It's hard to believe but it's been nearly two years since Lehman Brothers filed for bankruptcy -- and, as if to beg for the Understatement of the Century Award -- what an incredible two years it's been for Wall Street.
The Night They Drove Old Lehman Down
Among my most vivid memories of those days, when life as we knew it teetered on the brink, were the somewhat tragicomedic regulatory efforts that belatedly bubbled up from the Securities and Exchange Commission and the Financial Industry Regulatory Authority (FINRA) My suspicion is that those industry cops realized that they had been caught flat-footed and asleep while the crooks had gone in and robbed the bank. Those somnolent regulators generated a flurry of after-the-fact publicity as a way to show how dilgent they were (or, as I groused at the time, should have been).
One of the better pieces of journalism from those days was "We See Dead People: $250K Fine for Lehman Short Sales" ("Deal Journal," by Heidi N. Moore, October 22, 2008) at http://blogs.wsj.com/deals/2008/10/22/we-see-dead-people-250k-regulatory-fine-for-lehman-short-sales/:
[T]he Financial Industry Regulatory Authority, or Finra, scores our prize for Great Moments in Delayed Reactions for its fine and censure of Lehman's broker-dealer, Lehman Brothers Inc., which was liquidated by SIPC. As Bill Singer's Broke and Broker Blog discovered today, Finra has censured and levied a $250,000 fine on the defunct firm, which is in the process of unwinding what it owes to creditors.
Of course, Finra, a Wall Street self-regulatory group, was investigating the complaint before Lehman's bankruptcy filing in mid September. Finra's complaint-all too prescient, as it turns out-was that Lehman didn't provide enough disclosure about its short sales and didn't do enough to distinguish between the securities firm's own short-selling orders and those of customers.
. . .
Lehman's bankruptcy proceedings are teeming with angry creditors trying to figure out just how much the firm had in assets, and how much they can expect to get. Considering that those creditors are trying to figure out where over $630 billion in stated assets went, Finra's $250,000 claim is hardly the biggest concern. . .
NOTE: The referenced BrokeAndBroker column is at http://www.brokeandbroker.com/index.php?a=blog&id=83
Now for some fun legal stuff.
Way back in December 2009, Lehman Brothers Holdings, Inc. (LBHI) entered into a stipulation with its debtors and Lehman Brothers Inc. (LBI) as part of the Securities Investors Protection Act (SIPA) liquidation of LBI. Seems that LBI was the holder of 113 or so promissory notes evidencing loans made to employees of LBHI and LBI. Based upon court papers, those 113 notes were issued in the amount of over $79 million and as of December 2009 had remaining balances of about $51 million. If you do the math, that's an average of about $700,000 loaned per employee -- nice bucks if you can get it -- which may explain, in part, why firms such as LBI failed.
By way of a scorecard:
As you can imagine, the process of divvying up the 113 promissory notes between LBHI and/or LBI didn't gone particularly smoothly. Hence, the need to enter into the December 2009 Stipulation that I referenced above. In that Stipulation, we find the following peculiar language under the "Recitals" section:
C. LBI is listed as the holder of certain promissory notes set forth on Schedule A hereto (the "Promissory Notes"), evidencing certain loans that were made to certain employees of LBHI and/or LBI (the "Subject Employees") in the course of their employment.
D. The Trustee and LBHI are not currently in agreement as to which entity ultimately has the right to receive payment of any amounts outstanding under the Promissory Notes.
E. Notwithstanding the foregoing, LBHI and the Trustee agree that it is in their collective interests to commence the process of collecting any amounts outstanding under the Promissory Notes from Subject Employees. . . .
See, Stipulation at http://www.brokeandbroker.com/images/LBHI1.pdf
James W. Giddens, Esq. (as SIPA Trustee for LBI) and LBHI agreed that it was in everyone's best interests to at least go out and collect the unpaid balances and interest on those notes, and the generous Mr. Giddens assigned LBI's rights to collection on the notes to LBHI.
Based upon calls to my law firm by unhappy former Lehman employees, I'm betting that we may soon be off to the races as collection efforts on that $51 million balance seems to have started. Except, pardon the attorney in me stepping forward, I see a few ticklish issues here, which I fully expect will be advanced on behalf of any clients.
An EFL Is Not A Football League
What's with all those promissory notes, you ask (okay, so even if you didn't ask, this is a clever literary device that I use to smoothly explain the issue).
The simple explanation is that the types of promissory notes at issue here are actually signing bonuses given to brokers for the purpose of stealing them away from a competitor or keeping them at your firm -- except for the fact that, technically, the notes are loans and not bonuses, except for the fact that most folks who get the loans think that they're bonuses, which the brokerage firms extending the loans really encourage in the hopes that this critical confusion will keep the employee on board.
Okay, so now that you're totally confused, let me try to explain things a bit better.
Let's say that you were working for Merrill Lynch before 2008, when Merrill Lynch was Mother Merrill (and still had a thundering herd) and looked like it would never go out of business -- you know, like LBI looked. You're making big bucks at Merrill. A smooth-talkin' recruiter gets you on the phone and tells you how much LBI would love to have you work there. LBI is prepared to give you a 50% salary increase, the corner office, the sweet expense account. Nah -- you're not leaving Merrill for that. You can get that anywhere, and "anywhere" ain't Merrill.
