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

Life insurance settlements have precipitated a super deal of confusion for dealer sellers within the ultimate 24 months as an increasing number of registered representatives are getting aware of this controversial wealth management strategy. The existence settlement is the sale of an undesirable, unaffordable or underperforming life coverage this is sold to an institutional purchaser in lieu of letting the coverage lapse. As Registered Representatives grapple with the cross in advance with their compliance department, they may be normally confronted with combined answers as to its viability. To make sure, this approach is an area of problem for broker sellers and NASD members alike. Mary Schapiro, Vice Chairman of the NASD, spoke at the Chicago NASD Conference on May twenty-fifth, 2005. She addressed, in the component, three imperative problems:

1. “The first hazard is to count on that toddler boomers have a level of economic acumen that gets rid of the want for proper suitability analysis”.

2. “A 2nd danger comes from the very product innovation that has usually served your clients so nicely”.

Three. “A third danger is a failure to analyze the reputation of this new merchandise under the federal securities laws.”

Chairman Schapiro goes on to say that equity-indexed annuities are securities as well as life settlements and might constitute a “selling away” hassle amongst different concerns. She explains: “Equity-indexed annuities are simplest one instance of an economic product that a firm would possibly erroneously deal with as a non-safety. Other examples encompass tenants-in-not unusual exchanges and life settlements. NASD considers all of these products to be securities, concern to firm supervision. Life

The NASD is the “watchdog of the SEC” and its sole life is to protect the investing public. One of their preoccupations is to hold in the test the “egregious overcharging” of costs that are generated by using manufactured investment products. There appears to be a correlation by the NASD as to their problem with the character and size of charges that have been generated by way of the lifestyles agreement transaction.

The query remains; are life agreement transactions securities? The query of whether existence insurance settlements are to be treated as securities are divided into components-whether or not we’re discussing the returned end income hobby, i.E. The distribution of interests in a coverage or pool of policies or the front gives up interest, i.E. The solicitation and facilitation of the sale of a cover to an existing settlement organization. Once the coverage has been bought into the secondary market then one could conclude that the “transfer for cost rule” has been implemented and the coverage agreement could be construed as a security. Many, however, might conclude that the up-the front transaction of a life settlement could now not be subjected to securities law and jurisdiction.

Why all of the Fuss?

Does the life settlement market deserve such attention? According to the 2004 Life Insurers Fact Book, compiled by means of the American Council of Life Insurers, there’s $9.Four trillion of life coverage in-pressure on 167 million policies. Coupled with the reality that emerging demographics show our liked “Baby Boomers” are hitting retirement and you may definitely see that the existing settlement marketplace is getting on everyone’s radar display.

Moreover, in step with the Conning Research and Consulting whitepaper, “Life Settlements, The Concept Catches On” 2006, they provide an explanation for that the common lifestyles settlement offer approximates 25% and 30% of face amount.” If it is true that approximately 35% of all agreement proceeds will be re-deployed into new funding automobiles for boom or earnings then you could draw the conclusion that broker-sellers have to have a vested interest. This jewelry particularly actual where there may be competition for registered representative recruiting where he or she will be able to doubtlessly increase their gross commissions.

This article will take a look at the ability NASD issues and possible solutions towards the adoption of existence insurance settlement program. It isn’t always supposed to support the belief that a lifestyles agreement is a safety, but to provide a higher understanding in the event that a broking-provider wishes to feature the approach as a brand new income center.
The first attention from a compliance attitude is a way to deal with the lifestyles agreement. Some cord-residence compliance departments as an example have treated lifestyles-settlements as a passive referral and do no longer beside reimbursement. The not unusual idea being that they can gain the compensation by means of re-deploying the proceeds closer to a conventional product including an inventory, bond or mutual fund. In that way, as the reasoning goes, they did not whole a securities transaction and therefore did now not violate NASD manner. Moreover, a lot of those companies use the lifestyles agreement strategy towards the replacement of underperforming or superseded coverage.

For example, Client Clara has a $a million lifestyles coverage policy and is paying $60,000 a year in charges. Broker Bob tells her that she can promote the policy in the secondary market and use the proceeds to pay for brand spanking new coverage with a new no-lapse assure. She sells the coverage for $300,000 and uses the cash to shop for a brand new $1,500,000 with charges much less than her unique top class prices. Insurance

Many broker-sellers have followed this passive non-compensation approach to existing settlements. Other broker-sellers see the product a way to offset lagging markets and infuse new streams of sales for the company.
We need to emerge as more educated towards information of how to address complex compliance issues because it relates to lifestyles settlements. There are many elements that move into how the lifestyles settlement application should be set up into a BD machine. For instance: Should the BD study the program as a security or strictly as an outside commercial enterprise activity. There are few companies that can offer answers to those complex questions with a purpose to provide consulting as it issues lifestyles settlements.

