Trouble in the Workplace, Part I
Guest Blogger: Katherine Vessenes, JD, CFP® - President, Vestment Advisors
Investors are not the only group going after the industry’s deep pockets. With numerous class actions pending against broker dealers by unhappy reps, it has become clear that claims between reps and their firms can be even more costly than the claims made by unhappy investors.
With both broker dealers and their reps getting bad legal advice, the issues keep escalating. There are five common claims and issues that are currently making their way through the courts or arbitration. Let’s take a look at the first three:
1. Class actions for unpaid overtime
To avoid paying registered reps overtime, virtually every wire house has relied on legal counsel’s advice that their reps would qualify for the administrative exemption to the Federal Labor Standards Act. The problem: the advice was dead wrong.
“This is an area where the broker dealers got caught with their pants down,” said Jim Eccleston, a nationally known attorney from the law firm of Shaheen, Novoselksy, Staat, Filipowski & Eccleston, in Chicago, who specializes in securities litigation and employment law.
There are a number of conditions to be eligible for the exemption. “One of them is the employee must be paid a salary,” according to Eccleston. He says the law currently provides that $455 per week is the minimum amount an employee must receive in order to meet the criteria for the exemption. In addition, the salary must be a regularly received and predetermined amount that cannot be reduced by the quantity or quality of the employee’s work. Also commissions or draws don’t qualify.
Most brokers work more than 40 hours per week, and yet never knew they were entitled to overtime. This can add up to hundreds of hours per year per rep.
The bottom line: just about every brokerage firm has violated the employment law according to Eccleston and is now exposed to a barrage of lawsuits and claims. Eccleston’s firm and coalition of other law firms have already started filing class action suits on behalf of the reps. Their plan is to file class action suits against every firm in every state.
The settlements have been staggering. UBS settled nationally for $87 million dollars. Citigroup settled recently for a whopping $98 million by consolidating three suits from New York, New Jersey and California that involved about 20,000 reps. Merrill Lynch and Morgan Stanley each settled in California; Morgan Stanley for $42.5 million and Merrill for $37 million. Some of these firms are likely to be facing actions in the other 49 states as well.
On the surface it appears there are no legitimate defenses to these cases. Either the firms paid overtime to their reps or they did not. If they didn’t, they are probably going to be facing class actions until the statue of limitations expires. Some states have a two-year statue of limitations on these claims. But it can go up to five or six years in other venues.
“These are such open and shut cases that none of them are going to trial,” according to Eccleston. It is in the firm’s best interest to settle early rather than go to the time and expense of a trial where they don’t have any meaningful defenses.
Going forward Eccleston expects most brokerage firms to change their policies. “They will probably pay the minimum in salary and then create a plan for the reps to get the balance of their compensation in bonuses or commissions,” he explained. Many attorneys think this arrangement will allow brokerage firms to avoid paying overtime, but the issue has not been definitely decided.
In the meantime, Eccleston cautions that changing a compensation policy now does not affect liability for past behavior. There will still be lawsuits because the firms’ activities were illegal in the past.
The easiest cases are where the rep has recently left a firm and, feeling safe and secure with the new employer, knows they can seek unpaid overtime from the old broker dealer without jeopardizing their new employment. “We definitely want to hear from these people,” says Eccleston, “There is a good chance we can help them.” He goes on to say that he also likes to hear from reps who are currently employed at a firm they think violated the law. “Frequently they know a rep who has left the firm and that rep feels more comfortable about suing. In that case the current employee will still benefit once the case is filed and they don’t have to be labeled as the trouble maker who brought the suit,” according to Eccleston.
The coalition of law firms is open to meeting with reps who might be interested in being a plaintiff, particularly the lead plaintiff in the class action suits. Reps may hesitate to file a suit against their current firm because they fear retaliation. This is true even though some of the settlements have been $10,000 to $30,000 per rep, Eccleston explained.
Lessons for broker dealers: Now is the time to get good advice about your overtime policies. Every day you wait to change your policies increases your exposure.
Lessons for reps: if you think you are owed back overtime pay, you can contact a firm like Jim Eccleston’s to see if you qualify. Going forward you should keep track of the hours you work every week. This information may be helpful in your suit.
2. Claims for illegal charges for sales assistants, trading errors, marketing costs and technology fees
Another area that will be getting more attention in the near future is the practice of firms to charge their employee/brokers for sales assistants, trading errors, marketing costs and technology fees. Eccleston states it is illegal in most states for employee/brokers to pay for their own sales assistance. He sites New Jersey as a state where employers are not allowed to divert the wages of employees.
“These are all areas that are particularly irksome to brokers,” says Eccleston, “and they are fighting back.” It is really irritating to brokers to be charged for trading errors only when the firm looses money on the error. Most firms don’t share the profits of trading errors with reps, and this makes them angry Eccleston explained.
