Sales compensation on financial products sold to employer plans has always been a critical piece of making the private retirement system work, particularly in the small to mid-size marketplace. As policymakers attempt to adopt different policies to increase the “penetration” of plans in this important segment of the marketplace, no such effort will really be successful unless professionals are paid for the work it takes to get plans to those employers. It is the financial service companies which pay sales commission on their products which really makes these policy initiatives work.
Yet, there seems to have been a certain “ick” factor with the DOL’s approach to sales compensation. This is surely based in part on the sales abuses we have all seen; and the DOL really does see the ugly underbelly of sales on a regular basis. But this still does not diminish the importance of commissions to the successful implementation of retirement policy.
Perhaps it’s this “ick” factor which is leading to the growing ambivalence about the way the DOL approaches sales commissions.
Compensation paid on the sale of a financial product to a retirement plan, whether it be an insurance commission from the deposit to an annuity or from the payment of a 12b-1 fee related to the purchase of a mutual fund, is paid under a contract between the distributor and the financial service company. This compensation is paid in order to promote the company’s best interest, and there is the concept of “active and effective” by which agents and reps are judged. They are paid to promote the company’s interests, not the plan’s.
Under ERISA 406(b)(2), this is the classic adversity of interest. Which is really the reason why prohibited transaction rule 84-24 (originally 77-9) is necessary: it permits a fiduciary to authorize the payment of a commission to an adverse party as long as a few conditions are met.
The regs under 408(b) 2 (the drafting of which I am an unabashed fan), however, never really addresses this sort of inherent conflict. Instead, a strong argument can be made that the reg appears to cast sales commissions as service compensation, and serves to complicate this matter. Consistent with other recent DOL activity, it casts the payment of an asset or deposit based sales commissions as the payment of indirect compensation from the plan. Yet, this compensation is paid under a contract between the sales rep and the financial service company (not the plan and the rep) where the rep is duty bound to protect the interests of the company paying the comp, not in the interests of the plan.
So, though this disclosure may make the comp reasonable comp under 408(b)(2) (that is, if you view sales as a service), it still does not relieve the 406(b)(2) adversity problem. To make any sense of this, it looks like you still need to comply with PTE 84-24 in addition to the 408(b) 2 disclosures.
408(b) 2 did have a clarifying effect, by the way, on PTE 84-24. For years, there had been ongoing discussions on whether or not the recipient of a commission is really the receipt of compensation from the plan, and whether an agent or rep was really party-in-interest to a plan which would be covered by the prohibited transaction rules. By casting commissions as indirect compensation, this question is effectively closed.
I know this discussion sounds a bit tortured, and even a bit non-sensical. But it has real meaning; especially when we are talking about whether, and under what conditions, certain compensation related to a plan is permitted to be paid. I’m afraid that, as we integrate the PT rules into the growing body of fiduciary regulation, we will be stumbling into this sort of things more often.
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