In August 2006, the NASD issued NtM 06-38 to inform members of their obligations regarding the sale of existing variable life insurance policies to third-parties (Life Settlements). Up until this time, many broker/dealers treated life settlement activities by the registered representatives as an outside business activity or private securities transaction and were not directly involved in the determination of suitability, pricing or ongoing supervision related to this activity. However, with the issuance of NtM 06-38, the NASD has established that life settlements involving variable life insurance contracts are securities activities and subject not only to the supervision of the broker/dealer but to regulation by the NASD.

What does this mean?

• Broker/dealers who permit their registered representatives to engage in these activities must be approved by the NASD to engage in this business. Broker/dealers who are currently approved for Variable Insurance business but did not include Life Settlements in the initial application or any subsequent amendments to their approved business lines, will now have to file an application with the NASD (1017 application) to add Life Settlements to their approved business lines.

• Life Settlement Providers who engage in the purchase of variable life policies will also need to become registered with the NASD to engage in this activity.

• Broker/dealers will be responsible for developing supervisory procedures related to suitability review, due diligence on providers, best execution for the customer, compensation and training. 

1017 and New Member Applications – When the NASD issued the NtM in August, they were unprepared for the frenzy this would cause and are working diligently to develop criteria for the review and approval of the applications from broker/dealers. Since the product is related to a variable insurance policy, but is not an insurance product itself, special procedures will need to be developed to address sales charges and compensation as well as suitability standards and overall supervision. Unfortunately, it looks like those firms who have taken the lead in trying to get approved will be the guinea pigs in helping the NASD develop their own processes and standards for these procedures.

Procedures – In developing internal procedures related to these products, members should consider the following:

Suitability: Rule 2310 requires that members and/or their registered persons have a reasonable basis for believing that a transaction is suitable for the customer. This determination includes an evaluation of the client’s tax status, investment objectives, financial status, age, etc In the case of a life settlement, this will also include:

• The ongoing need for the insurance;
• The purpose for the life settlement;
• If the individual and the policy itself meet their criteria for a life settlement as established by the providers, and
• Other options available to the policyholder

Due Diligence: Broker/dealers will need to evaluate the providers with whom they or their representatives may conduct business to determine the criteria under which they will purchase policies, how they will ensure confidentiality of customer information, any special provisions that may render the transaction void and any ongoing responsibilities of the policy owner.

Compensation: Members must ensure that compensation paid in consideration of life settlements are paid in accordance with applicable rules and that sales charges/commissions do not exceed the NASD’s guidelines.

The moral to this story – If you are currently permitting your registered representatives to engage in the sale of life settlements as outside business activities or private securities transactions, you need to review this policy given the guidance in NtM 06-38 and either prohibit the activity or take steps to ensure your firm is approved for this business line and that you have procedures in place to supervise these activities. For more information, please refer to NtM 06-38 or give Regulatory Compliance a call at 603-434-3594.