Expect Focus Life Insurance, June 2018

Recalls of Loaned Securities by Insurance Dedicated Funds

Insurance   |   Financial Services Regulatory   |   Life, Annuity, and Retirement Solutions   |   Securities & Investment Companies   |   June 25, 2018

In March, the SEC sanctioned the investment advisers of two funds supporting variable insurance contracts for inadequate disclosure about the funds’ recalls of loaned portfolio securities in advance of the securities’ dividend record dates.

The SEC reasoned that this practice resulted in a conflict of interest between the variable contract holders and the advisers, because (a) recalling the loaned securities permitted the insurance company issuers of the variable contracts, which were affiliates of the advisers, to benefit from the dividends-received tax deduction with respect to dividends paid on the securities, while (b) the funds and variable contracts supported by those funds lost the benefit of securities lending income during the period when the securities were recalled. The funds’ prospectuses disclosed that a fund may lend its portfolio securities, that the loans earn income for the funds, and that the loans could be terminated or recalled at any time. The prospectuses, however, omitted any mention of the funds’ practice of exercising their recall rights in a manner that provided tax benefits to the insurance companies and deprived the funds and the contract holders of securities lending income.

The SEC found this omission, and similar omissions in communications from the advisers to the funds’ board, violated anti-fraud provisions in the Investment Advisers Act of 1940. As a result of the investment advisers’ conduct, since June 2011, the insurance companies received a tax benefit of $2,635,490, while the funds lost $2,024,355 in securities lending income. Accordingly, the SEC required the advisers to disgorge the former amount plus interest and pay a $500,000 civil penalty.

Insurance dedicated funds that have not already done so should review their securities lending procedures and disclosures in light of this enforcement proceeding.


©2023 Carlton Fields, P.A. Carlton Fields practices law in California through Carlton Fields, LLP. Carlton Fields publications should not be construed as legal advice on any specific facts or circumstances. The contents are intended for general information and educational purposes only, and should not be relied on as if it were advice about a particular fact situation. The distribution of this publication is not intended to create, and receipt of it does not constitute, an attorney-client relationship with Carlton Fields. This publication may not be quoted or referred to in any other publication or proceeding without the prior written consent of the firm, to be given or withheld at our discretion. To request reprint permission for any of our publications, please use our Contact Us form via the link below. The views set forth herein are the personal views of the author and do not necessarily reflect those of the firm. This site may contain hypertext links to information created and maintained by other entities. Carlton Fields does not control or guarantee the accuracy or completeness of this outside information, nor is the inclusion of a link to be intended as an endorsement of those outside sites.

Subscribe to Publications


The information on this website is presented as a service for our clients and Internet users and is not intended to be legal advice, nor should you consider it as such. Although we welcome your inquiries, please keep in mind that merely contacting us will not establish an attorney-client relationship between us. Consequently, you should not convey any confidential information to us until a formal attorney-client relationship has been established. Please remember that electronic correspondence on the internet is not secure and that you should not include sensitive or confidential information in messages. With that in mind, we look forward to hearing from you.