FINRA Targeting Small Firms and Individual Brokers?

John Crudele at the NY Post recently penned a column Small Firms Claim FINRA Targets Them that is generating quite a reaction. We represent a large number of small firms, ranging from firms with 5 registered representatives to approximately 300 registered representatives, and our clients are the ones who originally alerted us to the article. There is a fair amount of truth to the article - FINRA is much more aggressive with small firms than it is with big firms.

Anyone who follows FINRA enforcement proceedings has a hint of the disparity, when we see wirehouses like Merrill Lynch and Bank of America receive the equivalent of wrist-slap fines for their violations. What the general public does not know is that for the same violation at any of the other 4,000 firms in the country the fine would be multiples, on a percentage basis, against the small firm, and the charges would include charges against individuals at the firm, not just the firm. When was the last time you saw FINRA name Ken Lewis or John Thain in an enforcement proceeding? Don't bother looking, it has never happened, but take a look at how often they name the president or senior executive of a BD with hundreds of brokers as a respondent.

The simple fact is that FINRA is out to show how tough it is which causes numerous problems. FINRA examiners simply love to spend months at a firm during a routine audit - yes, I said months. Imagine trying to run your business while you have to dedicate a conference room to two examiners, provide them with a staff member to fetch documents and make copies for them, and make yourself available on a moments notice to answer questions. Now imagine that going on for 4 or 5 or 8 months, every day.

This of course is in addition to the hours spent complying with the morass of rules and regulations that often do not apply to your particular business model, knowing all the while that one missed form, one account not verified, or one other slip up could cost you a fine starting at $2,500.00. It is not a pleasant existence.
And FINRA knows that the small broker-dealers, and individual brokers, cannot afford the fight - so FINRA brings the fight, but brings it against the small broker-dealers and individual brokers, betting on the fact that the firm cannot afford to fight and will therefore settle the charges, regardless of how questionable the charges. It happens every day.

But now smaller firms and individuals are starting to fight back and are devoting the resources to defend themselves against the FINRA onslaught. And we are starting to see a turn in the statistics.
The heavy-handed issue remains, and Mr. Crudele has now posted a followup, - Tales from Wall St. about heavy-handed Finra detailing the reaction he has received to the original article and promising more articles on FINRA's apparent desire to destroy the small broker-dealer industry.

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Principal Protection Notes: Timely Warning from the SEC?

For the past two years we have been investigating investor claims regarding principal protection notes and the litigation and arbitrations that have followed. Millions of dollars have been lost in these notes.

Today the SEC demonstrated one of the more significant issues with its regulatory program - closing the barn door after the horses are gone. Today, years after these sales of principal protection notes to thousands of investors, the SEC's  Office of Investor Education and Advocacy and the Financial Industry Regulatory Authority (FINRA) has issued an investor alert regarding the product. Years after the fact.

The alert, called Structured Notes with Principal Protection: Note the Terms of Your Investment is intended to educate investors about the risks of structured notes with principal protection, and to help them understand how these complex financial products work. While the SEC correctly notes that the retail market for these notes has grown in recent years, it completely overlooks the fact that thousands of investors have already lost hundreds of millions of dollars in these notes.

Structured notes with principal protection typically combine a zero-coupon bond – which pays no interest until the bond matures — with an option or other derivative product whose payoff is linked to an underlying asset, index or benchmark. The underlying asset, index or benchmark can vary widely, from commonly cited market benchmarks to currencies, commodities and spreads between interest rates. The investor is entitled to participate in a return that is linked to a specified change in the value of the underlying asset. However, investors should know that these notes might be structured in a way such that their upside exposure to the underlying asset, index or benchmark is limited or capped.

Investors who hold these notes until maturity will typically get back at least some of their investment, even if the underlying asset, index or benchmark declines. But protection levels vary, with some of these products guaranteeing as little as 10 percent — and any guarantee is only as good as the financial strength of the company that makes that promise.

“Structured notes with principal protection contain risks that may surprise many investors and can have payout structures that are difficult to understand,” said Lori J. Schock, Director of the SEC’s Office of Investor Education and Advocacy. “This alert is a ‘must read’ for investors considering these products, especially those with the mistaken belief that these investments offer complete downside protection.”

“The current low interest rate environment might make the potentially higher yields offered by structured notes with principal protection enticing to investors,” said FINRA Senior Vice President for Investor Education John Gannon. “But retail investors should realize that chasing a higher yield by investing in these products could mean winding up with an expensive, risky, complex and illiquid investment.”

