “replacement” above is derived from the NAIC Life Insurance and Annuities Replacement Model Regulation. If a state has a different definition for “replacement,” the state should either insert the text of that definition in place of the definition above or modify the definition above to provide a cross‑reference to the definition of “replacement” that is in state law or regulation.

Duties of Insurers and Producers

The revision of Section 6 strikes the word “insurance” so that the title of Section 6 is now “Duties of Insurers and Producers.” [Section 6. Duties of Insurers and Insurance Producers].

Section 6.A limited the best interest obligation to “when making a recommendation of an annuity” (therefore, no ongoing duty); limited to the circumstances known at the time the recommendation is made (no retrospective look back, nor does it say “or should be known”); requires producers to not place financial interest ahead of the consumer’s interest (not “without regard to” producer’s financial interest); and sets forth that acting in the best interest is met if the producer has satisfied the four obligation “buckets,” as described below.

Section 6. Duties of Insurers and Producers. A. Best Interest Obligations. A producer, when making a recommendation of an annuity, shall act in the best interest of the consumer under the circumstances known at the time the recommendation is made, without placing the producer’s or the insurer’s financial interest ahead of the consumer’s interest. A producer has acted in the best interest of the consumer if they have satisfied the following obligations regarding care, disclosure, conflict of interest and documentation:

A. In recommending to a consumer the purchase of an annuity or the exchange of an annuity that results in another insurance transaction or series of insurance transactions, the insurance producer, or the insurer where no producer is involved, shall have reasonable grounds for believing that the recommendation is suitable for the consumer on the basis of the facts disclosed by the consumer as to his or her investments and other insurance products and as to his or her financial situation and needs, including the consumer’s suitability information, and that there is a reasonable basis to believe all of the following:

Care Obligation

Satisfying the Care Obligation requires the producer to exercise reasonable diligence, care and skill (does not require “exercising prudence”) while doing four specific things:

1.    Know the consumer’s financial situation, insurance needs and financial objectives;

2.    Understand the available recommendation options;

3.    Have a reasonable basis to believe the recommended option effectively addresses the consumer’s financial situation, insurance needs, and financial objectives over the life of the product, as evaluated in light of the consumer profile information; and

4.    Communicate the basis or bases of the recommendation.

Also, the producer must:

ü  Make reasonable efforts to obtain the consumer profile information prior to the recommendation.

ü  Consider the types of products the producer is authorized and licensed to recommend or sell that address the consumer’s financial situation, insurance needs and financial objectives. Does NOT require producers to analyze or consider products outside the authority and scope of their license, nor consider other possible alternative products or strategies in the market at the time of the recommendation. Producers held to standards applicable to producers with similar authority and licensure.

Explicitly states that requirements under the Care Obligation do not create a fiduciary obligation or relationship and only create a regulator obligation.

Additionally, producers must:

ü  Consider relevant factors pertaining to the consumer, the product, and the insurer when making a particular recommendation, but such factors may vary in importance. Cannot consider any one factor in isolation, however.

ü  Have a reasonable basis to believe the consumer would benefit from certain features of the annuity. (This is in the 2010 version.)

(g) Requirements under the Care Obligation apply to the particular annuity as a whole, as well as the underlying subaccounts, riders and similar product enhancements. (No change from current version.) (h) Requirements here do not mean that the recommended annuity must be the one with lowest one‑time or multiple occurrence compensation structures. (i) Producers do not have ongoing monitoring obligations—unless such obligations are separately owed under agreement between the producer and consumer. (j) As it relates to an exchange or replacement of an annuity, this is generally the same as the current 2010 version; however, the changes of note are as follows:  First, (ii) adds the word “substantially” before “benefit” in terms of the replacing products comparison to the replaced product and that comparison must be considered in light of the “life of the product;” and, second, consideration of whether the consumer has had another annuity exchange or replacement is extended from its current look back of 36 months (3 years) to 60 months (5 years). (k) This new provision explicitly disclaims any requirement under the whole of the regulation for a producer to obtain any license other than an insurance license, including any securities license, in order to fulfill the obligations and duties set forth in the regulation. Caveat here for producers is to not give advice or provide services that are otherwise subject to securities law or engage in any other activity that would require other professional licenses.

(1)(a) Care Obligation. The producer, in making a recommendation shall exercise reasonable diligence, care and skill to:

(i) Know the consumer’s financial situation, insurance needs and financial objectives;

(ii) Understand the available recommendation options after making a reasonable inquiry into options available to the producer;

(iii) Have a reasonable basis to believe the recommended option effectively addresses the consumer’s financial situation, insurance needs and financial objectives over the life of the product, as evaluated in light of the consumer profile information; and

(iv) Communicate the basis or bases of the recommendation.

(b) The requirements under subparagraph (a) of this paragraph include making reasonable efforts to obtain consumer profile information from the consumer prior to the recommendation of an annuity.

(c) The requirements under subparagraph (a) of this paragraph require a producer to consider the types of products the producer is authorized and licensed to recommend or sell that address the consumer’s financial situation, insurance needs and financial objectives. This does not require analysis or consideration of any products outside the authority and license of the producer or other possible alternative products or strategies available in the market at the time of the recommendation. Producers shall be held to standards applicable to producers with similar authority and licensure.

(d) The requirements under this subsection do not create a fiduciary obligation or relationship and only create a regulatory obligation as established in this regulation.

(e) The consumer profile information, characteristics of the insurer, and product costs, rates, benefits and features are those factors generally relevant in making a determination whether an annuity effectively addresses the consumer’s financial situation, insurance needs and financial objectives, but the level of importance of each factor under the care obligation of this paragraph may vary depending on the facts and circumstances of a particular case. However, each factor may not be considered in isolation.

(f) The requirements under subparagraph (a) of this paragraph include having a reasonable basis to believe the consumer would benefit from certain features of the annuity, such as annuitization, death or living benefit or other insurance-related features.

(g) The requirements under subparagraph (a) of this paragraph apply to the particular annuity as a whole and the underlying subaccounts to which funds are allocated at the time of purchase or exchange of an annuity, and riders and similar producer enhancements, if any.

(h) The requirements under subparagraph (a) of this paragraph do not mean the annuity with the lowest one-time or multiple occurrence compensation structure shall necessarily be recommended.

(i) The requirements under subparagraph (a) of this paragraph do not mean the producer has ongoing monitoring obligations under the care obligation under this paragraph, although such an obligation may be separately owed under the terms of a fiduciary, consulting, investment advising or financial planning agreement between the consumer and the producer.

(j) In the case of an exchange or replacement of an annuity, the producer shall consider the whole transaction, which includes taking into consideration whether:

(i) The consumer will incur a surrender charge, be subject to the commencement of a new surrender period, lose existing benefits, such as death, living or other contractual benefits, or be subject to increased fees, investment advisory fees or charges for riders and similar product enhancements;

(ii) The replacing product would substantially benefit the consumer in comparison to the replaced product over the life of the product; and

(iii) The consumer has had another annuity exchange or replacement and, in particular, an exchange or replacement within the preceding 60 months.

(k) Nothing in this regulation should be construed to require a producer to obtain any license other than a producer license with the appropriate line of authority to sell, solicit or negotiate insurance in this state, including but not limited to any securities license, in order to fulfill the duties and obligations contained in this regulation; provided the producer does not give advice or provide services that are otherwise subject to securities laws or engage in any other activity requiring other professional licenses.

Disclosure Obligation

The Disclosure Obligation contains the requirement for the producer to disclose certain information to the consumer prior to or at the time of the recommendation or sale, the substance of which is set forth in a new appendix to the regulation (Appendix A). This obligation generally requires a producer to disclose the scope/terms of the relationship with the consumer and the producer’s role in the transaction; what products the producer is licensed and authorized to sell; whether the producer is authorized to sell annuities from one or multiple insurers; a description of the types of cash compensation the producer will receive for the sale and the source of that cash compensation; a notice that the producer may receive non‑cash compensation and the source of the non‑cash compensation; and a notice that the consumer has the right to request additional information. If the consumer requests, the producer must disclose a reasonable estimate of the cash compensation to be received and whether the cash compensation is a one‑time or multiple occurrence amount (and if so, the frequency and amount of the occurrence). Amounts may be stated as a range of amounts or as a percentage. (c) This subparagraph was, generally, the “old” Section 6.A.(1), but this is slightly more restrictive in adding “prior to or at the time of…” and striking “reasonably” before informed. And, list of features of the annuity about which the producer must have a reasonable basis to believe that the consumer has been informed has been expanded to include such things as annual fees, potential charges for annuity options outside of riders, potential changes in nonguaranteed elements, and market risk.

(2) Disclosure Obligation.

(a) Prior to the recommendation or sale of an annuity, the producer shall prominently disclose to the consumer on a form substantially similar to Appendix A:

(i) A description of the scope and terms of the relationship with the consumer and the role of the producer in the transaction;

(ii) An affirmative statement on whether the producer is licensed and authorized to sell the following products:

(I) Fixed annuities;

(II) Fixed indexed annuities;

(III) Variable annuities;

(IV) Life insurance;

(V) Mutual funds;

(VI) Stocks and bonds; and

(VII) Certificates of deposit;

(iii) An affirmative statement describing the insurers the producer is authorized, contracted (or appointed), or otherwise able to sell insurance products for, using the following descriptions:

(I) One insurer;

(II) From two or more insurers; or

(III) From two or more insurers although primarily contracted with one insurer.

(iv) A description of the sources and types of cash compensation and non-cash compensation to be received by the producer, including whether the producer is to be compensated for the sale of a recommended annuity by commission as part of premium or other remuneration received from the insurer, intermediary or other producer or by fee as a result of a contract for advice or consulting services; and

(v) A notice of the consumer’s right to request additional information regarding cash compensation described in subparagraph (b) of this paragraph;

Drafting Note:  If a state approves forms, a state should add language to subparagraph (a) reflecting such approvals.

(b) Upon request of the consumer or the consumer’s designated representative, the producer shall disclose:

(i) A reasonable estimate of the amount of cash compensation to be received by the producer, which may be stated as a range of amounts or percentages; and

(ii) Whether the cash compensation is a one-time or multiple occurrence amount, and if a multiple occurrence amount, the frequency and amount of the occurrence, which may be stated as a range of amounts or percentages; and

(c1) Prior to or at the time of the recommendation or sale of an annuity, the producer shall have a reasonable basis to believe Thethe consumer has been reasonably informed of various features of the annuity, such as the potential surrender period and surrender charge, potential tax penalty if the consumer sells, exchanges, surrenders or annuitizes the annuity, mortality and expense fees, investment advisory fees, any annual fees, potential charges for and features of riders or other options of the annuity, limitations on interest returns, potential changes in nonguaranteed elements of the annuity, insurance and investment components and market risk.

Drafting Note: If a state has adopted the NAIC Annuity Disclosure Model Regulation, the state should insert an additional phrase in paragraph (1) subparagraph (c) above to explain that the requirements of this section are intended to supplement and not replace the disclosure requirements of the NAIC Annuity Disclosure Model Regulation.

(2) The consumer would benefit from certain features of the annuity, such as tax-deferred growth, annuitization or death or living benefit;

(3) The particular annuity as a whole, the underlying subaccounts to which funds are allocated at the time of purchase or exchange of the annuity, and riders and similar product enhancements, if any, are suitable (and in the case of an exchange or replacement, the transaction as a whole is suitable) for the particular consumer based on his or her suitability information; and

(4) In the case of an exchange or replacement of an annuity, the exchange or replacement is suitable including taking into consideration whether:

(a) The consumer will incur a surrender charge, be subject to the commencement of a new surrender period, lose existing benefits (such as death, living or other contractual benefits), or be subject to increased fees, investment advisory fees or charges for riders and similar product enhancements;

(b) The consumer would benefit from product enhancements and improvements; and

(c) The consumer has had another annuity exchange or replacement and, in particular, an exchange or replacement within the preceding 36 months.

Conflict of Interest Obligation

The Conflict of Interest Obligation requires a producer to (1) identify and (2) avoid or reasonably manage and disclose material conflicts of interest. Recall that material conflicts of interest are defined under Section 5.I. as a financial interest of the producer in the sale of an annuity that a reasonably person would expect to influence the impartiality of a recommendation but does not include cash or non‑cash compensation. No specific guidance is given here in regard to how a producer shall “reasonably manage” a material conflict of interest.

(3) Conflict of Interest Obligation. A producer shall identify and avoid or reasonably manage and disclose material conflicts of interest, including material conflicts of interest related to an ownership interest.

Documentation Obligation

Under the Documentation Obligation, producers are required to:

·         Make a written record of their recommendation and the basis for it;

·         Obtain a consumer-signed statement (on a form substantially similar to the second new appendix (Appendix B):

o   Customer’s refusal to provide consumer profile information; and

o   Customer’s understanding of the ramifications for not doing so;

·         Obtain a consumer-signed statement (on a form substantially similar to the third new appendix (Appendix C):

o   An acknowledgment that the customer decided to buy an annuity that was not based on the producer’s recommendation.

(4) Documentation Obligation. A producer shall at the time of recommendation or sale:

(a) Make a written record of any recommendation and the basis for the recommendation subject to this regulation;

(b) Obtain a consumer signed statement on a form substantially similar to Appendix B documenting:

(i) A customer’s refusal to provide the consumer profile information, if any; and

(ii) A customer’s understanding of the ramifications of not providing his or her consumer profile information or providing insufficient consumer profile information; and

(c) Obtain a consumer signed statement on a form substantially similar to Appendix C acknowledging the annuity transaction is not recommended if a customer decides to enter into an annuity transaction that is not based on the producer’s recommendation.

Drafting Note: If a state approves forms, a state should add language to subparagraphs (b) and (c) of this paragraph reflecting such approvals.

B. Prior to the execution of a purchase or exchange of an annuity resulting from a recommendation, an insurance producer, or an insurer where no producer is involved, shall make reasonable efforts to obtain the consumer’s suitability information.

C. Except as permitted under subsection D, an insurer shall not issue an annuity recommended to a consumer unless there is a reasonable basis to believe the annuity is suitable based on the consumer’s suitability information.

Applicability of the New Best Interest Obligation

Subsection 5 describes to whom the best interest obligation applies. This new clause was suggested by the New York delegate to the Working Group and comes from NY Insurance Reg. 187, adopted in August 2019. However, there are a few critical differences:  NY Reg. 187 applies to any producer who has “materially participated;” here, a producer must have exercised material control or influence. Also, the qualifier “direct” is before the compensation that results from the sale of the annuities. And, the scope of activities that would not fall under the application is broader under the revised MDL 275, to include other back office product support and the general supervision of a producer. Subsection B contains no substantive difference.

