How Can A Broker Defeat Or Offset A Brokerage Firm’s Promissory Note Arbitration?

A dispute that brokerage firms frequently arbitrate, before FINRA, against brokers concerns “transitional compensation” payments to brokers whom the firms have fired within a predetermined period of time. Such disputes are promissory notes, up-front bonuses, recruiting bonuses, forgivable loans, or forgivable employee loan (“EFL”) cases.

It is difficult, but by no means impossible, for a broker whose brokerage firm has harmed to defeat, or at minimum to prevailing on counterclaims offsetting in whole or in part, a brokerage firm’s claim to collect from the broker monies owed on a promissory note.

How Promissory Note Cases Arise

In the securities industry, brokerage firms frequently offer account executives transitional compensation to ease the account executives’ lateral moves to those firms. A firm intends such compensation to persuade the account executive to join the firm and ensure that the executive won’t receive a windfall if he leaves the new firm soon after arriving.

Thus, the up-front bonus or forgivable loan provision of a broker’s employment agreement usually provides that if the firm terminates the broker’s employment within a specified period for any reason or if the broker elects to leave the firm, the balance outstanding on loan immediately becomes payable to the firm.

The recruiting bonus provision of a broker’s employment contract typically provides that the brokerage firm will forgive the loan in equal annual installments over a specified period. That period is usually somewhere from five years to seven years.

A promissory note secures the repayment obligation outlined in a broker’s employment agreement. For years, brokerage firms’ lawyers have prepared, revised, and sharpened these promissory notes such that the notes are challenging to invalidate.

Typically, the forgivable loan amount is 100% or more of the broker’s trailing 12-month gross commissions. (Recently, at least one brokerage firm has offered, to brokers making lateral moves to the firm, forgivable loans equal to 50 basis points on assets under management which the broker transfers to the firm.)

If the terminated broker does not immediately repay the loan, the firm may bring a FINRA arbitration against the broker to collect the due amount.

Indeed, there are between 260 and 400 FINRA arbitrations each year in which brokerage firms seek to collect, from brokers, monies owed under promissory notes.

A Potential Defense In Promissory Note Arbitrations

In promissory note cases, the best defense is a good offense. That is, the broker may have a meritorious counterclaim that can offset all or a portion of any award to the brokerage firm.

That said, at least one defense (to collecting a forgivable loan) has prevailed, in part, during several instances. Specifically, at least one FINRA arbitration panel appears to have ruled that where a brokerage firm fires a broker to preclude the firm from being required to make a payment to the broker representing a portion of the balance owed by the broker to the firm under a promissory note, the arbitration panel (i) may cancel the broker’s debt under the promissory note and (ii), despite the panel’s cancellation of the note, may require the firm to make the precluded payment.

Specifically, in Merrill Lynch, Pierce, Fenner & Smith Inc. v. Connell, FINRA Arbitration No. 10-03486 (May 6, 2011), only two days before the claimant brokerage firm was required to forgive the first $476,500 of the respondent broker’s forgivable loan, the brokerage firm had fired the broker. The Connell arbitration panel held that the broker needed not to pay the firm the $3.3 million due on the promissory note. Further, the Connell panel directed the brokerage firm to pay the broker compensatory damages of $476,500.

For a further analysis of the Connell arbitration award, see my May 24, 2011 blog post.

Counterclaims In Forgivable Loan Cases

In promissory note cases, some of the counterclaims may offset, in whole or in part, any award to the brokerage firm as follows.

Fraudulent Inducement To Accept Employment. Respondent brokers frequently counterclaim against the claimant brokerage firms for fraudulently inducing the broker to leave a prior employer and work at the claimant firm. The respondent broker ruefully maintains that if the claimant brokerage firm hadn’t, by making promises to the broker that it knew to be false, caused him to cease working for his prior employer and to join the claimant firm, and if the claimant firm hadn’t then ruined the broker’s career by breaking those promises, the broker could have brought in or retained numerous customers and could have generated much revenue for the claimant firm and the broker.

For example, the respondent broker may contend that, during the job interview process, managers at the claimant brokerage firm orally promised him that, if he left his then-employer and joined the claimant firm, (1) the claimant firm would make him part of a particular team of brokers or would assign support staff to him, (2) the claimant firm would allow him to sell, to his customers, securities which the respondent broker had bought in the market at favorable prices, rather than requiring him to sell, to his customers, higher-priced securities which the claimant firm maintained in its inventory, or (3) the firm’s investment bankers would introduce the respondent broker to many of the bankers’ wealthy individual clients so that the broker could pitch these high net worth individuals on allowing him to manage their assets.

