Regulators have been all over brokerages, investigating mutual fund breakpoints and, more recently, the probity of fee-based accounts. Now, add forgivable loans to the list. Although NASD officials say this is something they've been looking at for years, some recruiters say that regulators say scrutiny of forgivable loans, the large, upfront bonuses used to entice successful reps to leave one brokerage house for another, has increased, in conjunction with concerns about large teams moving from one firm to another.
The problem with “forgivable loans” is that they can pressure reps to churn to meet production goals. Usually a signing bonus (technically a loan) is based on a percentage of trailing 12-month production; the bonus does not have to be paid back to the brokerage if the rep meets certain performance goals.
“It's something we've been concerned about for a long time,” says Elisse Walter, executive vice president of regulatory policy and programs at the NASD.
In addition, some recruiters say the IRS is also looking into the practice, since brokerages award lump sums in one year, but the taxes are paid out over the life of the advisor's contract.
The SRO's head of enforcement, Barry Goldsmith, recently said at a conference that the NASD is looking into the trend of reps changing firms in groups. One industry source says the regulators are concerned that moving would include inducements to put clients in products that are beneficial to that firm, specifically, or that the practice of upfront money is one that encourages advisors to jump firms every five years or so — which can be bad for clients.
“We're inherently loathe to put any kind of control on compensation,” says Walter. “But you don't want people put in a position to harm clients, so there's an incentive to keep looking at it.”
One recruiting head at a regional firm said it's more likely that the regulators are just looking around and that existing regulations regarding churning, giving out incentives to reps for selling specific company-proffered products and poor client service are already a bulwark against production-centric advisors.
“I could see how it could inject a suspicion or feeling that it creates some undue pressure to produce,” he says. “Everybody in this business has some pressure to produce to stay alive.”
Regulators have been more proactive in recent months, including making unsolicited phone calls to clients during the course of investigations, something Walter says is becoming more frequent.