While brokerage firms have every right to expect former brokers to honor the agreements they make when accepting recruiting and retention bonuses, Finra should resist pressure to rewrite its rules to make it easier for firms to collect unreturned bonuses.
While brokerage firms have every right to expect former brokers to honor the agreements they make when accepting recruiting and retention bonuses, Finra should resist pressure to rewrite its rules to make it easier for firms to collect unreturned bonuses.
The Securities Industry and Financial Markets Association, Wall Street's main lobbying group, wants the Financial Industry Regulatory Authority Inc. to help it crack down on deadbeat brokers. Specifically, it wants Finra to eliminate the so-called inability-to-pay defense in intra-industry cases under Finra Rule 9554.
As the rule now stands, Finra is allowed to suspend registered representatives who do not honor arbitration orders, including those that require brokers to repay “promissory notes,” which are essentially forgivable loans used to recruit and retain brokers over a period of time. Brokers who refuse to pay those arbitration awards are allowed to claim several defenses, including that they have an inability to pay. If successful, those brokers avoid suspension.
Recruiting and retention bonuses are nothing new. For years, firms have enticed and retained brokers with hefty bonuses in the form of loans that are gradually forgiven over time. If brokers stay put for the full term of the loan, the money is theirs. If they leave before the loan is paid off, they are expected to repay the outstanding balance.
At first glance, SIFMA's request seems reasonable.
After all, why should brokers be allowed to wriggle out of the golden handcuffs they so willingly accepted in exchange for five-, six- and even seven-figure bonuses? Furthermore, why should prudent brokers — that is, those who banked a portion of their bonus checks in the event they wanted to jump ship — be required to repay their bonuses while less prudent brokers get off scot-free?
The answer is that they shouldn't.
But rewriting Finra's rules is not the answer.
That's because eliminating the inability-to-pay defense would likely embolden brokerage firms to keep throwing large sums of cash at brokers as a way to recruit or retain them. If brokerage firms found it more difficult to collect on debts related to promissory notes, they likely would think twice before handing out massive hiring bonuses in the first place.
If anything, the practice of buying “production” should be discouraged. Brokers paid to switch firms — and then fulfill the terms of any agreement they sign — may feel pressure to engage in transactions that aren't in clients' best interests.
To be sure, by eliminating the inability-to-pay defense — just as it did in 2010 for unpaid awards involving individual investors — Finra would be sending a strong message to brokers that they are expected to make good on arbitration rulings. To get out of paying, brokers would have to file bankruptcy or leave the industry.
It would also lessen the self-regulator's role in assessing a broker's financial condition. That would put responsibility for determining whether a broker's debts should be discharged squarely on the shoulders of federal bankruptcy court, which SIFMA argues is the best forum for adjudicating a financial condition defense.
That said, we still believe that Finra should resist eliminating the rule.
An alternative strategy would be better disclosure of unpaid awards. We bet that brokers would hesitate to abuse the inability-to-pay defense if they thought it would be made public and their clients would find out that they couldn't pay their bills.