Our firm has been advising investors and financial advisors who were mislead by the wirehouses regarding the safety of principal protection notes since 2008, and continues to do so. If you have any questions about such cases, feel free to contact us at ppn@beamlaw.com

 

Firms Must Protect Customer Information - Always

Regulation S-P prohibits financial institutions from disclosing private personal information about their customers to third parties, without the customer's authorization, and is designed to protect consumers against unauthorized access to their personal information.

While the regulation has a noble goal, it is also a trap for the unwary brokerage firm, and I frequently see firms get caught in a Reg S-P violation without ever intending to do so. One example is in discovery. I handle a fair amount of employment litigation, representing firms and brokers in their employment disputes. Those cases often involve the exchange of customer records during discovery, and every so often I come across a firm which thinks nothing of producing customer account information in the litigation. That is a violation of Regulation S-P, regardless of the fact that the production is required in litigation. The information has to be redacted before production.

The SEC has provided another example of an unintentional violation, and charged three former brokerage executives for failing to protect confidential information about their customers. According to the Commission, when GunnAllen Financial Inc. was winding down its business operations last year, its former president and former national sales manager violated customer privacy rules by improperly transferring customer records to another firm. The SEC also accused the firm's compliance director with failing to enforce the supervisory procedures in an unrelated incident.

According to the settlement agreements, the president allowed 16,000 annuity and mutual fund account applications to be transfered to the Sales Manager's new firm. It appears that what actually happened is that the Sales Manager downloaded the applications, and once at his new firm, sent a letter to those customers, advising them that GunnAllen could no longer service their accounts, and that he and his new partners were going to service the accounts, and offering to let the customers opt out of the transfer of their account to the new firm.

While there is undoubtedly a proper motive behind these actions, and those customers do need to have someone handle their accounts, the procedure is backwards, and the letter should have been sent before the transfer, and should have been sent by GunnAllen, not the new firm. Customers would have been given the opportunity to opt out before the disclosure of their information, and the conduct would have been in compliance with Regulation S-P.

According to the settlement, GunnAllen did exactly that, sending a letter to the customers notifying them of the closing of the firm and providing them with information and choices as to how they wanted their accounts handled. But the Sales Manager jumped the gun, and two days after the letter was sent, arranged for the transfer of the accounts.

The individuals settled the charges with the SEC. The President and the Sales Manager each received a censure and a $20,000 fine. More...

Tax Consequences of Investments - Broker Duty to Consider?

In my view of the world, a broker has no duty to research or consider areas that are outside of their area of expertise, and tax implications of an investment are one of those areas. Excluding tax motivated investments, where the tax considerations  are the basis for the recommendation, it is the realm of tax attorneys and accountants to consider such issues, not brokers and advisers.

But is is an interesting question, addressed by Chris Lufrano in a recent blog post.

The analysis begins with a FINRA fine against Merrill Lynch for failure to supervise its representatives involved in the recommendation of college-savings products called 529 plans. FINRA’s disciplinary action against Merrill Lynch raises the question: do broker-dealers and their representatives have a duty to research, consider, or even understand the tax consequences of investment recommendations?

More...

BofA In A Panic? Unilaterally Imposes Garden Leave Provisions

It never ceases to amaze me that Bank of America has managed to stay in business. Personally, I always thought they were a terrible bank, with terrible rates, annoying terms and conditions, and really annoying marketing. As a brokerage firm, they have simply bumbled and stumbled their way through the acquisition of Merrill Lynch, turning a unique opportunity into a disaster.

There are too many misteps to detail, but the ones that directly affect brokers makes the point - plus there is a new disaster breaking.

Right after the merger Bank of America had a problem. Its US Trust brokers had some of the same clients as its Merrill brokers, and the two firms were, on a certain level, competitors. The same is true on the retail side, but the problem is what do you do about integrating the brokers and the customers?

There are any number of solutions, but Bank of America decided that brokers who Merrill recruited from US Trust could no longer solicit their US Trust clients to join Merrill. That obviously causes a significant problem for the new US Trust recruits - who are recruited by Merrill to bring their clients from US Trust. Imagine that series of conversations:
 
         "Bring your business to us, we want your US Trust clients, get them over here."

         "We will give you a huge bonus, as a loan, and you will be able to pay it off with the money that you make with us"

"Great you are here, glad to have you!"

"Oh wait, you can't solicit your old clients to come over here. Not a problem, you can start all over again here!"

A complete disaster for those US Trust recruits, and Bank of America offered no solutions, no enhanced compensation, no additional loan forgiveness. Nothing, it just told its new hires, many of whom were big producers with signficant clients who they had built relationships with over decades, "too bad", "start over."