(5) Application of the best interest obligation. Any requirement applicable to a producer under this subsection shall apply to every producer who has exercised material control or influence in the making of a recommendation and has received direct compensation as a result of the recommendation or sale, regardless of whether the producer has had any direct contact with the consumer. Activities such as providing or delivering marketing or educational materials, product wholesaling or other back office product support, and general supervision of a producer do not, in and of themselves, constitute material control or influence.

D.B. Transactions not based on a recommendation.

(1) Except as provided under paragraph (2) of this subsection, neither an insurance  a producer, nor an insurer, shall have any no obligation to a consumer under Subsection A(1) or C related to any annuity transaction if

(a) No recommendation is made;

(b) A recommendation was made and was later found to have been prepared based on materially inaccurate information provided by the consumer;

(c) A consumer refuses to provide relevant suitability consumer profile information and the annuity transaction is not recommended; or

(d) A consumer decides to enter into an annuity transaction that is not based on a recommendation of the insurer or the insurance producer.

(2) An insurer’s issuance of an annuity subject to paragraph (1) shall be reasonable under all the circumstances actually known to the insurer at the time the annuity is issued.

Carrier/Insurer Supervision Requirements

In order to issue an annuity, insurers must have a reasonable basis to believe the annuity would effectively address the particular consumer’s financial situation, insurance needs and financial objectives based on the consumer’s consumer profile information. (2) Generally in regard to the supervision system that is required, the language throughout is conformed to state “establish and maintain”—in the 2010 version, it sometimes stated “establish” and sometimes stated “maintain;” now “establish and maintain.” (d) Amends current requirement that the recommended annuity be “suitable” to the new best interest standard; i.e., that the “recommended annuity would effectively address the particular consumer’s financial situation, insurance needs and financial objectives.” (e) Requires that the insurer’s “reasonable procedures” are sufficient to detect recommendation that are not in compliance with subsections A (the Best Interest Obligation, with the four “buckets” of Care, Disclosure, Material Conflicts of Interest, and Documentation), B (Transactions not based on a recommendation), D (Prohibited practices), and E (Safe Harbor). To accommodate industry concerns regarding the difficulty for insurers to know what producers may or may not have disclosed and communicated to a consumer, language added here allows insurers to use “producer and consumer” interviews, as well as “producer statements or attestations” in order to create the reasonable procedures that would be compliant with the regulation. Also, an insurer may confirm the consumer profile information as well as other required information after issuance or delivery of the annuity. (f) The appendices and the documentation required under Section 6.A (4)(a) to make a written record of any recommendation and the basis for the recommendation, as well as the producer interviews and attestations provide a structure for insurer assessment. (h) It is important to note the qualifiers here; First, as the drafting note states, this is directed at sales contests, etc. based on sales of “specific” annuities “within a limited period of time” and is not directed at general incentives for an insurer’s products. Incentives based on premium volume, for instance, would not be prohibited as long as it is not tied to the sale of a particular annuity within a limited time period. (Note:  There is no definition of what a “limited” time period would be.) Also important is that the reference to non‑cash compensation is not intended to prohibit a producer’s receipt of general employee or retirement benefits, nor the receipt of office support, including rent. (I) Qualifies that the annual report be written.

C. Supervision system.

(1) Except as permitted under subsection B, an insurer may not issue an annuity recommended to a consumer unless there is a reasonable basis to believe the annuity would effectively address the particular consumer’s financial situation, insurance needs and financial objectives based on the consumer’s consumer profile information.

 (E) An insurance producer or, where no insurance producer is involved, the responsible insurer representative, shall at the time of sale:

(1) Make a record of any recommendation subject to section 6A of this regulation;

(2) Obtain a customer signed statement documenting a customer’s refusal to provide suitability information, if any; and

(3) Obtain a customer signed statement acknowledging that an annuity transaction is not recommended if a customer decides to enter into an annuity transaction that is not based on the insurance producer’s or insurer’s recommendation.

F. (1)(2) An insurer shall establish and maintain a supervision system that is reasonably designed to achieve the insurer’s and its insurance producers’ compliance with this regulation, including, but not limited to, the following:

(a) The insurer shall establish and maintain reasonable procedures to inform its insurance producers of the requirements of this regulation and shall incorporate the requirements of this regulation into relevant insurance producer training manuals;

(b) The insurer shall establish and maintain standards for insurance producer product training and shall establish and maintain reasonable procedures to require its insurance producers to comply with the requirements of section 7 of this regulation;

(c) The insurer shall provide product-specific training and training materials which explain all material features of its annuity products to its insurance producers;

(d) The insurer shall establish and maintain procedures for the review of each recommendation prior to issuance of an annuity that are designed to ensure that there is a reasonable basis to determine that a recommendation is suitable. the recommended annuity would effectively address the particular consumer’s financial situation, insurance needs and financial objectives. Such review procedures may apply a screening system for the purpose of identifying selected transactions for additional review and may be accomplished electronically or through other means including, but not limited to, physical review. Such an electronic or other system may be designed to require additional review only of those transactions identified for additional review by the selection criteria;

(e) The insurer shall establish and maintain reasonable procedures to detect recommendations that are not suitablein compliance with subsections A, B, D and E. This may include, but is not limited to, confirmation of the consumer’s suitability consumer profile information, systematic customer surveys, producer and consumer interviews, confirmation letters, producer statements or attestations and programs of internal monitoring. Nothing in this subparagraph prevents an insurer from complying with this subparagraph by applying sampling procedures, or by confirming the suitability consumer profile information or other required information under this section after issuance or delivery of the annuity; and

(f) The insurer shall establish and maintain reasonable procedures to assess, prior to or upon issuance or delivery of an annuity, whether a producer has provided to the consumer the information required to be provided under this section;

(g) The insurer shall establish and maintain reasonable procedures to identify and address suspicious consumer refusals to provide consumer profile information;

(h) The insurer shall establish and maintain reasonable procedures to identify and eliminate any sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sales of specific annuities within a limited period of time. The requirements of this subparagraph are not intended to prohibit the receipt of health insurance, office rent, office support, retirement benefits or other employee benefits by employees as long as those benefits are not based upon the volume of sales of a specific annuity within a limited period of time; and

Drafting Note: The intent of this subparagraph (h) is to prohibit sales contests, sales quotas, bonuses and non-cash compensation based on the sale of a particular product within a limited period of time, but not to prohibit general incentives regarding the sales of a company’s products with no emphasis on any particular product.

(f)(i) The insurer shall annually provide a written report to senior management, including to the senior manager responsible for audit functions, which details a review, with appropriate testing, reasonably designed to determine the effectiveness of the supervision system, the exceptions found, and corrective action taken or recommended, if any.

(2)(3)(a) Nothing in this subsection restricts an insurer from contracting for performance of a function (including maintenance of procedures) required under paragraph (1) this subsection. An insurer is responsible for taking appropriate corrective action and may be subject to sanctions and penalties pursuant to section 8 of this regulation regardless of whether the insurer contracts for performance of a function and regardless of the insurer’s compliance with subparagraph (b) of this paragraph.

(b) An insurer’s supervision system under paragraph (1) this subsection shall include supervision of contractual performance under this subsection. This includes, but is not limited to, the following:

(i) Monitoring and, as appropriate, conducting audits to assure that the contracted function is properly performed; and

(ii) Annually obtaining a certification from a senior manager who has responsibility for the contracted function that the manager has a reasonable basis to represent, and does represent, that the function is properly performed.

Exemptions From Insurer’s Supervision System

The addition of (b) here is very important as it recognizes that an insurer cannot know and should not be expected to know what other product options a producer may have nor what the compensation is for those other options or how such compensation compares to the compensation for the insurer’s products; insurers should only be required to establish and maintain a system of supervision related to a producer’s recommendation of products—and the compensation related thereto‑for only those products offered by the insurer. Section D contains no substantive change.

(3)(4) An insurer is not required to include in its system of supervision an insurance

(a) A producer’s recommendations to consumers of products other than the annuities offered by the insurer; or

(b) Include consideration of or comparison to options available to the producer or compensation relating to those options other than annuities or other products offered by the insurer.

GD. Prohibited Practices. Neither a producer nor an insurer shall An insurance producer shall not dissuade, or attempt to dissuade, a consumer from:

(1) Truthfully responding to an insurer’s request for confirmation of the suitabilityconsumer profile information;

(2) Filing a complaint; or

(3) Cooperating with the investigation of a complaint.

Safe Harbor

Section E broadens safe harbor beyond 2010 Model 275 compliance under FINRA suitability and supervision requirements to compliance made under standards that are comparable to the requirements under this regulation; and maintains the insurance commissioner’s ability to investigate and enforce this regulation, even where the financial professional is acting under comparable standards. However, if the recommendation and sale of an annuity is made by a financial professional under comparable standards outside of this regulation, the insurer is still obligated to comply with the insurer supervision system requirements under Section 6.C.(1)—requiring an insurer to have a reasonable basis to believe the annuity would effectively address the particular consumer’s financial situation, insurance needs and financial objectives based on the consumer’s consumer profile information. (3) Sets forth what the insurer needs to do to comply where the recommendation and sales of an annuity is made by a financial professional as defined in (4) under the safe harbor provision:  insurers are required to monitor the relevant conduct of the financial professional and assist the entity responsible for supervising the financial professional seeking to rely on the safe harbor, providing information and reports that are reasonably appropriate to assist such entity in maintaining its supervision system.

HE. Safe Harbor.

(1) Recommendations and sales of annuities Sales made in compliance with comparable standards FINRA requirements pertaining to suitability and supervision of annuity transactions shall satisfy the requirements under this regulation. This subsection applies to FINRA broker-dealer all recommendations and sales of annuities made by financial professionals in compliance with business rules, controls and procedures that satisfy a comparable standard even if such standard would not otherwise apply to the product or recommendation at issue if the suitability and supervision is similar to those applied to variable annuity sales. However, nothing in this subsection shall limit the insurance commissioner’s ability to investigate and enforce (including investigate) the provisions of this regulation.

Drafting Note: Noncompliance with comparable standards FINRA requirements means that the broker-dealer transaction recommendation or sale is subject to compliance with the suitability requirements of this regulation.

(2) Nothing in paragraph (1) shall limit the insurer’s obligation to comply with Section 6C(1) of this regulation, although the insurer may base its analysis on information received from either the financial professional or the entity supervising the financial professional.

(2)(3) For paragraph (1) to apply, an insurer shall:

(a) Monitor the FINRA member broker-dealer relevant conduct of the financial professional seeking to rely on paragraph (1) or the entity responsible for supervising the financial professional, such as the financial professional’s broker-dealer or an investment adviser registered under federal [or state] securities laws using information collected in the normal course of an insurer’s business; and

(b) Provide to the FINRA member broker-dealer entity responsible for supervising the financial professional seeking to rely on paragraph (1), such as the financial professional’s broker-dealer or investment adviser registered under federal [or state] securities laws, information and reports that are reasonably appropriate to assist the FINRA member broker-dealer such entity to maintain its supervision system.

Definition of a “Financial Professional” – A “financial professional” under the safe harbor provision is a producer who is regulated and is acting as:

·         A registered broker-dealer (B-D) or registered representative of a BD;

·         A registered investment adviser or IAR associated with the investment adviser; or

·         An ERISA or IRC plan fiduciary.

The drafting note clarifies that the financial professionals described under (4) must be explicitly acting in their capacity as such and in accordance and compliance with the relevant comparable standards that are applicable to those roles in order to be eligible for the safe harbor. If they are not, they are subject to this regulation.

(4) For purposes of this subsection, “financial professional” means a producer that is regulated and acting as:

(a) A broker-dealer registered under federal [or state] securities laws or a registered representative of a broker-dealer;

(b) An investment adviser registered under federal [or state] securities laws or an investment adviser representative associated with the federal [or state] registered investment adviser; or

(c) A plan fiduciary under Section 3(21) of the Employee Retirement Income Security Act of 1974 (ERISA) or fiduciary under Section 4975(e)(3) of the Internal Revenue Code (IRC) or any amendments or successor statutes thereto.

Drafting Note: The requirement that a producer be “regulated and acting” as a broker‑dealer, a registered representative of a broker-dealer, an investment adviser, an investment adviser representative or a plan fiduciary means that a producer who is not explicitly acting in compliance with the relevant comparable standards, as specified in paragraph (4) below, is not eligible for this safe harbor and is subject to compliance with the requirements of this regulation.

Definition of “Comparable Standards”

(a) For BDs and BD representatives, applicable SEC and FINRA rules pertaining to best interest obligations and supervision of annuity recommendations and sales (Reg. BI, for instance, and any amendments or successor regulations to Reg. BI). (b) For RIAs and IARs associated with the registered investment adviser, the fiduciary duties and requirements imposed under contract or under the Investment Advisers Act of 1940 (or applicable state securities law). (c) For plan fiduciaries, the duties, obligations, prohibitions and all other requirements attendant to ERISA or IRC rules and laws (and any amendments or successor statutes). The drafting note provides that each state may determine whether to extend the safe harbor to include state‑regulated financial professionals.

(5) For purposes of this subsection, “comparable standards” means:

(a) With respect to broker-dealers and registered representatives of broker‑dealers, applicable SEC and FINRA rules pertaining to best interest obligations and supervision of annuity recommendations and sales, including, but not limited to, Regulation Best Interest and any amendments or successor regulations thereto;

(b) With respect to investment advisers registered under federal [or state] securities laws or investment adviser representatives, the fiduciary duties and all other requirements imposed on such investment advisers or investment adviser representatives by contract or under the Investment Advisers Act of 1940 [or applicable state securities law], including but not limited to, the Form ADV and interpretations; and

Drafting Note: State-registered investment advisers in this safe harbor are included in brackets so that each individual state that implements this model regulation may determine whether to include the state-regulated investment advisers. Given the varying treatment of annuities, particularly variable annuities, under state law, the varying structures of state securities and insurance departments, and the varying levels of cooperation between the two agencies, this is a decision best made in each individual state.

(c) With respect to plan fiduciaries or fiduciaries, means the duties, obligations, prohibitions and all other requirements attendant to such status under ERISA or the IRC and any amendments or successor statutes thereto.

