FINRA last week released Regulatory Notice 13-02 that proposes to require disclosure of financial incentives (recruiting “bonuses”) paid to financial advisors to change firms. In the Executive Summary to the Notice, FINRA indicates that the purpose of the rule change is “to address conflicts of interest relating to recruitment compensation practices.” As you know, currently financial advisors are not required to disclose the financial incentives they receive when switching from one brokerage to another.

The proposal begs the questions: Is a recruiting bonus really a bonus? And what exactly are the conflicts of interest?

  • I think that FINRA’s stated purpose to “address conflicts of interest” in recruiting deals does not accurately describe what a recruiting bonus truly is. In some ways, the recruiting compensation package is not an outright bonus. It is, technically speaking, a forgivable loan (9 years in length) and is based upon an FA’s previous 12-month’s production (t-12). Usually there are performance hurdles that must be met to earn the full bonus. What’s more, if the advisor were to move during the term of the note, he would owe a proportionate amount back to the firm (e.g. if an FA were to leave after 5 years, 4/9ths of the amount received would be have to be paid back). 
     
  • On page 3 of the Regulatory Notice under “Concerns Regarding Enhanced Compensation Packages,” FINRA outlines, by example, the type of broker conduct it is trying to regulate: 

“(I)f a registered representative is aware that he or she will receive enhanced compensation for hitting increased commission targets, the registered representative could be motivated to churn customer accounts, recommend unsuitable investment products or otherwise engage in activity that generates commission revenue but is not in the investors’ interest.”

What FINRA appears to be trying to control is the unscrupulous advisor who churns accounts to meet revenue hurdles in order to be paid additional back-end bonus amounts. While there is a back-end portion to many of the recruiting bonuses that are paid today, most are based upon the increase in assets under management and not increases in revenues. Why should an advisor come under scrutiny for trying to build his business and gather assets? Back-end bonus payments based upon the growth of an advisor’s assets under management would clearly not lend itself to the “conflicts” argument.
 

  • In this same section of the Notice, FINRA posits that the offering by firms of enhanced compensation and transition packages based upon t-12 is said to be an “undisclosed conflict.” FINRA doesn’t state what this “undisclosed conflict” is, only that “customers would benefit from knowing the incentives” (again, without stating how or why they would benefit from this knowledge). 
     
  • Also contained in the Notice is a proposed de minimis exception to the disclosure requirement if an amount of $50,000 or less in transition money is paid. FINRA’s rationale appears to be that this amount would generally be paid to offset the ordinary costs of the transition process to the advisor and it does not raise the same conflicts as the “more lucrative” deals paid. I would suggest that this amount is rather arbitrary. If a smaller advisor were to move and get paid a transition package of under $50k, why wouldn’t that be seen as the same sort of conflict as for a more productive advisor being awarded a much larger sum of money?  Are they saying that only the amount of money paid determines a conflict? 
     
  • In FINRA’s Request for Comment (open until March 5), they appear to be asking for comment on whether the rule should mandate disclosure to customers while the advisor “is still at the previous firm.”  How could this be allowed in the non-independent advisor world? An advisor is precluded from pre-solicitation of customers prior to moving to a new firm. Also, if this were to be promulgated, it would almost certainly be seen as a violation of the Protocol for Broker Recruiting and could cause a torrent of additional litigation.

At the end of the day, regardless if FINRA puts into effect its proposed disclosure rule, it really will have little or no impact on the way brokerage firms and advisors do business. There is an insatiable demand for talented, honest and successful financial advisors by the brokerage houses. Simple supply/demand economics dictate that firms will continue to pay a premium for these advisors whether or not there is mandated disclosure of the size, scope and details of these payments. Quality advisors will continue to put their clients’ interests first, choosing to change firms because it would mean being able to offer better service and better outcomes for those clients. Generally speaking, the fact that a transitioning advisor is being paid a sum of money as an incentive to change firms has no bearing upon the way he serves his clients.

If new rules are to be promulgated, they should be well thought out, rational and based upon real conflicts of interest—not those that are merely speculative and illusory.

Howard Diamond is managing director & general counsel of Diamond Consultants, a recruiting firm.