There was also the 50% pay cut imposed on bank brokers. Yes, those stock brokers who sit in bank branches and provide investment services. Their compensation structure is different from that of a stock broker on the brokerage side of the business. Their payout is lower, but they have some advantages - a build-in client base, and referrals from the branch bankers. For reasons which still remain a mystery to the brokers involved, Bank of America decided one day to stop permitting bankers to give referrals to the bank brokers, and then in order to insure that they really screwed the brokers, they cut their payout in half. A 50% pay cut plus a loss of your largest source of referrals. Many brokers were simply forced to leave because of this flagrant breach of contract, and the reality that you cannot earn a living after a 50% paycut. You have to leave in order to support your family.

Then Bank of America refused to join the Broker Recruiting Protocol, creating the interesting situation where Merrill brokers were covered by the protocol, but Bank of America brokers were not. And just to make sure the process was an entire mess, they began to consolidate the bank brokers with the brokers at Merrill. That created significant problems with the Recruiting Protocol. While those were ultimately addressed, it created additional problems for individual brokers, many of whom were forced back to a branch that they left - brokers who got into a dispute with Bank of America managers and quit to go to Merrill are finding themselves back at their old Bank of America office, with the same manager.

To no one's surprise, Bank of America is having trouble recruiting brokers. Shocker. What would a reasonable firm do in such a situation? There are a ton of choices - increase pay packages, step up recruiting, and otherwise make your firm a place where brokers can bring their clients, with a good platform, favorable employment policies - things like that.

Did Bank of America do any of that? Of course not. Instead of making the firm a place to conduct a securities business, add value to the customers, all to entice brokers to join, Bank of America has done the exact opposite - they have announced unilateral employment terms on their existing brokers, and new hires,  in order to prevent them from leaving!

Some advisors at Bank of America Merrill Lynch's U.S. Trust unit recently received an ultimatum - a demand that they sign a new agreement that would effectively sideline them for up to eight months if and when they decide to leave the firm or else risk losing not only their 2010 bonuses but their jobs, too.

That's the ticket! We can't recruit brokers, so lets make sure the ones we have do not leave. Lets force them to give 60 days notice of termination, with a 6 month non-solicit of their customers! Not only does this move raise employment law questions, contract questions, and more,  it raises questions regarding the Broker Recruiting Protocol and a potential breach of the agreement with 450 other brokers firms.

The Protocol was put into place to stop all of the lawsuits between firms when a broker moved. Firms were spending tons of money suing each other over recruiting and solicitation of clients. Three firms created and signed the Protocol, which is in essence an agreement between the firms to allow brokers to solicit customers when they leave, provided the provisions of the Protocol are met. Bank of America acknowledges that its Merrill brokers are covered by the Protocol, but continues to insist that its US Trust brokers are not.

How Bank of America intends to compete in an industry where over 450 of the firms have signed onto the Protocol remains a mystery, but this latest move is the icing on the cake. Brokers are aware of the existence of the Protocol, and in considering a move, factor the Protocol into their decision making. It obviously makes a significant difference if the new firm is part of the Protocol, as it makes the transition easier, and gives the broker a measure of comfort knowing that he will not be sued if the new position does not work out, and he wants to leave in a year or two.

But now US Trust, which is not part of the Protocol, and already has problems recruiting, has make the situation significantly worse. Any broker who is considering a move to US Trust is going to have to consider that once he goes there, he can never leave, no matter what happens - because if he does leave, he will lose his clients.

A two month garden leave plus a 6 month non-solicit is draconian. Even Bank of America can convince clients not to leave the firm if they get an 8 month head start.

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Recruiting Bonus to Be Banned?

Last year Mary Shapiro started talking about bonuses on Wall Street and how bad they were. (That's almost funny given the source) and the SEC has finally gotten around to addressing the boss' concern.

On Wednesday, the SEC proposed new rules aimed at reigning in incentive comp. The rules, which stem from Section 956 of the Dodd-Frank Act, would prohibit incentive-based compensation arrangements that encourage “inappropriate” risk-taking or could lead to “material financial loss” at broker-dealers and investment advisers with $1 billion or more of assets.

The current proposal would not affect most investment advisors, and so far, recruiting bonuses are safe - so long as they do not provide additional bonuses for performance, and according to one source, so long as there are no claw-backs based on performance.

However, the traditional recruiting bonus does have a claw-back provision of sorts - if the broker leaves the firm before the term of the note and the additional compensation agreement, he has to pay back the note. In reality, the broker is paying back the bonus, and that is a claw back provision. Couple that with a termination for lack of production, and you have a true performance based bonus, which the SEC is going to ban.

The rule is not final yet, but if it is approved as is, we are going to have an interesting situation. Firms will be forced to restructure their bonus and notes, and are going to have to address the termination for lack of performance issue. There is certainly no way that firms are going to remove that clause, and they cannot realistically remove recruiting bonuses, which puts them in a bit of a bind.