Producer Training Requirements

Note:  The revision of Section 7 strikes the word “insurance” so that the title of Section 7 is now “Producer Training.” [Section 7. Insurance Producer Training]

Section 7.B.(3) is the big change to the training requirements—adding the appropriate “standard of conduct” to the list of things required to be included as part of the training course. This would imply that the new best interest standard and all its accompanying requirements would need to be part of the training. The question became:  what happens for those individuals who have already taken the one‑time four‑hour course? Do they need to retake it? Are they grandfathered in? The answer to that question came quite late in the process and was suggested by the joint trades. (6) Provides that producers who have already completed the annuity course required under the 2010 model regulation requirements need to complete either a new four‑credit training course or an additional one‑time one‑credit training course to provide training and education pertaining to the new standards and requirements of this amended regulation.

Section 7. Producer Training. A. An insurance A producer shall not solicit the sale of an annuity product unless the insurance producer has adequate knowledge of the product to recommend the annuity and the insurance producer is in compliance with the insurer’s standards for product training. An insurance A producer may rely on insurer-provided product-specific training standards and materials to comply with this subsection.

B. (1) (a) An insurance A producer who engages in the sale of annuity products shall complete a one-time four (4) credit training course approved by the department of insurance and provided by the department of insurance-approved education provider.

(b) Insurance pProducers who hold a life insurance line of authority on the effective date of this regulation and who desire to sell annuities shall complete the requirements of this subsection within six (6) months after the effective date of this regulation. Individuals who obtain a life insurance line of authority on or after the effective date of this regulation may not engage in the sale of annuities until the annuity training course required under this subsection has been completed.

(2) The minimum length of the training required under this subsection shall be sufficient to qualify for at least four (4) CE credits, but may be longer.

(3) The training required under this subsection shall include information on the following topics:

(a) The types of annuities and various classifications of annuities;

(b) Identification of the parties to an annuity;

(c) How fixed, variable and indexed annuity contract provisions affect consumers;

(d) The application of income taxation of qualified and nonqualified annuities;

(e) The primary uses of annuities; and

(f) Appropriate standard of conduct, sales practices, replacement and disclosure requirements.

(4) Providers of courses intended to comply with this subsection shall cover all topics listed in the prescribed outline and shall not present any marketing information or provide training on sales techniques or provide specific information about a particular insurer’s products. Additional topics may be offered in conjunction with and in addition to the required outline.

(5) A provider of an annuity training course intended to comply with this subsection shall register as a CE provider in this State and comply with the rules and guidelines applicable to insurance producer continuing education courses as set forth in [insert reference to State law or regulations governing producer continuing education course approval].

(6) A producer who has completed an annuity training course approved by the department of insurance prior to [insert effective date of amended regulation] shall, within six (6) months after [insert effective date of amended regulation], complete either:

(a) A new four (4) credit training course approved by the department of insurance after [insert effective date of amended regulation]; or

(b) An additional one-time one (1) credit training course approved by the department of insurance and provided by the department of insurance-approved education provider on appropriate sales practices, replacement and disclosure requirements under this amended regulation.

(6)(7) Annuity training courses may be conducted and completed by classroom or self-study methods in accordance with [insert reference to State law or regulations governing producer continuing education course approval].

(7)(8) Providers of annuity training shall comply with the reporting requirements and shall issue certificates of completion in accordance with [insert reference to State law or regulations governing to producer continuing education course approval].

(8)(9) The satisfaction of the training requirements of another State that are substantially similar to the provisions of this subsection shall be deemed to satisfy the training requirements of this subsection in this State.

(10) The satisfaction of the components of the training requirements of any course or courses with components substantially similar to the provisions of this subsection shall be deemed to satisfy the training requirements of this subsection in this state.

(9)(11) An insurer shall verify that an insurance a producer has completed the annuity training course required under this subsection before allowing the producer to sell an annuity product for that insurer. An insurer may satisfy its responsibility under this subsection by obtaining certificates of completion of the training course or obtaining reports provided by commissioner-sponsored database systems or vendors or from a reasonably reliable commercial database vendor that has a reporting arrangement with approved insurance education providers.

Compliance Mitigation, Penalties, and Enforcement

Note:  The revision of Section 8 adds the word “Enforcement” so that the title of Section 8 is now “Compliance Mitigation; Penalties; Enforcement.” [Section 8. Compliance Mitigation; Penalties; Enforcement] This is not a substantive change:  Insurers are already responsible for the action of its producers and the actions of any outside entity it contracts with to satisfy its supervision obligations (see Sec. 6.C.(3)). Section C reinforces the argument and position that this is an insurance‑based regulation, not subject to securities‑based enforcement.

Section 8. Compliance Mitigation; Penalties; Enforcement. A. An insurer is responsible for compliance with this regulation. If a violation occurs, either because of the action or inaction of the insurer or its insurance producer, the commissioner may order:

(1) An insurer to take reasonably appropriate corrective action for any consumer harmed by a failure to comply with this regulation by the insurer’s, insurer, an entity contracted to perform the insurer’s supervisory duties or by its insurance producer’s, violation of this regulation the producer;

(2) A general agency, independent agency or the insurance producer to take reasonably appropriate corrective action for any consumer harmed by the insurance producer’s violation of this regulation; and

(3) Appropriate penalties and sanctions.

B. Any applicable penalty under [insert statutory citation] for a violation of this regulation may be reduced or eliminated [, according to a schedule adopted by the commissioner,] if corrective action for the consumer was taken promptly after a violation was not part of a pattern or practice.

Drafting Note: Subsection B above is intended to be consistent with the commissioner’s discretionary authority to determine the appropriate penalty for a violation of this regulation. The language of subsection B is not intended to require that a commissioner impose a penalty on an insurer for a single violation of this regulation if the commissioner has determined that such a penalty is not appropriate.

Drafting Note: A State that has authority to adopt a schedule of penalties may wish to include the words in brackets. In that case, “shall” should be substituted for “may” in the same sentence. States should consider inserting a reference to the NAIC Unfair Trade Practices Act or the State’s statute that authorizes the commissioner to impose penalties and fines.

C. The authority to enforce compliance with this regulation is vested exclusively with the commissioner.

Recordkeeping Requirements

Note:  The revision of Section 9 strikes the word “Optional” so that the title of Section 9 is now “Recordkeeping.” [Section 9. Optional Recordkeeping]. Section A removes “Optional” from the Recordkeeping requirement, which, it should be noted, was always optional in any case; it also adds “disclosures that a producer made to the consumer—including summaries of any oral disclosures”— as part of the records that must be maintained.

Section 9. Recordkeeping. A. Insurers, general agents, independent agencies and insurance producers shall maintain or be able to make available to the commissioner records of the information collected from the consumer, disclosures made to the consumer, including summaries of oral disclosures, and other information used in making the recommendations that were the basis for insurance transactions for [insert number] years after the insurance transaction is completed by the insurer. An insurer is permitted, but shall not be required, to maintain documentation on behalf of an insurance a producer.

B. Records required to be maintained by this regulation may be maintained in paper, photographic, micro-process, magnetic, mechanical or electronic media or by any process that accurately reproduces the actual document.

Effective Date of the Model Act

Section 10 was changed to delete the suggested six month effective date set forth in the 2010 version. Sates sometime changed the timeframe in any case; this just allows states to set their own effective date.

Section 10. Effective Date. The amendments to this regulation shall take effect [six (6)X] months after the date the regulation is adopted or on [insert date], whichever is later.[3]

Appendix A – Insurance Agent Disclosure for Annuities

Note:  For ease of reading, the document has foregone the underlining required for new text, as this is all new. (See Sec. 6.A.(2))

Drafting Note: This disclosure may be adapted to fit the particular business model of the producer. As an example, if the producer only receives commission or only receives a fee from the consumer, the disclosure may be refined to fit that particular situation. This form is intended to provide an example of how to communicate producer compensation, but compliance with the regulation may also be achieved with more precise disclosure, including a written consulting, advising or financial planning agreement.

Appendix B – Customer Refusal to Provide Information

Note:  For ease of reading, the document has foregone the underlining required for new text, as this is all new. (See Sec. 6.A.(4)(b))

Appendix C – Consumer Decision to Purchase an Annuity NOT Based on a Recommendation

Note:  For ease of reading, the document has foregone the underlining required for new text, as this is all new. (See Sec. 6.A.(4)(c))

NAIC Recommendation Standards for Senior Consumers

(1)  Prior to recommending a transaction involving an annuity to a consumer, an insurer and an insurance producer shall make every effort to obtain relevant information from the senior consumer.

(2)  An insurer and an insurance producer shall make recommendations only of transactions that are appropriate to assist the senior consumer to meet the particular senior consumer’s insurance needs and financial objectives.

(3)  An insurer and an insurance producer shall not make a recommendation unless the insurer and the insurance producer comply with the standards, guidelines, procedures and data collection processes established by the insurer.

Chapter 1 Review Questions

Which of the following answers/completes each question/sentence the best?

1. The revisions to NAIC Suitability in Annuity Transactions Model Regulation (#275) include a new "________" Standard.

2. The revisions to NAIC Suitability in Annuity Transactions Model Regulation (#275) requires agents and carriers to act with "________" in making recommendations.

3. "The ethical requirement that people who care for others will do so in good faith, placing their assessment of that person's best interests above their own" refers to the:

Chapter 2

In 2018, the U.S. Securities and Exchange Commission (SEC) released a proposed rule package updating the standard of care broker‑dealers and investment advisers would be required to provide to retail investors. The NAIC submitted comments to the SEC during the exposure period to further coordinate efforts so that the respective regulatory developments can provide consistency for consumers, industry, and regulators. The final rule takes effect in conjunction with the NAIC Model Regulation revisions.

The SEC, under the Securities Exchange Act of 1934 established a “best interest” standard of conduct for broker‑dealers and associated persons when they make a recommendation to a retail customer of any securities transaction or investment strategy involving securities, including recommendations of types of accounts. As of June 30, 2020, the SEC’s Regulation Best Interest—or Reg BI, aka “Best Interest Standard”—is officially in effect. That means a new standard of conduct when working with retail clients has been set forth.

As part of the rulemaking package, the SEC also adopted new rules and forms to require broker‑dealers and investment advisers to provide a brief summary, Form CRS, to retail investors. SEC Chairman, Jay Clayton, made the following statement regarding the new regulation.

“The rules and interpretations we are adopting today address issues that the Commission has been actively considering for nearly two decades. Our staff, working collaboratively across all of our Divisions and many of our Offices, has leveraged its decades of experience and expertise in considering these issues. I believe that the exceptional work of the SEC staff, including their careful evaluation of the feedback we received, will benefit retail investors and our markets for years to come. This rulemaking package will bring the legal requirements and mandated disclosures for broker‑dealers and investment advisers in line with reasonable investor expectations, while simultaneously preserving retail investors’ access to a range of products and services at a reasonable cost.”

Requirements Under Reg BI

Under Regulation Best Interest, broker-dealers will be required to act in the best interest of a retail customer when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer. Reg BI is intended to enhance the broker‑dealer standard of conduct beyond existing suitability obligations and to make it clear that a broker‑dealer may not put its financial interests ahead of the interests of a retail customer when making recommendations.

The requirements under the Regulation Best Interest standard and Form CRS became effective 60 days after they were published in the Federal Register, and included a transition period until June 30, 2020 to give firms sufficient time to come into compliance.

The Commission recognizes that these new rules will require various market participants to make changes to their operations, including to mandatory disclosures, marketing materials and compliance systems. In order to assist firms with planning for compliance with these new rules, the Commission established an inter‑divisional Standards of Conduct Implementation Committee (the “Committee”).

The Compliance Obligation requires broker-dealers to establish, maintain and enforce policies and procedures reasonably designed to achieve compliance with Reg BI as a whole. The following information refers to the SEC’s “Small Entity Compliance Guide.”[5]

The Committee is currently reviewing relationship summaries from a cross-section of firms to assess compliance with the content and format requirements of Form CRS. The relationship summaries reviewed to date generally reflect effort by firms to meet the content and format requirements of Form CRS, and the Committee’s initial reviews have identified good examples of simple, clear disclosures. At the same time, the Committee’s initial reviews have identified examples that may lack certain disclosures or could be clearer or otherwise improved. The Committee will engage with firms to share best practices and provide feedback on the filings. Particular firms may need to consider ways to improve their relationship summaries and determine whether any specific amendments, or broader change in their overall approach, would be appropriate. To provide an additional opportunity to share best practices and general feedback, the Committee plans to host a roundtable In the Fall of 2020 in which the Commission staff will be able to share additional thoughts following the Committee’s review of firms’ initial relationship summaries.[6]

Form CRS Relationship Summary

The Form CRS Relationship Summary requires registered investment advisers (RIAs) and broker‑dealers (BDs) to provide retail investors with simple, easy to understand information about the nature of their relationship with their financial professional. The relationship summary promotes transparency and better‑informed decision making, through clear, concise disclosures, and by summarizing in one place selected information about a particular firm.

While facilitating layered disclosure, the format of the relationship summary allows for comparability among the two different types of firms in a way that is distinct from other required disclosures. Form CRS also includes a link to a dedicated page on the Commission’s investor education website, Investor.gov, which offers educational information about broker‑dealers and investment advisers, and other materials.

Many parts of Form CRS are already summarized in Form ADV, including services, fees and costs, and conflicts of interest. Form CRS also requires that you include your legal standard of conduct. BDs and RIAs must deliver this new disclosure form to retail investors at the start of the relationship. You also have to provide the form whenever you make a new account recommendation (e.g., moving from advisory to brokerage or vice versa, opening a new account, etc.), at the time of a rollover recommendation for retirement accounts, or similar types of events.

The relationship summary must present information about the firm using standardized headings in a prescribed order with the following items:

·         Introduction;

·         Relationships and Services;

·         Fees, Costs, Conflicts, and Standard of Conduct;

·         Disciplinary History; and

·         Additional Information.

Firms must generally use their own wording to address the required items, as well as prescribed language in some instances. Firms are prohibited from including disclosures in the relationship summary other than the disclosure that is required or permitted by the instructions and applicable items.

Firms must follow certain formatting requirements. Here are a few examples; however, it is important to refer to the instructions for a complete list of requirements.

Plain English – Firms must write their relationship summaries in plain English, taking into consideration retail investors’ level of financial experience. “Plain English” does not mean deleting complex information to make the document easier to understand. Plain English means creating a document that is visually inviting, logically organized, and understandable on the first reading. A plain English document uses words economically and at a level the audience can understand. Its sentence structure is tight; its tone is welcoming and direct; and its design is visually appealing. A plain English document is easy to read and looks like it’s meant to be read.[7]

English/Foreign Language

The staff would not object to the delivery of a complete translation of the relationship summary in a foreign language so long as the firm also delivers a separate English relationship summary at the same time. The translated version: (i) should be a complete, fair, and accurate translation of the English relationship summary; (ii) should not make any of the terms used in the relationship summary misleading; and (iii) would not count toward the applicable page limit. Lastly, a firm should not translate the term “U.S. Securities and Exchange Commission.”

