Although the federal securities law exempts insurance policies and annuity contracts, prior to 1964 there was no specific exemption from either the 1933 or the 1934 Acts for insurance company securities. Insurers whose stock was listed on a national securities exchange were subject to the registration, reporting, proxy and insider trading requirements. However, since the stock of most insurers was traded in the OTC market, insurers generally were not subject to these provisions. Nevertheless, as of 1963, under rules promulgated by the SEC, 169 insurers were reporting to the SEC and two additional insurers were listed on an exchange. The SEC lacked jurisdiction over mutual insurance companies, other than with respect to an occasional issue of debt securities, since mutual insurers did not issue stock.

In the deliberations leading up to the 1964 amendments extending the registration, reporting, proxy and insider trading requirements to companies whose securities were traded in the OTC market, there was a voluminous SEC study of the securities markets which included the finding that insurers as a group exhibited all the inadequacies in reporting and proxy solicitations characteristic of the whole group studied. A number of insurers failed to send information to their stockholders and many of those that did failed to provide adequate information. Consequently, the Senate passed a bill treating insurers like any other company. That is, any company, including insurers, possessing the specified amount of assets and having the specified number of stockholders must register under the 1934 Act and comply with its reporting, proxy and insider trading requirements.

Between the Senate and House hearings, the NAIC (representing state insurance regulatory authorities) urged that insurance companies should be exempted in accord with the tradition of state insurance regulation as embodied in the McCarran Act. While the NAIC did not deny existing inadequacies, it maintained that administering requirements in these areas should be left to the states as the regulators of the insurance business. Although at first the SEC vigorously opposed the exemption for stock insurance company securities, it ultimately and reluctantly agreed to the exemption so as not to jeopardize the entire bill.

As a consequence, when Congress extended the registration, reporting, proxy and insider trading provisions of the 1934 Act to the OTC markets, it provided a conditional insurance exemption if all three conditions are met. As enacted Sec. 12(g)(2)(G) exempts any security issued by an insurance company if all of the following conditions are met:

Through this conditional exemption, with respect to insurance companies, reporting, proxy and insider trading requirements were to be enforced by the state insurance regulators.

As the first condition, an annual statement which conforms to the statement prescribed by the NAIC must be filed with the insurer’s domiciliary insurance commissioner. To meet this condition, the NAIC developed the Stockholder Information Supplement which is attached to the insurer’s annual statement. This supplement requires information as to the distribution of financial reports, the content thereof, data on management, etc.

Congress not only delegated a legislative function to an organization of state regulatory officials (the NAIC), it did so in a manner to preclude the SEC and the federal courts from overseeing compliance in individual cases. A commissioner’s determination is conclusive as to the issue of substantial compliance (at least in the absence of genuine abuse of regulatory discretion).

As a second condition for the exemption, the domiciliary state must regulate proxies as to the insurer’s securities in conformity with the regulations prescribed by the NAIC. There was debate as to what regulation would suffice to meet this condition since the clause did not require that state regulation "substantially" conform to the SEC pattern. Nevertheless, in adopting its Model Regulation Regarding Proxies, Consents and Authorizations of Domestic Stock Insurers Regulation, the NAIC concluded that the controls should be comparable to those imposed by the SEC on companies in general. Virtually all jurisdictions enacted enabling legislation to authorize their insurance commissioners to adopt the NAIC recommended proxy rules which were basically those of the SEC. Those insurers complying with the federal Act are exempt from the state regulation.

In essence, state proxy regulation applies to solicitations to equity securityholders of the insurer for proxies (authority to vote on behalf of the securityholder). Solicitations must be accompanied by a proxy statement containing specified information presented in a clear manner to enable the securityholders solicited to make informed judgments as to the matters to be voted upon and to whom they give their proxies. Provisions apply to both proxies solicited by management and by other securityholders. Proxy materials must be filed with the commissioner. False, misleading statements and omissions of material facts are prohibited.

The third condition for the insurer exemption is that the domiciliary state must regulate insider trading in substantially the same manner as provided by Sec. 16 of the 1934 Act. In response, the NAIC adopted its Model Act Concerning Insider Trading of Domestic Stock Insurance Companies Equity Securities and an accompanying Model Regulation (patterned after the Sec. 16 of the 1934 Act and the SEC regulation promulgated thereunder) as to (1) filing of reports required of insiders (officers, directors and persons who are beneficial owners of more than a specified percentage of any class of equity security of a domestic insurer) disclosing their security holding positions in the insurer and reporting whenever there are changes therein, (2) the recapture of short swing profits from the purchase and sale or sale and purchase of any equity security of such insurer within a 6-month period to protect against the unfair use of insider information, and (3) the prohibition against selling short. This Model Act and Model Regulation have been adopted in every state.

Both the NAIC and each insurance commissioner must carefully monitor future SEC rules or form amendments which strengthen Sec. 16 requirements. Such changes automatically affect the clause (iii) exemption.

Insurers must keep in mind that the exemptive scheme of Sec. 12(g)(2)(G) is on an all or nothing basis. Failure to comply with one clause invalidates the exemption with respect to the other clauses as well.

With the 1964 amendments of the Securities Exchange Act of 1934 and the state response thereto, a system of dual federal-state regulation has been instituted with respect to corporate matters concerning holders of insurance company stock. Although insurers domiciled in states meeting the three conditions are exempt from federal reporting, proxy and insider trading requirements of the 1934 Act, the states have been compelled to implement the pattern of the federal securities laws. In effect, the nature of the regulatory policy is determined at the federal level while the administration of such policy has been left to the states subject to the watchful eye of the SEC. Of course, those insurers listing on a national exchange are directly regulated under the 1934 Act.

Interestingly, the effort to retain regulation at the state level and avoid direct SEC control may have backfired for several insurers. Due to the complex interrelationships between the insurance exemption, provisions of state law and the various securities issues insurers offer, many insurers find it necessary to comply with the federal requirements despite the insurance exemption. Thus, even after the efforts to obtain the exemption, such insurers find themselves subject to dual federal and state regulation in the context of reporting, proxy and insider trading requirements.