My money is on the third choice - an exemption for repayment of loans on termination for lack of production. I'll update as events move forward.

Friday Q&A - Are EFLs and Promissory Notes Enforceable?

Friday Q & A – I recently left Bank of America after the ML merger, and they now want me to repay the bonus that I received. BofA killed my business, and ML actually made it worse? Do I have to repay the money? Will they settle or do I have to go to arbitration?

This is almost becoming a daily question in our office, and not only with Bank of America reps. The turmoil in the financial markets has cause turmoil for brokers and firms as well. Add to that the move to become independent, and/or starting your own RIA (finally!) and there is quite a bit going on in broker transition these days.

The short answer is that assuming you have the “standard” promissory note that the firms use you are probably going to have to repay the money. The promissory notes are unconditional promises to repay. In most cases, they are clear that if you do not work at the firm, or any reason, the note is due and payable.

However, that is not the end of the story. Many reps that leave firm have claims against the firm – after all, that is why they left. Those claims may constitute a counterclaim against the firm – for mismanagement, unilaterally changing the terms of your employment (like reducing payouts by 50%), a harassing manager, or even closing your branch. While the counterclaim does not void the note, and award in your favor on the counterclaim may offset, or eliminate, the amount owed on the note, and in some cases, an award on the counterclaim will exceed the amount of the note, resulting in a net payment to the broker, rather than the other way around.

Those cases are not the norm, but they do exist. And like most things legal, the counterclaim depends on the specific facts. I have represented brokers with great counterclaims, and those cases get resolved – that is why you do not see them in the arbitration award database. When the counterclaim is not as viable as it might be, we negotiate the note, enter into a new long term payment agreement, or otherwise settle the case. That sometimes takes some work, but at the end of the day the settlement is typically a better outcome than going to an arbitration and losing for the full amount.

The only way to have an idea of the viability of the claim is to have an experienced securities employment attorney review the facts – and of course your contract and note. Not all employee forgivable loan documents are the same.

And call me for a consultation before you leave your firm, not after. After all of these years it still amazes me how often brokers leave a firm, negotiate a new deal at a new firm, and wait until they are at the new firm to ask for a consultation. Do yourself a favor; call an attorney before you give notice, not after.

Questions? Email me at astarita@beamlaw.com or call my office at 212-509-6544. We represent brokers nationwide and have been doing so for 25 years. My CV is online at SECLaw.com

Keeping Your Signing Bonus May Get Easier?

A recent article at a financial adviser publication ran this headline, without the question mark, reporting on a broker's win on a promissory note case as if it was a major breakthrough in the financial world. It's not.

Certainly the award against the broker of approximately $20,000 on a $142,000 note is a win, but the broker also had to pay $13,000 in forum fees, presumably because he filed a third party claim against two individuals (on which he did not receive any award).

Still, it is a win, but not unusual. I have been representing brokers on promissory note cases for years; decades even. The overwhelming majority of the cases settle, as there are just too many uncertainties in the litigation, and no one wants the risk of loss. I have had instances where my client's note was entirely forgiven, and awards where my clients paid back 20% to 50% of the outstanding balance - which in a case involving a note for over $1 million dollars is a significant win for the broker. In a recent case, the panel awarded my client his attorneys fees, despite the fact that it found for the firm on the promissory note.

The entire concept of structuring a signing bonus as a promissory note in order to keep the new hire at the firm for 5, or 7 or even 9 years is odd, but it certainly has become the standard in the brokerage industry. These  promissory notes have been carefully crafted by the firms to insure that brokers do not leave the firm until the note is completely forgiven, and to insure that the funds are repaid if the broker leaves before the term expires.

In most instances they are completely one-sided affairs - the broker promises to repay the note, and the firm promises nothing except to forgive a percentage of the note on each anniversary date. Firms do not make any representations or promises regarding anything that was said during the recruiting process, and in fact, some firms put language in the compensation agreement that attempts to remove all promises made during the recruiting process.

The promissory note is an unconditional promise to repay, but it does not necessarily stand alone. If the broker had an attorney involved when he was hired, he may have additional clauses in his hiring agreements that provide a defense to the note, or a counterclaim for breach or contract, or the covenant of good faith and fair dealing.

What is going to change these cases is the recent conduct of the wire houses. Firms have always been aggressive in enforcing the notes. Now they are aggressive in attempting to reduce costs by forcing brokers out of the firms, then trying to collect the note. In the last year or so I have seen payout reductions by 50%, removal of all support staff, mysterious re-calculations of payouts, forced changes in business models,  trumped up termination language and a host of other conduct designed to either fire the broker, or force him to leave.

