Ghost of 151A laid to rest in Illinois

Although the proposed SEC Rule 151A that would have classified fixed indexed annuities (FIAs) as securities was defeated quite some time ago, the contentious issue was revived recently in Illinois. A ruling in a case involving Pinnacle Investment Advisors led some annuity issuers to conclude that the state was characterizing FIAs as securities.

One insurer, Fidelity & Guaranty Life Insurance Co., asked the state's Securities Department to clarify that Illinois does, in fact, exempt FIAs from securities legislation. Their answer came last week, when the department issued a no-action letter, stating that fixed indexed annuities and the agents that sell such products are not subject to securities legislation under Illinois law.

To get a better understanding of the case and its background, LifeHealthPro.com spoke to Eric Marhoun, right, general counsel, senior vice president and secretary at Fidelity & Guaranty Life.

LHP: How did this no-action letter come about?

Eric Marhoun: It arose initially out of an enforcement action brought against Pinnacle Investment Advisors. We and other annuity issuers were concerned about the potentially ambiguous findings in an order entered by the Illinois Securities Department against Pinnacle that was issued in May 2011. The order potentially created the impression that FIAs or other fixed annuities might be securities under Illinois securities law. So we approached the department and made a formal request for clarification that fixed annuities and fixed indexed annuities aren't subject to securities legislation. We made the request in the form of a request for a no-action letter. The letter of January 10 is in response to that request.

LHP: Wasn't that issue settled when 151A was defeated?

Marhoun: They issued the order in 2011. 151A was struck down in the Harkin amendment in 2010. Because there was an appeal of this [Pinnacle] order, in the briefing, the Illinois Securities Department through the Attorney General's office took the position that Illinois didn't follow federal law in all instances. That, I think, was part of the reason for the confusion. Under Illinois law, there are two reasons why annuities that satisfy the requirements of the Harkin amendment are not securities. One is just by operation of Illinois law, properly understood, they are not subject to regulation. And Illinois does generally follow federal law and therefore it would follow the Harkin amendment. The confusion seemed to arise because the briefing in the [Pinnacle] action was unclear as to when Illinois would follow federal law. Obviously, the no-action letter simply clarifies under Illinois law these products are exempt.

LHP: Why should FIAs not be considered securities?

Marhoun: Because they provide guarantees that are regulated by state insurance laws and are consistent with the prior safe harbor of SEC Rule 151. Securities law has generally recognized that products that satisfy the requirements under state law relative to the standard non-forfeiture law should not be treated as securities because the insurance company bears the investment risk. The Harkin amendment clearly codifies that.

LHP: How did Fidelity & Guaranty Life get involved in case?

Marhoun: Although we were not directly involved in the Pinnacle Investment Advisors action, and our products were not specifically at issue, some of the statements made in the order and the briefing caused concern relative to all fixed annuities and particularly all fixed indexed annuities. As an issuer we were concerned and simply sought clarification. The no-action letter was the result of a lot of good discourse with the Illinois Securities department and we appreciate their efforts and are pleased with the no action letter. I think it's notable that the no-action letter does not detract from the Illinois Securities Department's authority over investment advisors, which was somewhat at the heart of the Pinnacle case. The letter does set the record straight that lawfully issued indexed annuity product sold by properly licensed insurance agents are not subject to securities regulation at either the state or federal level.

LHP: What was the language in the ruling that made you think the state wanted fixed indexed annuities to be regulated as securities?

Marhoun: In the actual enforcement order against Pinnacle Investment Advisors there were references to investment contracts and it wasn't clear if they were referring to the package of financial advice offered by Pinnacle Investment Advisors or the indexed annuities. That was one source of confusion. The other source of confusion was some of the briefings in the litigation implied that these products were investment contracts because Illinois claimed that it didn't necessarily need to follow federal law. The issue is somewhat unique to Illinois, because Illinois and a very small handful of other states deviate somewhat from the Uniform Securities Act. So it isn't as clear in some of these states that fixed annuities are not securities. In our opinion, those differences are probably more form over substance. But it was a departure that might cause some confusion in Illinois. In our view, Illinois does exempt annuities from the definition of securities. It's just that the exception is found in a different place than in the Uniform Securities Act.

LHP: What does this mean for insurance agents in Illinois?

Marhoun: It removes any cloud over their heads as to whether they would have to get registered as securities brokers. Now it's clear, there is no need for them to do that.

See also:

A regulatory roadmap for annuities

No rest for the weary

Lighting the fuse