Involving the perception that a life agreement is a security, it’s miles vital to apprehending what a protection is to determine if it’s miles relevant to existing settlements. The keystone case on the definition of securities is SEC v. W.J. Howey.1 In Howey, the Supreme Court turned into asked to outline the time period “funding settlement” because the time period is used within the definition of a safety beneath the Securities Act of 1933. In its decision, the Court described an investment security as any transaction that: Involves the investment of money, in a common corporation, with an expectation of income, and which happens solely from the efforts of others. It is immaterial if the company is evidenced by the formal certificate or nominal pursuits in physical assets. In SEC v. Mutual Benefits Corp. The Eleventh Circuit affirmed a U.S. District Court finding that Mutual Benefits changed into concerned in a viatical settlement that qualified as “investment contracts” underneath the securities act of 1933 and 1934. Prior to the Mutual advantages case, the settlement enterprise constantly cited a district court docket decision, SEC v. Life Partners Inc. As the basis for coverage regulation of the settlement business. Despite dropping, the SEC has continued in its opinion that investments in settlements are securities. The precedent set via SEC v. Mutual Benefits has created a cavalcade of potential securities troubles that should be checked out by a seasoned expert within the agreement/NASD enterprise.
Just as essential is the fact that many Broker-Dealers have selected to ignore the lifestyles agreement in the hopes that they can at some point declare lack of knowledge. This “stick your head inside the sand” posture is a recipe for disaster due to the fact empirically the NASD has made it pretty clear that they may not tolerate this kind of strategy under any occasions.
Common experience dictates that so one can keep away from problems is to constantly place the client’s quality interest first, accordingly stopping troubles by now not being compliant.

There are many policies, regulations, and techniques that would practice to lifestyles settlements below NASD suggestions. This article will most effective study some very germane problems. It is vital to notice that any prudent compliance branch will need to undertake written methods on processing existence settlements.


In supplying lifestyles settlement offerings in a prudent SEC and NASD compliant manner we need to recognize how the method should practice NASD processes. Thus ways, the SEC and the NASD have now not definitively end up the reputable SROs of the lifestyles agreement enterprise even though they have prosecuted and brought punitive movements on RRs. To make sure, the NASD has declared that the again-cease of the transaction is a safety and has made it clear that “fractionalization “is a risky vicinity of the product. The application has gained in recognition and the aforementioned law frame will probably lead the regulatory rate. It is therefore extremely vital to apprehending written techniques concerning: While there are over 20 identifiable problems and strategies that could influence NASD procedures, here are 7 that should apply right away:

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)Settlements

NASD Rule 2320: Best execution via the “three Quote Rule” is applicable whenever there may be an imparting to the majority. That is to mention, we as experts are held to the very best of requirements and have a fiduciary to get the nice pricing for our clients. This due diligence method is to make sure towards flawed preferred company preference and price solving. The fact that the firm has a couple of offers won’t be sufficient. Indeed, it’s miles extraordinarily crucial to have greater than 3 costs to get pleasant execution, due to the carriers with the intention to”take a bypass” at acquiring the coverage agreement. Today, there are broking-sellers presently carrying out life settlements that are probably in violation of this technique.

NASD Rule 2110: High Standards of Commercial Honor and Principles of Trade are paramount to live compliantly. The NASD has ruled and punished each broking-dealers and registered representatives combining rule 2110/ 3030 & 3040 because it pertains to existing settlements. It is critical to notice that there may be “failure to oversee” problems wherein promoting away and personal placements are performed.

NASD Rule 2310: The NASD has made it clear that we all should conduct our business in a way consistent with the customer’s targets and corresponding suitability. Moreover, we have to divulge all cloth data and preserve complete disclosure. By no longer supplying a useful strategy whilst suitable is in direct conflict with NASD Rule 2310 (b) (4). (B.D. Beware)

NASD Rule 2430: Charges, if any, for services performed, such as miscellaneous services along with collection of money due for major, dividends, or hobby; change or transfer of securities; value determinations, safe-maintaining or custody of securities, and different services, will be reasonable and no longer unfairly discriminatory among clients .States that adjust excessive charges need to be adhered to appropriately. Empirically speak me the NASD sees immoderate expenses to be something over 5-6%. Since existence settlements create cost in extra of the coverage regulations coins surrender value then a payout grid can be hooked up to comply with NASD rule 2430. One should are seeking out professional consultation regarding this very paramount trouble.