That conduct is resulting in more claims for constructive discharge, as well as breach of contract and related claims, all of which are starting to come to hearing in the next few months.

I expect that we are going to see even more of these cases, where the firms lose on their promissory note claims, and wind up paying the brokers for breach of contract. Firms have been cost cutting off of the backs of brokers for far too long. The recent trend, of forcing a broker to quit, and then aggressively pursuing him for the outstanding promissory note, is going to come back to haunt the firms. The right way to handle a decline in business is to reach an accomodation with the employee, compensate him for the firm's desire to cut his position (or to take his accounts), release him from the promissory note, or some combination of those alternatives, and stop all of this nonsense with forcing brokers to quit, and then suing them because they quit.

If the firms don't act appropriately, you can be sure that arbitration panels will render an award to adjust for what should have been the proper course of conduct. Panels have been doing in in the past, and will continue to do so in the future.

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Brokers Being Trashed Again By FINRA

We all know that FINRA, along with the SEC, has been taking a beating over the past year for its failures to uncover significant frauds that have costs investors millions of dollars. There is no need to re-hash all of that, but now FINRA is attempting to do something to fix its image.

And that something is to expand BrokerCheck. Not increased survelliance of brokerage firms, not better education of examiners, not more training for the examination teams - they are going to expand the disclosures on BrokerCheck to further defame and discredit individual brokers.

There has been a discussion over recent months to keep brokers information on BrokerCheck for more than two years after a broker leaves the industry. There are a number of good arguments on both sides of that debate, but FINRA is going ahead with a proposal to keep those records online for an undisclosed period of time after the broker is no longer under its jurisdiction.

At the same time FINRA also announced that it wants to expand the civil and criminal complaint histories of its BrokerCheck service, which would give the general public more information on brokers. Sure, more information is always good, right?

Wrong. FINRA is proposing to include information that is not reportable on Form U-4 and is going to do so on the Internet. Certain reporting items, such as customer complaint letters that are filed, but never pursued, are not reportable on Form U-4 after two years have passed. The rationale for non-disclosure is clear and simple - a customer filed a complaint, he never filed an arbitration or a lawsuit, and the firm and broker never paid him any money. There is no reason to continue to report that complaint, since there is no finding of wrongful conduct, and an implication that the complaint was not a meaningful complaint, since the customer never pursued it.

Having taken that position for decades, and while continuing to maintain that position, FINRA is now proposing to disclose these non-meaningful, unsworn and unproved complaints on BrokerCheck! A customer sends a complaint letter, accusing his broker of all sorts of wrongful conduct, never pursues the complaint, never files an arbitration, and FINRA wants to make that complaint public. Sure, that will ehance the public's respect for FINRA, at the expense of the tens of thousands of brokers who have such an item in their history.

FINRA also takes the position that an arbitration claim that is settled for less than $15,000 is not reportable, for similar reasons. Suddenly, while maintaining that these decisions are not meaningful or significant, they are proposing to put them on BrokerCheck as well.

The disclosures that brokers must make are intrusive, and unnecessary to the regulatory purposes. The argument has always been that the information about arrests that are dismissed, complaints that are never proven, are all part of the mix of information that is necessary to properly regulate the industry. Fair enough, and since the information was not going to be publicly disclosed, there was not too much of a debate about the disclosures.

Now FINRA is changing course, and going to make that information public, as if that information would have stopped the 50 billion dollar fraud that FINRA's examiners missed year after year.

Why is it that FINRA attempts to address its own regulatory failings by trashing brokers. Why not clamp down on misconduct at the firm themselves?

Could it be that brokers are easy targets, with no trade organization, and have no meaningful voice in the process that affects them so profoundly?

 More>>>

Wells Fargo To Add 1,400 Advisors

Stories about Merrill adding trainees surfaced last week, now we learn that Wells Fargo Advisors is looking to add 1,400 financial advisors. A published report said that the advisors will be a combination of 1,000 recruits from other firms and 400 trainees. More>>>

Technorati Tags: broker transition, stock brokers

Bad Advice -Ignore FINRA Social Media Guidance

Securities regulation is a big deal for those in the industry. The mix of rules, regulations and regulators is a dangerous web of potential violations, fines and suspensions. But those who are in the industry know that the regulators are serious, that they are looking for violations, and will bring actions for those violations.

Maybe it is a sign of the Madoff times, but I can't help but shutter when I read comments from supposedly educated and experienced people who comment on rules and regulations. We all know that FINRA has released its social media guidelines. And we know that like most topics, there can be more than one opinion on the impact of new pronouncements.