Concise and Direct

Page Limits – The relationship summary should be concise and direct. For example, for BDs and IAs, the relationship summary must not exceed two pages in paper format, or the equivalent limit if in electronic format. For dual registrants that include their brokerage services and investment advisory services in one relationship summary, it must not exceed four pages.

Formatting

Electronic and Graphical Formatting – You are encouraged but not required to use electronic and graphical formatting. For relationship summaries that are posed on your website or otherwise provided electronically, you must follow certain requirements, which are outlined in the instructions.[8]

Amendments to the Relationship Summary

Firms must update their relationship summary within 30 days whenever any information in the relationship summary becomes materially inaccurate. Certain subadviser changes may result in the relationship summary of the investment adviser becoming materially inaccurate. However, in circumstances where an adviser replaces a subadviser, and there are no changes to the advisory agreement, services, investments, or conflicts of interest that would make the information in the adviser’s relationship summary materially inaccurate, the state would not object if the firm does not amend its relationship summary.

Relationship Summary Format

No! Each broker-dealer or investment adviser must only prepare one relationship summary summarizing all of the principal relationships and services it offers to retail investors. For example, if an investment adviser offers a wrap fee program, advice to participants in a 401(k) plan, and discretionary asset management for high net worth clients, the investment adviser would be required to prepare a single relationship summary describing all of the firm’s different services. Similarly, if a broker‑dealer offers a range of brokerage services to retail investors, including, for example, self‑directed, full‑service, and employer‑sponsored retirement plan options, the broker‑dealer would be required to prepare a single relationship summary describing all of the firm’s different services. To the extent a dually registered firm prepares a single relationship summary addressing both brokerage and investment advisory services (rather than two separate relationship summaries), the firm must summarize all of the principal brokerage and investment advisory relationships and services the firm offers to retail investors.

Who is a “Retail Customer?”

A “Retail Customer” as defined by Reg BI refers to:

·         A “natural person, or the legal representative of such natural person, who:

o   receives a recommendation of any securities transaction or investment strategy involving securities from a broker‑dealer; and

o   uses the recommendation primarily for personal, family, or household purposes.”

A “legal representative” of such person includes the non‑professional legal representatives of such a natural person, for example, a non‑professional trustee that represents the assets of a natural person.

The Commission interpreted the term “legal representative” to only cover non‑professional (i.e., non‑regulated) legal representatives. Examples of non‑professional legal representatives are non‑professional trustees that represent the assets of natural persons and similar representatives such as executors, conservators, and persons holding a power of attorney for a natural person. A non‑professional legal representative is covered pursuant to this rule even if another person is a trustee or managing agent of the trust. A workplace retirement plan representative (e.g., plan sponsor, trustee, other fiduciary) generally is not considered a non‑professional legal representative of a natural person except in limited circumstances (e.g., where the plan representative is a sole proprietor or other self‑employed individual who will participate in the plan).

If a legal representative were a regulated financial services industry professional, he or she would not be covered by the definition of “retail investor.” Examples of regulated financial services industry professionals include registered investment advisers and broker‑dealers, corporate fiduciaries (e.g., banks, trust companies and similar financial institutions) and insurance companies, and the employees or other regulated representatives of such advisers, broker-dealers, corporate fiduciaries and insurance companies. A legal representative who was formerly a regulated financial services industry professional, but who is not currently regulated, would be considered a non‑professional legal representative that would be covered by the definition.

A retail customer “uses” a recommendation of a securities transaction or investment strategy involving securities when, as a result of the recommendation:

·         the retail customer opens a brokerage account with the broker-dealer, regardless of whether the broker‑dealer receives compensation;

·         the retail customer has an existing account with the broker-dealer and receives a recommendation from the broker-dealer, regardless of whether the broker-dealer receives or will receive compensation, directly or indirectly, as a result of that recommendation; or

·         the broker-dealer receives or will receive compensation, directly or indirectly as a result of that recommendation, even if that retail customer does not have an account at the broker‑dealer.

A retail customer who uses the recommendation primarily for “personal, family or household purposes” means any recommendation to a natural person for his or her account would be subject to Reg BI, other than recommendations to natural persons seeking these services for commercial or business purposes.[9]

Fiduciary Duty

The Commission also issued an interpretation to reaffirm and, in some cases, clarify the Commission’s views of the fiduciary duty that investment advisers owe to their clients under the Advisers Act. This duty is principles‑based and applies to the entire relationship between an investment adviser and its client. By highlighting principles relevant to the fiduciary duty, investment advisers and their clients will have greater clarity about advisers’ legal obligations.

“Solely Incidental” Exclusion

The Commission issued an interpretation of the “solely incidental” prong of the broker‑dealer exclusion under the Advisers Act, which is intended to more clearly delineate when a broker‑dealer’s performance of advisory activities causes it to become an investment adviser within the meaning of the Advisers Act. This interpretation confirms and clarifies the Commission’s position, and illustrates the application in practice in connection with exercising investment discretion over customer accounts and account monitoring.

The broker-dealer exclusion under the Advisers Act excludes from the definition of investment adviser—and thus from the application of the Advisers Act—a broker or dealer whose performance of advisory services is solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation for those services.

Specifically, the final interpretation states that a broker-dealer’s advice as to the value and characteristics of securities or as to the advisability of transacting in securities falls within the “solely incidental” prong of this exclusion if the advice is provided in connection with and is reasonably related to the broker‑dealer’s primary business of effecting securities transactions.

Disclosure Obligation

Broker-dealers must disclose material facts about the relationship and recommendations they make, including specific disclosures about the capacity in which the broker is acting (as a BD or a fiduciary), fees, the type and scope of services provided, conflicts, limitations on services and products, and whether the broker‑dealer provides monitoring services.

Prior to or at the time of the recommendation the retail customer must be provided, in writing, full and fair disclosure of:

·         all material facts relating to the scope and terms of the relationship with the retail customer; and

·         all material facts relating to conflicts of interest that are associated with the recommendation.

Oral Disclosures:  Although the disclosures necessary to satisfy the disclosure obligation must be in writing, in certain circumstances, you may satisfy your disclosure obligation by making supplemental oral disclosure not later than the time of the recommendation, provided that you maintain a record of the fact that oral disclosure was provided to the retail customer.

Disclosure After the Recommendation:  In addition, in the limited instances where existing regulations permit disclosure after the recommendation is made (e.g., trade confirmation, prospectus delivery), you may satisfy your disclosure obligation regarding the information contained in the applicable disclosure document by providing such document to your retail customer after the recommendation is made.

Initial Written Disclosure:  Before supplementing, clarifying or updating written disclosures in the limited circumstances described above, you must provide an initial disclosure in writing that identifies the material fact and describes the process through which such fact may be supplemented, clarified or updated.

·         Product-level fees:  With regard to product-level fees, you could provide an initial standardized disclosure of product-level fees generally (e.g., reasonable dollar or percentage ranges), noting that further specifics for particular products appear in the product prospectus, which will be delivered after a transaction in accordance with the delivery method the retail customer has selected, such as by mail or electronically.

·         Capacity:  Similarly, with regard to the disclosure of a broker-dealer’s capacity, a dual registrant could disclose that recommendations will be made in a broker-dealer capacity unless otherwise expressly stated at the time of the recommendation, and that any such statement will be made orally.

·         Associated person conflicts of interest:  A broker-dealer could disclose that its associated persons may have conflicts of interest beyond those disclosed by the broker-dealer, and that associated persons will disclose, where appropriate, any additional material conflicts of interest not later than the time of a recommendation, and that any such disclosure will be made orally.

Care Obligation

A broker-dealer must exercise reasonable diligence, care and skill when making a recommendation to a retail customer. The broker‑dealer must understand potential risks, rewards, and costs associated with the recommendation. The broker‑dealer must then consider these factors in light of the retail customer’s investment profile and make a recommendation that is in the retail customer’s best interest. The regulation explicitly requires the broker‑dealer to consider the costs of the recommendation.

Under the care obligation, you must exercise reasonable diligence, care, and skill when making a recommendation to a retail customer to:

·         understand potential risks, rewards, and costs associated with recommendation, and have a reasonable basis to believe that the recommendation could be in the best interest of at least some retail customers;

·         have a reasonable basis to believe the recommendation is in the best interest of a particular retail customer based on that retail customer’s investment profile and the potential risks, rewards, and costs associated with the recommendation and does not place the interest of the broker-dealer ahead of the interest of the retail customer; and

·         have a reasonable basis to believe that a series of recommended transactions, even if in the retail customer’s best interest when viewed in isolation, is not excessive and is in the retail customer’s best interest when taken together in light of the retail customer’s investment profile.

The first component of the care obligation requires the broker-dealer to exercise reasonable diligence, care, and skill to understand the potential risks, rewards, and costs associated with the recommendation. What would constitute reasonable diligence, care, and skill will vary depending on, among other things, the complexity of and risks associated with the recommended security or investment strategy and the broker-dealer’s familiarity with the recommended security or investment strategy. While every inquiry will be specific to the particular broker-dealer and the recommended security or investment strategy, you generally should consider important factors such as:

·         the security’s or investment strategy’s investment objectives, characteristics (including any special or unusual features), liquidity, volatility, and likely performance in a variety of market and economic conditions;

·         the expected rate of return of the security or investment strategy; and

·         any financial incentives to recommend the security or investment strategy.

Together, this inquiry should allow you to develop a sufficient understanding of the security or investment strategy and to be able to reasonable believe that it could be in the best interest of at least some retail customers.

The second component of the care obligation requires the broker-dealer to consider the risks, rewards, and costs in light of the retail customer’s investment profile and have a reasonable basis to believe that the recommendation is in that particular customer’s best interest and does not place the broker-dealer’s interest ahead of the customer’s interest.

The third component of the care obligation requires the broker-dealer, when recommending a series of transactions, to have a reasonable basis to believe that the transactions taken together are not excessive, even if each is in the customer’s best interest when viewed in isolation. The requirement applies irrespective of whether you exercise actual or de facto control over a customer’s account. What would constitute a “series” of recommended transactions would depend on the facts and circumstances, and would need to be evaluated with respect to a particular retail customer.

You should consider reasonably available alternatives, if any, offered by your broker‑dealer in determining whether you have a reasonable basis for making the recommendation. This exercise would require you to conduct a review of such reasonably available alternatives that is reasonable under the circumstances, which will depend on the facts and circumstances at the time of the recommendation.

With respect to account type recommendations, you should generally consider:

·         the services and products provided in the account;

·         the projected cost to the retail customer of the account;

·         alternative account types available;

·         the services requested by the retail customer; and

·         the retail customer’s investment profile.

When making recommendations to open an IRA, or to roll over assets into an IRA, you should consider a variety of factors including, but not limited to:

·         fees and expenses;

·         level of services available;

·         available investment options;

·         ability to take penalty-free withdrawals;

·         application of required minimum distributions;

·         protections from creditors and legal judgments;

·         holdings of employer stock; and

·         any special features of the existing account.

Conflict of Interest Obligation

The conflict of interest obligation applies solely to the broker-dealer entity, and not to the associated persons of a broker‑dealer. (For purposes of discussing the conflict of interest obligation, the term “broker‑dealer” or “you” refers only to the broker-dealer entity, and not to such individuals.)

The broker-dealer must establish, maintain, and enforce written policies and procedures reasonably designed to identify and, at a minimum, disclose or eliminate conflicts of interest. Specifically, the written policies and procedures must be reasonably designed to:

·         identify and at a minimum, disclose, pursuant to the disclosure obligation, or eliminate all conflicts of interest associated with such recommendations;

·         identify and mitigate any conflicts of interest associated with such recommendations that create an incentive for the broker-dealer’s associated persons to place their interest or the interest of the broker-dealer ahead of the retail customer’s interest;

·         identify and disclose any material limitations, such as a limited product menu or offering only proprietary products, placed on the securities or investment strategies involving securities that may be recommended to a retail customer and any conflicts of interest associated with such limitations, and prevent such limitations and associated conflicts of interest from causing the broker-dealer or the associated person to place the interest of the broker-dealer or the associated person ahead of the retail customer’s interest; and

·         identify and eliminate sales contests, sales quotas, bonuses, and non‑cash compensation that are based on the sale of specific securities or specific types of securities within a limited period of time.

Compliance Obligation

The compliance obligation, as with the conflict of interest obligation, applies solely to the broker‑dealer entity, and not to its associated persons.

You must establish, maintain and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest.

This is an affirmative obligation with respect to the rule as a whole, and provides flexibility to allow you to establish compliance policies and procedures that accommodate your business model.

Whether policies and procedures are reasonably designed will depend on the facts and circumstances of a given situation. You should consider, when adopting policies and procedures, the nature of your operations and how to design such policies and procedures to prevent violations from occurring, detect violations that have occurred, and to correct promptly any violations that have occurred.

Your compliance policies and procedures should be reasonably designed to address and be proportionate to the scope, size, and risks associated with your operations and the types of business in which you engage.

In addition to the required policies and procedures, depending on your size and complexity, a reasonably designed compliance program generally would also include:

·         controls;

·         remediation of noncompliance;

·         training; and

·         periodic review and testing.

Recordmaking and Recordkeeping

You must meet new recordmaking and recordkeeping requirements with respect to certain information collected from or provided to retail customers in connection with Regulation Best Interest. This builds upon existing recordmaking and recordkeeping obligations.

·         For each retail customer to whom a recommendation of any securities transaction or investment strategy involving securities is or will be provided, you must keep a record of all information collected from and provided to the retail customer pursuant to Regulation Best Interest, as well as the identity of each natural person who is an associated person, if any, responsible for the account.

·         You must retain all records of the information collected from or provided to each retail customer for at least six years after the earlier of the date the account was closed or the date on which the information was replaced or updated.

Yes! Rule 17a-3(a)(24) requires broker-dealers to make a record of the date that each Form CRS was provided to each retail investor, including any Form CRS provided before such retail investor opens an account. There is no exception from the recordmaking requirements of Rule 17a‑3a)(24) for delivering a relationship summary to prospective customers who do not ultimately open accounts or become customers.

Under Rule 17a-4(e)(10), firms must maintain all records made pursuant to Rule 17a‑3(a)(24), as well as a copy of each Form CRS, until at least six years after such record or Form CRS is created. Like Rule 17a‑3(a)(24), the recordkeeping requirements of Rule 17a‑4(e)(10) do not exclude retention of records for retail investors who do not ultimately open accounts.

