Speech by SEC Staff:
Remarks Before the National Association for Variable Annuities 2006 Compliance and Regulatory Affairs Conference
by
Andrew J. Donohue1
Director, Division of Investment Management
U.S. Securities and Exchange Commission
Washington, DC
June 26, 2006
I. Introduction
Good afternoon. It is my pleasure to be here today. I would like to thank NAVA for its generous invitation to speak at this conference. Before I begin, I need to remind you that my remarks represent my own views and not necessarily the views of the Commission, the individual Commissioners, or my colleagues on the Commission staff.
I am very pleased to be speaking to this group because of the important role that you play in variable insurance product compliance. Among my many past experiences, I've been an officer and a director of an insurance company, and I know the challenges that you face. From my vantage point, I understand both how difficult the work that you do is and also how important it is to this nation's investors. I look forward to a continued dialogue with you concerning the regulatory issues confronting your industry.
As I thought about my remarks for today, I took note of the theme of your conference, "Maintaining a Competitive Edge in Today's Regulatory Environment." The theme perhaps suggests that maintaining a competitive edge is something that happens in spite of the regulatory environment and not because of it — that regulation and competition are somehow at cross-purposes. In reality, I think that, in this industry, regulation and competition at their best both have the same goal — serving the needs of investors.
Today I will be talking to you about some current initiatives of the Division of Investment Management and the Commission. I would emphasize, though, that I am only at the start of my seventh week at the Commission, and I am very interested in hearing from you regarding the challenges that you confront and your views on what the Division's priorities should be. My remarks are intended to serve as a starting-point for a dialogue. I know that I speak for Susan Nash, Bill Kotapish, and all of the staff in the Office of Insurance Products when I say that we want to work with you in the service of investors. I commend to you the panel discussion this afternoon that will involve several of the Division's fine staff members — Bob Plaze, Bill Kotapish, and Rick Sennett. I know that you will find their remarks to be of great interest, and they will fill in many areas that I will only touch upon.
II. Disclosure
As I'm sure you are all aware, Chairman Cox has made improving investment company disclosure one of his top priorities. As the Chairman has emphasized on a number of occasions, the Internet and interactive data have the potential to improve the quality of disclosure for the average investor — to revolutionize how investors access, use, and ultimately understand information. Our goal is to empower individual investors to make better decisions for their financial goals, not the least of which is retirement. This is where you come in. Your industry is very much focused on helping individual investors to accumulate the savings needed for retirement and, increasingly, on the distribution of those retirement savings. As such, the variable products industry, like the mutual fund industry, should be one of the starting points for better disclosure and the use of interactive data.
The Commission already requires variable annuities and their underlying funds, like other investment companies, to disclose a great deal of important information in a number of filings. Much of this information is delivered directly to investors, typically in paper. There are prospectuses for new and existing contract owners, twice-yearly shareholder reports, and proxy statements in connection with shareholder meetings. A wealth of other information is available through the Commission's EDGAR website, including semi-annual reports on Forms N-CSR and N SAR, quarterly reports of portfolio holdings on Form N-Q, and annual proxy voting records filed on Form N-PX.
The essential data that a typical investor would need and want lies buried within these documents, as does a great deal of other important information that is used by financial advisers, third-party analysts, and other intermediaries who help investors. To state the obvious, though, the average investor with access to these documents in paper, or even with access to the online equivalent of this paper, will have a difficult time figuring out what the critical information is, much less finding and digesting it in a timely manner, and will have an even harder time comparing it against similar disclosures for other variable annuities.
The Division is interested in finding a better way to highlight the key information that is critical to a typical investor, perhaps a short summary of the most essential information. We also want to tame the mass of available data and make it useable, whether for an annuity investor or one of the many intermediaries who digest the information and repackage it for investors. It is here that interactive data holds so much promise. Perhaps interactive data could help investors quickly pull up and compare the surrender charges for five different variable annuities at a glance. Or it might allow an advisor to track changes in the portfolio holdings of an underlying fund to better assess how closely the stated objectives and strategies of the fund are followed. The possibilities are endless and full of great promise.
