Generally unnoticed in the DOL’s proposed fiduciary reg was the implicit recognition that the commissioned based sales function is important to the operation of the market, and that you can “sell” until the cows come home (a good friend tells me, by the way, that the cows actually do eventually come home),  or until you become a fiduciary.  Anyone familiar with the successful salesperson knows that they are only able to sell once they establish a level of trust with the plan fiduciary, which is why trade organizations are taking the DOL to task on the requirement that the salesperson, in order to be recognized as not being a fiduciary, must then advise the fiduciary (with whom a relationship is being forged) that he or she may have adverse interests to the plan.

However that language is eventually finalized, it raises an important question that hasn’t really been addressed well, being a sort of red-haired stepchild of ERISA: Just what is “sales”and how are commissions treated? Finding your way through it can be trying, as if its a practice in ERISA metaphysics, mysticism and alchemy.

It starts with the basic question of whether or not “sales” is considered a service. It does seems almost metaphysical, and would be amusing if it didn’t have a very real impact.   Commissions from pure sales of an investment product to a plan from a party without an existing relationship to a plan (either on its own or through an affiliate) does not seem to be governed either by 408(b)(2) or by the prohibited transaction rules.  “Sales,” by itself does not seem to be a service covered by 408(b)(2), and the payment of a commission to a someone who is not a party of interest may raise fiduciary concerns if too much is paid, but it is NOT, in itself, a prohibited transaction.  But there are times where sales and the payment of commission may eventually be considered services, where there becomes an ongoing, supportive relationship.

Lets go over some “pure sales” scenarios, with the impact of “sales as service” perhaps being handled in a future blogs:

 Scenario 1.  A trust company (independent of a mutual fund company) is a covered service provider which has a contract with a fiduciary. The trust company purchases the mutual funds chosen by the plan, and the underwriter of the mutual fund company then pays a 12b-1 fee or finder’s fee to a registered representative through its broker dealer which is unrelated to the trust fund or the underwriter.  The result:

  • Prohibited transaction. The payment to the b/d (then to the rep) is not a prohibited transaction, as there is not a payment to a party in interest;
  • Prior disclosure. The payment to the b/d  (and rep) is not subject to prior disclosure under 408(b)(2) because “sales” is not a service subject to 408(b) (2) and it is not being paid by the covered service provider or an affiliate (though there is disclosure of a 12b-1 fee by delivery of a prospectus, required by 408(b)(2)); and
  • Annual reporting.  The amount of the compensation paid to the b/d or rep is not reportable on Schedule C as it is “eligible indirect compensation” because a prospectus has been delivered to the trustee. (Compare this to Schedule A, by the way, however, where detailed information on the amount of commissions paid are required. Odd.)

Scenario 2.  Same facts as Scenario #1, except that the trust company is owned by the parent company of the underwriter of a mutual fund chosen by the plan, which then pays a 12b-1 fee or finder’s fee to a registered representative which is supervised by a broker dealer unrelated to the trust fund or the underwriter.  What then?

  • Prohibited transaction. The payment to the b/d (then to the rep) is not a prohibited transaction, as there is not a payment to a party in interest.
  • Prior disclosure. The payment to the b/d  (but not the rep) may be subject to prior disclosure under 408(b)(2) because it is indirect compensation paid by an affiliate (the underwriter) of the covered service provider (the trustee); and
  • Annual reporting.  The amount compensation paid to the rep is not reportable on Schedule C as it is “eligible indirect compensation” because a prospectus has been delivered to the trustee.

Scenario 3. Same facts as Scenario #2, but the b/d to whom the payments are made is an affiliate of the underwriter.

  • Prohibited transaction. The payment to the b/d (then to the rep) could be a prohibited transaction because the b/d is now a party in interest by virtue of being an affiliate of another party in interest. It could be a violation of ERISA 406(b) (note that the commission is not a direct payment of a plan asset because of ERISA’s plan asset rules). Prohibited Transaction Class Exemption 84-24  then should be be used, which discloses directly to the fiduciary the compensation to be paid, prior to the sale,which approves it by execution of the sale.  (Note, again, the difference with annuities under 84-24: for annuities, and not mutual funds, the comp must be approved in writing by the fiduciary. Again, Odd.), 
  • Prior disclosure. The payment to the b/d and possibly the the rep seems also to be subject to prior disclosure under 408(b)(2) because it is indirect compensation paid by an affiliate (the underwriter and the b/d) of the covered service provider (the trustee); and
  • Annual reporting.  The amount of compensation paid to the rep is not reportable on Schedule C as it is “eligible indirect compensation” because a prospectus has been delivered to the trustee.

Get it? 

Besides seeing that a fiduciary never knows how much is actually ever paid in 12b-1 fees and mutual fund commissions to anyone, what seems clear is that nothing is really clear or easy when it comes to commissions. Just wait ‘til we add group annuity contracts, insurance companies and insurance agents into the mix……

 

 

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