Technology charges are another area that seems to make reps upset enough to seek out legal advice. Eccleston explained that it is not unusual for a firm to charge a branch $10,000 to $30,000 per month in technology fees. This is really an offset of the company expenses against an employee’s wages. Eccleston pointed out that no class action has been settled or won but, in his opinion, the law seems to be on the side of the employee. He has noticed some firms are hoping these cases will slip under the radar, so they are quietly settled without much publicity.
Lessons for broker dealers: Do a careful review of the labor laws in every state you do business. Then you can determine if you should end these practices.
Lessons for registered reps: If you think you might be charged illegally, contact a law firm that specializes in the employment issues facing reps and broker dealers. They should be able to tell you if you have a good claim.
3. Promissory notes
Another area that is receiving a lot of attention is promissory notes. Although this is not a new issue, some recent trends in the amount of the loans and their durations have brought it to the forefront.
It is becoming increasingly common for a rep to receive a large up front bonus, frequently called a “waffle”, as an inducement to switch firms. Although called a bonus, it is in fact a loan that can be forgivable if the rep stays long enough with the receiving firm. As each portion is forgiven, the rep must report it to the IRS and pay taxes on the forgiven amount.
These loans are usually based on 100 to 150 percent of the rep’s trailing 12 month commission. They are getting so large, it is not unusual to see bonuses in the range of $1 to $1.5 million be used to motivate a rep to switch firms. As the bonuses have gotten larger, so has the length of the term of the loan. The notes are now commonly six to nine years long.
For the reps, it looks good on the surface, but the strings to the bonuses could cause problems down the road. Reps need to realize they will be an indentured servant for the period of the loan, and six to nine years can be a very long time if they are not happy at the new firm.
Should the rep leave before the note expires, there can be some very unpleasant tax consequences. Eccleston explains it like this: "A typical situation is where the rep doesn’t want to leave the receiving firm, but some circumstances force him to move on. Many of these cases involve a bad start at the new firm. Typically there were problems with the on-boarding process and the rep has suffered financially as a result. It could be the ACAT transfers did not come over as quickly or completely as anticipated. Maybe the new manager was uncooperative in some way and it cost the rep some commissions, or maybe the phones aren’t working. The net result is the rep realizes they are not making nearly as much money as they should and they decide to leave.
The firm will then file a lawsuit against the rep for the balance of the loan. The portion of the note not then forgiven is owed and accelerated. The rep, who was struggling anyway, now finds they owe the firm a great deal of money.
“Sometimes, after reviewing the facts, we feel the firm should owe a check to the rep, not the other way around,” Eccleston explained. That is because the firm made the rep’s life so difficult, they couldn’t make a decent living at the new firm and in fact ruined the rep’s business.
By this time the rep has had enough, according to Eccleston. First their business is ruined and then they are asked to pay back the loan. “That’s when they call me and ask about their remedies,” he said.
A typical counterclaim is brought by the registered rep for lost revenue over three years. These cases usually settle, according to Eccleston. The problems arise when the rep consults with an attorney who may not be familiar with the tax consequences of these issues. Eccleston says when they negotiate on behalf of the rep they try to string out the payments over as long a period of time as possible. The reason is at the final payment all the unforgiven portions, those the broker dealer agreed to waive during the settlement process, are reportable as income and taxable.
Here is the example Eccleston gave. Say the rep was given a bonus of $500,000 and signed the promissory note. At the point in time where $250,000 had been forgiven, reported and the rep paid the taxes due, she decides to leave the firm, accelerating the balance due of $250,000. After hiring an ace attorney to negotiate a lower settlement, our rep is determined to only owe $100,000 because the broker/dealer agreed to waive $150,000 to settle the suit. It is at this point where Eccleston has seen a number of reps hurt by incompetent counsel. The reason is the firm will issue a 1099 for the unpaid amount, in our example, a whopping $150,000, treating it like a further forgiveness of the original loan. The rep will then owe taxes on the $150,000.
Unfortunately, Eccleston says most reps are clueless until they get the tax bill. In the higher income tax brackets they could be looking at close to 40 percent of the amount the broker dealer waived going to the IRS. At that stage the settlement doesn’t look nearly as good.
Lessons for registered reps:
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Read the language in the promissory note very carefully.
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Get legal advice before you sign the note.
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If you decide to leave, take careful notes about any problems with the on-boarding process. Make sure they are detailed and dated because this will help strengthen your case.
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Watch out for the tax consequences.
Lessons for broker/dealers:
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Good file notes can also strengthen your case. Make sure your branch office managers are documenting the transfer process and noting things are going smoothly. If the transfer is not going smoothly, you should document how you fixed the problem.
In my next post, I'll discuss the final three most common claims between reps and their firms.
Katherine Vessenes, JD, CFP® is the country’s best known authority on the legal and ethical issues facing financial advisors. As president of Vestment Advisors, she helps broker dealers and financial advisors build safer, more profitable businesses. You can reach her at 952-401-1045 or Katherine@vestmentadvisors.com. This article first appeared in Broker/Dealer magazine.