NASD Rule 3030: No individual related to a member in any registered ability shall be employed by way of, or be given reimbursement from, every other individual as a result of any business hobby, aside from a passive investment, outside the scope of his relationship along with his company firm, unless he has furnished spark off written note to the member. As previously stated, the NASD has made it clear that life settlements are included in their interpretation of “promoting away” and it’s far a paramount region of problem where fallacious supervision exists.

NASD Rule 3040: Provides, amongst different things, that previous to participating in a securities transaction outside the path or scope of his or her employment, a person associated with a member firm ought to give that firm previous written notification. In addition, if the company is notified that the associated character may additionally get hold of promoting compensation, it’s far required to issue written approval or disapproval.

Licensing and Compensation Issues

The “Desk Drawer Broker-Dealer”
This approach is very simplistic in nature and is a logical opportunity to partnering with an unmarried Funder. The involved broker-supplier would create a promoting settlement with the specialized broking-dealer element that could behavior the life agreement transaction for a rate. All transactions could meet NASD necessities inclusive of pleasant execution. The broking-supplier with the undesirable policy would transact under an arms period association.

NASD “Blue Sky” Regulations
Aside from having a trendy securities license series 7 and collection sixty-three there are a few recommendations that must be adhered to. Although there’s confusion via most of the Funders as to how existence agreement transactions have to be conducted from state to country, it’s far logical that the broker-supplier and its Registered Representative need to maintain registrations in the kingdom from which the repayment originates, i.E., the Funder’s domestic state of commercial enterprise transactions. It needs to be emphasized but, that it is right business practice by using an RR to grow to be legal in every country that she or he plans on engaging in the business of life settlements.

Variable Policy Clearing
Although most of the guidelines bought within the secondary market are fixed, there’s the occasion when “variable rescue” may also come into play. In this case, it is usually recommended to clear via a “table drawer” dealer-provider as noted above. Needless to mention, shifting the sub-accounts to the coverage’s cash market does no longer constitute a set product and hence isn’t enough to avoid capacity NASD regulation.

USAPatriot Act
USA PATRIOT Act in October 2001Life settlement transactions are not excluded and should follow all rules and policies concerning us Patriot Act. Therefore, on the way to comply with anti-cash laundering (AML) legal guidelines, it follows that a regular commercial enterprise version of repayment fee could include the settlement broking company notifies its reduced in size worker and RR/BD of the particular greenback amount of a transfer a good way to derive from a source Provider company. The Registered Representative notifies the broker-supplier approximately the payment amount and its source to make sure Blue Sky registrations. After the dealer-supplier gets the charge to the Registered Representative (in compliance with NASD guidelines), the Registered Representative will deposit the budget into his LLC bank account (in compliance with the aforementioned IRS pointers), and offer separate invoices that meet uniform and unique identity requirements to both the agent’s broking-provider and to the life agreement broking company. The invoices might be signature executed with the aid of every entity and returned to the Registered Representative for inclusion in an everlasting document because of the reimbursement recipients. After payment is made with the aid of the Registered Representative’s LLC to the agent’s broker-supplier and to the life agreement dealer firm, the latter will offer the Registered Representative with an electronic replica of the unique case file that the Registered Representative will maintain within the identical permanent record because of the related bill copies.

The Life Insurance Settlement is an emerging and often misunderstood enterprise. While the concept of selling a coverage policy has been around for over a century, we’re now entering a generation wherein it may turn out to be commonplace. The secondary market, while nevertheless in its infancy, appears to have “grew to become the nook” and is quickly turning into a permanent a part of our economy and wealth control making plans. As the enterprise expands and matures we can see increasingly seniors benefit from the method. Moreover, we are able to see Registered Representatives experience developing new a brand new supply of finances for their customers which they, in turn, will place in a more appropriate and more appropriate funding. Today, greater than ever, broking-dealers and wire-houses are setting into impact “written techniques” or are mastering the potential advantages of the secondary marketplace for existence insurance. If conducted with prudence and with strict adherence to NASD policies and regulations existence settlements need to emerge as a major factor of mainstream wealth management for the dealer-dealer and wire-house network.

Jonathan H. Proby, CSA, MBA is a South Florida native having been born and raised in Coral Gables, Florida. He is the writer of “The Seven Most Costly Financial Mistakes Made By Seniors”, “The Ten Most Essential Things That You Must Know When Selling Your Insurance Policy”, and “Life Insurance Settlements and the NASD… A Study in Compliance”, is the past host of the Southern Most Wall Street Report on Conch FM and has authored different literary and columnist works.