Court Overturns SEC’s Annuities Rule, but Gives Agency Leeway to Re-establish It

Wednesday, Jul 22,2009, 11:19:28 AM Click:

U.S. Court of Appeals overturned Rule 151A, sending it back to the Securities and Exchange Commission to examine its effect on the market but the judges supported the rule itself.

The three-judge court decision in American Equity vs. Securities and Exchange Commission said the SEC was correct in defining indexed annuities as securities, but the agency failed to determine if Rule 151A would “promote efficiency, competition and capital formation.”

“The SEC’s reasoning with respect to competition supports at most the conclusion that any SEC action in this area could promote competition, but does not establish Rule 151A’s effect on competition,” the decision reads. “Section 2(b) requires more than this.”

The judges said the SEC incorrectly assumed that simply because it would require what the agency believes is greater transparency in pricing and risks it would lead to greater efficiency and competition.

“Having determined that the SEC’s § 2(b) analysis is lacking, we conclude that this matter should be remanded to the SEC to address the deficiencies,” the decision reads.

But the court agreed with the SEC’s view that indexed annuities could be considered securities. The judges disagreed with American Equity’s argument that “annuity contracts that have interest rates tied to a securities index can fall within the Rule 151 safe harbor so long as the rate of interest to be credited is not modified more frequently than once a year.”

The judges say the “safe harbor” requires that the annuity’s interest rates tied to the securities index are calculated “prospectively.” Indexed annuity rates are set retroactively after the year is completed and therefore they are not “prospectively” established, according to the court decision.

The SEC will now have to conduct what the court considers a more complete analysis of the rule’s effect. After which, the agency appears to be free to re-establish the rule.

“After a more thorough review of the existing state law regime, the Commission may decide ultimately that Rule 151A will promote competition, efficiency and capital formation,” the decision reads. “Nevertheless, the Commission must either complete an analysis sufficient to satisfy its obligations under § 2(b), or explain why that section does not govern this rulemaking.”