Financial Advisor Promissory Notes (Up-front Forgivable Loans)

Promissory Notes (often called an up-front forgivable loans) are commonly used as a recruiting tool by many of the major brokerage firms in the securities industry, including Morgan Stanley, Merrill Lynch, Wells Fargo, Ameriprise and UBS Financial Services. Essentially, brokerage firms use the up-front forgivable loans to recruit financial advisors from other firms to bring their clients (or “book of business”) to the new firm.

Typically these loans are then forgiven by the hiring firm on a monthly or annual basis and if the financial advisor remains with the new firm through the duration of the forgiveness period of the loan, the broker does not have to repay the loan. If, however, the financial advisor resigns from the brokerage firm, or is terminated, before the loan is forgiven, the broker is contractually obligated to repay the outstanding amounts owed on the loan and the brokerage firm will often move to collect the outstanding amount still owed on the loan.

Often, the brokerage firm does this by sending a “demand letter” requesting that the financial advisor repay the money owed on the promissory note or notes. If this demand letter is sent by an outside collection agency, including an outside law firm, the demand letter is required to be in compliance with the Fair Debt Collection Practices Act. As such, the demand letter should include (1) the outstanding balance on the promissory notes (the amount owed, including interest), (2) the demand letter should provide the debtor with thirty days to dispute the debt, and (3) the demand letter should provide validity of the debt (usually by attaching a copy of the promissory note).

What Happens When the Broker and Firm Can’t Reach an Agreement?

If the broker fails to respond to the demand letter or if the financial advisor and brokerage firm are unable to reach a mutually satisfactory settlement agreement, the brokerage firm will often then elect to sue the broker for failure to repay the promissory note(s). If the brokerage firm does sue the former financial advisor, such suit will likely be filed with FINRA since virtually all brokers at the onset of their employment with their now former employer agreed to arbitrate any dispute between themselves and their employers through FINRA arbitration as part of their employment agreements. A similar arbitration clause is also usually included in the promissory notes. Moreover, the financial advisor’s U-4 sets forth that a financial advisor (or associated person in the industry) agrees to FINRA’s jurisdiction for disputes.

Once the brokerage firm’s claim against the former broker is filed, pursuant to FINRA Rule 13303, the financial advisor has 45 days to file an Answer. The common defenses/counterclaims asserted by financial advisors in defending against claims brought by brokerage firms to collect on these promissory notes are misrepresentation/fraudulent inducement (related to promises regarding the terms of employment), discrimination, wrongful termination/constructive discharge, unjust enrichment (related to clients the financial advisor may have left behind), and breach of contract.

Another equity argument that is often asserted is that the forgiveness of the notes should be prorated (although the notes are often forgiven on an annual basis, the broker can still argue that equity should provide that the forgiveness date should be the date that the broker left the firm and not the date of the last annual forgiveness).

Once the defenses or counterclaims are filed, the parties then proceed to the discovery process and set the matter for hearing. The case is then decided by either an industry or public panel (depending on the counterclaims raised).

If the brokerage firm takes their claim all the way to hearing and gets an award against the financial advisor, the financial advisor is required by FINRA Rules to pay the award.

Specifically, Rule 9554(a) provides that an associated person’s failure to comply with a settlement agreement or award related to an arbitration or mediation within 21 days of notice by FINRA will result in a suspension of the associated person from the industry. As such, if a financial advisor gets an arbitration award against him/her related to his/her obligations on their promissory notes, and fails to pay that award, the broker may be suspended from the industry. There are a few ways to avoid being suspending without paying the award (including agreeing with the brokerage firm to settle the award with payments over time, declaring bankruptcy, or demonstrating to FINRA a legitimate inability to pay the award) but generally speaking a financial advisor is obligated to pay the award if the brokerage firm prevails.

Significant Provisions of a Financial Advisor Promissory Note

Before entering into any up-front forgivable loan agreement with a brokerage firm, there are a few significant provisions in virtually every Promissory Note of which financial advisors should be aware.

(1) A Promissory Note will almost always include a provision setting forth the financial advisors employment as an “at-will” employee. A typical example of such a provision is as follows:

“This Agreement is not a contract of employment for any period of time. The Borrower’s employment with the Lender is on an “at-will” basis which means that the employment relationship can be terminated at any time for any reason or no reason by either party. Nothing herein shall be construed as a contract of employment for a definite term.”

The reasons this provision is included are obvious. While most employees are at-will employees, brokerage firms still want this arrangement to be spelled out so that the employee cannot later argue that the brokerage firm made promises of employment for a specified period of time. Although there is case law that claims that FINRA arbitration agreement changes a broker’s at-will relationship with a brokerage firm to “something else,” requiring justification for a discharge (see, e.g. Paine Webber v. Agron, 49 F. 3d. 347, 352 (8th Cir. 1994)), “at-will” provisions are generally enforced.

(2) Promissory Notes also almost always provide for the broker being obligated to reimburse the brokerage firm for any costs of collection in the event of default (including attorney’s fees and costs). Although many states require that an attorney fees provision be reciprocal (meaning that the broker would be entitled to his/her attorneys’ fees if he/she disputes the debt and ultimately prevails), the provision in the promissory notes will likely not be drafted that way, and a broker should be aware that they may be on the hook for the brokerage firm’s attorney fees if they fail to repay their prior employer.

(3) Similarly, the Notes also generally provide for interest to accrue both while the broker remains with the brokerage firm and after default. As such, if the broker is in default and is considering settling, it is better to do so sooner rather than later.

(4) Another provision that is significant is that the Notes usually provide for the brokerage’s firm authority to restrict the broker’s brokerage account if any amounts owed on the loans become outstanding. A typical example of such a provision is as follows:

“The Lender shall have the right, upon default, without notice, to withhold any monies payable by it to the Borrower, as commissions or otherwise or from any amounts payable under any non-qualified deferred compensation or similar arrangement sponsored by the Lender, and to withhold other monies, securities, commodities or other properties of the Borrower which may at any time be in the possession of the Lender for any purpose; and to apply such monies, etc., to satisfy the indebtedness due under this Note. The Borrower hereby authorizes and consents to the aforementioned deductions.”

Depending on the broker’s separate customer agreements, these restrictions may apply to joint accounts in addition to individual accounts, and if the financial advisor leaves his/her employer owing money on a promissory note and with money in a brokerage account held by their employer, the brokerage firm is likely to restrict that account.

Brokerage firms are typically very aggressive when attempting to collect on unpaid promissory notes. Financial advisors would be wise to consult with an attorney before engaging in settlement discussions with their former employer and certainly should do so if their former broker-dealer has already filed a FINRA arbitration claim.

D. Daxton White is a member of the Florida and Illinois Bar Associations, as well as the Indian River County Bar Association. He is also a member of the Public Investors Arbitration Bar Association (PIABA), an association of securities attorneys who dedicate their practices to the representation of investors defrauded by their financial professional or brokerage firm.

Mr. White has handled over 600 FINRA arbitration cases, including handling claims against most of the FINRA registered broker-dealers.

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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.

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