Life Insurance Settlements Viewed Through the Eye of the NASD – A Study in Compliance

Life coverage settlements have caused a superb deal of misunderstanding for broking sellers within the final 24 months as increasingly more registered representatives are getting aware of this controversial wealth management strategy. The lifestyle agreement sells an undesirable, unaffordable, or underperforming lifestyle coverage policy offered to an institutional patron instead of letting the coverage lapse. As Registered Representatives grapple for the go-ahead with their compliance department, they may be commonly faced with mixed answers as to its viability. To be sure, this approach is an area of concern for broking dealers and NASD individuals alike. Mary Schapiro, Vice Chairman of the NASD, spoke at the Chicago NASD Conference on May twenty-fifth, 2005. She addressed, in part, 3 crucial issues:

Life Insurance

1. “The first danger is to assume that toddler boomers have a degree of economic acumen that removes the need for correct suitability evaluation.”

2. “A second danger comes from the very product innovation that has normally served your clients so properly.”

3. “A third risk is a failure to analyze the fame of these new products below the federal securities laws.”

Chairman Schapiro is going on to mention that fairness indexed annuities are securities in addition to lifestyle settlements and can constitute a “promoting away” trouble, among other worries. She explains: “Equity-listed annuities are most effective one instance of an economical product that a firm would possibly erroneously deal with as a non-safety. Other examples consist of tenants-in-not unusual exchanges and existing settlements. NASD considers all of this merchandise to be securities, subject to company supervision.


The NASD is the “watchdog of the SEC” whose sole lifestyles are to guard the investment public. One of their preoccupations is to hold in check the “egregious overcharging” of prices, which can be generated with the aid of manufactured investment products. There appears to be a correlation by way of the NASD regarding their challenge with the nature and length of expenses generated by using the lifestyles agreement transaction.

The query remains; are lifestyles settlement transactions securities? The question of whether life coverage settlements are to be dealt with as securities is split into two parts-whether or not we are discussing the returned end sales interest, i.E. The distribution of hobbies in a policy or pool of regulations, or the front quit hobby, i.E—the solicitation and facilitation of the sale of a policy to an existing settlement enterprise. Once the coverage has been bought into the secondary market, one should conclude that the “switch for fee rule” has been carried out and the coverage settlement will be construed as a safety. Many, but, would finish that the up-front transaction of a lifestyles settlement would not be subjected to securities regulation and jurisdiction.

Why all the Fuss?

Does the existence settlement marketplace deserve such attention? According to the 2004 Life Insurers Fact Book, compiled with the American Council of Life Insurers’ aid, there may be $nine.4 trillion of lifestyles insurance in-pressure on 167 million policies. Coupled with the reality that rising demographics show our beloved “Baby Boomers” are hitting retirement, and you could actually see that the lifestyles agreement marketplace is getting on anyone’s radar screen.

Moreover, according to the Conning Research and Consulting whitepaper, “Life Settlements, The Concept Catches On” 2006, they explain that the average existence agreement provide approximates 25% and 30% of face quantity.” If it is actual that approximately 35% of all settlement proceeds may be re-deployed into new investment vehicles for increase or income then you can still draw the belief that dealer-sellers need to have a vested hobby. This earrings mainly genuine in which there may be opposition for registered consultant recruiting in which he or she will be able to doubtlessly increase their gross commissions.

This article will study the potential NASD issues and possible solutions closer to the adoption of life coverage agreement software. It isn’t always intended to guide the notion that a existence agreement is a security, but to provide a higher understanding within the occasion that a dealer-supplier needs to add the strategy as a brand new profit center.

The first attention from a compliance perspective is a way to deal with the life agreement. Some twine-residence compliance departments, as an example, have dealt with existence-settlements as a passive referral and do no longer besides compensation. The common idea is that they can achieve the reimbursement by re-deploying the proceeds towards a traditional product wthat includes a stock, bond, or mutual fund. In that manner, as the reasoning is going, they did no longer whole a securities transaction and consequently did not violate the NASD technique. Moreover, lots of those companies use the existing settlement method in the direction of the substitute of underperforming or outmoded coverage.

For instance: Client Clara has a $a million lifestyle coverage policy and pays $60,000 a year in premiums. Broker Bob tells her that she will promote the coverage inside the secondary marketplace and use the proceeds to pay for new coverage with a brand new no-lapse guarantee. She sells the policy for $300,000 and uses the cash to shop for a brand new $1,500,000 with premiums less than her unique premium prices.