Two weeks ago, I had the pleasure of moderating an SEC-sponsored roundtable discussion on interactive data and the exciting possibilities that the internet brings to mutual fund disclosure. One of the panels featured a frank discussion about the types of information that are most useful to mutual fund investors. Panelists were drawn from the ranks of investor advocates, industry, research organizations, academia, and self-regulatory organizations. What struck me was the consensus among all these individuals representing many viewpoints that a short-form document could be more effective than the current mutual fund prospectus as a tool for getting key information into the hands of investors — and by that I mean the information they want and need to make an informed investment decision. Of course, the problem of information overload is magnified for variable annuities, where the two-tier structure results in delivery of prospectuses for both the contract and the many underlying fund investment options.
For that reason, I was very pleased to learn that NAVA is working on recommendations for an improved disclosure regime for variable annuities, using a streamlined document containing key disclosures, which could potentially be hyperlinked to more detailed information. I applaud the efforts that you are undertaking in the critical task of getting better information to variable annuity investors. I hope that NAVA will take a long and hard look at the use of interactive data as you move forward. The Division welcomes your help in making interactive data a reality within the variable annuity world.
Before I leave the topic of disclosure, I want to say just a word about plain English and, more broadly, clear communications. I don't need to remind any of you that your products are often complex. The proliferation and complexity of alphabet soup benefits available under variable annuity contracts — gmdbs, gmwbs, gmibs, to name a few — make it critically important that your investors understand what these benefits are, how they work from an investor's standpoint, and what they cost. You've got to use the tools at your disposal — required disclosures, sales materials, and your sales force — to communicate plainly to your customers what they are buying and how much it costs. This challenge lies squarely in your court — the cost to you of not meeting this challenge will be confused and disappointed investors and, ultimately, damage to your reputation.
III. Exemptive Applications
One area to which I expect to devote significant attention is the processing of exemptive applications. I know that a number of people have expressed concerns about the time it takes to get an application through the Division. We will focus on novel applications, like those for exchange-traded funds. And we will focus on the processing of more routine applications as well. I and the Division staff are committed to doing all that we can to streamline the process while maintaining appropriate investor protections. If you have particular concerns about our exemptive applications process, I would be pleased to hear of them.
One way to streamline the exemptive applications process is to codify some of our more routine application types through exemptive rules. Just last week, the Commission published final rules that broaden the ability of funds to invest in other funds without obtaining individual exemptive relief. The rules will also enhance the transparency of expense disclosures for funds of funds. The Division is considering whether there are other particular areas of exemptive relief that may be appropriate for Commission rulemaking. As the Commission adopts exemptive rules, I expect the queue of outstanding exemptive applications to diminish.
IV. Rule 22c-2
I would like to say a few words about Rule 22c-2, the Commission's redemption fee rule, which was adopted to combat the market timing abuses that were uncovered in the mutual fund and variable product industries in recent years. In February of this year, the Commission requested comment on proposed amendments to the rule that would, if adopted, refine the information-sharing requirements of the rule. We have received a number of thoughtful comment letters, including several from NAVA and others in the variable insurance industry. I know that a number of you have raised serious concerns in your comment letters. Though I can't predict where the Commission will come out with respect to any particular issue, I do want to assure you that the comments you have provided will receive full consideration.
Along with a number of other commenters, NAVA has requested that the October 16 compliance date for information-sharing agreements between funds and financial intermediaries be extended. While no decisions have been made in this area, the Division is mindful both that the proposed amendments are still pending and of the efforts that will be necessary to come into compliance with the rule. In this regard, I do want to acknowledge NAVA's ongoing work to develop a standardized agreement for use by the variable annuity industry to facilitate information-sharing. We are pleased that you are working to facilitate a smooth transition to compliance with Rule 22c-2.
V. Sales Practices
I'd like to turn next to the area of sales practices. Sales practices associated with variable annuities are a persistent area of interest for a variety of reasons, perhaps most prominently the high level of exchange activity in the industry, which is estimated to represent more than half of gross sales. The rate of exchanges, coupled with product complexity and sales to seniors, combine to make variable annuity sales practices an area of continuing concern. As regulators, our bottom line in this area is that the investor's interests should come first.
