Advisers who walk out of a brokerage without paying back a bonus may confront a legal hurdle they hadn’t expected.
According to bonus contracts reviewed by Dow Jones and several securities lawyers, at least some advisers in recent years have waived their right to file counterclaims against their ex-employer in arbitration proceedings that involve unpaid bonuses.
This clause appears in at least some Morgan Stanley Smith Barney bonus contracts dating back as far as 2009, but it’s unclear if it’s standard language in the company’s contracts. The clause hasn’t attracted much attention, perhaps because it isn’t prominent in the contract and because few brokers who signed it have moved to other firms at this point.
Under these contracts, if an adviser leaves the company without repaying a bonus, and the brokerage takes the adviser to arbitration to reclaim the money, the adviser can’t respond with direct counterclaims unless it’s simply a claim to prove that they did repay the bonus.
Brokers who have other grievances would have to file claims in separate proceedings. Counterclaims, an important negotiating tool for brokers in bonus cases, can involve complaints about failed promises, like a promotion that didn’t come through. They’re often the type of grievance that wouldn’t warrant filing a separate case, which typically involves more time and expense, lawyers say.
Quietly getting advisers to waive their counterclaim rights has other distinct advantages for a brokerage. Straightforward bonus cases can get fast-tracked by the Financial Industry Regulatory Authority, the Wall Street self-policing watchdog that runs the securities industry’s mandatory arbitration process. So if a brokerage can eliminate counterclaims, it’s likely to recoup its money months sooner.
Dow Jones interviewed over half a dozen lawyers for this story, and nearly all of them said it’s unusual for a brokerage to include a no-counterclaim clause in a bonus contract. However, a couple of them said it’s not uncommon. David S. Rich, a New York-based employment and business litigation lawyer called the clause “one of a number of provisions in a promissory note contract that brokers don’t give sufficient thought to” before entering the deal.
MSSB, a joint venture between Morgan Stanley (MS) and Citigroup Inc. (C), appears to be the only big brokerage using this clause. The company declined to comment for this story.
A spokesman for Wells Fargo Advisors said it doesn’t have a provision like this in its contracts, while UBS AG’s (UBS) UBS Wealth Management Americas says it used to have a clause like this, but started using a new format in September 2009 that no longer includes the provision. Bank of America Corp.’s (BAC) Merrill Lynch declined to comment, but a source familiar with the matter said the brokerage doesn’t use this clause.
If the clause used by Morgan Stanley Smith Barney isn’t knocked down by arbitration panels–and at least one panel has let it stand–it wouldn’t be surprising if more firms follow MSSB’s lead.
Bonus contracts are a big source of legal wrangling when advisers switch companies. Lucrative bonuses are a key way brokerages attract and retain talented advisers. But these bonuses have strings attached: They come in the form of a loan that is gradually forgiven over the life of a contract, often seven years. If an adviser leaves the company before the contract ends, they owe the balance of the loan.
Several lawyers think that the no-counterclaim clause may not hold up to legal challenge. They cite a fundamental legal principle recognized in state and federal courts, called the “entire controversy doctrine,” which requires that all aspects of a legal dispute involving the same parties be presented in one case.
But at least one attempt to cite that principle failed. James Eccleston, a Chicago-based securities and financial-services lawyer, says he had a client who left MSSB last year without repaying a retention bonus, and MSSB filed an arbitration claim with Finra to seek repayment.
Eccleston received notice that MSSB had asked Finra to defeat the counterclaims, citing the waiver the adviser had signed. Eccleston argued the entire controversy doctrine before the panel, but the arbitrators still sided with MSSB. The case was eventually settled, in part because the counterclaims were defeated, he says.
It may be in their interest to say so, but the lawyers note that the clause shows how important it is for brokers to have an attorney check out legal documents they’re planning to sign. “We would never counsel a client to sign a contract with that in it,” Eccleston says.
By Jennifer Hoyt Cummings
A DOW JONES NEWSWIRES COLUMN
(Jennifer Hoyt Cummings writes about financial advisers and their jobs, with a focus on news and trends related to large retail brokerages. She covers topics such as adviser compensation, management structure, regulation, products, technology, recruitment and best practices. Jennifer can be reached at 212-416-2474 or by email at jennifer.cummings@dowjones.com. You can also follow Broker’s World on Twitter @BrokersWorld.)
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