Some think that the guidelines are too vague, and therefore meaningless. The vagueness that they are referring to is a desire to meet two goals - first to insure that new rules and regulations address a wide range of situations, and second, to allow firms to create their own supervisory system to meet the challenges of their particular mix of issues. For the inexperienced, bright line tests are better because they are easier. The experienced prefer principle-based regulation - tell me what you want to accomplish, and I will figure out the best way for me and my firm to get there.

But that claim of vagueness has led to another unfortunate, and potentially dangerous conclusion. From a legal blog today, talking about FINRA's social media guidelines:

Investing blogs seem to be eyeing the rules with a wary eye, but the consensus seems to be something a long the lines of "it's impossible for them to enforce this, and they're probably not going to be too aggressive anyway."

I hope that any financial professional who is guided by that statement has my business card on his desk. He is going to need it shortly.

FINRA is taking this seriously, and is already requesting documents regarding the use of Facebook, LinkedIn and Twitter. It is not impossible for them to monitor the use of social media, they will do so, and will seek sanctions for misuse.

Investors Filing Claims Against Lehman Brokers

Investors are starting to file arbitration claims against their Lehman brokers, in an attempt to collect their losses on investments in Lehman principal protected notes. I warned of this eventuality some time ago, as customers who lost money in the notes are going to look to recover those losses. Obviously suing Lehman is not going to accomplish anything, but some customers and their attorneys believe that suing the broker just might.

Lehman brokers have been through quite a bit. These professionals relied management's statements that "all is well" with the company, and were blindsided by the failure of Lehman.  The demise of Lehman was devastating for many, for not only did they lose their jobs, they lost their investments, their deferred compensation and for many, their retirement funds, which were invested in Lehman stock.

Now the other shoe is dropping. Many Lehman brokers recommended the principal protected notes to their customers, relying on the information provided to them by Lehman itself. With the corporation gone, these brokers are being forced to defend themselves from claims for those losses - in effect paying twice for the failure of their employer.

Those claims are going to be difficult for the customers to win, but the brokers still have to defend themselves from the claims. Should a customer prevail in an arbitration and obtain an award, that award has to be paid in 30 days, or the broker's securities license will be suspended. And an arbitration award can be confirmed in a court, at which time it becomes a judgment, enforceable like any other judgment.

The solution? Unfortunately there is no good solution. If customers are going to blame their broker for the demise of Lehman, the brokers must defend themselves. Using an experienced securities arbitration defense attorney is the first step, and hiring one who is familiar with Lehman principal protected notes is another. These cases will be difficult for the customer to win, but the experience of the attorney will not only provide a better chance for success, it might even result in reduced defense costs, as there is no learning curve.
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Mark Astarita, Esq. is a securities attorney who represents brokers and firms in every aspect of their litigation, compliance and regulatory matters. He can be contacted at 212-509-6544 or by email at astarita@beamlaw.com

Compensation Cuts Leads to Broker Transitions

In my practice I have seen a huge increase in the number of wirehouse brokers who are changing firms, as those firms consolidate and attempt to increase their profits.

Unfortunately for some, the wirehouses are ramping up profits at the expense of their brokers, and ultimately, their customers. In all of the years that I have been representing wirehouse brokers, I have never seen such a large number of brokers who are being terminated on the basis of trumped up charges. I certainly understand the need and desire to run a compliant firm, and to weed out brokers who have difficulty following the rules. And I am aware that brokers, like everyone else, tend to downplay their own culpability in such matters. But really, some of these terminations are simply beyond the pale, and nothing more than an asset grab.

I have been saying for almost a decade that the wirehouses want to get rid of brokers and move their business model to salaried employees. See my column from the January 1998 issue of Research Magazine - Death of a Salesman. But now there is a new attack - lower payouts.

It started with the small producers - who can forget Bank of America's decision to cut payouts for brokers on the banking side by 50%, causing a exodus of brokers from the firm, and a mess of promissory note arbitrations.

Citigroup, never the friend to its brokers, apparently has plans to force its brokers into a fee based model, regardless of what the customers want, or need. In an article titled "FAs Disgruntled over New Comp Plan at Citi Personal Wealth Management", David Geracioti, the editor-in-chief of Registered Rep magazine, details the information he has received regarding this forced transition from broker to investment adviser.

As Mr. Gercioti points out, brokers are upset; and leaving. Just take a look at the discussion at the Advisor Forum at Registered Rep titled "Citi PWM Exodus" for a peek at what some brokers are facing, and thinking.

Certainly, in many instances, the fee based model works for customers, and brokers. In many cases, it aligns the interests of the broker with the interests of the customer, and both do well if the assets increase in value, without any selling pressure on the broker or the customer.

