APPENDIX Re H.R. 9419, proposed District of Columbia Securities Act. Chairman, Securities and Exchange Commission, MAY 12, 1964. DEAR MR. CHAIRMAN: Pursuant to the request of Senator Vance Hartke, chairman of the Judiciary Subcommittee of the Senate Committee on the District of Columbia, I have been requested to seek from you a clarification of your position on section 2(1) of the above bill dealing with inclusion of variable annuities under the proposed law. May I call your attention to your testimony before Committee No. 2 of the House Committee on the District of Columbia, on May 2, 1963 (pages, as marked, 41 and 42); and a comparison of that position with that taken by you before the Judiciary Subcommittee of the Senate Committee on the District of Columbia, on April 29, 1964 (pages, as marked, 6 through 10, vol. 1, of the attached transcript). May I further call your attention to a statement by Senator Hartke, set out on page 152 of the Judiciary Subcommittee of the Senate Committee on the District of Columbia hearings, held on April 29, 1964, and detailed on pages 152 and 153, volume 3, attached transcript, in further explanation of the above. It will be appreciated if this position clarification could be provided at an early time since it is hoped the subcommittee can act in this area in the near future. Sincerely yours, CHESTER H. SMITH, Staff Director. SECURITIES AND EXCHANGE COMMISSION, Re H.R. 9419, proposed District of Columbia Securities Act. Staff Director, Senate Committee on the District of Columbia, DEAR MR. SMITH: This is in reply to your letter of May 12 in which you request a clarification of my position with respect to the provisions of H.R. 9419 dealing with the inclusion of variable annuities under the bill. You refer to my testimony before a House Subcommittee on the District of Columbia on May 2, 1963, and to my testimony before the Judiciary Subcommittee of the Senate Committee on the District of Columbia on April 29, 1964, together with certain remarks of Senator Hartke contained in the transcript of the hearings of the Senate subcommittee. It is our basic position with respect to this legislation that there is need for a strong blue sky law in the District of Columbia to be administered by an appropriate agency of the District government. I testified to this effect both before the House subcommittee and before the Senate subcommittee. At the time when I testified before the House subcommittee in 1963, I was under the impression that there was agreement among the proponents of the legislation that, as a matter of local regulatory policy, sellers of variable annuities should be regulated by the Superintendent of Insurance rather than by the Public Service Commission. Although, as I pointed out to the House subcommittee in the testimony to which you refer, it was our view that "persons who sell variable annuity contracts may be more appropriately regulated by a securities commissioner." I did not think it necessary for us to attempt to disturb what I assumed to be a local agreement as to the selection of the local regulatory agency. I did think it necessary to make it clear, however, that this selection of a local agency was not intended to have any significance with respect to the treatment of variable annuities as securities within the meaning of the Federal securities laws. I made this point in the last paragraph of the testimony to which you refer before the House subcommittee, which is as follows: "In any event, it is not our understanding that considerations leading to a choice of regulatory authorities on a local level are intended to have any significance with regard to our administration of a problem which is national in scope." I subsequently learned that there was no firm agreement as to the selection of the local agency and that there was a substantial feeling that sellers of variable annuities in the District should be regulated under the securities law rather than under the insurance law. In the course of efforts to resolve these differences, I was requested to advise Hon. Walter M. Tobriner, President of the Board of Commissioners of the District of Columbia, of our views as to the solution and I accordingly wrote to him on July 3, 1963, stating that the Commission believed that the appropriate position was to treat variable annuities in the same manner as other securities, and to provide no exemption for them. In my testimony before the Senate subcommittee on March 5, 1964, I referred to these developments and elaborated on our reasons for concluding that regulation of sellers of variable annuities under H.R. 9419 would be more appropriate and would bring about a better coordination with the Federal regulation of such sellers as brokerdealers under the Securities Exchange Act of 1934. I also indicated, at the end of the testimony to which you refer, that we felt it would be in the public interest for the Senator to concur in the decision of the House with respect to this matter rather than entangling this important legislation in a controversy over the regulation of a relatively small group. In summary, when I testified before the House subcommittee, I did not think it necessary for this Commission to take a firm position as to the selection of a local regulatory agency, if all the local interests concerned were in agreement with respect to that matter. Finding they were not in agreement and being requested to state the Commission's position, I did so in my letter to Commissioner Tobriner and in my testimony before the Senate subcommittee. I trust that the foregoing will clarify my position as requested by Senator Hartke. In connection with Senator Hartke's remarks set out on page 152 of the transcript of the hearings on April 29, 1964, it seems to me that Mr. Gilbertson confused the issue to some extent by suggesting a conflict between my position and the assumed position of Allan Conwill, the Director of our Division of Corporate Regulation. Mr. Gilbertson quoted