Investment advisers have separate recordmaking and recordkeeping obligations with respect to prospective clients. Pursuant to Rule 204‑2(a)(14)(i) under the Advisers Act, advisers are required to make and keep a record of the dates that each Form CRS, and each amendment or revision thereto, was given to any client or any prospective client who subsequently becomes a client.

Account Recommendations Covered

Reg BI expressly applies to account recommendations including recommendations of securities account types generally (e.g., to open an IRA or other brokerage account, or an advisory account), as well as recommendations to roll over or transfer assets from one type of account to another (e.g., from a workplace retirement plan account to an IRA).

The type of securities account recommended is an investment strategy that has the potential to greatly affect retail customers’ costs and investment returns. For example, different types of securities accounts can offer different features, products, or services, some of which may—or may not—be in the best interest of certain retail customers. Account recommendations will almost always involve a “securities transaction” (such as a securities purchase, sale, or exchange), and thus would generally be subject to Regulation Best Interest in any case.

The determination of whether a broker-dealer has made a recommendation that triggers application of Reg BI turns on the facts and circumstances of a particular situation and, therefore, whether a recommendation has been made is not susceptible to a bright line definition. Factors considered in determining whether a recommendation has taken place include whether the communication “reasonably could be viewed as a ‘call to action’ and ‘reasonably would influence an investor to trade a particular security or group of securities.’” The more individually tailored the communication to a specific customer or target group of customers about a security or group of securities, the greater the likelihood that the communication may be viewed as a “recommendation.”

Any securities transaction or investment strategy involving securities includes:

·         explicit hold recommendations; and

·         implicit hold recommendations that are the result of agreed-upon account monitoring between the broker‑dealer and retail customer.

Dually Registered Financial Professionals

If you are a financial professional who is dually registered (i.e., an associated person of a broker‑dealer and a supervised person of an investment adviser, regardless of whether you work for a dual registrant, affiliated firm, or unaffiliated firm) making an account recommendation to a retail customer, whether Regulation Best Interest or the Advisers Act applies will depend on the capacity in which you are acting when making the recommendation. If you are acting as a broker‑dealer or associated person, you must comply with Reg BI and will need to take into consideration all types of accounts that you offer (i.e., both brokerage and advisory accounts) when making the recommendation of an account that is in the retail customer’s best interest.

Registered Broker-Dealers or Associated Persons

If you are only registered as an associated person of a broker-dealer (regardless of whether that broker‑dealer entity is a dual registrant or affiliated with an investment adviser), Reg BI will apply to that account recommendation, but you need to take into consideration only the brokerage accounts available. You can only recommend a brokerage account that the broker‑dealer offers if you have a reasonable basis to believe that the recommended brokerage account is in the best interest of the retail customer, and the broker‑dealer otherwise complies with Regulation Best Interest.

Reg BI/Form CRS Comparison Checklists

On April 7, 2020, the SEC’s Office of Compliance Inspections and Examinations (OCIE) released Risk Alerts for Reg Bi and Form CRS. These Risk Alerts set forth OCIE’s expectations for firms’ compliance with Reg BI and Form CRS and provide broker‑dealers with information about the scope and content of OCIE’s initial examinations following the compliance date of June 30, 2020. Their initial approach will focus primarily on assessing whether firms have made a good faith effort to establish and implement policies and procedures reasonably designed to comply with Reg BI and Form CRS; and FINRA will take action in the event of customer harm or conduct has been observed that would violate current standards (e.g., suitability).

FINRA has provided checklists to help members assess their obligations under Reg BI and Form CRS. These checklists explain key differences between FINRA rules and Reg BI and Form CRS. The checklist is not a substitute for any rule. Only the rule can provide definitive information regarding its requirements. [10]

Reg BI Firm Checklist

We will begin here with Reg BI; after which we will present the firm checklist for Form CRS.

Securities recommendations must be in the retail customer’s best interest. The firm and the associated person (AP) may not place their interests ahead of the retail customer’s. This is a change from FINRA’s suitability standard, which does not have an explicit best interest requirement. The best interest standard is an overarching obligation, which is satisfied only if you comply with four component obligations: Care, Disclosure, Conflict of Interest and Compliance.

Unlike FINRA’s suitability rule, the best interest standard explicitly applies to recommendations of types of accounts. A broker‑dealer (BD) or association person (AP) must have a reasonable basis to believe that a recommendation of a securities account type (e.g., brokerage or advisory, or among the types of accounts offered by the firm, including IRAs) is in the retail customer’s best interest at the time of the recommendation and does not place the financial or other interest of the BD or AP ahead of the interest of the retail customer.

In general, when considering recommendations of types of accounts, you should consider: (a) services and products provided in the account; (b) projected cost of the account; (c) alternative account types available; (d) services the retail customer requests; and (e) the retail customer’s investment profile.

With regard to IRAs, in addition to the factors above, you should consider: (a) fees and expenses; (b) level of services available; (c) ability to take penalty-free withdrawals; (d) application of required minimum distributions; (e) protections from creditors and legal judgments; (f) holdings of employer stock; and (g) any special features of the existing account.

Reg BI imposes no duty to monitor a customer’s account following a recommendation. However, if you agree to perform account monitoring services, you are taking on an obligation to review and make recommendations regarding the account (e.g., to buy, sell or hold) on the specified, periodic basis that you have agreed to with the retail customer. In such circumstances, Reg BI would apply even where you remain silent (i.e., an implicit hold recommendation).

For example, if you agree to monitor a retail customer’s account on a quarterly basis, the quarterly review and resulting recommendation will be subject to Reg BI, including an implicit recommendation to hold if you are silent as to the securities in the account. In addition, if you agree to monitor the customer’s account, you are required to disclose the terms of such account monitoring services (including the scope and frequency of such services) pursuant to the Disclosure Obligation. IA registration requirements also might apply if a BD agrees to conduct ongoing monitoring in a manner not reasonably related to providing buy, sell or hold recommendations.

Importantly, you may voluntarily, and without any agreement with your customer, review the holdings in your retail customer’s account for the purposes of determining whether to provide a recommendation to the customer. This voluntary review is not considered to be “account monitoring,” and would not create an implied agreement with the customer to monitor the account.

Reg BI incorporates FINRA’s reasonable-basis (i.e., knowing the product and having a reasonable basis to believe it is appropriate for at least some investors) and customer‑specific (i.e., knowing the customer and having a reasonable basis to believe a particular recommendation is appropriate for a specific customer based on that customer’s investment profile) suitability obligations with important enhancements.

Care, skill and costs (in addition to applying a best interest standard) are new express elements for consideration when making recommendations to retail customers.

Cost must always be considered when making a recommendation. Moreover, consideration of cost includes not only the cost of purchase, but also any costs that may apply to the future sale or exchange of the security, such as deferred sales charges or liquidation costs. However, while cost must always be considered, it is not dispositive, and its inclusion in the rule text is not intended to limit or foreclose a recommendation of a more costly product if there is a reasonable basis to believe that product is in the best interest of a particular retail customer.

Reg BI incorporates FINRA’s quantitative suitability obligation (that a series of recommended transactions are appropriate and not excessive). However, in a change from FINRA’s quantitative suitability obligation, Reg BI applies the best interest standard to a series of recommended transactions, irrespective of whether the BD exercises actual or de facto control over a customer’s account.

[Note:  Under FINRA’s quantitative suitability obligation, control can be “actual” or “de facto.” In general, actual control exists when a broker has formal discretionary authority over a customer’s account. A showing of de facto control over a customer’s account depends on whether the customer routinely follows the broker’s advice, perhaps because the customer is unable to evaluate the broker’s recommendations and/or exercise independent judgment.]

You should consider reasonably available alternatives, if any, offered by your BD in determining whether you have a reasonable basis for making the recommendation. An evaluation of reasonably available alternatives does not require an evaluation of every possible alternative (including those offered outside the firm) nor require BDs to recommend one ‘‘best’’ product.

A BD should have a reasonable process for establishing and understanding the scope of such “reasonably available alternatives” that would be considered by particular APs or groups of APs (e.g., groups that specialize in particular product lines) in fulfilling the reasonable diligence, care and skill requirements under the Care Obligation.

Although not a rule requirement, BDs should consider, as a best practice, applying heightened scrutiny as to whether high-risk or complex investments, such as inverse and leveraged ETFs, are in a retail customer’s best interest.

The capacity in which you are acting (BD or IA). A standalone BD generally may satisfy this requirement by delivering the Form CRS to the retail customer.

For BDs who are dually registered, and APs who are either dually registered or who are not dually registered but only offer BD services through a firm that is dually registered, providing Form CRS will not be sufficient to disclose their capacity, and they must disclose if they are acting as a BD when making a recommendation.

In addition, an AP of a dual registrant who does not offer investment advisory services must disclose that fact as a material limitation. Similarly, an AP registered in a limited capacity (e.g., a Series 6) must disclose that limitation (i.e., he/she cannot recommend all available products).

Material fees and costs that apply to the retail customer’s transactions, holdings, and accounts. This should build upon the fees and costs disclosure in Form CRS, with more particularity, such as whether fees are deducted from the customer’s account per transaction or quarterly. This obligation would not require individualized disclosure for each retail customer. Rather, the use of standardized numerical or other non‑individualized disclosure (e.g., reasonable dollar or percentage ranges) is permissible.

The type and scope of services – whether or not the BD will monitor the retail customer’s account and, if so, the scope and frequency of those services. Although Form CRS may disclose that the firm provides account monitoring services, Reg BI requires disclosure about whether or not account monitoring would occur for the particular retail customer and the scope and frequency of those services.

Any requirements for retail customers to open or maintain an account or establish a relationship (e.g., minimum account size). This would include any requirements for retail customers to open or maintain an account, or to avoid additional fees when a threshold is crossed, such as a low account balance.

Any material limitations on the securities or investment strategies involving securities that may be recommended to the customer. Material limitations include recommending only proprietary products or a specific asset class; products with third‑party arrangements (revenue sharing, mutual fund service fees); products from a select group of issuers; the fact that IPOs are available only to certain clients; and that an AP of a dually registered firm does not offer investment advisory services or is registered in a limited capacity (e.g., Series 6).

The general basis for the recommendation (i.e., what might commonly be described as the firm’s investment approach, philosophy, or strategy). This may be standardized or a summary; however, the disclosure should also address circumstances when a standardized basis does not apply, and how the BD will notify the customer when that is the case.

As a best practice, firms should encourage Aps to discuss the basis for any particular recommendation with their retail customers and the associated risks, particularly when the recommendation is significant to the customer (e.g., the decision to roll over a 401(k) into an IRA).

Risks associated with the recommendation. Standardized disclosure is permitted.

Material facts regarding conflicts of interest include, for example: conflicts associated with proprietary products, payments from third parties and compensation arrangements. BDs must disclose all material facts relating to conflicts of interest associated with the recommendation. This does not require that information regarding conflicts be disclosed on a recommendation‑by‑recommendation basis. Standardized written disclosure of this information may be made, provided that it sufficiently identifies the material facts relating to conflicts of interest associated with a particular recommendation.

Use of the terms “advisor” or “adviser” in a name or title by:  (a) a BD that is not also an RIA; or (b) a financial professional that is not a supervised person of an RIA, would presumptively violate Reg BI. Exceptions would include a BD/AP that acts on behalf of a municipal advisor or commodity trading advisor, or an advisor to a special entity. In addition, an RR of a dually registered BD may use firm materials when the BD/IA firm has the term “advisor” or “adviser” in its title.

Oral disclosure of a material fact may be required to supplement, clarify or update written disclosure made previously. BDs must maintain a record that oral disclosure was provided to the retail customer (but not the substance of the disclosure).

Although not required by Reg BI, the SEC encourages, as a best practice, following oral disclosures with timely, written disclosure summarizing the information conveyed orally.

Firms must have written policies and procedures reasonably designed to identify and, at a minimum, disclose or eliminate all conflicts of interest associated with recommendations covered by Reg BI.

A conflict of interest is an interest that might incline a BD or AP—consciously or unconsciously—to make a recommendation that is not disinterested.

Conflicts that create an incentive for the AP to place the BD’s or AP’s interest ahead of the retail customer’s interest must be mitigated. Mitigation measures will depend on the nature and significance of the incentives and a variety of factors related to a BD’s business model, such as its size and retail customer base, and the complexity of the security or investment strategy that is being recommended.

Material limitations include, for example, recommending only proprietary products or a specific asset class; products with third‑party arrangements; products from a select group of issuers; or making IPOs available only to certain clients.

Policies and procedures to prevent harm from material limitations could consist of establishing product review processes for products that may be recommended, including establishing procedures for identifying and mitigating the conflicts of interests associated with the product, or declining to recommend a product where you cannot effectively mitigate the conflict, and identifying which retail customers would qualify for recommendations from the product menu.

As part of this process, firms may consider:  evaluating the use of “preferred lists;” restricting the retail customers to whom a product may be sold; prescribing minimum knowledge requirements for APs who may recommend certain products; and conducting periodic product reviews to identify potential conflicts of interest, whether the measures addressing conflicts are working as intended, and to modify the mitigation measures or product selection accordingly.

Reg BI bans these practices. This requirement does not apply to compensation practices based on, for example, total products sold, or asset growth or accumulation, and customer satisfaction.

This requirement would not prevent a BD from offering only proprietary products, placing material limitations on the menu of products, or incentivizing the sale of such products through its compensation practices, so long as the incentive is not based on the sale of specific securities or types of securities within a limited period of time.

The requirement also is not intended to prohibit:  training or education meetings, provided that these meetings are not based on the sale of specific securities or types of securities within a limited period of time; or receipt of certain employee benefits by statutory employees, as these benefits would not be considered to be non‑cash compensation for purposes of Reg BI.

Reg BI’s Compliance Obligation requires that BDs establish, maintain and enforce written policies and procedures reasonably designed to achieve compliance with Reg BI. In addition to the required policies and procedures, depending on the BD’s size and complexity, a reasonably designed compliance program generally would also include controls, remediation of noncompliance, training, and periodic review and testing. Firms may be able to satisfy the Compliance Obligation by adjusting their current systems of supervision and compliance, rather than creating new ones.

Rules 17a-3(a)(35) and 17a-4(e)(5) codify the recordkeeping requirements associated with Reg BI. Current recordkeeping practices will not fully satisfy Reg BI. For example, BDs must provide retail customers with additional disclosures that require records. Firms may use a risk‑based approach to documenting compliance with Reg BI.

