Advisor Alert — Promissory Note Collection Disputes Likely to Increase in Current Market Conditions
Current employment market conditions for financial advisors, driven by the continuing trend of advisors departing wirehouses for alternative employment channels, as well as recent labor market softening due to the Covid-19 pandemic, will likely give rise to more promissory note collection disputes. If an advisor is contemplating a move to an independent broker-dealer, considering a transition to a Registered Investment Advisor (RIA), or has been recently discharged from employment at a broker-dealer, then he or she should consider the important implications of any outstanding promissory note.
To be sure, in the wake of the 2008 Great Recession, Wall Street firms have aggressively ramped up the long-standing industry practice of granting advisors up-front Employee Forgivable Loans (EFLs) structured as forgivable promissory notes. These forgivable loans can serve as either a powerful retention or recruiting tool depending on the circumstances. In fact, according to some statistics, in recent years tens of thousands of registered representatives across the brokerage industry have accepted such retention or recruiting EFLs. Unfortunately, however, some advisors who entered into these deals may not have fully understood the important legal and financial implications within these agreements.
In most instances—when an advisor breaches the terms of any retention or recruitment package, which are commonly structured to include promissory notes on terms from 7-14 years—brokerage firms will pursue the advisor to collect on any remaining balance due. These collection efforts may include the broker-dealer initiating a FINRA arbitration claim. In fact, promissory note disputes are frequently the subject of FINRA arbitration, with approximately 250-400 disputes going to arbitration each year, for years 2016-2019. This year, through September 2020, some 184 FINRA cases involving promissory note disputes have been filed.
Because EFLs are regarded as contracts, brokers facing a promissory note dispute may seek to assert certain defenses under principles of contract law. In fact, one defense that has prevailed against brokerage firms seeking to enforce the terms of a promissory note involves the timing of a broker’s discharge. Merrill Lynch, Pierce, Fenner & Smith Inc. v. Connell, FINRA No. 10-03486. In Connell, the Panel assigned to the case took a very dim view of the fact that the broker was terminated by Merrill Lynch only two days before he would have been eligible for his first loan forgiveness installment payment of $476,500, payable in 7 annual installments for an aggregate amount of approximately $3.3 million. The FINRA arbitrators assigned to the Connell case determined that the Claimant was not required to pay Merrill Lynch the $3.3 million due on a forgivable up-front loan. Furthermore, the arbitration panel held Merrill Lynch liable for compensatory damages of $476,500, representing one-seventh of the entire promissory note loan.
Where appropriate, brokers addressing promissory note disputes through FINRA arbitration may also make claims or counterclaims that may serve to offset, partially or fully, any award to a brokerage firm seeking to collect on a promissory note. Such counterclaims often center around the recruitment process, when a broker may be induced to leave his or her current employer based upon certain assurances. For example, a broker may be induced to take a new position based on the promise that he or she will be able to pursue certain lines of business, maintain or pursue certain clients, or have critical support staff or other infrastructure in place to adequately service their book of business. After the recruitment process has concluded and the initial honeymoon period has worn off, however, a broker may come to realize that he or she was fraudulently induced into leaving a prior employer.
The attorneys at Giarrusso Law Group LLC have considerable experience in working with financial advisors in connection with up-front Employee Forgivable Loans underpinning a recruitment or retention package. Advisors who wish to discuss a promissory note dispute may contact us by telephone at (201) 771-1115 or by email at info@gialawgroup.com for a no-cost, confidential consultation.