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Securities Professionals Employment Disputes – Forgivable Loans

Veteran securities lawyer Rob Herskovits looks at Forgivable Loans in high stakes securities industry employment disputes. His New York based securities law firm handles both the defense and prosecution of employee forgivable loan cases. Disputes typically arise when a financial advisor and a broker dealer where he was formerly employed are at odds on repayment of a promissory note. An insider’s guide to the rules and realities of employee forgivable loans and disputes from an experienced industry lawyer.

Transcript – Forgivable Loans Rules & Realities Video with Rob Herskovits, Securities Professionals Employment Disputes Attorney and Managing Partner Herskovits Law PLLC

Hi, this is Rob Herskovits. I wanted to talk about today the prosecution and defense of what are commonly referred to as employee forgivable loan cases. What we'll talk about are some of the common defenses that are raised by financial advisers who used to work at a broker-dealer who have now received a demand letter from the former firms seeking repayment of the promissory note or even in an arbitration claim.

The first thing that we need to be mindful of are a shift that has taken place in the securities industry. Years back, these used to be structured as forgivable loans. Simply stated, a firm would give you, say, $100,000 and it would be forgiven 20% per year over a five year period of time. That's the way those frequent forgivable loans used to be structured. That has since shifted, and what firms typically do now are they have FAs sign a straightforward promissory note, in which they promise to repay principal and interest, whatever that may be, typically over a seven to nine year period, and then enter into a corresponding bonus agreement, which says that so long as the FAA is continuously employed at the firm, they will receive annual bonus payments that essentially are designed to offset the payments that would be due on an annual basis on the promissory note. But of course once employment ends, the obligation of the employee from to continue paying on the bonus agreement ceases.

People call me regularly in connection with employee forgivable loan cases. In part, it's because I represent both sides in these. I represent major broker dealers pursuing promissory note claims, and I've also defended countless promissory note claims on behalf of FAs, so I really see this issue from both sides. So, I wanted to share some thoughts regarding what are typical defenses that I often see FAs raising and whether those defenses are weak or constitute strong defenses. This is important, because we need to be mindful of the fact that statistically speaking, firms have a very high rate of successfully pursuing promissory note claims.

And if we think about it, it makes a lot of sense. The firms go to an arbitration panel and say, "Look, here's a copy of the cancel check. There's no dispute that the person received the money. Here's a copy of the promissory note. There's no dispute that the person signed the promissory note. The terms of the promissory note are clear, they're unambiguous. He or she owes us the money." Those are very simplistic and very compelling claims for a firm to make. It's easy to digest legitimate breach of contract claim.

So, very high burden really falls on the FA if they're claiming that not withstanding the terms of the promissory note, they need not be forced to repay the note. Let's talk about some of the defenses that are often brought forward. Some of the ones that to my mind are weak are defenses relating to, say, onboarding issues where the FA transfers from broker dealer A to broker dealer B, and on the way in, they were expecting more support in connection with transferring their book of business. That's a common claim that FAs make.

One of the reasons why it's particularly weak is because these promissory note arbitrations typically come up years later. Someone joins a firm in, say, 2013 and departs in, say, 2016 and arbitration panels are sitting there scratching their heads saying, "Well, if what the firm did was so bad, why'd you wait three years to raise these issues?" Onboarding issues oftentimes are not ones that are successful issues for the FA to raise.

Another one would be bad press from the broker-dealer. It's certainly no secret that a lot of major brokerage firms will receive bad press for one reason or another, and certainly there are instances in which customers, or perhaps more so institutional customers than traditional retail customers, say to themselves, "We really can't do business with a firm that has some reputational issues." Those are tough claims to pursue unless it becomes abundantly clear that this is a customer that would have stayed but for some type of conduct of the firm that was brought to light in the press. Those are tough ones. And even if you could really sort of put forth all the links in the chain there, generally speaking, difficult defenses to raise.

Another common defense would be, generally speaking, "My supervisor just didn't like me." Oftentimes, you see this defense brought forward in a setting of maybe the supervisor was reaching out to customers, and in so doing, maybe the customers brought forward customer complaints, or otherwise from the perception of the FA, somehow negatively impacted the relationship between the FA and his or her customers. Those are tough simply because, look, brokerage firms have an obligation to supervise and compliance officers have an obligation to effectively administer compliance and oversight from a compliance perspective. So, arbitrator generally recognize it's a little bit of a damned if you do, damned if you don't. Firms are certainly subject to second guessing, not only from customers, but from the perspective of regulators if they don't properly supervise. Firms feel they're under an obligation to do sound and reputable firms will go ahead and supervise in an inappropriate manner, and if that means reaching out to customers, so be it.

