[In]Securities: Who'll Be Watching Whom? by Aegis Frumento Esq

November 21, 2019

Who'll Be Watching Whom?

"I can only warn people," Michael Cohen told Congress. "The more people that follow Mr. Trump as I did blindly are going to suffer the same consequences that I'm suffering." https://www.reuters.com/article/us-usa-trump-russia-warning/cohen-warns-republican-lawmakers-dont-protect-trump-idUSKCN1QG2EZ. The "same consequences" include getting thrown in the slammer for a few years, a lesson learned too late by half-dozen other Trump flunkies. Yesterday, Gordon Sondland, figuring he didn't really want to share a cell with Roger Stone and his nasty back tattoo, took the warning. So, Sondland recanted his prior deposition testimony and threw President Trump and his "in the loop" inner circle under the impeachment bus before they could do the same to him. "We followed the President's Orders," he testified at the impeachment hearings, and produced a ream of emails to prove it.

God, it's hard to find loyal henchmen these days! That's because loyalty begets loyalty, which The Donald, ever loyal to no one but himself, never learned. But I don't really want to say more about him today -- he bores me so! -- and I don't have to because there's a whole industry of other bosses who haven't learned that lesson either. I'm talking about the securities industry.

The general practice on the Street is to recruit promising brokers with money, which used to be called signing bonuses, and now are now almost universally called employee forgivable loans, EFLs for short. The new firm throws a big wad of cash to the new broker, for which the broker signs a promissory note. The promissory note provides that the "loan" is either forgiven, or repaid from the commissions that the broker earns, over time, from 4 to as long as 10 years. All this works great if the broker stays at the firm for the time needed to discharge the EFL.

However, it is not uncommon for a broker to discover, within a year or so of joining a new firm, that the place isn't for him. He wants to leave. But, if he leaves before the EFL is satisfied, he has to pay back the balance. If he jumps from one big firm to another big firm, and the second big firm also pays him a huge upfront cash inducement, then he might have the money to be able to pay off the EFL to his prior firm. Unfortunately, it doesn't usually go down that way.

More often than not, the reason the broker is leaving his original firm is because he's not making as much money at that firm as he thought he would. That means that he now goes to a new firm with a lower production base, and a lower compensation structure, and a lower upfront bonus. He just won't have enough money to pay the balance of the EFL. Or even worse, on signing on with the old firm, the broker promised not to compete with that firm, or not to solicit the customers of that firm, for some period of years. Now that broker can't get a new job at a new firm at all, and has no money with which to pay off the old EFL. And before you protest that the broker should have saved the upfront money he got when he signed the EFL in the first place, let me just say that you don't know brokers very well.

And so, brokers leave firms owing money on their EFL, and inevitably the firm tries to collect it. Since all employment disputes between broker-dealers and their brokers need to be arbitrated, almost all these EFL cases now end up in a FINRA arbitration. FINRA has even established a whole set of procedures to accommodate them. See FINRA Rule 13806: Promissory Note Procedures. https://www.finra.org/rules-guidance/rulebooks/finra-rules/13806

It is tough to defend against a promissory note case. You got the money; you promised to pay it back; you didn't pay it back; and that's it. You can't really argue that you don't owe it. Therefore, the standard defense to an EFL case is an offense; it is to prove that the firm breached its employment agreement first, and so it owes you more than you owe it. The firm generally breaches the employment agreement by failing to support the broker's business, or actively interfering with the broker's business, or in some way shape or form being responsible for the broker not being able to perform his business as it was expected he would so that he could pay off the EFL. Often this argument is couched as a fraud claim, in that the broker was fraudulently induced to join the firm to begin with. But all amount to the same theory.

Now, thanks to a recent decision by the Second Circuit Court of Appeals in New York, brokers have a new card to play. It's not really a new defense, but we now understand it better. A couple of weeks ago, I commented on the award side of the SEC whistleblower program. Today's issue involves the whistleblower retaliation provisions of that same program.

There are two whistleblower retaliation provisions in the securities law. The first was established by the Sarbanes-Oxley Act, but that's not so useful. Whistleblowers under Sarbanes-Oxley must file a retaliation complaint with OSHA within 180 days of the retaliation. The broker's retaliation arguments are heard by OSHA and then appealed to a Labor Department administrative judge. Those procedures don't really help a broker who is facing an arbitration to repay an EFL, because the one can't be offset directly against the other.

However, the anti-retaliation provisions in the Dodd Frank Act -- which is also the source of the whistleblower award program -- don't go to OSHA. They also have a much longer six-year statute of limitations, the same as the FINRA eligibility rule that governs EFL cases. The news is that, according to the Court of Appeals, Dodd Frank whistleblower claims must be arbitrated between securities firms and registered representatives. See Daly v. Citigroup, Inc., http://www.ca2.uscourts.gov/decisions/isysquery/fc55e99c-7ca2-492c-b07d-2c52438199ea/1/doc/18-665_opn.pdf.