In response to your "no thanks," LBI brings out the big gun: How about we give you an Employee Forgivable Loan (EFL) of, I dunno, let's see, hmm, how about $600,000. Of course, the guy that's recrutiting you then leans over the table and in hushed tones says, "You know that it's not really a loan, right? Our lawyers want us to pretend it is but we all know how this works. You're getting a fat signing bonus."
Gee, a $600,000 EFL? That's a sweet signing bonus. Okay, goodbye Merrill hello LBI.
The Carrot and The Stick
How did firms come up with the amount of the EFL? It varied but the formula was based upon the size of the commissions a given stockbroker generated or how much profit a given trader realized in the prior year. The employer firm would then calculate your EFL by taking that base number and multiplying it by a variable percentage. Those dollars then become the carrot.
In reality, an EFL is a promissory note(s) that lends money to an employee for a stated term -- let's say three years. On the anniversary of each of those three years, one-third of the principal of the EFL is forgiven. So, in the example of our $600,000 EFL, after the first year, the employee only owes $400,000, and after the second year, $200,000, and at the end of the three-year term, the debt is erased. If you leave anytime before the expiration of the term (or you're fired for "Cause"), then you likely have to repay the unexpired balance. The unforgiven balance of the EFL then become the stick.
Historically, what gets repaid on those promissory notes is subject to after-employment horse trading. I've been writing about these disputes for years and you can get a flavor of the back-and-forth at
The fun part of these EFL / Promissory Note disputes is when the former employee and the former employer reach an impasse in settlement negotiations. Often, the former employee refuses to repay a penny. That stockbroker or trader is livid -- the former firm lied, didn't deliver the support services it promised, reneged on the corner office. Then there is the really nasty issue of what happens when the employee contemplated staying on the job but the employer ran into business problems and laid him or her off -- or sold the entire firm. As this scenario often goes, the employee bargained for a deal with Firm X, not Firm Y and, frankly, Firm Y has a lousy reputation and isn't prepared to conduct the same type of business as Firm X. Now the allegations fly fast and furious! I was defrauded. You lied to me. I never agreed to this!
In response, the former employer smiles, pushes the promissory note across the table, points to the signature, takes out the calculator, and informs the dyspeptic debtor as to the remaining balance, now due, on the disputed loan.
The Art of Collection
As the Stipulation above discloses, LBHI and LBI dispute which of them actually owns any collectible debt from the 113 notes. It's quite lovely that those two firms seem to think that they have the final say-so on how, when, and where those notes will be repaid. It's as if those two firms conveniently glossed over all that nasty stuff about thousands of employees losing their jobs, investors seeing their life savings devastated, and, oh, almost forgot, the nearly devastating impact upon the U.S. economy.
Why is the issue of "who owns the notes" important? LBI was a FINRA member firm. However, LBI's former holding (LBHI) company was not a FINRA member firm. I'll bet you that some clever collection lawyer argues that FINRA arbitration is the only proper place to adjudicate these cases. You know, the FINRA that's the Wall Street self-regulatory organization that sort of failed to catch and prevent the entire Lehman meltdown, along with Madoff and some other high profile cases. And that's the same FINRA that makes it mandatory for all registered Wall Street employees to arbitrate so-called intra-industry at FINRA. Not to mention that nice bonus to FINRA of getting paid the filing fees and all for these mandatory arbitrations.
Why is the "where" of these collections cases so important? For starters, no registered employee of any FINRA member firm is entitled to vote on any proposed rule or in any election at FINRA. Those privileges are afforded only to the member firms. However, not to be seen as biased or anything, FINRA does insist that all those disenfranchised FINRA firm employees submit to the jurisdiction of FINRA's own arbitration forum. I'm sure everything in that process is on the up-and-up and there's absolutely no bias or prejudice inherent in those conditions. I mean, after all, FINRA's arbitration process must be totally fair for the industry's employees otherwise FINRA wouldn't have made participation mandatory. Hmmm . . . that really is a contradiction, isn't it? I wonder why intra-industry disputes are mandatory at a self-regulatory organization that is largely funded from the activities of its member firms? Lemme get back to you on that one.
Quite a dilemma facing those 113 employees. A few years ago, a lot of them were enticed to join LBI. They left their jobs at other firms based upon the recruitment packages they were offered. Of course, a lot of those folks trusted their employer and FINRA and well, you know, they just thought that life didn't get any better than a job at LBI. Relying upon that belief, many of those 113 employees probably invested in Lehman products and probably recommended that their clients do the same. Nasty little thing that LBI bankruptcy. Sort of hard to really figure out which are the good guys and which are the bad guys and who owes whom what.
But what's an inconvenient thing like bankruptcy among family, friends, and once dedicated employees? So what if those duped employees are bankrupt, lost their life savings, found their professional reputations savaged and their clients enraged? Let's not forget that there are thousands of public customers also victimized by Lehman's collapse, and the monies recovered in the bankruptcy/liquidation (less lawyers' fees, of course, thank god!) may find its way into those folks pockets. The hell with Wall Street and its employees. It's payback time. Frankly, it's hard to argue against that position too.
Apparently, LBHI and LBI view those employee and customer complaints as unfortunate details. Those employees were given loans that contemplated forgiveness if the employees remained employed at LBI for a few more years. Too bad that LBI couldn't quite manage to stay in business long enough to allow those employees the chance to keep their jobs, savings, and clients. Someone's always gotta pay, and payback is hell.
Oh well, business is business. It should be fun to see where these collection cases are litigated and how each one is decided. If the initial wave of calls to my law firm is any indication, there are a lot of unhappy campers out there who are not going quietly into this good night.