Many broker-dealers have followed this passive non-reimbursement approach to existing settlements. Other dealer-dealers see the product to offset lagging markets and infuse new streams of sales for the firm.
We want to be extra educated in the direction of expertise of how to cope with complex compliance issues because it pertains to existing settlements. Many elements move into how the life settlement application has to be established right into a BD system. For instance, should the BD look at the program as security or strictly as an outside business pastime. Few companies can offer answers to those complex questions to provide consulting as it concerns existing settlements.

Involving the belief that a existence settlement is a safety, it is vital to apprehend what a safety is to decide if it’s miles applicable to existence settlements. The keystone case at the definition of securities is SEC v. W.J. Howey.1 In Howey, the Supreme Court was asked to outline the term “funding settlement” because itis used within the definition of a safety underneath the Securities Act of 1933. In its choice, the Court described an funding protection as any transaction that: Involves the funding of cash, in a common corporation, with an expectation of income, and which happens totally from the efforts of others. It is immaterial if the business enterprise is evidenced by formal certificates or nominal interests in physical assets.

In SEC v. Mutual Benefits Corp. The Eleventh Circuit affirmed a U.S. District Court finding that Mutual Benefits turned into involved in a viatical agreement agreement that certified as “investment contracts” beneath the securities act of 1933 and 1934. Prior to the Mutual advantages case, the agreement enterprise consistently stated a district court decision, SEC v. Life Partners Inc. As the premise for ithe settlement enterprise’s insurance law, Despite losing, the SEC has persevered in its opinion that investments in settlements are securities. The precedent set through SEC v. Mutual Benefits has created a cavalcade of ability securities problems that have to be checked out with a pro professional’s aid in the settlement/NASD industry.

Just as important is the fact that many Broker-Dealers have selected to disregard the life settlement within the hopes that they could at some point declare lack of expertise. This “stick your head in the sand” posture is a recipe for catastrophe because, empirically, the NASD has made it quite clear that they will no longer tolerate this kind of method under any circumstances.

Common feel dictates that to avoid issues is always to locate the customer’s fine interest first, preventing issues with not being compliant.

There are many policies, guidelines, and techniques that could observe to lifestyles settlements underneath NASD recommendations. This article will handiest study some very germane problems. It is vital to word that any prudent compliance branch will need to adopt written approaches on processing lifestyles settlements.


In presenting life agreement services in a prudent SEC and NASD compliant way we ought to apprehend how the approach ought to observe NASD tactics. Thus away, the SEC and the NASD have no longer definitively turn out to be the professional SROs of the existing agreement enterprise even though they’ve prosecuted and brought punitive actions on RRs. To make certain, the NASD has declared that the back-end of the transaction is a security and has made it clear that “fractionalization “is a risky place of the product. The application has gained in reputation, and the aforementioned law frame will in all likelihood lead to the regulatory charge. It is, therefore, extraordinarily vital to apprehend written approaches regarding While there are over 20 identifiable troubles and strategies that can affect NASD techniques, here are 7 that need to observe right now:

1. NASD Rule 2320 (g) (1) (Best Execution)
2. NASD Rule 2110 “Standards of Commercial Honor and Principles of Trade.”
3. NASD Rule 2310 “Recommendations to Customers” (Suitability)
4. NASD Rule 2430 “Charges for Services Performed.”
5. NASD Rule 3030 “Outside Business Activities of an Associated Person.”
6. NASD Rule 3040 “Private Securities Transactions of an Associated Person.”
7. NASD Procedures (*should be Written and Consistent)

NASD Rule 2320: Best execution via the “3 Quote Rule” is relevant every time there may be an imparting to the majority. That is to mention, we as experts are held to the best of requirements and have a fiduciary to get the first-class pricing for our customers. This due diligence manner is to make sure in opposition to improper favorite organization desire and fee-solving. The fact that the firm has more than one gives may not be sufficient. Indeed, it’s far extraordinarily important to have more than three quotes to get the est execution—companies area good way to”take a pass” at obtaining the insurance contract. Today, broker-dealers are presently carrying out existing settlements that might be probable in violation of this method.

NASD Rule 2110: High Standards of Commercial Honor and Principles of Trade are paramount to live compliantly. The NASD has dominated and punished each dealer-sellers and registered representatives combining rules 2110/ 3030 & 3040 because it pertains to life settlements. It is crucial to be aware that there may be “failure to oversee” issues wherein promoting away and personal placements are conducted.

