NASD's Hot Topics for Protecting Investors

James J. Eccleston, esq.

eriodically the National Association of Securities Dealers (NASD) publishes its "Examination Priorities" and "Frequently Found Violations" in a document entitled, "Improving Examination Results." The publication is helpful as a roadmap to determine what NASD believes to be the hot topics for protecting investors. Let's explore some of those hot topics recently revealed.

The NASD discusses 14 Examination Priorities. Investors, and their lawyers, should pay particular attention to these priorities: variable insurance products; mutual fund share sales practices; equity indexed annuities; private securities transactions; and new products and non-conventional instruments.

Variable insurance products are a focus because of their "complexity" and the "numerous sales practice violations and supervisory failures." The NASD is concerned with problems such as the "overselling of enhanced riders", as well as supervision of hypothetical illustrations, variable annuities offered within qualified plans, and the "appropriateness of multiple contracts per client." The NASD also announces that it will "review contract financing which includes the use of free withdrawals to fund additional contracts."

The NASD focuses upon mutual fund share sale practices. That is because there are various share classes of mutual funds and firms that recommend mutual funds must ensure that the particular share class recommended is suitable for the customer, accounting for the effects of the fee structure on the investor's return. Firms also must protect investors by ensuring that they have sufficient supervisory systems to verify that customers are receiving appropriate breakpoints in the sales charge as well as sales charge waivers.

Equity indexed annuities (EIAs) concern the NASD because of the way that financial advisers "are marketing and selling unregistered EIAs, and the potential absence of adequate supervision of these sales practices." An equity indexed annuity is a costly insurance product that guarantees a stated interest rate and an opportunity to earn additional interest based upon the performance of a particular market index. The NASD states that it will focus on how well firms supervise their financial advisers in selling EIAs. Additionally, the NASD will concentrate its examinations upon "the suitability and supervision of variable annuity distributions, exchanges and replacements, the proceeds of which were used to purchase equity indexed annuities."

Private securities transactions will continue to be in the NASD's sights because some of the more egregious frauds are committed when financial advisers sell their clients securities offerings or deals outside of their firms. As a result, the NASD requires that financial advisers provide written notice to their firms, prior to the transaction, and the notice must include details about the transaction and the financial adviser's role in the transaction. In its publication, NASD warns that "once a firm approves the transaction, it must be recorded on the firm's books and records and supervised as if it were a transaction executed by the firm itself." NASD "closely" will monitor the adequacy of the firm's supervision of such transactions.

Finally, new products and non-conventional instruments concern the NASD. Why? Such products are "increasingly complex" and financial advisers frequently sell them to retail customers who may not understand them or be able to bear the risk of loss associated with them. NASD announces that "these new products raise suitability and supervisory concerns." Specifically, NASD is concerned about and will review to ensure that firms protect investors by having policies "that address the need to perform a product-level suitability analysis, customer-specific suitability analysis, ensure that promotional materials are fair, accurate and balanced, implement adequate internal controls, and provide training to registered representatives selling the products."

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James J. Eccleston is a securities attorney, representing customers as well as brokers and brokerage firms nationwide in arbitration, litigation and regulatory matters. He maintains an informative website at www.FinancialCounsel.com. He is an equity partner with Shaheen, Novoselsky, Staat, Filipowski & Eccleston, and can be reached at 312-621-4400.