As a result, now a broker who faces EFL claims in an arbitration has the ability to raise, in that same arbitration, anti-retaliation claims under Dodd Frank. Dodd Frank anti-retaliation remedies include double back pay and attorneys' fees. However, there's a catch: The Supreme Court ruled a couple years back, in Digital Realty Trust Inc. v. Somers, that in order to be eligible for Dodd Frank anti-retaliation remedies, one must be a "whistleblower." And one becomes an "whistleblower" only by filing an appropriate tip with the SEC. And for those who don't know, a tip is filed with the SEC by filing of Form TCR. See https://www.supremecourt.gov/opinions/17pdf/16-1276_b0nd.pdf.

You see where this is going. Brokers have to file a TCR to claim whistleblower retaliation as an offset to an EFL arbitration against them by their firm. This suggests some universal practical advice. Any broker who contemplates raising concerns internally about unethical behavior at the firm would be well advised to file a form TCR before the firm fires them. That way, if the broker does get fired, the broker will have one more arrow in their quiver to shoot back at the firm when the firm tries to collect the EFL in arbitration.

There is a certain amount of karmic irony to this whole scenario. Firms have had a long habit of using compliance as an excuse to get rid of troublemakers. Compliance has become so granular that it is too easy to find some fault somewhere that can be leveraged to justify a termination. But as we all know, enterprises that put too great a premium on making money at all cost tend to have more than a few skeletons in their own closet. The broker's use of whistleblower retaliation tends to level -- at least a little -- a playing field that has for too long been skewed in favor of the firm. What goes around comes around. Firms keep watch over their brokers; brokers should be watching every move their firms make too.

Aegis J. Frumento
Stern Tannenbaum & Bell
Co-Head, Financial Markets Practice

380 Lexington Avenue
New York, NY 10168

Aegis Frumento is a partner of Stern Tannenbaum & Bell, and co-heads the firm's Financial Markets Practice. Mr. Frumento represents persons and businesses in all aspects of commercial, corporate and securities matters and dispute resolution (including trials and arbitrations); SEC and FINRA regulated firms and persons on regulatory compliance issues and in SEC and FINRA enforcement investigations and proceedings; and senior executives of public corporations personal securities law and corporate governance matters.  Mr. Frumento also represents clients in forming and registering broker-dealers and registered investment advisers, in developing compliance policies, procedures and controls, and in adopting proper disclosure documents. Those now include industry professionals looking to adapt blockchain technologies to finance and financial market enterprises.

Prior to joining the firm, Mr. Frumento was a managing director of Citigroup and Morgan Stanley, a partner and the head of the financial markets group of Duane Morris LLP, and the managing partner of Singer Frumento LLP.

He graduated from Harvard College in 1976 and New York University School of Law in 1979. Mr. Frumento is a frequent author and speaker on securities law issues, and is often quoted in the media on current securities law developments.

NOTE: The views expressed in this Guest Blog are those of the author and do not necessarily reflect those of BrokeAndBroker.com Blog. 

Former Trader for Major Multinational Bank Convicted for Price Fixing and Bid Rigging in FX Market (DOJ Release)

Former Beaufort Securities Investment Manager Pleads Guilty to Conspiracies to Commit Securities Fraud and to Defraud the United States by Failing to Comply With Foreign Account Tax Compliance Act (DOJ Release)

10 Defendants Charged In Manhattan Federal Court With Running Nationwide Telemarketing Fraud Scheme Targeting The Elderly / Defendants Allegedly Created and Used "Money Sucking Website" to Identify Vulnerable Victims Whom They Then Targeted and Victimized (DOJ Release)

[In]Securities: Who'll Be Watching Whom? by Aegis Frumento Esq (BrokeAndBroker.com Blog)

CEO Of Security Company Charged With Multimillion-Dollar Stock And Carbon Credit Fraud (DOJ Release)

Former CEO of Braskem Indicted for His Role in Bribery Scheme / Approximately $250 Million Allegedly Diverted from Braskem Through a Secret Slush Fund to Pay Bribes to Government Officials and Political Parties in Brazil (DOJ Release)

FINRA Censure and Fines NYLIFE over Higher-Risk Mutual Funds' Suitability Supervision. In the Matter of NYLIFE Securities LLC, Respondent (FINRA AWC)

FINRA Suspends MML Investors' Rep Over Outside Business Activity and Untimely Rule 8210 Responses. In the Matter of Alexander G. Lycouris, Respondent (FINRA AWC)