As is customary in the financial industry, many financial advisors receive a transition and/or retention bonus in the form of a promissory note. The “bonus” often contains a number of restrictive provisions, generally tying the advisor to the firm for a number of years as well as forcing him/her to return the “bonus” if he/she were to transition to another firm (before the restrictive period ends). But as we have recently discovered, some financial firms do not actually own the “promissory note” signed by the advisor. As a result, advisors should be vigilant as to which entity is attempting to enforce the terms of the promissory note.
When firms merge (and at times even if they don’t), we are often finding that a non-FINRA member owns and holds all rights and interests in the financial advisor’s note. This non-FINRA member is usually a subsidiary of the Broker-Dealer or a related entity to the Holding Company or the Broker-Dealer. Consequently, even if the actual note allows the non-FINRA member (as an assignee) to possibly force the advisor into FINRA arbitration (as opposed to a court) to pursue collection on the note, it does not allow the non-FINRA member to invoke the infamous “expedited proceeding” provided for in FINRA Rules (and may call into question the arbitrability of the dispute as well).
The expedited proceeding for promissory note cases was instituted on September 14, 2009, and applies to all arbitration cases filed on or after that date. This allows broker-dealers to potentially obtain a FINRA arbitration award against the advisor in as little as a month or two. Nevertheless, the expedited proceeding for promissory note cases can only be asserted if a number of requirements are met. The most important requirement is that the Claimant (i.e., the institution attempting to collect the money allegedly owed on the note) has to be a FINRA member. Specifically, FINRA Rule 13806 provides the following:
(a) Applicability of Rule
This rule applies to arbitrations solely involving a member’s claim that an associated person failed to pay money owed on a promissory note. To proceed under this rule, a claim may not include any additional allegations. Except as otherwise provided in this rule, all provisions of the Code apply to such arbitrations.
In other words, if the promissory note is owned or was assigned to a related entity or subsidiary of the broker-dealer and it is not a FINRA member, expedited procedures cannot be utilized by the holder of the note. Regretfully, in an effort to invoke the rule to obtain a judgment against the advisor as quickly as possible, many broker-dealers are sending out demand/collection letters to financial advisors demanding checks be written to the broker-dealer, despite the fact that the broker-dealer is well aware they have no right to the notes or payment on the notes.
To defend themselves from the standing challenge, financial firms are attempting to cure the problem by adding rather than substituting the proper party. In doing so, they are trying to both protect the right to pursue claims in FINRA arbitration on an expedited basis (under the FINRA Arbitration promissory note rules) and also attempting to have the funds from any favorable arbitration award made payable to the broker-dealer, despite its complete lack of standing. And although broker-dealers could presumably cure this defect by simply assigning all the Financial Advisors notes to the broker-dealer, it appears that the broader issues in play (e.g., net capital requirements) far outweigh the impropriety of falsely pursuing these claims through the broker-dealer without standing to do so.
We are continuing to investigate the tax, net capital, securitization, or balance sheet/income statement (i.e., management of income) reason(s) for broker-dealers to offload these notes to a sister holding company in the first place. As recently publicized in a New York Times article noting Vernon Litigation Group’s successful challenge of FINRA member Morgan Stanley’s standing to pursue collection on promissory notes, some brokerage firms have set up entities exclusively for the purpose of holding financial advisor notes in order to obtain bigger picture benefits (such as minimizing their net capital requirements).
Based on our research and analysis, we encourage advisors to promptly retain competent counsel to determine whether to challenge the right to collect on the note in arbitration or the applicability of the expedited proceedings rule (or both), is in the advisor’s best interest. In some cases, we believe financial advisors should question the broker dealer’s authority to pursue collection on the note (i.e., standing) immediately upon receipt of a demand/collection letter.
Although dismissal in an arbitration proceeding is rare (due to the very limited grounds for dismissal provided in FINRA Rules), an early and ongoing objection before and during the FINRA arbitration proceeding should result in the FINRA arbitrators refusing to allow the claim to proceed under the expedited arbitration rules. Additionally, in the event an award is rendered in favor of a broker-dealer with no standing, then the award may be subject to a successful vacatur petition in court. This is particularly true in cases where it is made clear that the broker-dealer had no standing to pursue claims against the financial advisor.
If you have switched firms and have received a demand letter from your previous employer, you should speak to an attorney and explore your options in defending collection claims initiated by the broker-dealer or other financial institution. Vernon Litigation Group’s financial advisor employment team of attorneys continues to represent both investors and financial advisors nationwide in disputes against broker-dealers and investment firms. With respect to advisors, this includes transition disputes, promissory note disputes, wrongful termination, Form U-5, CRD, and other defamatory disclosures, discrimination, and other employment-related abuses by the financial institutions.