A. Product Complexity
Competition in the financial services industry is intense. The variable insurance industry is no exception, and competition has often led to product complexity. Several years ago, the industry saw the introduction of bonuses. Along with bonuses came the need to explain the bonuses and, in particular, the need to explain the complex charge structure that accompanied the bonuses. More recently, the staff has seen a proliferation of various optional benefits, in the form of riders that a customer can opt to purchase at an additional charge. I alluded earlier to the alphabet soup of gmdbs, gmwbs, and gmibs, each a guarantee of one sort or another. Product innovation is a good thing, and certainly some of the newer guarantees are attempting to fill a desire of those nearing retirement to remain invested while, at the same time, having a cushion of security. At the same time, all of the available bells and whistles can have the effect of confusing investors and, quite frankly, can be difficult to understand for the selling brokers as well. In such an environment, good sales practices become particularly important. It is imperative that you know your customer and your customer's needs, and that you explain clearly to your customer what he or she is buying and what it costs.
B. Sales to Seniors
Throughout their lives, the baby boomers have been a target for marketers. As the boomers have aged, and their wealth has accumulated, they have become a target market for financial products that address retirement needs. In many ways, this is a good thing. With the decline in defined benefit pension plans, and the rise of 401(k) plans, Americans have increasingly become responsible for providing for their own financial needs in retirement. With improved health care and increased longevity, retirees are faced with planning for a longer retirement. America's aging population needs financial products and financial advice that will help to secure their futures for many years to come. Variable annuities, and particularly some of the recently-introduced guarantees, are aimed at meeting these needs and helping the elderly to ensure that they do not outlive their assets.
At the same time, some industry professionals target seniors for inappropriate investments, and the variable annuity industry has been the subject of concerns regarding this type of conduct. Chairman Cox has spent a good portion of his time as SEC Chairman working to ensure that America's seniors are protected against those who would cheat them out of their life savings, and you can expect to see a continued focus at the Commission on seniors issues. The Commission's focus, of course, extends well beyond variable annuities, but I thought that you would be interested in what we are doing because of your industry's interest in retirement products.
The Commission has announced a three-pronged approach to combat investment fraud on senior citizens, which includes education, examinations, and enforcement. The SEC has education programs specifically aimed at older Americans. I urge you to look at the Commission's website. The website has a portion specifically directed to seniors issues, which provides links to information about investments that are commonly marketed to seniors, including variable annuities, promissory notes, and certificates of deposit. To detect abusive sales tactics that target seniors, Commission examiners will share regulatory intelligence with their counterparts at the state level and with other regulators. Once the staff identifies firms that may be preying on seniors, they will examine the sales practices of those firms. Finally, we will address fraud aggressively. Our Enforcement Division has brought a significant number of enforcement actions aimed specifically at protecting elderly investors in recent years, and we intend to keep up our efforts.
As the Commission and its staff work to protect seniors, we are joined in our efforts by both state regulators and the NASD. The work that we do has a much larger impact because of these cooperative efforts. Recently, Chairman Cox announced that he will convene a "Seniors Summit" of regulators and organizations that are vitally concerned with seniors to publicly discuss what steps can be taken to better protect our nation's seniors.
C. NASD Rule 2821
In the area of sales practices, I want to call your attention to the fact that, last week, the Commission noticed for public comment NASD's amendment to its proposed rule 2821, which includes suitability, principal review and approval, and supervisory and training requirements tailored specifically to transactions in deferred variable annuities. We welcome your comments.
VI. Closing Remarks
At the outset of my remarks, I indicated that in my view, in this industry, regulation and competition at their best both have the same goal — serving the needs of investors. Today, I have sketched for you the broad outlines of some initiatives that the Division will be working on in the coming months. My pledge to you today is that, in all that we do, the Division will keep its eyes on America's investors and on what will serve their needs. I trust that you and your companies will do the same as you develop and market variable insurance products. As long as both we and you remain true to America's investors, I believe that your companies will be well along the pathway to maintaining a competitive edge within the regulatory environment.
I look forward to working with each of you for the good of America's investors. Enjoy the rest of the conference. Thank you.
Endnotes
http://www.sec.gov/news/speech/2006/spch062606ajd.htm