Rule 17a-3(a)(35):  “For each retail customer to whom a recommendation of any securities transaction or investment strategy involving securities is or will be provided a record of all information collected from and provided to the retail customer as well as the identity of each natural person who is an associated person, if any, responsible for the account.”

Rule 17a-4(3)(5):  “All account record information required pursuant to §240.17a‑3(17) and all records required pursuant to §240.17a‑3(a)(35), in each cash until at least six years after the earlier of the date the account was closed or the date on which the information was collected, provided, replaced, or updated.”

Rule 17a-3(17):  “For each account with a natural person as a customer or owner (i)(A) an account record including the customer’s or owner’s name, tax identification number, address, telephone number, date of birth, employment status (including occupation and whether the customer is an associated person of a member, broker or dealer), annual income, net worth (excluding value of primary residence), and the account's investment objectives. In the case of a joint account, the account record must include personal information for each joint owner who is a natural person; however, financial information for the individual joint owners may be combined. The account record must indicate whether it has been signed by the associated person responsible for the account, if any, and approved or accepted by a principal of the member, broker or dealer. For accounts in existence on the effective date of this section, the member, broker or dealer must obtain this information within three years of the effective date of the section.”

The SEC noted that training generally is an important vehicle to communicate firm culture, specific requirements of a firm’s code of conduct and its conflicts management framework.

Retail Customer – Reg BI only applies to recommendations to “retail customers.” Reg BI defines a “retail customer” as a natural person, or the legal representative of such person, who (a) receives a recommendation for any securities transaction or investment strategy from a BD or AP; and (b) uses the recommendation primarily for personal, family or household purposes.

Legal Representative – “Legal representative” includes the non-professional legal representatives of such a natural person; e.g., a non‑professional trustee that represents the assets of a natural person. Reg BI would not apply when the legal representative is acting in a professional capacity as a regulated financial services industry professional retained to exercise independent professional judgment. Therefor, recommendations to registered IAs and BDs or corporate fiduciaries would not trigger Reg BI. On the other hand, recommendations to non-professional trustees, executors, conservators and persons holding power of attorney that represent natural persons are covered.

Recommendation – The final rule release for Reg BI states that this is keyed off of the guidance for FINRA’s suitability rule.

Investment Strategy – The final rule release for Reg BI states that this is keyed off of the guidance for the FINRA’s suitability rule; however, this will include recommendations of types of accounts.

Receives and Uses – The SEC has stated that “use” means when, as a result of the recommendation:

·         the retail customer opens a brokerage account with the BD, regardless of whether the BD receives compensation;

·         the retail customer has an existing account with the BD and receives a recommendation from the BD, regardless of whether the BD receives or will receive compensation, directly or indirectly, as a result of the recommendation; or

·         the BD receives or will receive compensation, directly or indirectly, as a result of that recommendation, even if that retail customer does not have an account at the firm.

Personal, Family, or Household Purposes – The phrase “primarily for personal, family, or household purposes” covers any recommendation to a natural person for his or her account, other than recommendations to a natural person seeking these services for commercial or business purposes. Reg BI would not cover, for example, an employee seeking services for an employer or an individual seeking services for a small business or on behalf of another non‑natural person entity, such as a charitable trust.

Conflict of Interest – A conflict of interest is an interest that might incline a BD or AP—consciously or unconsciously—to make a recommendation that is not disinterested.

Full and Fair – Sufficient information to enable a retail customer to make an informed decision with regard to a recommendation.

Form CRS Firm Checklist

Now we will study the checklist for firms’ adherence to Form CRS regulations.

This applies to both IAs and BDs. Firms must write their relationship summaries in plain language, taking into consideration retail investors’ level of financial experience. Firms are encouraged, but no required, to use electronic and graphical formatting.

An introduction to the firm – This must include:  (a) the name of the BD or IA, and whether the firm is registered with the SEC as a BD, IA or both; (b) an indication that BD and IA services and fees differ and that it is important for the retail investor to understand the differences; and (c) a statement that free and simple tools are available to research firms and financial professionals on the SEC’s investment education website (Investor.gov/sec), which provides educational materials about BDs, IAs and investors.

A description of services and advice that can be provided – The relationship summary must describe all relationships and services offered to retail investors, even if the investor at issue does not qualify for or is not being offered a particular service currently.

A description of fees and costs, applicable standard of conduct, and examples of how the firm makes money and conflicts of interest – Firms must summarize the principal fees and costs that retail investors incur with respect to their BD and IA accounts, and the conflicts they create.

Relevant disciplinary history – The relationship summary must include a separate section about whether a firm and its financial professionals have reportable disciplinary history and where investors can conduct further research on these events.

How additional information may be obtained – Firms must state where retail investors can find additional information about their BD and IA services.

Prescribed “conversation starters” for investors to ask – If a required disclosure or conversation starter is inapplicable to your business, or specific wording required by the Form’s instructions is inaccurate, you may omit or modify that disclosure or conversation starter.

Firms must file the relationship summary through Web CRD^© (dual registrants will be required to file their relationship summaries using both IARD™ and Web CRD^©).

Firms must update Form CRS and file it within 30 days whenever any information becomes materially inaccurate.

Firms must communicate any changes in the updated relationship summary to retail investors who are existing clients or customers within 60 days after the updates are required to be made and without charge. Firms can make the communication by delivering the amended relationship summary or by communicating the information through another disclosure that is delivered to the retail investor.

Form CRS General Instruction 8 sets forth requirements for updating the relationship summary, including filing and delivering an exhibit that highlights changes to an updated relationship summary.

(a) A recommendation of an account type, a securities transaction or an investment strategy involving securities; (b) placing an order for the retail customer; or (c) the opening of a brokerage account for the retail customer?

If included in a packet of information, the relationship summary must be placed first. If the relationship summary is delivered electronically, it must be presented prominently in the electronic medium, for example, as a direct link or in the body of an email or message, and must be easily accessible for retail investors.

Firms must deliver the relationship summary to existing retail investor customers before or at the time firms open a new account that is different from the retail investor’s existing account. In addition, firms must deliver the relationship summary when they recommend that the retail investor roll over assets from a retirement account, or when they recommend or provide a new service or investment outside of a formal account (e.g., variable annuities or a first‑time purchase of a direct‑sold mutual fund through a ‘‘check and application’’ process). With respect to existing customers, firms should deliver the relationship summary in a manner consistent with the firm’s existing arrangement with that customer and with the SEC’s electronic delivery guidance.

Firms must initially deliver the relationship summary to each existing retail investor customer within 30 days after the date by which they are first required to electronically file the relationship summary with the SEC.

Firms must post the current version of the relationship summary prominently on your public website, if you have one. The instructions set forth requirements, including design requirements, for a relationship summary that is posted on your website.

BDs must make and keep current a record of the date that each relationship summary was provided to each retail investor, including any relationship summary that was provided before such retail investor opens an account.

BDs must maintain and preserve, in an easily accessible place, the following records until at least six years after such record or relationship summary is created:  (a) all records of the dates that each relationship summary was provided to each retail investor, including any relationship summary that was provided before such retail investor opens an account, as well as (b) a copy of each relationship summary.

Note:  The SEC’s Federal Register notices for Reg BI, Form CRS, Interpretation of Solely Incidental and Interpretation of Investment Advisers’ Obligations are available at https://www.sec.gov/rules/final.shtml. The SEC’s Regulation Best Interest, A Small Entity Compliance Guide is available at https://www.sec.gov/info/ smallbus/secg/regulation-best-interest, and Form CRS Relationship Summary; Amendments to Form ADV, A Small Entity Compliance Guide is available at https://www.sec.gov/info/smallbus/secg/form-crs-relationship-summary.

OCIE Examinations of Reg BI After the Compliance Date

After the compliance date, OCIE will begin examinations to assess implementation of Regulation Best Interest. These initial examinations, which will likely occur during the first year after the compliance date, are designed primarily to evaluate whether firms have established policies and procedures reasonably designed to achieve compliance with Reg BI. OCIE will also evaluate whether firms have made reasonable progress in implementing those policies and procedures as necessary or appropriate, including making such modifications as may be necessary or appropriate, in light of information gained from the implementation process and other facts and circumstances.

These Risk Alerts are intended to highlight for firms risks and issues that OCIE staff has identified. In addition, Risk Alerts describe risks that firms may consider to (i) assess their supervisory, compliance, and/or other risk management systems related to these risks, and (ii) make any changes, as may be appropriate, to address or strengthen such systems. Other risks beside those described in these Risk Alerts may be appropriate to consider, and some issues discussed may not be relevant to a particular firm’s business. The adequacy of supervisory, compliance and other risk management systems can be determined only with reference to the profile of each specific firm and other facts and circumstances. [11]

Disclosure Obligation Assessment

To assess compliance with this obligation, the content of disclosures and other firm records will be reviewed to determine if the disclosures provide the required information to retail customers. OCIE staff may also review the timing of the disclosures and other documents such as:

·         Schedules of fees ad charges assessed against retail customers and disclosures regarding such fees and charges, including disclosures regarding the fees and costs related to services and investments that retail customers will pay or incur directly and indirectly (e.g., custodian fees, account maintenance fees, fees related to mutual funds and variable annuities, and other transactional fees and product-level fees);

·         The broker-dealer’s compensation methods for registered personnel, including (i) compensation associated with recommendations to retail customers, (ii) sources and types of compensation (e.g., direct payments by an investor, payments by a product sponsor), and (iii) related conflicts of interest (e.g., conflicts associated with recommending proprietary products or with receiving payments for inclusion on a product menu);

·         Disclosures related to monitoring of retail customers’ accounts;

·         Disclosures on material limitations on accounts or services recommended to retail customers; and

·         Lists of proprietary products sold to retail customers.

Care Obligation Assessment

To assess compliance with this obligation, OCIE staff may review:

·         Information collected from retail customers to develop their investment profiles (including any new account forms, correspondence, and any agreements that customer has with the broker-dealer);

·         The broker-dealer’s process for having a reasonable basis to believe that the recommendations are in the best interest of the retail customer (which may include, e.g., any process for establishing, understanding, and implementing the scope of reasonable available alternatives when making a recommendation:

o   The factors the broker-dealer considers to assess the potential risks, rewards, and costs of the recommendations in light of the retail customer’s investment profile,

o   The broker-dealer’s process for having a reasonable basis to believe that it does not place the financial or other interest of the broker‑dealer ahead of the interest of the retail customer;

·         How the broker-dealer makes recommendations related to significant investment decisions, such as rollovers and account recommendations, and how the broker-dealer has a reasonable basis to believe that such investment strategies are in a retail customer’s best interest; and

·         How the broker-dealer makes recommendations related to more complex, risky or expensive products and how the broker‑dealer has a reasonable basis to believe that such investments are in a retail customer’s best interest.

Conflict of Interest Obligation Assessment

To assess compliance with this obligation, OCIE staff may review the broker-dealer’s policies and procedures to assess whether and how the policies and procedures address the following:

·         Conflicts that create an incentive for an associated person to place its interest or the interest of a broker‑dealer ahead of the interest of the retail customer;

·         Conflicts associated with material limitations (e.g., a limited product menu, offering only proprietary products, or products with third‑party arrangements) on the securities or investment strategies involving securities that may be recommended to a retail customer; and

·         The elimination of the following conflicts:  sales contests, sales quotas, bonuses, and non‑cash compensation based on the sale of specific securities or specific types of securities within a limited period of time.

Compliance Obligation Assessment

To assess compliance with this obligation, OCIE staff may review the broker-dealer’s policies and procedures and evaluate any controls, remediation of noncompliance, training, and periodic review and testing included as part of those policies and procedures.

OCIE Examinations of Form CRS After the Compliance Date

Initial examinations of firms with retail investors conducted after June 30, 2020 may include an assessment relating to Form CRS. Examples of the areas the staff may focus on during examinations are discussed below.[12]

Delivery and Filing

OCIE staff may (1) review whether the firm has filed its relationship summary, including any amendments, with the Commission and whether the relationship summary is posted on the firm’s public website, if any; (2) evaluate the process for delivering the relationship summary to existing and new retail investors; and (3) review policies and procedures to assess whether they address the required relationship summary delivery processes and dates. In particular, the staff may review records of the dates that each relationship summary was provided to retail investors to validate whether the firm has complied with the following delivery obligations:

·         Existing Retail Investors. The initial delivery of the relationship summary to existing retail investors by July 30, 2020, and before or at the time of:

o   The opening of a new account that is different from the retail investor’s existing account;

o   A recommendation of a rollover of assets from a retirement account into a new or existing account or investment; or

o   A recommendation of a new brokerage or investment advisory service or investment that does not necessarily involve the opening of a new account and would not be held in an existing account (e.g., a first time purchase of a direct‑sold mutual fund through a “check and application” process).

·         New Retail Investors. The delivery of the relationship summary to new retail investors before or at the earliest of:

o   Entering into an investment advisory contract with the retail investor;

o   A recommendation to a retail investor of an account type, a securities transaction, or an investment strategy involving securities;

o   Placing an order for the retail investor; or

o   The opening of a brokerage account for the retail investor.

Content

OCIE staff may review a firm’s relationship summary to assess whether it (1) includes all required information; and (2) contains true and accurate information and does not omit any material facts necessary in order to make the required disclosures, in light of the circumstances under which they were made, not misleading. For example, the staff may review relationship summaries for information about:

·         How the firm describes the relationships and services it offers to retail investors, including statements regarding account monitoring and investment authority; and

·         How the firm describes its fees and costs, including disclosures about the principal fees and costs that retail investors will incur, other fees and costs related to services and investments that retail investors will pay directly or indirectly, and examples of the categories of the most common fees and costs applicable to the firm’s retail investors (e.g., custodian fees, account maintenance fees, fees related to mutual funds and variable annuities, and other transactional fees and product‑level fees).

Formatting

Staff may review a firm’s relationship summary to assess whether it is formatted in accordance with the instructions (e.g., it includes particular wording where required, it uses text features where required, and it is written in plain English).

Updates

Staff may review a firm’s policies and procedures for updating the relationship summary to:  (1) assess how and whether a firm updates and files its relationship summary within 30 days after any information becomes materially inaccurate; (2) assess how and whether a firm communicates these changes to retail investors within 60 days after the updates are required to be made; and (3) assess the firm’s process for highlighting to retail investors the most recent changes and including an exhibit highlighting or summarizing material changes with any filed updates.

Recordkeeping

Staff may review the firm’s records related to delivery of the relationship summary, and the policies and procedures regarding recordmaking and recordkeeping, to assess how the firm complies with applicable delivery and recordkeeping obligations.

