Business & Corporate Articles


Tips for Financial Advisors: Avoid the Pitfalls of Misrepresentation During the Recruitment Process

An Industry is Born

Most would not associate Philadelphia with the birth of the modern American securities industry.  Traders auctioning stocks on the street corners of downtown Manhattan instead come to mind.  But in 1790, the City of Brotherly Love spawned the nation’s first market maker.

It was first called the “Board of Brokers” and operated out of the Merchants Coffee House in downtown Philadelphia. The Coffee House later became City Tavern, which is still in business today. The exchange, meanwhile, moved around to several different locations in downtown Philadelphia before settling about a mile west of City Tavern on Walnut Street. It wouldn’t change its name to the Philadelphia Stock Exchange until 1875. By then, the industry it fostered was in full blossom, and the New York Stock Exchange had assumed its role as the largest exchange in the country.

The founders of the Philadelphia Exchange could not have appreciated the magnitude of the industry they helped create and the effects, both positive and negative, it would have on the global economy.  Without an organized exchange, the brokerage business could not have grown into the multi-trillion-dollar industry it is today.  And while Wall Street remains the hub of the U.S. securities industry, the U.S. Bureau of Labor Statistics recently estimated the industry employs more than 803,000 individuals across the country.1 Many of those employed in the securities industry work as stock brokers and financial advisors.

Recruitment in the Modern Securities Industry

According to the Financial Industry Regulatory Authority (FINRA), which regulates the securities industry in the U.S., there are roughly 635,000 licensed “registered representatives”— licensed individuals who work for a brokerage firm—in the country. Those representatives, in turn, work for approximately 4,300 securities firms. The biggest names left standing on Wall Street—Morgan Stanley, Merrill Lynch and UBS—are most familiar to the public. But there are hundreds of other firms, banks and independent broker dealers, such as LPL Financial, Raymond James and Commonwealth, as well as small, single office “mom and pop” firms vying for brokers by offering higher commission payouts and broader product and service offerings.

The industry is in flux.  There have been a number of widely publicized, high-profile defections from the legacy wirehouse firms, and there is no question the industry is trending toward the independent model. Some brokers, meanwhile, are shucking the broker-dealer model altogether, and the heavy yoke of FINRA supervision, joining independent, “fee-only” Registered Investment Advisory firms. With so many new options and platforms available, broker attrition and movement among firms is at an all-time high.

Firms historically used comprehensive training programs to groom young advisors, teach them the industry and train them to build their business. In the late 1980’s, however, firms realized that hiring experienced brokers with established books of business was easier—and less expensive—than developing them from within. Instead of spending tens of millions of dollars per year on broker training programs for young brokers with no assets under management and unproven track records, firms discovered they could “buy” existing books of business by paying up-front money to experienced brokers to lure them into the firm. By the mid-2000’s, up-front bonuses, which traditionally were around 25 percent of a broker’s trailing-12 commission production, had snowballed to total up-front deals exceeding 300 percent of the broker’s prior-year gross production. That meant in some cases a broker generating $750,000.00 in annual gross commissions could cash a check for more than $2 million after joining a new firm and meeting certain revenue or asset thresholds.2 These “bonus” payments are then tied to promissory notes forgiven over a period of 7-10 years or longer. 

A brokerage firm cannot make money without assets under management. Firms need brokers to generate commissions off those assets. And a primary focus of every firm is recruiting new advisors and increasing assets under management.  But the “up-front money model” has spiraled out of control, and firms now find themselves trapped in a system of their own design. To attract top producers, they have to offer more and more up-front money, bonuses and perks in hopes to entice those top producers to leave their current firm.3 Even independent firms, which historically did not pay large up-front bonuses, have begun offering up-front money and other benefits to compete with larger firms.

The net result is competition in recruiting quality brokers—those with established books of business, steady revenues and limited compliance issues—is higher than ever. In most firms, branch and regional managers are chiefly responsible for recruiting new advisors, though outside recruiters and headhunters sometimes play a part. In either scenario, however, the recruiting manager’s compensation is generally tied directly to the number of recruits they attract and the assets they bring to the firm.

