Promissory Notes (often called up-front forgivable loans) are commonly used as a recruiting tool by many of the major brokerage firms in the securities industry, including Morgan Stanley Smith Barney, Banc of America Investment Services, Wachovia Securities, Wells Fargo, Merrill Lynch, Ameriprise (formerly H&R Block), and UBS Financial Services. Essentially, brokerage firms use the up-front forgivable loans to recruit financial advisors from other firms to bring their clients (or “book of business”) to the new firm. Typically these loans are then forgiven by the hiring firm on a monthly or annual basis and if the financial advisor remains with the new firm through the duration of the forgiveness period of the loan, the broker does not have to repay the loan. If, however, the financial advisor resigns from the brokerage firm, or is terminated, before the loan is forgiven, the broker is contractually obligated to repay the outstanding amounts owed on the loan and the brokerage firm will often move to collect the outstanding amount still owed on the loan.
Typically, the brokerage firm does this by sending a “demand letter” requesting that the financial advisor repay the money owed on the promissory notes. If this demand letter is sent by an outside collection agency, including an outside law firm, the demand letter is required to be in compliance with the Fair Debt Collection Practices Act. As such, the demand letter should include (1) the outstanding balance on the promissory notes (the amount owed, including interest), (2) the demand letter should provide the debtor with thirty days to dispute the debt, and (3) the demand letter should provide validity of the debt (usually by attaching a copy of the promissory notes).
If the broker fails to respond to the demand letter or if the financial advisor and brokerage firm are unable to reach a mutually satisfactory settlement agreement, the brokerage firm will often then elect to sue the broker for failure to repay the promissory note(s). If the brokerage firm does sue the former financial advisor, such suit will likely be filed with FINRA (formerly the NASD) since virtually all brokers at the onset of their employment with their now former employer agreed to arbitrate any dispute between themselves and their employers through FINRA arbitration as part of their employment agreements. A similar arbitration clause is also usually included in the promissory notes. Moreover, the financial advisor’s U-4 sets forth that a financial advisor (or associated person in the industry) agrees to FINRA’s jurisdiction for disputes.
Once the brokerage firm’s claim against the former broker is filed, pursuant to FINRA Rule 13303, the financial advisor has 45 days to file an Answer. The common defenses/counterclaims asserted by financial advisors in defending against claims brought by brokerage firms to collect on these promissory notes are misrepresentation/fraudulent inducement (related to promises regarding the terms of employment), discrimination, wrongful termination/constructive discharge, unjust enrichment (related to clients the financial advisor may have left behind), and breach of contract. Another equity argument that is often asserted is that the forgiveness of the notes should be pro rated (although the notes are often forgiven on an annual basis, the broker can still argue that equity should provide that the forgiveness date should be the date that the broker left the firm and not the date of the last annual forgiveness).
Once the defenses or counterclaims are filed, the parties then proceed to the discovery process and set the matter for hearing. The case is then decided by either an industry or public panel (depending on the counterclaims raised).
If the brokerage firm takes their claim all the way to hearing and gets an award against the financial advisor, the financial advisor is required by FINRA Rules to pay the award. Specifically, Rule 9554(a) provides that an associated person’s failure to comply with a settlement agreement or award related to an arbitration or mediation within 21 days of notice by FINRA will result in a suspension of the associated person from the industry. As such, if a financial advisor gets an arbitration award against him/her related to his/her obligations on their promissory notes, and fails to pay that award, the broker may be suspended from the industry. There are a few ways to avoid being suspending without paying the award (including agreeing with the brokerage firm to settle the award with payments over time, declaring bankruptcy, or demonstrating to FINRA a legitimate inability to pay the award) but generally speaking a financial advisor is obligated to pay the award if the brokerage firm prevails.
Before entering into any up-front forgivable loan agreement with a brokerage firm, there are a few significant provisions in virtually every Promissory Note of which financial advisors should be aware.
(1) Promissory Notes will almost always include a provision setting forth the financial advisors employment as an “at-will” employee. A typical example of such a provision is as follows:
“This Agreement is not a contract of employment for any period of time. The Borrower’s employment with the Lender is on an “at-will” basis which means that the employment relationship can be terminated at any time for any reason or no reason by either party. Nothing herein shall be construed as a contract of employment for a definite term.”
The reasons this provision is included are obvious. While most employees are at-will employees, brokerage firms still want this arrangement to be spelled out so that the employee can not later argue that the brokerage firm made promises of employment for a specified period of time. Although there is caselaw that claims that an NASD (now FINRA) arbitration agreement changes a broker’s at-will relationship with a brokerage firm to “something else,” requiring justification for a discharge (see, e.g. Paine Webber v. Agron, 49 F. 3d. 347, 352 (8th Cir. 1994)), “at-will” provisions are generally enforced.
(2) Promissory Notes also almost always provide for the broker being obligated to reimburse the brokerage firm for any costs of collection in the event of default (including attorney’s fees and costs). Although many states require that an attorney fees provision be reciprocal (meaning that the broker would be entitled to his/her attorneys’ fees if he/she disputes the debt and ultimately prevails), the provision in the promissory notes will not be drafted that way, and a broker should be aware that they may be on the hook for the brokerage firm’s attorneys fees if they fail to repay their prior employer.
(3) Similarly, the Notes also generally provide for interest to accrue both while the broker remains with the brokerage firm and after default. As such, if the broker is in default and is considering settling, it is better to do so sooner rather than later.
(4) Another provision that is significant is that the Notes usually provide for the brokerage’s firm authority to restrict the broker’s brokerage account if any amounts owed on the loans become outstanding. A typical example of such a provision is as follows:
“The Lender shall have the right, upon default, without notice, to withhold any monies payable by it to the Borrower, as commissions or otherwise or from any amounts payable under any non-qualified deferred compensation or similar arrangement sponsored by the Lender, and to withhold other monies, securities, commodities or other properties of the Borrower which may at any time be in the possession of the Lender for any purpose; and to apply such monies, etc., to satisfy the indebtedness due under this Note. The Borrower hereby authorizes and consents to the aforementioned deductions.”
Depending on the broker’s separate customer agreements, these restrictions may apply to joint accounts in addition to individual accounts, and if the financial advisor leaves his/her employer owing money on a promissory note and with money in a brokerage account held by their employer, the brokerage firm is likely to restrict that account.
If you have questions about securities industry promissory notes, The White Law Group may be able to help. To speak to a securities attorney, please call our Chicago office at 312-238-9650.
The White Law Group, LLC is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm with offices in Chicago, Illinois and Boca Raton, Florida.
To learn more about The White Law Group, visit http://www.whitesecuritieslaw.com.