COMMISSIONS CAN GO ON AND ON: HAPPY TRAILS… AFTER DEATH, TOO

As growing numbers of independent commission-based financial planners contemplate retirement — or their mortality — they’re increasingly striking deals with brokerages to sell the rights to their lucrative trail commissions and even bequeath them to spouses and children.

At stake is control of billions of dollars in annual payouts — some $6.8 billion in mutual fund 12(b)1 fees alone last year, according to Lipper Inc. of Summit, N.J.

Such fees represent a near-guaranteed flow of annual income that the sponsors of mutual funds, variable annuities and life insurance pay to brokerage firms.

Brokerages normally pass along the fees to active advisers servicing an account. But retired advisers who are no longer registered — or their unregistered widows or other beneficiaries — can continue to receive what are meant to be “service” fees under a National Association of Securities Dealers rule, so long as the adviser spells out the details in a contract while still registered and actively employed.

To restrict potential abuses and protect shareholder pockets, the NASD bans such arrangements if they are struck after the adviser’s retirement or death. In addition, retired advisers who are no longer licensed can sell their rights to continuing commissions to a registered adviser for a one-time flat fee.

Though this rule has existed for years, it is becoming increasingly scrutinized as advisers migrate from transaction-based commissions to continuing commissions charged through 12(b)1 fees (ranging from 0.25% to 0.75%) and mutual fund Class C shares (1%). Also stoking the issue: renewal and asset-based commissions on variable annuities and life insurance, which run as high as 3% annually.

The International Association for Financial Planning, which has 17,000 members, hired a Washington law firm to draw up guidelines for its broker-dealer members in paying trail commissions to non-registered individuals.

“More and more independent financial advisers are approaching the age where they want to retire or sell their business, or be prepared so that their business can be passed on to their spouses or their heirs in some way,” says Dale Brown, who directs the IAFP’s government relations and broker-dealer divisions.

“We are helping our broker-dealer members understand the rules so they can help their reps be prepared,” says Mr. Brown. “There are broker-dealers who are at various stages of grappling with the issue. Some have already got programs in place to help reps with these kind of transfer issues and some are now just starting to do that.”

‘a call a week on this subject’

Regional brokerage firms are also holding “business continuity planning” seminars to help advisers fashion sale agreements with other registered advisers.

Early last month, Radnor, Pa.-based Capital Analysts Inc. — which clears 550 commission-based advisers with more than $2 billion under supervision — sponsored a three-day seminar on the topic for its 45 biggest commission-generating advisers.

Capital Analysts president Robert Cogan says he sponsored the event at the request of advisers who clear through the brokerage. A second seminar for the entire sales force is scheduled in October.

“I probably have a call a week on this subject,” says Mr. Cogan, whose firm is a unit of insurance holding company Western Southern Enterprise in Columbus, Ohio.

“As the population of planners has aged it’s become a much bigger issue,” he adds, “particularly as people move more into the asset management business because there is value in those recurring revenues.”

Some big Wall Street brokerages, like Morgan Stanley Dean Witter & Co., decline to comment on whether they allow such arrangements.

A spokeswoman for Merrill Lynch & Co. Inc. says “only in extraordinary circumstances” would the company allow brokers to sell the rights to commission trails upon retirement or death. In almost all cases, she says, the account is reassigned.

Many brokers elsewhere have struck such deals for years. “This is a clarification of an established practice,” says Mark Tibergien, a consultant to financial advisers with accounting firm Moss-Adams LLP in Seattle.

Striking deals to receive such fees in retirement or to bequeath them also raises ethical questions, since advisers cannot service such accounts after their securities registrations lapse.

Mutual fund companies have no way of knowing if trail fees go to retired advisers or the beneficiaries of deceased brokers because they pay such fees in lump sums to brokerages.

“It’s up to each firm to decide how that is distributed among their brokers and the firm,” says a spokesman for Fidelity Investments in Boston.

“Trails are compensation for continuing to serve the client,” notes Michael Cemo, president of Aim Distributors Inc. in Houston. “If the broker is gone and the firm decides to service the client, we are willing to pay the fee. The key is that the client must get service. If the client doesn’t get serviced and moves to another broker, all that is off.”

From an adviser’s perspective, says Mr. Tibergien, “the key point, regardless of how they generate their income, is to consider some type of cross-purchase agreement with another licensed rep in the event of death or major disability.”

The irony is compelling, adds Russell Bishop, 57, president of Harvest Advisers, a Philadelphia financial advisory with $25 million under management.

“We do a lot of work with businesses on succession planning where we are advising how to transfer a business to family members or employees,” he says. “We need to take our own advice instead of leaving it to the NASD or your own broker-dealer.”