Covering All Bases in the Recruitment Process

The recruitment process can take many months and involves hours of clandestine meetings and discussions with recruiters or hiring managers. But the process is not all lunches and happy hours. It can be a stressful and daunting time for financial advisors, particularly if they have never moved firms before. They may be fearful that a good portion of their clients will not move with them. There is the possibility their prior firm will initiate litigation for alleged misappropriation of trade secrets or violations of the Broker Protocol. Perhaps most importantly, advisors may be concerned the new firm cannot support their business and service their clients. 

Industry regulations require the recruiting firm to conduct due diligence to ensure the firm’s products and services are compatible with the broker’s book of business. Unfortunately, much of the recruitment process is spent not on conducting thorough due diligence, but on trying to win the broker over and discussing the terms of their upfront and backend compensation. Recruiters know if they do not pay top dollar to top advisors, they risk losing them to a competitor. The pressure to recruit new advisors is so high—whether caused by a desire to meet regional recruitment targets, achieve a bonus threshold or impress a new boss—that recruiters often paint a rosier picture than what the reality will be at the new firm. Some will flat out tell the recruit whatever they want to hear to bring them over. After all, once the recruit joins the new firm they will be locked in to a forgivable promissory note and very hesitant to put their clients through another move in the near future.

These negligent—and sometimes intentionally fraudulent—misrepresentations are, regrettably, fairly common in the recruitment process. Recruiters will make promises involving anything from the firm’s compensation and commission payout policies to product and service offerings, the advisor’s prospects for advancement within the firm or the availability of management positions. But when a deal is struck, brokers are presented with a litany of prolix, standardized paperwork—including letters of understanding, offer letters, promissory notes, bonus agreements and complicated employment agreements—carefully prepared by the firm’s team of lawyers.  Those agreements say, in essence: Forget about everything we discussed during the recruitment process. If it’s not written in these documents, our prior discussions never took place, and you cannot rely on anything we told you during the past several months.

By this time, the advisor has already decided to move to the new firm and selected a move date; held numerous meetings with the recruiting managers; met with product specialists at the new firm; discussed the move with their business partners, family and perhaps some of their clients; and probably even ordered new business cards. And while he or she may ask the recruiting manager for written confirmation of their prior discussions or agreements, the agreements are by and large presented to the recruit on a take-it-or-leave-it basis with no possibility of negotiation.  It is not uncommon, however, for the recruiter to further assure the financial advisor that all previously-discussed commitments will be upheld and that the paperwork is more of a formality required by the corporate back-office to initiate the transition process.

Of course, an agreement doesn’t always need to be in writing to be enforced. In many instances, oral agreements are just as valid as written agreements. In an industry notorious for deals sealed with a handshake, however, an ounce of prevention is worth a pound of cure. It is best to get all material terms of the deal in writing. If that’s not feasible, as is often the case, recruits should keep detailed, contemporaneous notes of recruitment meetings, indicating who was present, where the meeting took place and what was discussed. They should ask difficult questions of the recruiting manager and, if possible, meet with other new recruits to the firm to discuss their transition experience. Finally, during the recruitment process, recruits should seek the advice of counsel with experience in the securities industry to help ensure they are doing everything they can to protect their interests and understand what they are signing up for. Their livelihood, after all, hangs in the balance.

-- By George Miller, Shustak Reynolds & Partners, P.C.


1 This figure does not account for hundreds of thousands of individuals employed in other financial sectors—such as banking, credit, insurance and real estate—that are closely related to the securities industry.  http://www.bls.gov/news.release/pdf/empsit.pdf.

2 These “golden handcuff” deals are not without their drawbacks.  Generally up-front “bonuses” are tied to promissory notes forgiven over a 7-9 year period (or longer), and brokers are responsible for the substantial tax liabilities caused by the forgiveness of the note.

3 In April 1995, at a time when up-front bonuses peaked around 60% of trailing-12, the SEC released a report authored by the Commission on Compensation Practices recommending the elimination of up-front bonuses or, at a minimum, paying them over several years to reduce attrition amongst brokers.  See http://www.sec.gov/news/studies/bkrcomp.txt.  The commission was chaired by Daniel P. Tully, then Chairman and Chief Executive Officer of Merrill Lynch & Co.  Tully is credited with doubling the firm’s assets under management in just four years—assets brought in using up-front notes no doubt helped achieve that accomplishment.

This article is for information purposes and does not contain or convey legal advice. The information herein should not be relied upon in regard to any particular facts or circumstances without first consulting with a lawyer.