Morningstar Advisor - Summer 2007 - (Page 22)

When It Comes to VAs, It’s Seller Beware NASD Rule 2821 would put the onus on advisors to prove a sale is appropriate for clients. Here’s how to ensure you have a suitability system in place. by Alan Lavine If financial advisors plan to invest part of their clients’ assets in a deferred variable annuity, they had better make sure the sale is appropriate. NASD Rule 2821, which sets requirements for a suitability obligation, principal review and approval, and supervisory and training, is expected to take effect within the next several months. Brokers will have 180 days to comply. The rule would codify and make mandatory best practice guidelines the NASD had previously issued concerning variable annuities. The bottom line to the financial advisor: A variable annuity should be considered a long-term investment that is carefully scrutinized by the brokerage firm before a sale is approved. And it should be well documented that the annuity is an appropriate investment for a specific client. “The proposed rule underscores the importance of good record-keeping,” says William D. Nelson, an attorney who represents wirehouses, independent broker-dealers, and state and federal registered investment advisors with the Denver law firm of Rothgerber Johnson & Lyons LLP. “As with any area of supervision, the best set of procedures in the world is essentially useless in the absence of clear contemporaneous records demonstrating that the procedures were implemented. It is essential that member firms establish efficient systems of reporting at crucial steps of the process and perhaps use the opportunity to review and improve procedures and systems in other product areas.” Rule 2821 would apply only to the initial purchase, the exchange of a variable annuity, and the initial asset allocation of the subaccount’s mutual funds. Subsequent transactions must adhere to NASD Rule 2310, which covers the sales suitability of all types of securities. At this writing, the NASD sought comments on an amending rule to the pending rule, involving the time supervisory principals would have to review a variable annuity sale. The amending rule would expand the review process to seven days from five days before the broker-dealer submits the application to the insurance company. Fortunately, most broker-dealers already have suitability compliance systems that adhere to the new rules, says Judith Hasenauer, who chairs the regulatory affairs committee of the National Association of Variable Annuities (NAVA), a Reston, Va.-based trade group. Many smaller broker-dealers are up to speed, she says, and those who aren’t are hiring third-party vendors to set up variable annuity compliance systems. Wilma Anderson, a financial advisor in Littleton, Colo., says that her suitability checklist is already in place and that she recently walked away from the prospect of a 1035 exchange that might have netted a huge commission. A new client had $450,000 in a variable annuity that had been performing poorly for two years. The variable annuity had a six-year surrender period. Rather than cash out the annuity and do a 1035 tax-free exchange into a new product, however, she reallocated the investment into a better managed mutual fund within the existing variable annuity. 22 Morningstar Advisor Summer 2007

Table of Contents Feed for the Digital Edition of Morningstar Advisor - Summer 2007

Morningstar Advisor - Summer 2007 Contents Letter from the Publisher Get to Know the Bond “All-Stars” Research Briefs Our Stewardship Test Gets Tougher Save It for Later Too Many Oranges Best of Both Worlds No Two Clients Are Alike When It Comes to VAs, It’s Seller Beware Hands On: Finding the Suitable Fund Share Class for Your Client Fund Style Can Drift Off Course Sticking to Their Style, Through Thick and Thin Marathon Man Growth, With a Chaser A Menu of Ideas to Fill Five Market Baskets Funds: Finding Funds with Conviction Stocks: So You Say You Want Income? All Eyes on China Mutual Fund Analyst Picks Undervalued Stocks Most Popular Variable Annuities What’s New at Morningstar and on the Web The Advisor’s Economic Moat

Morningstar Advisor - Summer 2007

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