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FINRA Issues New Guidance on Variable Life Settlement Transactions

On July 30, 2009, the Financial Industry Regulatory Authority (“FINRA”) issued Regulatory Notice 09-42 entitled “Variable Life Settlement Transactions - FINRA Reminds Firms of Their Obligations With Variable Life Settlement Activities” (the “Notice”).  The Notice reaffirms and expands on the guidance regarding variable life settlements set out in FINRA's August 2006 Notice to Members 06-38.  

The stated impetus for issuing the Notice is “poor economic conditions, volatility in the financial markets and negative economic forecasts,” and FINRA’s concern that “investors may consider selling their variable life insurance policies to obtain additional cash without fully appreciating the risks of variable life settlements.  The potential risks on which FINRA focuses are: unexpected tax liabilities, diminished insurable capacity, privacy issues and potentially high commissions. 

The Notice also expresses concern about the treatment of investors who purchase investment products that are derivative of or based on life settlements - what the Notice refers to as “related products.”  In an endnote, the Notice defines “related products” as “a security that is an interest in a single life policy, or a group or a pool of such policies, whether variable or not, such as an asset-backed security backed by life insurance policies, or a security where the obligation to pay interest or principal to the holder is contingent or partially contingent upon the death of one or more insured persons under life insurance policies . . . .” (Emphasis added).

While there is no debate as to whether instruments sold to investors backed by life settlements are securities, it is somewhat startling that the Notice specifically includes an interest in “a single life policy” “whether variable or not” within the definition of “related products.”  The Notice flatly states that “[t]ransactions in related products are also securities transactions that are subject to the federal securities laws and all applicable FINRA rules.”  Because FINRA does not have the authority to designate that any specific financial product is a security, it must be assumed that FINRA’s reference to a single policy, whether variable or not, as a related product (and, thus, a security) refers to a single policy that has been fractionalized and interests therein sold to several different investors. 

Also worthy of note is FINRA’s conclusion that engaging in business activities related to variable life settlements constitutes a material change in a firm’s business operations under NASD Rule 1011(k), and that prior to engaging in variable life settlements, a firm must file a Continuing Membership Application and receive approval of the change in business operations under NASD Rule 1017.  FINRA also provides additional guidance on suitability and disclosure, advertising and commissions and fees. 

Specifically on the topic of commissions and fees, the Notice expresses unease that policy owners who sell their variable life policies may be charged excessively high commissions or fees.  FINRA addresses several factors that it suggests do not necessarily support a firm’s ability to charge commissions that FINRA suggests are excessive.  FINRA invites firms to review the factors set out in NASD Rule 2440 for determining the fairness of a commission, but notes that securities products sold for commissions in excess of 5% will be subject to heightened scrutiny.

The Notice makes clear that FINRA continues to be focused on transactions involving variable life policies, and member firms that transact such policies will need to confirm that they are complying with all of the obligations as FINRA members.

Please click here for a link to the full FINRA Notice.

Copyright © 2009 Morris, Manning & Martin, LLP.


About this Author

Jim Maxson, Insurance lawyer, Morris Manning & Martin

James W. Maxson is Of Counsel in the firm’s Insurance and Reinsurance Practice. Mr. Maxson’s areas of expertise include life settlements, mergers and acquisitions, securities and regulatory issues.

Mr. Maxson is Co-Chair of the firm’s Life Settlements group and his practice focuses on all aspects of the life settlement industry. He has performed extensive work in the areas of licensing, regulatory compliance, fund structuring, and policy acquisitions.

Mr. Maxson worked for four...