Another category of common defenses, which are generally weak, would be, "I was promised X, or Y, or Z on the way in and didn't get it." It could be I was promised a lot of syndicate, or I was promised that when an FA would leave and his book was distributed, I would get the lion's share of the former FA's customers. It could take a lot of forms, but one of the reasons why these defenses often don't work is that largely they're not written anywhere. Sometimes people have emails, and a shrewd FA ought to negotiate into a contract any preemployment promises, but oftentimes it's simply oral, and it's raised down the road, and it doesn't generally speaking, make for a very compelling defense if they're oral.

And lastly, another weak defense would be post-employment defamation. What that generally looks like is, "I left, and then next thing I knew there was four, or five, or 10 people from my former branch reaching out to my customers saying, Look on BrokerCheck, look why this person left." Or maybe even saying worse things, "This FA was bad for reasons A, or B, or C." Those can be either weak or strong, and the distinction here is do you have customers willing to come forward and say that person A or person B at the former firm was telling me things that were on their face defamatory to you. So, the problem that FAs often encounter is that they just don't have the ability to line up any customers or a sufficient number of customers to be able to make a proper show into an arbitration panel that they were subjected to defamation.

So now on the other side of the ledger, certainly there are times when people come forward with strong defenses. Over the years, I brought a number of myself, and over the years a number of my clients have been able to either get a walkaway in which they paid nothing on the loan or there was an offset or a reduction in the amount that was due.

What would be a stronger claim would be if any preemployment promises were made in writing. do you have any emails or are the terms incorporated into any agreements? If for some reason there were conversations that were recorded and it was done lawfully in the state, do you have that? What do you have to substantiate that you were promised something and then the firm walked away from those promises, and because of that, you suffered monetary damages. The strong claims are those in which the FA has something that an arbitration panel can look, and touch, and hear that will substantiate those claims.

Sometimes, firms discontinue a line of business, and that hurts in FA's individual book of business. I'll give you an example. Over the years with increasing AML concerns, sometimes firms don't really want to engage in penny stock business. But there are certainly legitimate penny stock business, and sometimes an FA may come to a firm doing a substantial amount of penny stock business, and that was known, and understood, and okay with the firm on the way in. And next thing you know in year two or three of the firms says, "You know what? We're not comfortable with this business or we're not comfortable with those customers, and they got to go." If you have a situation like that, that may very well make for a much stronger claim. That you weren't doing anything wrong, you weren't doing anything that the firm didn't know you were doing prior to coming in, but for whatever reason, the firm just started to shut down your book of business.

Another strong claim, and we touched on it earlier, is the post-employment defamation, but this really turns on whether or not you have credible third parties that can come forward. By third parties, I'm talking about customers that can come forward and substantiate the claims. You do see this from time to time. In my experience, arbitrators are moved when a customer who has no skin in this game comes forward and says, "Look, I was told to pack a lies by the former firm, and that was why either I didn't transfer my account with the FA or I did transfer my account, but I had strong reservations." So if you have enough customers lined up and you could show that your book really got walloped, those are particularly strong claims.

But in any event, it makes sense for the departing FA to reach out to experienced counsel to talk through these issues. I appreciate you tuning in.

Client Reviews
I give Rob Herskovits and his law firm my strongest possible recommendation. He expertly guided me through a challenging and highly adversarial FINRA disciplinary hearing. Due largely to Rob's extraordinary efforts, each of FINRA's charges were ultimately dismissed by the hearing panel. It is unusual to beat FINRA on their home court, and I'm grateful to have had Rob by my side. Matt D.
Rob has handled customer matters (mediations and arbitrations) as well as regulatory matters for my firm. He is very knowledgeable about the process, and can explain the details in layman's terms. Rob presented our case very well and achieved successful results in every engagement. Jay
I give Robert my highest recommendation. He and his firm helped me through what could have been an extended and financially troubling time. I am not sure that I could have cleared up a false accusation by a previous client had it not been for Robert and his firm, and for that I am very grateful. Derrick
Rob was great he helped my partner and I last year get two cases removed from our record that had no merit. You know how the firms are they represent themselves and settle we suffer. Rob represents you and he’s great!! Jeremy