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SEC Rule 151A Challenged in Federal Appeals Court

By Jim Hamilton

SEC Rule 151A defining indexed annuities as not being exempt annuity contracts under Section 3(a)(8) of the Securities Act is being challenged in federal court by issuers of fixed indexed annuities that will be subject to SEC regulation as a consequence of the rule. Fixed indexed annuities as described by the SEC are annuities, argued the issuers, not regulated securities. They are uniformly recognized as such by the states and are
subject without exception to the state laws that exist to assure that insurance products provide protections against risk commensurate with the name. Unlike variable annuities and mutual funds, noted the issuers, fixed indexed annuities are not marketed or valued according to the investment management of the issuer. The petitioners asked the federal appeals court to vacate Rule 151A.

Earlier this year, the SEC adopted Rule 151A in order to clarify the status under the federal securities laws of indexed annuities, under which payments to the purchaser are dependent on the performance of a securities index. Section 3(a)(8) of the Securities Act provides an exemption for annuity contracts. The new rule prospectively defines indexed annuities as not being ?annuity contracts? under this exemption if the amounts payable by the insurer under the contract are more likely than not to exceed the amounts guaranteed under the contract. The effective date of Rule 151A is January 12, 2011, two years after its adoption. Rule 151A was challenged in the US Court of Appeals for the District of Columbia Circuit. American Equity Investment Life Insurance Company v. SEC, No. 09-1021. Oral argument was held on May 8, 2009.

In its brief defending its adoption of Rule 151A, the SEC, relying on a series of US Supreme Court rulings, said that, given the unpredictability of the securities markets, index annuities contain substantial risk that must be addressed by the disclosure regime established by the Securities Act so that investors can accurately evaluate their investment risk.

The petitioner contended that fixed indexed annuities are exempt from regulation as securities according to the plain terms of Section 3(a)(8), which exempts ?any? annuity contract from SEC regulation, and there was no need to deploy the analysis used in the Supreme Court opinions. Picking and choosing which annuities to regulate as securities was outside the Commission?s authority, argued the brief.

But even if the Supreme Court analysis is deployed, continued the issuers, fixed indexed annuities plainly satisfy that analysis, while the terms of Rule 151A conflict with the Supreme Court?s decisions and the statutory text. Further, the issuers said that the rule?s invalid terms result from the SEC?s use of a definition of investment risk that conflicts with the governing case law and common parlance. In its haste to finalize the rule only a month after the comment deadline, contended the petitioners, the Commission ignored record evidence about the meaning of investment risk and the marketing of indexed products.

The petitioners also said that the SEC incorrectly characterized indexed annuities as similar in many ways to mutual funds, variable annuities, and other securities in that purchasers of indexed annuities assume many of the same risks as investors in mutual funds and variable annuities. The petitioner noted that, in contrast to mutual funds and variable annuities, fixed indexed annuities are subject to the full panoply of state insurance laws whose function is to protect against risk of loss, guaranteeing that a contract owner receives no less than 87.5 percent of premiums even if the contract is surrendered in the first year, and assuring that the minimum contract value will increase at a rate of at least 1 to 3 percent annually for the life of the contract.

These are identical to the guarantees for traditional fixed annuities. Moreover, fixed indexed annuity premiums are invested in insurers? general account subject to special state investment requirements, and contract values are not based on insurers? investment management.

Full post as published by Jim Hamilton's World of Securities Regulation on May 27, 2009 (boomark / email).