Further, the respondent broker may maintain that the claimant brokerage firm, through its supervisory employees, made these verbal assurances to him with a preconceived and unrevealed intention not to perform them. Because the claimant brokerage firm broke these verbal promises (the broker contends), the broker was unable to originate an adequate number of customers at the claimant firm. They also could not keep a sufficient number of clients upon joining the claimant firm or convince their customers to engage in enough fee-generating transactions.

Absent any contractual disclaimers, when a brokerage firm makes to a broker, at the beginning of the employment relationship between them, oral representations which the firm when it makes the promises, knows that it does not intend to fulfill, that broker may well have a meritorious claim against the firm for fraudulently inducing him to accept employment with the firm. See, e.g., Stewart v. Nash, 976 F.2d 86 (2d Cir. 1992).

For a further discussion of brokers’ counterclaims, in promissory note cases, of fraudulent inducement to accept employment, see my June 15, 2011 blog post.

Unpaid Overtime Compensation. Many New York State brokers work more than 40 hours per workweek. If a broker at a brokerage firm in Manhattan works more than 40 hours per workweek but is not paid each workweek and regardless of the quantity or quality of his work, at a minimum salary level of at least $1,125 per week ($58,500 per year), that broker may have a (counter)claim against his brokerage firm for unpaid overtime compensation.

Defamation. In New Jersey and in some other states, to successfully sue a brokerage firm or other former employer in the securities industry for defaming a broker or other registered employee for defaming a broker or other registered employee on a Form U-5 (Uniform Termination Notice for Securities Industry Registration), the broker or other registered employee must prove the usual elements of defamation, plus that the former employer acted with malice. See, e.g., Wells Fargo Investments v. Shaffer, FINRA Arbitration No. 10-0073 (in promissory note arbitration governed by California law, holding that the claimant/counter-respondent brokerage firm was liable to the respondent/counter-claimant employee for $75,000 for libeling the employee by stating on his Form U-5, in substance, that the brokerage firm had fired the employee for good cause).

(By contrast, in New York State, statements made by an employer on a Form U-5 are subject to an absolute privilege in a suit by the employee for defamation. Rosenberg v. MetLife, Inc., 8 N.Y.3d 359, 362, 371, 866 N.E.2d 439, 834 N.Y.S.2d 494 (N.Y. 2007)).

For a more detailed discussion of how, in New Jersey, a broker can win a claim against his brokerage firm or another former employer for defaming him on a Uniform Termination Notice for Securities Industry Registration, see my April 11, 2011 blog post. For additional discussion of the Shaffer arbitration award, see my February 7, 2011 blog post.

Unpaid Wages, Unpaid Bonuses, or Unpaid, Deferred Compensation.

Other counterclaims that, if viable, may offset, in whole or in part, any award to the brokerage firm in a promissory note case include, without limitation, unpaid wages claims, unpaid bonus claims, and causes of action for unpaid, deferred compensation. See, e.g., Greene v. Credit Suisse Secs. (USA) LLC, FINRA Arbitration No. 17-00112 (Mar. 4, 2019) (awarding, to the respondent/counter-claimant brokerage firm, $2,977,933 owed under a promissory note and $56,916 in an overpayment of compensation, but holding the brokerage firm liable to the claimant/counter-respondent broker for compensatory damages of $3,234,830, consisting of $2,159,541 in severance payment, $369,073 in deferred compensation, and $706,216 in assets under management); Oppenheimer & Co., Inc. v. Roche, FINRA Arbitration No. 17-03404 (Jan. 7, 2019) (awarding, to the claimant/counter-respondent brokerage firm, principal and interest of $135,611 owing under the promissory note, but holding the brokerage firm liable to the respondent/counter-claimant broker for $262,500 for unpaid salary, unpaid bonus, and accrued but unused vacation days).

It may be in a terminated broker’s interest to file a FINRA arbitration, raising his claims against the brokerage firm, before the broker brings an arbitration against the broker seeking to collect on the forgivable loan owed by the broker.

If the broker commences his causes of action against the brokerage firm before the brokerage firm files to collect the monies owing under the broker’s promissory note, the FINRA arbitration panel may attach more importance to the broker’s claims. By filing first, a broker may highlight that his claims against the brokerage firm are viable and are not something made up to stave off the firm’s promissory note claim.

If you are a securities industry professional residing in the Manhattan area, and the brokerage firm which formerly employed you demands that you repay monies due under a promissory note, call Attorney David S. Rich at (347) 970-5550.

If you are a securities industry employee living in the Manhattan area, and the brokerage firm where you formerly worked has brought, before FINRA, an arbitration against you to collect the amount you owe under a promissory note, call Attorney David S. Rich at (347) 970-5550.