FINRA Rule 2111 Adapts to BI Standard

FINRA has amended its suitability rule, Capital Acquisition Broker (CAB) suitability rule and rules governing non‑cash compensation to provide clarity on which standard applies and to address potential inconsistencies with the SEC’s Regulation Best Interest (Reg BI). These changes have been approved by the SEC and become effective on June 30, 2020, the compliance date of Reg BI.

FINRA has not eliminated its suitability rule because there will be recommendations that will not be subject to Reg BI but that would still warrant suitability protections. FINRA amended the rule to state that it will not apply to recommendations subject to Reg BI.

Both Reg BI and FINRA’s suitability rules apply to standards of conduct but contain key definitional differences. To avoid ambiguity and conflict, FINRA limited its suitability rule to situations in which Reg BI does not apply. As set forth in Reg BI, compliance is met when a broker satisfies four obligations:  (1) a Disclosure Obligation, (2) a Care Obligation, (3) a Conflict Obligation and (4) a Compliance Obligation. However, as set forth in Reg BI’s explanation, to satisfy the Care Obligation, the broker‑dealer will have to satisfy, at a minimum, all of the elements of FINRA Rule 2111, plus some additional elements.

Before these changes, FINRA Rule 2111 applied broadly to all recommendations to customers (albeit with an exemption to customer‑specific suitability for recommendations to institutional customers under specified circumstances). Reg BI applies only to recommendations to “retail customers,” which Reg BI defines as a natural person, or the legal representative of such natural person, who receives a recommendation of any securities transaction or investment strategy involving securities from a broker‑dealer and uses the recommendation primarily for personal, family, or household purposes. Thus, FINRA’s suitability rule is still needed for entities and institutions (e.g., pension funds), and natural persons who will not use recommendations primarily for personal, family, or household purposes (e.g., small business owners and charitable trusts). In addition, other FINRA rules that have a suitability or suitability‑like component (e.g., FINRA Rule 2330, “Member’s Responsibilities Regarding Deferred Variable Annuities,” and FINRA Rule 2360, “Options”) are not impacted by these rule changes and remain in place.

Suitability Rule

FINRA Rule 2111 (aka “Suitability Rule”) requires, in part, that a broker-dealer or associated person “have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the firm or associated person to ascertain the customer’s investment profile.” The rule identifies the three main suitability obligations as “reasonable‑basis,” “customer‑specific” and “quantitative” suitability.

·         Reasonable-basis suitability — Requires a broker to have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors.  Reasonable diligence must provide the firm or associated person with an understanding of the potential risks and rewards of the recommended security or strategy.

·         Customer-specific suitability — Requires that a broker, based on a particular customer’s investment profile, has a reasonable basis to believe that the recommendation is suitable for that customer. The broker must attempt to obtain and analyze a broad array of customer‑specific factors to support this determination.

·         Quantitative suitability — Requires a broker with actual or de facto control over a customer’s account to have a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, is not excessive and unsuitable for the customer when taken together in light of the customer’s investment profile. No single test defines excessive activity, but factors such as the turnover rate, the cost‑equity ratio, and the use of in‑and‑out trading in a customer's account may provide a basis for a finding that a member or associated person has violated the quantitative suitability obligation.

Reg BI’s Care Obligation addresses the same conduct with respect to retail customers that is addressed by Rule 2111, but employs a best interest, rather than a suitability, standard in addition to other key enhancements. Absent action by FINRA, a broker‑dealer would be required to comply with both Reg BI and Rule 2111 regarding recommendations to retail customers. In such circumstances, compliance with Reg BI would result in compliance with Rule 2111 because a broker‑dealer that meets the best interest standard would necessarily meet the suitability standard.

To provide clarity on which standard applies and to avoid unnecessary duplication, FINRA has amended Rule 2111 to state that it will not apply to recommendations subject to Reg BI. FINRA has also removed the element of control from the quantitative suitability obligation, a change that is consistent with Reg BI. Finally, FINRA has conformed the CAB suitability rule, CAB Rule 211, to the amendments to Rule 2111.

Context of FINRA Rule 2111

(a) A member or an associated person must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer's investment profile. A customer's investment profile includes, but is not limited to, the customer's age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation.

(b) A member or associated person fulfills the customer-specific suitability obligation for an institutional account, as defined in Rule 4512(c), if (1) the member or associated person has a reasonable basis to believe that the institutional customer is capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies involving a security or securities and (2) the institutional customer affirmatively indicates that it is exercising independent judgment in evaluating the member's or associated person's recommendations. Where an institutional customer has delegated decision‑making authority to an agent, such as an investment adviser or a bank trust department, these factors shall be applied to the agent.

.01 General Principles.  Implicit in all member and associated person relationships with customers and others is the fundamental responsibility for fair dealing. Sales efforts must therefore be undertaken only on a basis that can be judged as being within the ethical standards of FINRA rules, with particular emphasis on the requirement to deal fairly with the public. The suitability rule is fundamental to fair dealing and is intended to promote ethical sales practices and high standards of professional conduct.

.02 Disclaimers.  A member or associated person cannot disclaim any responsibilities under the suitability rule.

.03 Recommended Strategies.  The phrase “investment strategy involving a security or securities” used in this Rule is to be interpreted broadly and would include, among other tings, an explicit recommendation to hold a security or securities. However, the following communications are excluded from the Coverage of Rule 2111 as long as they do not include (standing alone or in combination with other communications) a recommendation of a particular security or securities:

(a) General financial and investment information, including (i) basic investment concepts, such as risk and return, diversification, dollar cost averaging, compounded return, and tax deferred investment, (ii) historic differences in the return of asset classes (e.g., equities, bonds, or cash) based on standard market indices, (ii) historic differences in the return of asset classes (e.g., equities, bonds, or cash) based on standard market indices, (iii) effects of inflation, (iv) estimates of future retirement income needs, and (v) assessment of a customer’s investment profile;

(b) Descriptive information about an employer-sponsored retirement or benefit plan, participation in the plan, the benefits of plan participation, and the investment options available under the plan;

(c) Asset allocation models that are (i) based on generally accepted investment theory, (ii) accompanies by disclosures of all material facts and assumptions that may affect a reasonable investor’s assessment of the asset allocation model or any report generated by such model, and (iii) in compliance with Rule 2214 (Requirements for the Use of Investment Analysis Tools) if the asset allocation model is an “investment analysis tool” covered by Rule 2214; and

(d) interactive investment materials that incorporate the above.

.04 Customer’s Investment Profile.  A member or associated person shall make a recommendation covered by this Rule only if, among other things, the member or associated person has sufficient information about the customer to have a reasonable basis to believe that the recommendation is suitable for that customer. The factors delineated in Rule 2111(a) regarding a customer's investment profile generally are relevant to a determination regarding whether a recommendation is suitable for a particular customer, although the level of importance of each factor may vary depending on the facts and circumstances of the particular case. A member or associated person shall use reasonable diligence to obtain and analyze all of the factors delineated in Rule 2111(a) unless the member or associated person has a reasonable basis to believe, documented with specificity, that one or more of the factors are not relevant components of a customer's investment profile in light of the facts and circumstances of the particular case.

.05 Components of Suitability Obligations.  Rule 2111 is composed of three main obligations: reasonable‑basis suitability, customer-specific suitability, and quantitative suitability.

(a) The reasonable-basis obligation requires a member or associated person to have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors. In general, what constitutes reasonable diligence will vary depending on, among other things, the complexity of and risks associated with the security or investment strategy and the member's or associated person's familiarity with the security or investment strategy. A member's or associated person's reasonable diligence must provide the member or associated person with an understanding of the potential risks and rewards associated with the recommended security or strategy. The lack of such an understanding when recommending a security or strategy violates the suitability rule.

(b) The customer-specific obligation requires that a member or associated person have a reasonable basis to believe that the recommendation is suitable for a particular customer based on that customer's investment profile, as delineated in Rule 2111(a).

(c) Quantitative suitability requires a member or associated person to have a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, are not excessive and unsuitable for the customer when taken together in light of the customer's investment profile, as delineated in Rule 2111(a). No single test defines excessive activity, but factors such as the turnover rate, the cost‑equity ratio, and the use of in‑and‑out trading in a customer's account may provide a basis for a finding that a member or associated person has violated the quantitative suitability obligation.

.06 Institutional Investor Exemption.  Rule 2111 prohibits a member or associated person from recommending a transaction or investment strategy involving a security or securities or the continuing purchase of a security or securities or use of an investment strategy involving a security or securities unless the member or associated person has a reasonable basis to believe that the customer has the financial ability to meet such a commitment.

.07 Customer’s Financial Ability.  Rule 2111(b) provides an exemption to customer-specific suitability regarding institutional investors if the conditions delineated in that paragraph are satisfied. With respect to having to indicate affirmatively that it is exercising independent judgment in evaluating the member's or associated person's recommendations, an institutional customer may indicate that it is exercising independent judgment on a trade‑by‑trade basis, on an asset‑class by asset‑class basis, or in terms of all potential transactions for its account.

.08 Regulation Best Interest.  This Rule shall not apply to recommendations subject to SEC Regulation Best Interest.

Non-Cash Compensation

FINRA Rules 2310 (Direct Participation Programs), 2320 (Variable Contracts of an Insurance Company), 2341 (Investment Company Securities), and 5110 (Corporate Financing Rule – Underwriting Terms and Arrangements) each includes provisions restricting the payment and receipt of non‑cash compensation in connection with the sale and distribution of securities governed by those rules.

As a general matter, these rules limit non‑cash compensation arrangements to:  (1) gifts that do not exceed $100 in value and that are not preconditioned on the achievement of a sales target; (2) an occasional meal, a ticket to a sporting event or the theater, or other comparable entertainment that does not raise any question of propriety and is not preconditioned on the achievement of a sales target; (3) payment or receipt by “offerors” (generally product sponsors and their affiliates) in connection with training or education meetings, subject to specified conditions, including that the payment of such compensation is not conditioned on achieving a sales target; and (4) internal non‑cash compensation arrangements between a member and its associated persons, subject to specified conditions. If the internal non‑cash compensation arrangement is in the form of a contest in connection with the sale and distribution of variable insurance contracts or investment company securities, the contest must be based on the total production of associated persons with respect to all securities within those product categories, and credit for those sales must be equally weighted.

Reg BI’s Conflict of Interest Obligation requires broker‑dealers to establish, maintain, and enforce written policies and procedures reasonably designed to identify and eliminate any sales contests, sales quotas, bonuses, and non‑cash compensation that are based on the sales of specific securities or specific types of securities within a limited time period. To avoid any potential inconsistency between the FINRA non‑cash compensation rules and Reg BI’s limitations in this area, FINRA has amended its rules to ensure that the arrangements addressed must also be consistent with the applicable requirements of Reg BI. The purpose of these amendments is to ensure that these rules’ limits on non‑cash compensation are read consistently with the SEC staff’s interpretations of Reg BI.[13]

FINRA Warns of Fraudulent Phishing Emails

Given the many changes that are taking place in conjunction with these updated regulations, FINRA issued a Regulatory Notice (20‑12) warning member firms of a widespread, ongoing phishing campaign that involves fraudulent emails purporting to be from FINRA officers, including by name, so the email at first glance seems totally legitimate.

These emails have a source domain name “@broker-finra.org” and request immediate attention to an attachment relating to your firm. In at least some cases, the emails do not actually include the attachment, in which case they may be attempting to gain the recipient’s trust so that a follow‑up email can be sent with an infected attachment or link, or a request for confidential firm information. In other cases, what appears to be an attached PDF file may direct the user to a website which prompts the user to enter their Microsoft Office or SharePoint password. FINRA recommends that anyone who entered their password change it immediately and notify the appropriate individuals in their firm of the incident.

The domain of “broker-finra.org” is not connected to FINRA and firms should delete all emails originating from this domain name. In addition, FINRA has requested that the Internet domain registrar suspend services for "broker‑finra.org." FINRA reminds firms to verify the legitimacy of any suspicious email prior to responding to it, opening any attachments or clicking on any embedded links.[14]

Sample Phishing Email

Following is a sample of one of these phishing emails.

Chapter 2 Review Questions

Which of the following answers/completes each question/sentence the best?

1. Firms must write their relationship summaries in ________, taking into consideration retail investors' level of financial experience.

2. Broker-dealers and registered investment advisers are required to deliver Form CRS to retail investors:

3. Broker-dealers must disclose material facts about the relationship and recommendations they make, including specific disclosures about the capacity in which the broker is acting (as a BD or a fiduciary). Which of the following disclosures is NOT required?

Chapter 3

Individual states are rapidly grasping the “best interest” standard by passing legislation at the state level. New York was the first state to do so. In 2018, the New York State Department of Financial Services proposed a new “best interest” standard for agents and brokers licensed to sell life insurance and annuity products in the state aligning with the now vacated DOL “fiduciary rule” for retirement savings. Under the rule, product sales must prioritize customer’s interest over sales commissions; and agents’ and brokers’ compensation should not be influenced by the products recommended. The rule went into full effect on February 1, 2020.

Like the NAIC Model, standards and procedures for recommendations to consumers that result in transactions involving annuity products must appropriately address the insurance needs and financial objectives of the consumer. As an example of state implementation, we present the highlights of New York’s Regulation 187.

New York Suitability and Best Interest Standard

Under the New York regulation, insurers and producers must comply with the imposed requirements for any transaction with respect to an annuity contract. Six months from the effective date, insurers and producers must comply with the requirements for any transaction with respect to a life insurance policy. The title of Part 224 is amended to read:  “Suitability and Best Interests in Life Insurance and Annuity Transactions” (formerly “Suitability in Annuity Transactions”).

State law establishes standards of conduct for insurance producers, including that producers must act in a competent and trustworthy manner. The amended regulation clarifies the duties and obligations of insurers, including fraternal benefit societies, by requiring them to establish standards and procedures for recommendations to consumers with respect to policies delivered or issued for delivery in the state so that any transaction with respect to those policies is in the best interest of the consumer and appropriately addresses the insurance needs and financial objectives of the consumer at the time of the transaction—and also clarifies the nature and extent of supervisory controls that an insurer must maintain to achieve compliance.

These standards and procedures are substantially similar to the NAIC Suitability in Annuity Transactions Model Regulation for annuities, and FINRA’s National Association of Securities Dealers (NASD) Rule 2310, which has been superseded by FINRA Rule 2111, for securities. This state regulation brings these national standards for annuity contract sales to New York.

This NY amendment applies to any transaction or recommendation with respect to a proposed or in‑force policy though, as you will see, there are a few differences between the requirements of the two.[15]

Violations of the Rule

Any violation of the requirements of the Rule will be deemed to be an unfair method of competition or an unfair or deceptive act and practice in the conduct of the business of insurance in this state.

