With Finra's recent proposal to require advisers to disclose recruiting incentives, those considering a move would be wise to look closely at how compensation packages are structured within the independent marketplace.
While certain arrangements can ease the costs associated with a shift, advisers must evaluate terms carefully before signing on the dotted line.
During the past decade, some broker-dealers began offering advisers joining their firms “enhanced compensation” packages. The Financial Industry Regulatory Authority Inc. defines enhanced compensation as “signing bonuses, upfront or back-end bonuses, loans, accelerated payouts, transition assistance and similar arrangements.”
Finra's proposal calls for disclosing the “timing, amount and nature of the enhanced-compensation arrangement” to clients for one year after changing firms. (See “Finra seeks comments on bonus disclosure plan,” InvestmentNews, Jan. 4.)
In this article, we'll focus on accelerated payouts and upfront compensation.
In an accelerated-payout agreement, the adviser receives a higher payout percentage for a fixed period. This type of incentive may appeal more to those who don't want a hefty commitment to a broker-dealer. In some cases, accelerated payouts may be equivalent to an upfront-compensation package.
They are more common at smaller firms, which often don't have the capital to pay upfront. Larger firms may be more flexible, sometimes even offering a combination of an accelerated payout and upfront money.
Upfront-compensation agreements are tied to notes that can be structured in a number of ways. A broker-dealer generally requires that advisers meet defined production levels — a percentage of their trailing-12-month production — in exchange for incremental forgiveness of the upfront payout.
In a typical five- to seven-year commitment, advisers may have to generate 80% of their trailing- 12-month production for the first year and ramp up to 90%, 100% or even more toward the end of the agreement.
Advisers must be clear on the terms and confident that they can reach their targets, which do not account for down markets or other circumstances out of an adviser's control. If production falls short, the broker-dealer may waive that year, offer an extension or call the note, in which case the adviser owes the outstanding amount (not yet forgiven) and/or interest. Notes also may be tied to collateral, and terms typically are binding to heirs and successors.
In addition, advisers need to be aware of the potential tax consequences of upfront packages. Upfront money is taxed when it's forgiven — making it important to remember that upfront money is actually a loan until the adviser fulfills his or her part of the agreement.
The ramifications of not hitting production numbers can be tough but are hardly arbitrary. For instance, a broker-dealer paying upfront for a five- to seven-year commitment may not make a profit on an adviser for at least that long.
Broker-dealers don't want to collect on defaulted notes any more than advisers want to miss their numbers, but broker-dealers must protect themselves.
Notes typically are written in the broker-dealer's favor, so advisers should obtain a copy of the terms early in the recruiting process and hire a lawyer and a tax professional to represent their interests.
Accelerated- and upfront-payment packages can make a move extremely attractive, but it's vital that advisers understand their commitment. Not doing so can result in unpleasant surprises later on.
On the other hand, advisers comfortable with the terms of their enhanced compensation can benefit from a great opportunity.
Jodie Papike is the executive vice president of Cross-Search, a third-party, independent-broker-dealer adviser and executive placement firm.