from portions of a speech which Mr. Conwill made before the National Association of Insurance Commissioners in June 1962, which was well before any question with respect to the treatment of this matter in the proposed District of Columbia securities law had ever arisen. I enclose for your information a copy of Mr. Conwill's speech. As you note, he was suggesting a method by which State regulation of the issuers of variable annuities might be coordinated with Federal regulation of such issuers under the Investment Company Act of 1940. This has no particular relevance to the selection of an agency to regulate sellers of variable annuities under the local law of the District of Columbia. I hope that this will clarify the matter, and if there is any further information which you need, please let me know. Sincerely, WILLIAM L. CARY, Chairman. SPEECH BY ALLAN F. CONWILL, DIRECTOR, DIVISION OF CORPORATE REGULATION, SECURITIES AND EXCHANGE COMMISSION, BEFORE THE NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS, MONTREAL, QUEBEC, CANADA, JUNE 19, 1962 COMPATIBLE REGULATION OF VARIABLE ANNUITIES May I first express my appreciation for your gracious invitation to appear before you this morning. The invitation is particularly welcome because it affords the staff of the Securities and Exchange Commission the opportunity to present for your consideration the results to date of our extensive, if not exhaustive, search for a compatible method of State and Federal regulation of variable annuity contracts and their issuers. I am sure you are all familiar with the 1959 decision of the Supreme Court in Securities and Exchange Commission v. Variable Annuity Life Insurance Co., the so-called Valic case, where it was held that variable annuity contracts were securities subject to registration under the Securities Act of 1933 and that the companies issuing those variable annuity contracts were subject to regulation under the Investment Company Act of 1940. Following the Valic decision, the Commission granted ad hoc relief to Variable Annuity Life Insurance Co. and Equity Annuity Life Insurance Co., the two companies involved in the case, in order to avoid subjecting them to undue hardship and to permit them to continue in businesses established and operated for several years prior to the ultimate result of the litigation in the good faith belief that the Investment Company Act was inapplicable to them. The relief was in the form of conditional exemptions from the operation of some but by no means all-of the provisions of the Investment Company Act. I want to emphasize the purely ad hoc nature of this Commission action. The Commission was well aware at the time that the treatment afforded Valic and Ealic in no sense represented a satisfactory overall method of investment company regulation of variable annuity companies. The Commission recognized that it had the responsibility of exploring and developing a solution to a much broader problem; namely, how may the Commission carry out its statutory investment company regulatory responsibilities in a consistent manner without unrealistic burden upon the regulated companies and-more important-without intruding in areas properly within the scope of State insurance regulation. Accordingly, the Commission directed the staff of its Division of Corporate Regulation to conduct an extensive study of the problem. My purpose this morning is to suggest an approach developed as a result of that study which the staff believes contains the germ of solution and invite, indeed urge, your cooperation in working out the problem which, after all, is common to all of us. presenting our approach to you I am, of course, expressing the views of the staff rather than the Commission, for the Commission has taken no action directed toward either approval or disapproval of the approach. In The problem is a real one and one which your commissions and ours have to live with. It is far more than a technical problem. It is one of substance. It involves the mutual accommodation of two substantially different philosophies of regulation. We cannot ignore the congressional mandate of the Investment Company Act. Although we have exemptive powers under the act, they are intended to be used sparingly and not in a way which defeats vital and inherent policies of the act. We cannot, for example, grant an exemption if it would destroy those fundamental operating provisions of the act which provide for stockholder control and which are grounded on the proposition that he who bears the investment risk must have a voice in the management and policy of the fund. We conceive this firm congressional policy to be of special importance in the case of the variable annuity where the annuitant not only bears the investment risk but is locked into that risk for the remainder of his lifetime once he reaches the payout period. We must, therefore, find a method of preserving the important regulatory policies of the act which will also preserve the state regulatory functions which are equally vital to you. Before discussing our approach I should mention a pending proceeding before the Commission brought by the Prudential Insurance Co. of America. I imagine that for several years Prudential has made no effort to hide from you gentlemen its intention to enter the variable annuity field. In that connection it has filed an application with the Commission for an order which in substance would declare the Investment Company Act inapplicable to Prudential, or, alternatively if the Commission should find the act applicable, for certain exemptions which for practical purposes would remove Prudential from the major operating provisions of the act. Prudential seeks to avoid the Valic decision by contending that it applied only to companies whose business consisted almost entirely of issuing variable annuity contracts. The staff opposed the Prudential application. Extensive adversary hearings were held, the case has been briefed and argued, and