Section 224.7 is renumbered to section 224.8 and changes the placement of the words “Insurance Law” consistent with other recent regulatory revisions.

§[224.7] 224.8 Violations

A contravention of this Part shall be deemed to be an unfair method of competition or an unfair or deceptive act and practice in the conduct of the business of insurance in this [State] state and shall be deemed to be a trade practice constituting a determined violation, as defined in Insurance Law section 2402(c) [of the Insurance Law], except where such act or practice shall be a defined violation, as defined in Insurance Law section 2402(b) [of the Insurance Law], and in either such case shall be a violation of Insurance Law section 2403 [of the Insurance Law]. [16]

Exemptions

Section 224.2 is revised to replace the term “contract” with the term “policy” for consistency with the amendment, and to clarify and/or expand the exemptions.

Unless otherwise specifically included, Regulation 187 does not apply to transactions involving:

·         Purchase of a policy where the application is solicited and received in response to a generalized offer by the insurer by mail, at the worksite, or under other methods without producer involvement (other than customer service, administrative support, or enrollment services) and where there is no recommendation made;

·         A policy used to fund:

o   an ERISA employee pension or welfare benefit plan;

o   an employer-provided 401(a), 401(k), 403(b), 408(k) or 408(p) plan;

o   an IRC Section 414 government or church plan, a government or church welfare benefit plan, or a deferred compensation plan of a state or local government or tax exempt organization under IRC 457;

o   an employer-sponsored (or plan sponsored) nonqualified deferred compensation arrangement;

o   a settlement or assumption of liabilities associated with personal injury litigation or any dispute or claim resolution process; or

o   terminating employee pension plans or to assume liability of certain segments of ongoing plans;

·         Any corporate or bank owned policy authorized by Insurance Law section 3205(d) where substantially all benefits under the policy are payable to the corporate or bank policyowner;

·         Any group credit life insurance; or

·         Any life settlement contract.

Terminology Used in the Regulation

Section 224.3 adds new definitions and revises current definitions consistent with the broadening of the regulation, which now includes life insurance and transactions other than a purchase or replacement, such as modifications and elections of contractual provisions. The amendment to this section adds to the definition of “suitability information” for consistency purposes and adds a definition for the term “suitable.” The amendment to this section also adds definitions of “insurance producer,” “policy,” “transaction,” “sales transaction” and “inforce transaction.”

Consumer means the owner or prospective purchaser of a policy.

In-force transaction means any modification or election of a contractual provision with respect to an in‑force policy that does not generate new sales compensation.

Note: New sales compensation does not include compensation provided to a producer when, after the initial premium or deposit under a policy, the consumer pays further premiums or deposits pursuant to the policy.

Insurer producer or producer means an insurance agent or insurance broker.

Policy means a life insurance policy, an annuity contract, a certificate issued by a fraternal benefit society, or a certificate issued under a group life insurance policy or group annuity contract.

Recommendation means one or more statements or acts by a producer, or by an insurer where no producer is involved, to a consumer that:

·         Reasonably may be interpreted by a consumer to be advice and that results in a consumer entering into or refraining from entering into a transaction in accordance with that advice; or

·         Is intended by the producer/insurer to result in a consumer entering into or refraining from entering into a transaction.

Note: A recommendation does not include general factual information to consumers. A recommendation also does not include use of an interactive tool that solely provides a prospective consumer with the means to estimate insurance, future income or other financial needs to compare different types of products or refer the consumer to a producer.

Replace or Replacement means a transaction that involves the purchase of a life insurance policy or annuity contract in connection with the surrender, lapse or change of existing life insurance policies or annuity contracts.

Sales transaction means the purchase or issuance of a policy, any replacement, conversion, or any modification or election of a contractual provision with respect to an in‑force policy that generates new sales compensation. New sales compensation does not include compensation provided to a producer when, after the initial premium or deposit under a policy, the consumer pays further premiums or deposits pursuant to the policy.

Suitability information means:

·         For a policy solely providing term life insurance with no cash value, information that is reasonably appropriate to determine the suitability of a recommendation commensurate with the materiality of the transaction to a consumer’s financial situation at the time of the recommendation and the complexity of the transaction recommended, including some or all of the following, as relevant to the consumer:

o   age;

o   annual income;

o   financial situation and needs, including the financial resources used for the funding of the policy;

o   financial objectives;

o   intended use of the policy, including any attached riders;

o   financial time horizon, including the duration of existing liabilities and obligations;

o   existing assets, including investment and insurance holdings;

o   liquidity needs;

o   liquid net worth;

o   risk tolerance; and

o   willingness to accept nonguaranteed elements in the policy, including variability in premium, death benefit, or fees; and any other information provided by the consumer which in the reasonable judgment of the producer/insurer is relevant to the suitability of the transaction.

·         For any policy other than a policy solely providing term life insurance with no cash value, information that is reasonably appropriate to determine the suitability of a recommendation commensurate with the materiality of the transaction to a consumer’s financial situation at the time of the recommendation and the complexity of the transaction recommended, including some or all of the following, as relevant to the consumer (the same information is required with a few additions/revisions):

o   financial experience;

o   willingness to accept nonguaranteed elements in the policy, including variability in premium, death benefit, or fees;

o   tax status; and

o   any other information provided by the consumer which in the reasonable judgment of the producer/insurer is relevant to the suitability of the transaction.

Suitable means in furtherance of a consumer’s needs and objectives under the circumstances then prevailing, based upon the suitability information provided by the consumer and all products, services, and transactions available to the producer.

Transaction means any sales transaction or in-force transaction.[17]

Duties of Insurers and Producers

Sections 224.4 and 224.5 detail the duties of insurers and producers with respect to both sales transactions and in‑force transactions. Again, the first requirement is to adhere to the requirement to act only in the “best interest of the consumer.” These provisions also detail exactly what this term means.

The producer/insurer recommendation must be based on an evaluation of the relevant suitability information of the consumer, reflecting the care, skill, prudence, and diligence that a prudent person acting in a like capacity and familiar with such matters would use under the circumstances, barring any consideration to compensation or other incentives.

Not only must a sales transaction must be suitable, but the producer/insurer must also have a “reasonable basis” to believe that the consumer has been reasonably informed of various features of the policy and potential consequences of the sales transaction, both favorable and unfavorable. Any differences in policy features among fee‑based and commission‑based versions and the manner in which the producer is compensated must be disclosed.

In the case of a policy replacement, the replacement must be suitable including taking into consideration such things as the surrender charge, increased/decreased coverage and premium rates, tax implications, adverse health rating, etc.; and it must be demonstrated that the consumer would benefit from the replacement policy enhancements/improvements. Special consideration and due diligence is required if the consumer has entered into a policy replacement within the preceding 36 months.

Reasonable efforts must be made to obtain the consumer’s suitability information prior to any recommendation. Following is a breakdown of these pertinent sections.

Duties of Insurers/Producers with Respect to Sales Transactions

Section 224.4 is amended so that the duties of insurers and producers, in addition to applying to annuity recommendations, also now apply to life insurance recommendations. Section 224.4 is amended to clarify that a producer, or an insurer where no producer is involved, shall act in the best interest of the consumer. The section is also amended to explain that the producer, or the insurer where no producer is involved, acts in the best interest of the consumer when the recommendation is based on the consumer’s suitability information and reflects the care that a prudent person in a like capacity would exercise in a similar situation, when the transaction is suitable, and when the consumer has been reasonably informed of the consequences of the transaction.

The section also clarifies that only the interests of the consumer shall be considered in making the recommendation and the receipt of compensation or other incentives is permitted provided its receipt does not influence the specific recommendation.

Section 224.4 is also amended to add new subsections that require a producer, or an insurer where no producer is involved, to disclose to the consumer the information used to provide the recommendation and document any refusal to provide suitability information or any decision to enter into a sales transaction that is not based on the producer’s recommendation; prohibit a producer from making a recommendation unless the producer has a reasonable basis to believe that the consumer can meet the financial obligations under the policy; and prohibit a producer from stating that a recommendation is part of the financial or investment planning unless the producer has an appropriate professional designation.

This section is further amended to state that any requirement applicable to a producer under the regulation applies to every producer in the transaction who has participated in the making of the recommendation and received compensation as a result of the sales transaction, regardless of the level of contact made with the consumer. This section is also amended to state that nothing in the regulation shall be construed to prohibit or limit compensation of a producer that is otherwise permitted under the Insurance Law and regulations. This section is also amended to clarify that a producer may limit the range of policies recommended to consumers based on a captive or affiliation agreement with a particular insurer as long as required disclosures are provided.

Duties of Insurers/Producers with Respect to In-Force Transactions

Section 224.5. Section 224.5 is renumbered to Section 224.6 and this new section (224.5) is added to address duties of insurers and producers with respect to in‑force transactions and to establish a best interest standard of care. The new section explains that the producer, or the insurer where no producer is involved, acts in the best interest of the consumer when the recommendation is based on the consumer’s suitability information and reflects the care that a prudent person in a like capacity would exercise in a similar situation, when the transaction is suitable, and when the consumer has been reasonably informed of the consequences of the transaction.

The section also clarifies that only the interests of the consumer shall be considered in making the recommendation and the receipt of compensation or other incentives is permissible provided its receipt does not influence the specific recommendation. The section prohibits a producer from stating that a recommendation is part of the financial or investment planning unless the producer has an appropriate professional designation, and also states that any requirement applicable to a producer under the regulation applies to every producer in the transaction who has participated in the making of the recommendation. Lastly, this new section prohibits a producer from making a recommendation to a consumer to enter into an in‑force transaction about which the producer has inadequate knowledge.

This new section also adds new subdivisions requiring an insurer to:  establish, maintain, and audit a system of supervision that is designed to achieve compliance; ensure that producers are adequately trained with respect to the insurer’s policies to make recommendations; establish and maintain procedures to prevent financial exploitation and abuse; provide any policy information reasonably requested by the consumer regarding the consumer’s in‑force policy; provide comparison information showing differences between fee‑based and commission‑based versions of a product; and provide relevant policy information and information required by NY Insurance Regulation 60 to a producer for evaluating a replacement transaction.

If No Recommendation is Made.  These requirements are not applicable if no recommendation is made; or if a recommendation was made and was later found to have been prepared based on materially inaccurate material information provided by the consumer; or if a consumer refuses to provide relevant suitability information and the transaction is not recommended; or a consumer decides to enter into a sales transaction that is not based on a recommendation of the insurer or the producer.

An insurer’s effectuation of a sales transaction with respect to its policies must be suitable based on all the information actually known to the insurer at the time of the sales transaction.

Disclosure and Documentation.  At the time of recommendation the producer/insurer must disclose to the consumer in a reasonable summary format all relevant suitability considerations and product information that provide the basis for the recommendation. All records pertaining to the basis of the recommendation must be documented. The producer/insurer must also document if the consumer refuses to provide the required suitability information, or decides to enter into a sales transaction that is not based on the recommendation.

Consumer’s Financial Ability.  The recommending producer/insurer must also have a reasonable basis to believe that the consumer has the financial ability to meet the financial commitments under the policy; and is prohibited from entering into any sales transaction unless the producer has adequate knowledge of the recommended product and the consumer’s financial ability.

Consumer Discouragement Prohibition. Producers/insurers are prohibited from dissuading or attempting to dissuade a consumer from truthfully responding to an insurer’s request for confirmation of suitability information, as well as exerting pressure to dissuade the consumer from filing a complaint with the superintendent or cooperating with a complaint investigation.

Unearned Professional Designations.  Achieving professional designations can be a boon to your knowledge, competence, success, and business overall. However, using a title or designation that is unearned is prohibited. Although a producer may state or imply that a sales recommendation is a component of a financial plan, the producer is prohibited from stating or implying that a recommendation to enter into a sales transaction is comprehensive financial planning, comprehensive financial advice, investment management or related services unless the producer has a specific certification or professional designation in that area.

Policy Range Limitations.  A producer may limit the range of policies recommended to consumers based on a captive or affiliation agreement with a particular insurer if the producer prominently discloses to the consumer the nature of the agreement and the circumstances under which the producer will and will not limit the recommendations.

Insurer Responsibility and Supervision

Section 224.6 (formerly 224.5) adds the term “and supervision” to the section title.

An insurer must have a reasonable basis to believe that any sales transaction is suitable without regard to the availability of products, services, and transactions of companies other than the insurer. However, this does not apply to a sales transaction that results from the exercise of a contractual right in a policy.

Insurers are required to establish, maintain, and audit a supervisory system to assure compliance with this regulation—insurers may also use a third party to effectuate compliance. Such procedures call for the documentation of information directly related to any sales transaction or recommendation, a review of complaints received regarding recommendations that are inconsistent with the best interest of the consumer, and use a reasonable risk‑based approach to audit/review producers’ recommendations to identify recommendations of the greatest risk of violation of these requirements.

Insurers are responsible to ensure that every producer recommending any transaction with respect to the insurer’s policies is adequately trained, but are not required to warrant that a producer is acting in the consumer’s best interest. To act accordingly is the obligation of the producer.

Insurers are also responsible for establishing and maintaining procedures that are designed to prevent financial exploitation and abuse.

With regard to an in-force policy, insurers are required to provide policyowner’s with all policy information that is reasonably requested by that consumer.

Where a producer is authorized by an insurer to offer different versions of an insurer’s product, one with a fee‑based structure and one with a commission‑based structure, the insurer must provide the consumer with a comparison showing the differences between the products.

In the case of a proposed replacement, the insurer is responsible for providing the producer with all relevant policy information that is necessary for the evaluation of the replacement.

Finally, the insurer is responsible for taking appropriate corrective action on behalf of any consumer who has been harmed by a violation of the requirements, whether conducted by the insurer, the producer, or any third party with whom the insurer contracts.

Effective Date

Section 224.9 is added to address the effective date.

The amendments to this Part made on July 17, 2018 shall be effective August 1, 2019. As of the effective date, insurers and producers shall comply with the requirements of this Part for any transaction with respect to an annuity contract. Six months from the effective date, insurers and producers shall comply with the requirements of this Part for any transaction with respect to a life insurance policy.

Chapter 3 Review Questions

Which of the following answers/completes each question/sentence the best?

1. The title of Part 224 of Title 11 has been renamed from "Suitability in Annuity Transactions" to "Suitability and Best Interests ________."

2. At the core of the amended regulation is the concept that both life insurance and annuity transactions must be:

3. Insurers are required to warrant that a producer is acting in the consumer's best interest.