10th Circuit Affirms District Court Analysis of Broker-Dealer Exemption under Advisers Act as Applied to Broker-Dealer Affiliate of Insurance Company Selling Variable Insurance Product (Part 2 of 2)

10th Circuit Affirms District Court Analysis of Broker-Dealer Exemption under Advisers Act as Applied to Broker-Dealer Affiliate of Insurance Company Selling Variable Insurance Product

The U.S. Court of Appeals for the Tenth Circuit (the "Appeals Court") affirmed a district court decision granting summary judgment to an insurance company and its affiliated broker-dealer (collectively referred to as the "company") that were being sued for alleged violations of the Investment Advisers Act of 1940 (the "Advisers Act") in connection with the sale of a variable universal life insurance policy. (The district court decision was discussed in the September 15, 2009 Alert.) The plaintiffs alleged that a sales representative of the company had acted as an investment adviser in recommending that the plaintiffs purchase the policy, and thus the company was subject to the Advisers Act. The plaintiffs further alleged that the company had violated the fiduciary duty it owed to the plaintiffs under the Advisers Act by failing to disclose the conflicts of interest created by the commission structures, fees and other policies that gave the sales representative an incentive to put his own financial interest ahead of the plaintiffs'.

Broker-Dealer Exclusion. The Appeals Court's analysis focused on the whether the investment advisory services provided by the sales representative fell within the broker-dealer exclusion in Section 202(a)(11)(C) of the Advisers Act, which provides that that "any broker or dealer whose performance of [advisory] services is solely incidental to the conduct of its business as a broker or dealer and who receives no special compensation therefor" is not an investment adviser for purposes of the Act. The Appeals Court found that the exclusion applies to "a broker-dealer who provides advice that is attendant to, or given in connection with, the broker-dealer's conduct as a broker or dealer, so long as he does not receive compensation that is (1) received specifically in exchange for the investment advice, as opposed to for the sale of the product, and (2) distinct from a commission or analogous transaction-based form of compensation for the sale of a product. The quantum or importance of the broker-dealer's advice is relevant only insofar as the advice cannot supersede the sale of the product as the 'primary' goal of the transaction or the 'primary' business of the broker-dealer."

Evidentiary Record. The Appeals Court held that the record established that (a) advice was given by the sales representative only in connection with the selling the variable insurance product to the plaintiffs, which was the primary object of the transaction, (b) the compensation paid the sales representative relating to the transaction was for selling the variable insurance product, not for providing investment advice; and (c) the $500 "Production Credit" paid to the sales representative for the sale of the variable insurance product was a traditional, transaction-based commission and thus was not "special compensation." Responding to plaintiffs' argument that an issue of fact sufficient to defeat a motion for summary judgment existed because of the possibility of a link between the advice given by the sales representative and the compensation received, the Appeals Court pointed to the following undisputed facts: (A) the sales representative received compensation...