NASD Rule 2310: The NASD has made it clear that we have to conduct our enterprise regularly with the consumer’s targets and corresponding suitability. Moreover, we need to disclose all cloth facts and hold full disclosure. No longer providing a useful strategy when suitable is in direct war with NASD Rule 2310 (b) (4). (B.D. Beware)

NASD Rule 2430: Charges, if any, for offerings executed, which includes miscellaneous services inclusive of series of money due for important, dividends, or hobby; alternate or switch of securities; appraisals, safe-maintaining or custody of securities, and other offerings, shall be reasonable and now not unfairly discriminatory among customers. States that alter excessive fees ought to be adhered to correctly. Empirically speakme the NASD sees high costs to be something over five-6%. Since life settlements create fee in extra of the insurance policies cash give up fee, a payout grid can conform with NASD rule 2430. One must are trying to find out expert sessions concerning this very paramount trouble.

NASD Rule 3030: No man or woman associated with a member in any registered capacity shall be hired via, or be given reimbursement from, some other individual as a result of any commercial enterprise interest, other than a passive investment, out of doors the scope of his courting with his company, except he has furnished prompt written notice to the member. As formerly stated, the NASD has made it clear that lifestyles settlements are included in their interpretation of “promoting away” and it’s far a paramount region of problem where flawed supervision exists.

NASD Rule 3040: Provides, among other matters, that previous to collaborating in a securities transaction outside the path or scope of their employment, someone related to a member company should provide that company previous written notification. The firm is notified that the associated character may also get hold of selling repayment; it’s far required to trouble written approval or disapproval.

Licensing and Compensation Issues

The “Desk Drawer Broker-Dealer”

This method is very simplistic in nature and is a logical opportunity to partnering with a single Funder. The fascinated dealer-dealer might create a promoting settlement with a specialized broking-dealer factor that would behavior the existing settlement transaction for a price. All transactions might meet NASD requirements such as quality execution. The broking-supplier with the unwanted policy could transact beneath a palms duration arrangement.

NASD “Blue Sky” Regulations

Aside from having a fashionable securities license series 7 and series sixty-three, a few hints have to be adhered to. Although there is confusion utilizing among the Funders as to how existing settlement transactions ought to be carried out from country to nation, it’s miles logical that the dealer-dealer and its Registered Representative must preserve registrations in the state from which the repayment originates, i.E., the Funder’s home kingdom of commercial enterprise transactions. However, it must be emphasized that it is good enterprise exercise with the aid of a RR to grow to be authorized in each state to conduct the commercial enterprise of existence settlements.

Variable Policy Clearing

Although most of the regulations bought in the secondary market are fixed, there’s the occasion while “variable rescue” may come into play. In this example, it’s miles constantly advisable to clean thru a “table drawer” dealer-supplier as stated above. Needless to say, transferring the sub-debts to the policy’s money marketplace does now not constitute a hard and fast product and therefore isn’t always enough to keep away from capability NASD law.

USAPatriot Act

USA PATRIOT Act in October 2001Life agreement transactions aren’t excluded and have to comply with all policies and regulations concerning America Patriot Act. Therefore, to observe anti-money laundering (AML) laws, it follows that an ordinary enterprise version of repayment charge should consist of the settlement dealer firm notifies its reduced in size employee and RR/BD of the specific dollar amount of a transfer on the way to derive from a supply Provider firm. The Registered Representative notifies the broking-provider about the charge quantity and its source to ensure Blue Sky registrations. After the dealer-dealer gets the payment to the Registered Representative (in compliance with NASD recommendations), the Registered Representative will deposit the price range into his LLC bank account (in compliance with the aforementioned IRS suggestions) and provide separate invoices that meet uniform and precise identity necessities to each the agent’s broker-provider and to the life agreement broking firm. The invoices could be signature completed through each entity and again to the Registered Representative for inclusion in a permanent report as the reimbursement recipients. After the Registered Representative’s LLC makes payment to the agent’s broker-provider and the lifestyles settlement broker firm, the latter will provide the Registered Representative with an electronic reproduction of the Registered Registered case file Representative will hold within the identical everlasting document because the related invoice copies.

John R. Wright
Social media ninja. Freelance web trailblazer. Extreme problem solver. Music fanatic. Spent several months marketing pubic lice in the financial sector. Spent 2002-2008 supervising the production of ice cream in Africa. Had some great experience developing robotic shrimp in the aftermarket. Spent several years getting my feet wet with puppets in Miami, FL. Was quite successful at supervising the production of corncob pipes worldwide. What gets me going now is working with electric trains in Mexico.