SEC Delays Effective Date of Rule 151A on Fixed Index Annuities as It Works to Cure Analysis on DC Circuit Remand

As part of its request to the court of appeals to not vacate Securities Act Rule 151A while it is being cured on remand, the SEC agreed to a two-year stay of the rule’s effective date to run from the date of publication of a reissued or retained rule in the Federal Register. Rule 151A was to have taken effect January 12, 2011. Last year, a panel of the US Court of Appeals for the District of Columbia ruled that the rulemaking process was flawed by the fact that the SEC’s consideration of the effect of Rule 151A on efficiency, competition, and capital formation, as required by Securities Act Section 2(b), was arbitrary and capricious. American Equity Investment Life Insurance Co. v. SEC, No. 09-1021, CA DofC Circuit.

Rule 151A defines indexed annuities as not being exempt annuity contracts under Section 3(a)(8) of the Securities Act. Relying on a series of US Supreme Court rulings, the SEC reasoned 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. A fixed index annuity is a hybrid financial product that combines some of the benefits of fixed annuities with the added earning potential of a security. Like traditional fixed annuities, fixed index annuities are subject to state insurance laws, under which insurance companies must guarantee the same 87.5 percent of purchase payments. Unlike traditional fixed annuities, however, the purchaser’s rate of return is not based upon a guaranteed interest rate.

In its supplemental brief, the SEC assured the court that it can readily address judicial concerns with the Commission’s analysis of the effect of Rule 151A on efficiency, competition, and capital formation. Indeed, SEC staff have taken significant steps in this regard even before the court issued its mandate. Thus, the Commission believes that remand without vacatur is the most equitable and appropriate remedy in this case.

Refuting the petitioning company’s assertion that vacatur is required in all instances in which a rule violates the APA, the SEC pointed out that the practice in the DC Circuit has been to remand without vacating an agency regulation found to have been deficient for a failure to engage in reasoned decisionmaking or because the agency failed to follow the appropriate rulemaking procedures. Underlying the court’s decisions in this regard is a recognition that countervailing considerations often may justify allowing a rule to remain in place by remanding without vacatur to permit an agency to address a deficiency in the rule’s adoption that can be readily remedied.

In order to guide this determination, the court has used a two-prong test which the SEC believes that it passes, especially given the equitable circumstances. The first prong considers the seriousness of the deficiencies of the action, that is, how likely it is the SEC will be able to justify its decision on remand, while the second prong weighs the disruptive consequences of vacatur.

Vacatur will serve no equitable purpose, said the SEC, because concerns over when firms would have to comply with reissued Rule 151A are alleviated by the Commission’s consent to delay the effective date for two years. In addition, the Commission is working in good faith to promptly address the defect in its rule. To date, SEC staff have conducted a comprehensive survey of state insurance regulation of indexed annuities. Based on that state-law baseline, the staff is currently analyzing the impact Rule 151A would have on efficiency, competition, and capital formation.

The staff intends to complete this process and to bring a recommendation before the Commission in the Spring of 2010. If the staff recommends retaining Rule 151A, the staff also expects to recommend that the Commission seek public notice and comment on the efficiency, competition, and capital formation analysis.

Addressing specifically the first prong of the court’s test, the SEC noted that there is, at a minimum, a substantial likelihood that the Commission will be able to address on remand the court’s concerns regarding the Section 2(b) analysis. In initially remanding without vacatur, the court identified two alternative ways in which the Commission could remedy its deficient Section 2(b) analysis. First, the Commission could determine that it is not required to conduct the analysis here because it was proceeding under Section 19(a), a provision of the Securities Act to which Section 2(b), by a plain reading of its text, does not apply. Or, second, the SEC could undertake the analysis after first conducting a baseline analysis of efficiency, competition, and capital formation under the existing state-law regime. Either approach, or both, could be followed on remand and, the Commission staff already has taken significant steps towards addressing the court’s concerns.

The Commission did not conduct a baseline study of state insurance regulation of indexed annuities in adopting Rule 151A because it believed that prior Supreme Court’s holdings obviated any need to assess the current level of state-law regulation. Although the appeals court agreed with the Commission’s reading of the Supreme Court rulings, the panel held that the SEC’s obligations under § 2(b) are distinct from the questions posed before the Supreme Court, and that the Commission was therefore required to consider the state-law baseline in a Section 2(b) analysis in this case.

The court remanded Rule 151A to allow the Commission the opportunity to conduct a more thorough review of the existing state law regime, which could lead the Commission to decide ultimately that Rule 151A will promote competition, efficiency, and capital formation.

Bi-partisan legislation introduced by in the Senate would nullify the Commission’s adoption of Rule 151A before it has a chance to take effect. The Fixed Indexed Annuities and Insurance Products Classification Act, S. 1389, provides that Rule 151A will have no force or effect. There is a companion bill in the House, HR 2733. The draft legislation expresses a congressional sense that the SEC’s adoption of Rule 151A interferes with state insurance regulation, harms the insurance industry, reduces competition, and creates unnecessary and excessive regulatory burdens. The measure also embodies a congressional finding that indexed insurance and annuity products offered by insurance companies are subject to a wide array of state laws and regulations, including non-forfeiture requirements that provide for minimum guaranteed values, thereby protecting consumers against market swings.

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