After years of relative silence related to variable annuity exchanges on the regulatory front, the U.S. Securities and Exchange Commission announced last week settled charges against RiverSource Distributors, Inc. (“Distributor”) under Section 11 of the Investment Company Act of 1940, which regulates variable annuity exchanges. This is the first SEC enforcement action under Section 11.
Section 11 prohibits variable annuity principal underwriters from making or causing to be made an offer to exchange one variable annuity contract for another variable annuity contract unless the terms of the exchange offer have been approved by the SEC by rule or order (technically, Section 11 applies to exchanges of securities issued by unit investment trusts, which covers most variable annuity exchanges).
According to the SEC order, between January 2017 and May 2018, the Distributor violated Section 11 by efforts of certain wholesalers to develop lists of in-force annuity contract holders and then using the lists to encourage registered representatives to offer to the identified contract holders new variable annuity contracts as replacements for their current variable annuity contracts. The SEC order noted that the lists highlighted compensation that the registered representatives would receive through the exchange.
Without admitting or denying the SEC’s finding, the Distributor consented to an order finding that it violated Section 11 and imposing a cease-and-desist order, a censure, and a $5 million civil penalty.
According to the SEC order, the lists identified variable annuities underwritten by the Distributor and issued by an affiliated insurance company. Exchanges involving those annuities fell outside of the 1994 Alexander Hamilton no-action letter, in which the SEC staff took the position that Section 11 does not apply to exchanges involving unaffiliated insurance companies (unless the companies agree formally or informally to develop an exchange program).
The SEC order does not mention Section 11’s so-called retail exception, which provides that the prohibition of Section 11 does not include “an offer made by such principal underwriter to an individual investor in the course of a retail business conducted by such principal underwriter.” Presumably, the SEC does not view the activity described in the order as covered by the retail exception. It is notable that the Distributor itself ceased the activity in 2018 when its compliance department put a stop to the activity. The SEC’s most recent published guidance on the retail exception is the 2001 letter issued to industry trade groups.
Exchanges are expressly permitted under the conditions specified in the one rule covering annuity exchanges, Rule 11a-2 under the 1940 Act. The SEC has approved by order some exchange programs outside of Rule 11a-2, including a series of exchange programs involving bonus products from 2000-2005 and several more recent orders.
The Financial Industry Regulatory Authority (“FINRA”) is also involved in variable annuity exchanges, including a recent Investor Insights posting and a lengthy section in FINRA’s 2022 Report on its examination and risk monitoring program (which also addresses compliance with FINRA Rule 2330).