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Vedder Thinking | Articles SEC Articulates Standards for Relief Under Section 26(c) for Variable Insurance Product Substitution Orders


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On December 4, 2020, the SEC granted a substitution order under Section 26(c) of the Investment Company Act of 1940 to Allianz Life Insurance Company of North America and Allianz Life Insurance Company of New York, together with their respective separate accounts (collectively, Allianz). Section 26(c) of the 1940 Act prohibits the substitution of shares of mutual funds offered as an investment option to variable annuity and variable life insurance contracts with shares of a different mutual fund (a Substitution) unless the SEC determines that the evidence establishes that the Substitution is consistent with the protection of investors and the purposes of the 1940 Act.

Following Allianz’s application for a Substitution, a fund company raised several issues relating to Allianz’s proposed Substitution, and requested that the SEC consider such issues in a hearing. The objecting party made the following assertions in challenging the application for a Substitution order:

  • Prior Substitutions dealt primarily with single-fund Substitutions, instead of “slate-clearing” Substitutions. Accordingly, the SEC should analyze the effects and harm of slate-clearing Substitutions differently than single-fund Substitutions and require different terms and conditions for the proposed Substitutions.
  • A Substitution should only be permitted where affected investors would demonstrably benefit from the modifications.
  • Contract holders and their financial advisers may incur additional expenses due to contract holders seeking advice on the Substitutions.
  • The effects of the proposed Substitutions on the contractual benefits and guarantees of the contracts should be considered.
  • Contract holders will experience a loss of economies of scale from the transfer of their assets from the funds being replaced (or Target Funds) to the much smaller replacement funds (or Destination Funds).
  • The proposed Substitutions arise from the commercial objectives and not from necessity.
  • Instead of replacing the Target Funds with the Destination Funds, Allianz should add the Destination Funds as additional investment options.
  • The Destination Funds have investment strategies that are insufficiently similar to the Target Funds and thus, the Substitutions will adversely affect the investment choices available to contract holders.
  • After the assets are transferred from the Target Funds to the Destination Funds, the remaining shareholders of the Target Funds may be adversely affected.

In granting a Substitution order to Allianz, the SEC responded to objecting party's assertions as follows:

  • A slate-clearing Substitution should not be treated differently than a single-fund Substitution, and the SEC has granted similar Substitutions in the past to other applicants. Accordingly, the SEC declined to require different terms or conditions.
  • Section 26(c) requires that a Substitution be consistent with the protection of investors; it does not require a demonstrable benefit to investors, but rather the absence of harm.
  • Section 26(c) is concerned with the protection of investors, not the burden on an investor’s financial adviser and does not take into account the cost of personal financial advice that an investor may seek. In fact, the legislative history indicates that the purpose of Section 26(c) was to protect shareholders from being subject to a new sales load.
  • Section 26(c) does not require consideration of the impact on the value of contract guarantees or economies of scale because such analysis would be speculative, complex and rely on numerous assumptions and would be of limited use in determining whether a Substitution is consistent with the protection of investors.
  • Section 26(c) does not require exceptional or exigent circumstances in order for an insurance company to engage in a Substitution.
  • Section 26(c) does not require the applicants or the SEC to analyze alternative actions to a Substitution.
  • The relevant variable annuity and variable life insurance contracts offer numerous investment options with the understanding that the insurance company will have the ability to make changes among the investment options in appropriate circumstances, and such contracts expressly permit Substitutions.
  • The objecting sponsor’s assertion that the Destination Funds must have substantially similar investment strategies to the Target Funds is not a requirement under Section 26(c); however, Allianz agreed to analyze the comparability of the funds as one of the conditions to being granted a Substitution order. In addition, the protection of investor choice was not a fundamental purpose of Section 26(c), but rather the protection of investors from incurring certain costs.
  • Consideration of the effects that a Substitution will have on third-party investors is inconsistent with the text and purpose of Section 26(c) and, accordingly, the extension of such a determination under Section 26(c) is not required. 

Accordingly, the SEC found that the Substitutions were consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the 1940 Act and granted the Substitution order under Section 26(c) to Allianz.

The SEC order is available here.


John S. Marten


Nathaniel Segal


Jacob C. Tiedt