RIA Compliance Blog
In a letter sent to the Financial Industry Regulator Authority (FINRA) last November, the Securities Industry and Financial Market Association (SIFMA) wants FINRA to give harsher punishments to brokers who have failed to pay back promissory notes to firms. It specifically sought to prevent brokers from being able to plead poverty to escape arbitration payment orders. The purpose of the notes is to provide cash for recruiting and retention incentives. They are typically designed as forgivable loans as long as the broker stays at the firm for a specified amount of time. If the brokers choose to leave early, then they are required to pay back the note.
As a result of not paying the promissory note back, firms have gotten more aggressive in filing arbitration claims for repayment, and in most cases the firm wins. In 2011, there were 778 promissory note cases filed which is a decrease from 2010 during which 1,152 cases were filed. If a broker does not pay the promissory award, FINRA files an action against him/her that could lead to suspension. Once a monetary award has been issued in a FINRA arbitration proceeding, the broker has 30 days to pay the award. If the broker can show an inability to pay back the note; however, he/she will not be suspended and can continue to work for another firm.
SIFMA wants to see FINRA taking more aggressive action to ensure that these brokers pay back the award and eliminate the inability-to-pay defense for industry cases. SIFMA general counsel Kevin Carroll stated, “This is money firms gave in good faith to these brokers, so I’m not sure why regulators wouldn’t facilitate.” If FINRA decides to take this course of action, it would likely mean that if a broker were unable to repay a promissory note, he/she would likely be suspended or have to file for bankruptcy.
In the letter, SIFMA stated it was concerned that the inability-to-pay defense was being abused which has resulted in compliance and regulatory risk as well as creating an unnecessary risk to investors. It also claimed that FINRA Rule 9554 discriminates against industry claimants. The rule states, “When a member or associated person fails to comply with an arbitration award or a settlement agreement related to an arbitration or mediation under Article VI, Section 3 of the FINRA By-Laws involving a customer, a claim of inability to pay is no defense.” The only defenses available for a respondent who is involved in a failure to pay related to a customer are:
- They paid the award in full
- They have agreed to pay in installments
- They have filed a motion to vacate that has not been denied
- They have filed a petition in bankruptcy
To date, FINRA does not seem persuaded by SIFMA’s arguments. If there is not a change in this rule then SIFMA may raise the issue with the Securities and Exchange Commission (SEC) directly. It will decide in the coming weeks what their next move will be.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds and issuers of securities, among others. Our regulatory practice group assists financial service providers with the complex issues that arise in the course of their businesses, including compliance with federal and state laws and rules.