But it doesn't work well for everyone. Customers with fixed income accounts, customers who adjust their portfolios once a year, and a host of others, will pay lower fees with a commission based account. Unless of course you lower the management fee to less than a percent.

Citigroup would obviously love to get rid of brokers, and the payouts, and it just may get its wish. Brokers are leaving. If a broker wants to be an RIA, he certainly can do so without the heavy hand of a wirehouse.

Setting up an investment advisory firm, using the platform of a major broker-dealer like Fidelity, is not expensive, nor is it difficult. For the enterprising professional, it is an excellent business model. For an overview of what is involved, take a look at my article, Registration and Regulation of Investment Advisers at SECLaw.com and our update of the SEC publication, Guide to Broker-Dealer Registration.

Or, becoming an independent, and associating with an independent broker-dealer. Doing so lets brokers do exactly what they and their customers need - the flexibility to use a commission based model when appropriate, or a fee based model for those customers who need that model.

Some brokers are reluctant to go into business on their own, and certainly some customers will be reluctant to leave a "big" name like Citigroup. Brokers who stay may find their compensation continually reduced, being forced into teams, and their smaller accounts sent to a call center. Ultimately, the firms will keep the assets, and continue to have less overhead, and more profit, all to the detriment of the financial professionals who cultivated those relationships and serviced those clients.

Does the big name make a difference? I am sure it does. But given the recent financial crisis, are customers still impressed with those "big" name wirehouses? Do customers really believe that those firm offer better advice than an independent? Are they in better financial shape than their competitors? Aren't customers really relying on the relationship with their financial adviser?

Time will tell, but like the brokers in the Registered Rep forums and those who are calling my office, the outlook is not good.

Naturally, any move needs the assistance of professionals, including an experienced securities attorney. Creating an investment advisory firm is not difficult, but requires guidance through the regulatory maze. But all of that can be achieved with effort, and the cost is going to be less than the loss that you will incur over the course of a single month.

My firm offers free consultations to financial professionals who are seeking to change firms, join independents or to start their own RIAs or broker-dealers. Feel free to email me at astarita@beamlaw.com, or to call 212-509-6544 to discuss the possibilities.

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Nationwide Financial Tells Advisors To Find New BDs

Nationwide Financial has advised its independent financial advisers to find new broker-dealer relationships before April 30, according to Investment News.

The article states that the move is intended by Nationwide to focus its efforts on its proprietary sales force and to expand its insurance business.

Independent brokers have a number of choices for new affiliations, as there are any number of independent firms that are available, depending on the needs of the adviser and his clients. I would like to remind brokers that these agreements should be reviewed by an attorney prior to moving to a new firm, as there are a number of clauses which could cause difficulties down the road. While many brokers believe that employment agreements, promissory notes and related contracts are not negotiable, many are, depending on the circumstances. Additional consulting an attorney before entering into any type of agreement involving your career and clients is money well spent, if for no reason other than to prevent surprises down the road.
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Custodial Firm Not Liable for RIA's Alleged MisManagement

Clearing firms, those entities which perform back office, bookkeeping, accounting, custodian and record-keeping functions for other broker-dealers, hedge funds and investment advisers, are not liable for the investment losses of their client's customers. That has been clear for quite some time, and really isn't in dispute.

The outcome makes sense. Firms like Fidelity and Schwab are not in direct contact with the customers of the firms and RIAs that they carry accounts for, they do not make decisions in the account, and are not the party providing investment advice. They are not compensated for selling securities, or for giving advice, and have no responsibility for the investments, or the advice that the broker or investment adviser provides.

Certainly, if the firm makes a mistake or is negligent in carrying out its obligations, it might be liable to the customer damaged by the negligence, but that is not the same as bearing responsibility for investment losses.

Securities attorneys are well aware of this legal concept, and you don't see many cases brought against clearing firms alleging violations of sales practice violations or inappropriate investment recommendations or choices. But every once in a while you see one, and the decision is typically in line with the concept.

A FINRA arbitration panel rendered such an award, and  gave a zero award to an investor who tried to claim that Fidelity was responsible for the losses in their RIA managed accounts. The panel denied the claim as against Fidelity. The RIA was not a party to the arbitration, presumably because there was no arbitration agreement with the RIA firm.

Another interesting point. The customers claimed that they stopped opening their statements when the investments went bad. That was a huge mistake, as the panel found, since customers are charged with the knowledge of the information contained in those statements. Further, by not opening the statements, customers have denied themselves of the ability to monitor and control their own investments, putting a damper on any claim that they were unaware of ignorant of the investments, or the losses.

Read your statements. Take action when you think something is wrong, or run the risk of a zero award.

