Application of Rule 2820 (h) to a non-cash compensation arrangement that excludes variable annuity contracts that are sold in exchange transactions pursuant to Internal Revenue Code Section 1035 or pursuant to a rollover transaction under Internal Revenue Code Section 402.


April 3, 2000

 

Michael L. Kerley, Esq.
Vice President and Chief Legal Officer
MML Investors Services, Inc.
1414 Main Street
Springfield, MA 01144-1013

 

Dear Mr. Kerley:

 

This letter is in response to your January 26, 2000 letter to Larry Kosciulek, regarding the application of Rule 2820(h) to non-cash compensation programs under consideration by MML Investors Services, Inc. ("MML Investors") and Massachusetts Mutual Life Insurance Company ("MML Insurance").

 

Background

 

MML Investors is an NASD member and wholly owned subsidiary of MML Insurance. MML Insurance develops certain proprietary variable annuity contracts ("proprietary products"), for which MML Investors serves as co-underwriter. MML Investors also offers non-proprietary variable annuity products, and registered representatives of MML Investors sell both proprietary and non-proprietary products.

 

MML Insurance and MML Investors are planning to sponsor sales contests in the year 2000. Winners of these contests will receive various types of non-cash compensation such as attendance at a recognition conference or other prizes. All of these non-cash compensation programs will provide equal credit and weighting for both proprietary and non-proprietary products sold by registered representatives of MML Investors.

 

In determining the criteria for these non-cash compensation programs, MML Investors and MML Insurance have identified several categories of transactions that they do not believe are appropriate to include in their non-cash compensation programs. These are variable annuity contracts that are sold in exchange transactions pursuant to Internal Revenue Code Section 1035 or pursuant to a rollover transaction under Internal Revenue Code Section 402. These transactions would include:

 

the issuance of a proprietary product as the result of an exchange from another proprietary product (i.e. internal exchange);

 

  1. the issuance of a proprietary product as the result of an exchange from a non-proprietary product;
  2. the issuance of a non-proprietary product as the result of an exchange from a proprietary product; and
  3. the issuance of a non-proprietary product as the result of an exchange from another non-proprietary product.

 

Your letter notes that both NASD Regulation and the Securities and Exchange Commission have expressed concern over the propriety/suitability of variable product exchanges, citing NASD Notice to Members 99-35 (May 1999) and Notice to Members 96-86 (December 1996). Your letter indicates that by removing such exchange transactions from your firm’s non-cash compensation programs, it will reduce the temptation for a producer to recommend inappropriate exchanges to his or her clients, and is therefore consistent with Notices to Members 99-35 and 96-86.

 

Your letter also indicates that such a contest would be consistent with both the intent of and the language of Rule 2820, in that the primary purpose of Rule 2820(h) is to prevent firms from adopting policies that have inappropriate "point of sale" influences on registered representatives. In this regard, your letter notes that removing exchange contracts from non-cash compensation programs would discourage exchanges and provide assurance that such exchanges are not motivated by non-cash compensation factors.

 

In addition, your letter references Notice to Members 98-75 (September 1998), in which NASD Regulation states that:

 

[M]ethods for determining compensation credits could vary, including measurements based on gross production to the firm or net commissions to the associated person. Either practice, as well as other arrangements, such as new accounts opened or assets under management, would be acceptable so long as the concept of "equal weighting" is met and not skewed by disparate commission, payout or reallowance structures for individual products.

 

Your letter analogizes the exclusion of contracts resulting from exchanges or rollovers with the example provided in Notice to Members 98-75 of using the criteria of new accounts opened to determine compensation credits. Your letter notes that production implies the creation of new assets, and internal exchanges do not constitute "production" because the new contract contains the same assets as the prior contract. Under your proposed criteria, both proprietary and non-proprietary products would be equally weighted, such that only the circumstances of the sale, and not the nature of the product itself, would determine whether the sale qualifies as "production."

 

Response

 

The criteria for the non-cash compensation programs represented in your letter would satisfy the requirements of Rule 2820(h). Specifically, Rule 2820(h)(4)(D) permits non-cash compensation arrangements that, among other things, are based on total production and provide for credit for each variable contract that is equally weighted. As your letter referenced, in Notice to Members 98-75, NASD Regulation recognized that the methods for determining compensation credits could vary, including such arrangements as new accounts opened or assets under management. Therefore, the staff believes it is appropriate to use criteria that would exclude exchanges or rollovers for a non-cash compensation program, so long as the criteria is applied equally to all products sold by registered representatives of MML Investors.

 

I hope this is responsive to your inquiry. Please note that the opinions expressed herein are staff opinions only and have not been reviewed or endorsed by the Board of Directors of NASD Regulation. This letter responds only to the issues that you have raised based on the facts you have described, and does not address any other rule or interpretation of the Association, or all the possible regulatory and legal issues involved.

 

Sincerely,

 

Stephanie M. Dumont
Assistant General Counsel

 

cc:

 

Larry Kosciulek
Director, Advertising/Investment Companies Regulation
Frederick McDonald
Director, District 11