it is now sub judice before the Commission. I mentioned the Prudential case only for the purpose of assuring you that my subsequent remarks are relevant no matter how the Commission may decide the Prudential case. Should the Commission decide adversely to Prudential, it is hardly likely that all interest in variable annuities will dissolve. Should the Commission decision be favorable to Prudential, the regulatory problem will not disappear. There will in any event remain issuers with structures similar to Valic and Ealic who will concentrate predominantly on the sale of variable annuities rather than insurance. We have had extensive conferences with many who propose to enter the field on this basis. Thus the regulatory problem must be resolved. I must make it quite clear that we are not laying before you a suggested solution which purports to be a finished product. To the contrary it is largely in the conceptual stage. If you find we are moving in the right direction, we would be hopeful for your active assistance in translating our concepts into a fully detailed and comprehensive plan of regulation. I should also make it clear that our approach relates only to the conventional variable annuity offered to individuals. It is not being suggested in connection with the group deposit administration or flexible funding type of contract such as those contemplated by the recent New York legislation. While the staff of the Commission believes that group deposit administration contracts fall within the ambit of the Investment Company Act, we also feel that they may be sufficiently different from the conventional variable annuity to justify special treatment. For example, we recognize that the terms of many group deposit administration contracts will be separately and vigorously negotiated by firms far more financially informed and with far more professional advice available than the average purchaser of a variable annuity. In other words, General Motors is in a better position to protect itself in negotiating the terms of a flexible funding contract than is the housewife in resisting a variable annuity salesman. For this and other reasons the staff has under serious study a conditional exemptive rule which it may recommend to the Commission. At times during and after the Valic litigation we may have been overinclined to analyze the variable annuity in terms of having either predominantly investment or primarily insurance characteristics. All thoughts of this one or the other theory have long since been abandoned. Its rejection occurred once and for all shortly after the arrival at the Commission of Prof. Francis W. Coker, Jr., of the Yale University School of Law. Mr. Coker was retained as a consultant to the Commission to study in depth investment company problems. In that connection he has made valuable contributions to the staff's thinking on variable annuity regulatory problem. Our approach starts with the direct recognition that a variable annuity is neither solely an investment contract nor solely an insurance contract. As Mr. Jusice Brennan stated in his concurring opinion in the Valic case: "It is rather meaningless to view the problem as one of pigeonholing these contracts in one category or the other." We fully accept his further observation that these contracts contain certain obvious elements of conventional insurance as well as plain elements of the traditional investment company. Furthermore we believe-and our approach is premised upon the belief-that the insurance and investment company elements can be segregated with sufficient precision so that the insurance elements may be regulated by State authorities with no intrusion by our Commission, and the investment company elements may be regulated by our Commission without interfering with the State regulatory functions. May we examine for a moment the clear insurance elements. First and undeniable is the mortality guarantee. Here is a promise on which the insurance company alone is at risk. Here is a function where State regulation is vital, for the State commissioners have the experience and expertise necessary to control and evaluate the use of mortality tables, the computation of proper reserves and the propriety of the rates charged for this guarantee, to name a few. And may I here state unequivocally that we do not intend, nor do we have any desire to intrude into State areas of insurance regulation. Not only do we know our limitations, not only is our workload sufficient to keep us active to a degree that one is tempted to recall wistfully those years before the variable annuity was invented, but I think you will also find that the Commission is and traditionally has been conservative. It well realizes and applauds the wisdom that long ago reposed the supervision of insurance functions within the States. Other clear insurance elements are the disability waiver of premium insurance which is an integral part of the presently marketed variable annuities, insurance administration expense, and a portion of the selling expense. In each of these instances the State authorities know precisely the nature and extent of regulation which public interest demands. It is not only sensible but mandatory that State commissioners be given precedence in these matters. On the other hand, the unique investment risk of the variable annuity is not, in our opinion, an insurance element. Unlike the fixed dollar annuity, the insurance company makes no promise as to payment of an amount certain. As Mr. Justice Douglas observed in the Valic case, the payment "* * * may be a lot, a little, or nothing." The annuitant alone bears the risk of loss or reaps the benefit of gain from the investments. It is this feature which makes the variable annuity attractive and salable in a manner closely comparable to those features which are held out as attractive to prospective purchasers of conventional investment company shares. It is precisely this for which the Investment Com |