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Congress to Give FINRA Authority over RIAs

According to InvestmentNews.com, there has been an amendment to the Investor Protection Act which gives FINRA authority over the advisory activity of any broker-dealer that it regulates.

The bill would affect anyone who is dually registered as an investment adviser and a broker, and would greatly expand FINRA's authority over the financial markets.

On one level the proposal makes sense. In recent years we have seen the distinctions between brokers and advisers blurr, and in the retail area, there often is no substantive difference between the two. At least not to the investor, who often does not know, nor does he care, whether his financial adviser is a stock broker or an investment adviser.

The most notorious example is Madoff, who, although presenting himself and his firm as a brokerage firm, was actually acting, or purporting to act, as an investment adviser. In that example, a distinction without a difference, and giving FINRA authority over the RIA side of the BDs business might have made a difference.

That is not to say that FINRA should have authority over all RIAs. There are thousands of investment advisers who are not brokers and who do not work for broker-dealers. Those adviser are now regulated by the states, or by the SEC, depending on how much money they manage.


The committee is scheduled to vote on the Investor Protection Act Nov. 4. According to InvestmentNews.com, it is likely to approve the bill. More>>>

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Hedge Funds On Wall Street Talent Hunt

From Financial Planning.com - Less than a year after the credit crisis forced the closure of some 1,000 hedge funds, these firms are back out looking for capital and hiring professionals from Wall Street firms. In addition to poaching from investment banks, the funds are bringing in professionals from endowments, foundations, and traditional asset managers, according to a recent report More>>>

Branch Managers Being Forced to Produce

There are hundreds of producing branch managers at the wirehouses, and over recent years, the wirehouses have been pushing their BOMs to drop production and concentrate on supervision. There is some appeal to using a non-producing manager, but the firms seemed to miss an important issue - compensation.

As firms pushed managers out of production there was a disconnect on the compensation side. After all, firms were asking managers to give up a business that many of them had spent years building.

There is of course nothing wrong with having producing managers. If you staff the branch properly, a BOM can service his own clients while running a branch. It happens all over the country all the time, without incident.

But the key is staffing the branch. The BOM needs an assistant, and an ops manager, and maybe a compliance officer. You simply cannot force a BOM to supervise a branch on his own, without proper support, regardless of his personal production.

But after years of forcing managers to drop their own clients, some of the wirehouses are putting managers back into production. Why? To save costs. The firms have figured out that a non-producing manager is an expense. Shocker.

According to Registered Rep Magazine, in an effort to cut costs, some brokerage firms such as UBS and Morgan Stanley Smith Barney are restructuring their branch office organization and changing the rules about which managers must generate production. 

Putting aside the turmoil that this creates for the managers ("no more production" and then "do more production") the move is a complete upheaval of the branch dynamics and creates a conflict between the BOM and the reps in his office.

Brokers like having a non-producing manager because it removes a number of conflicts. Putting non-producing managers into production creates those conflicts, and will undoubtedly increase costs in the long run, as staffing needs to be increased, and brokers feel the effects of the newly created conflicts.

Check out the full article at Registered Rep.

Morgan Stanley Plans to Double High Net Worth Advisors

Morgan Stanley Smith Barney announced the integration of Smith Barney’s Citi Family Office into its own ultra-high-net-worth division, which will now be called Morgan Stanley Private Wealth Management. Unlike the old family office, the newly combined unit will exclusively serve clients with a minimum of $20 million in assets. Morgan said it plans to add more advisors to PWM through a combination of “organic growth and selective acquisitions.” More>>>

FINRA Seeks Further Erosion of Broker Rights - BrokerCheck Forever

FINRA has proposed rule SR-FINRA-2009-050 under which it would permanently disclose a condensed record for any broker who has been fined, suspended or barred by securities regulators on its Internet based Broker-Check system. The proposed rule was published in the Federal Register on August 17, 2009 and the SEC solicited comments for submission on or before September 8, 2009.

Broker-check has been a significant intrusion into the private and personal lives of employees of the brokerage community for years. Is there any other industry or profession where such detailed information regarding allegations (not proof; allegations) of wrongful conduct are available to the public?

Broker-check was designed to allow the investing public to review information regarding their broker and potential broker. Therefore there is no reason to keep making this information public after the broker has left the industry.

That is not to say that a broker's record should be removed forever. A broker's CRD record is always available from FINRA, and all 50 state securities regulators, it is just not available on the Internet for the entire world to view.

Customer allegations are simply that - allegations. Unproven, unsworn, untested allegations by customers against brokers should never be publicly disclosed, and help no one. Why in the world would anyone want to continue the damage caused by this continued violation of broker's privacy rights?