Merrill Lynch & Co. Inc. is pursuing a legal strategy that could give it a leg up in collecting from brokers who owe the firm money on retention packages.
The move affects many of the approximately 6,200 Merrill brokers who accepted packages offered when
Bank of America Corp. took over the brokerage firm last year. Brokers received anywhere from nothing up to 100% of annual production, with three-quarters of the amount paid upfront in cash under a seven-year note.
But instead of arbitration, brokers who took the deal and then left the firm without paying off their promissory notes are being taken to court in New York state — where it is easy for creditors to obtain relatively quick legal judgments against debtors.
Being forced into court “is an unknowing waiver of rights, to the tune of thousands of brokers” who took the retention deal, said David Gehn, a partner at Gusrae Kaplan Bruno & Nusbaum PLLC who is defending two former Merrill brokers in the New York courts.
The retention package notes, reportedly totaling about $3.6 billion, were issued in January by Merrill Lynch International Finance Inc., which is the legal entity pursuing reps for unpaid balances. Since MLIF isn't a broker-dealer, it isn't subject to mandatory arbitration, said Mr. Gehn, who thinks that Merrill's legal strategy is a deliberate effort by the firm to avoid Finra rules that require arbitration.
The
Financial Industry Regulatory Authority Inc. requires that disputes arising from the “business activities of a member or an associated person” be arbitrated. Brokers also agree on their U-4 registration forms to arbitrate claims.
But in court papers, MLIF argued that it “is not a party to any agreement [with brokers] whereby it agreed to arbitrate its claims.”
This year, MLIF brought at least eight note cases to New York courts. Some of those cases have been settled, while others are still pending, according to court records.
Financial advisers who accepted retention deals “agreed to repay those loans if they departed the firm,” said Merrill spokesman Bill Halldin. “In those instances where they have not lived up to their agreements, we've sought court orders to enforce the agreements.
The retention agreements “very clearly” say that collection proceedings will be in New York courts, Mr. Halldin added.
"INCREDIBLY CLEVER'
Merrill's strategy is “incredibly clever,” said Jonathan Kord Lagemann, a securities attorney.
If it were Merrill's broker-dealer entity that was owed the money, the strategy wouldn't work, said Mr. Kord Lagemann, who isn't connected with any of the Merrill cases.
“Our position is that the dispute should be arbitrated” under Finra arbitration rules, said John Ohman, a partner at Vandenberg & Feliu LLP who represents former Merrill broker Chadwick Collins in a New York note case.
Mr. Collins, a registered representative in Carlsbad, Calif., who moved to
Wells Fargo Advisors LLC in July, is awaiting a court decision on his request to force Merrill to arbitrate.
Mr. Ohman declined to comment further.
Mr. Gehn won a partial victory this month by persuading a state court to order one of his cases to arbitration.
That might help other brokers who can cite the decision as a precedent, said David E. Robbins, an attorney at Kaufmann Gildin Robbins & Oppenheim LLP.
Merrill's court strategy is “surprising,” Mr. Robbins added, because if a broker had a dispute with the firm, the rep would have to go to arbitration.
In the meantime, Merrill gains negotiating leverage by using New York courts, Mr. Kord Lagemann said, “particularly if you [the broker] live somewhere else than in New York — you've got to find a lawyer here.”
And that New York lawyer “will tell you don't have a prayer,” he added. The state's courts are “very business-friendly,” Mr. Kord Lagemann said.
With a judgment in hand, Merrill can begin the collection process, and possibly avoid a more lengthy arbitration, Mr. Gehn said.
A broker stuck in New York courts probably couldn't file a separate arbitration case because “if an issue has already been tried, they can't try it again” in another forum, Mr. Robbins said.
“If there was merit to [a broker's] defense, it's better to present it to an arbitration panel rather than a court, which won't understand” the case, he said.
A judgment is also reportable on the form U-4, and if it goes unpaid, a rep could be suspended by Finra, Mr. Gehn added.
Brokers win about one in 10 disputed-note cases in arbitration, Mr. Robbins said.
“What Merrill Lynch is doing is probably recognizing [that] reality,” he said. The firm is “trying to eliminate the [arbitration] middle man.”
Even a new expedited arbitration process for note cases isn't as fast as getting a summary judgment in court, Mr. Robbins said.
The SEC in June approved Finra's new arbitration procedure.
Observers say that the rule change appears to anticipate that the number of promissory-note disputes resulting from aggressive recruiting and industry turmoil will grow.
This isn't the first controversy that Merrill has had with regard to its retention package.
Last November, after getting push-back from the sales force, the firm amended its contract language to make clear that Bank of America Corp. would honor the recruitment protocol, which lets departing brokers take basic customer contact information.
E-mail Dan Jamieson at [email protected].
