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New rules governing broker recruiting bonuses? The idea, floated by Mary Schapiro at the SIFMA annual conference in New York on Monday, met with skepticism this week from securities industry attorneys, compensation experts and recruiters.

Schapiro told Charlie Rose in an interview during the SIFMA conference that the regulator is planning to write rules in the next few months that reign in compensation programs. Schapiro said she doesn’t like incentive pay that encourages individuals to take short-term risks at the expense of the long-term stability of the franchise and at the expense of investors—among other things, she mentioned the “big upfront bonuses” paid to “brokers who deal with retail customers.”

But this would be a very slippery and difficult issue to regulate, said industry insiders, because incentives are built into almost every broker compensation program, including typical payout grids and retention agreements. Where would the SEC draw the line?

“How far do you go?” asks attorney Michael Taaffe, with Shumaker, Loop & Kendrick in Sarasota, Fla. “Some brokers get greater compensation for certain kinds of products, A shares, B Shares, all that stuff. [Regulators could require that firms] tell clients, ‘Your broker is being compensated for the transition of your account,’ but they’d have to send a similar notice if accounts stayed at the former firm, because sometimes brokers are compensated for taking departing brokers’ accounts,” he said. “Sometimes they also offer fee-waivers to clients who stay in place. Is that fair to all the other clients who aren’t getting free service and have their accounts there?”

Regulators are most concerned that the bonuses, which are as high as 300 percent of trailing 12-months production in some cases, provide outsized incentives for brokers to try to reach certain production goals by churning client accounts—whether that’s the $1 million in 12-month production required to get certain deals, or the sales growth hurdles a broker needs to meet to get bonus money on the back end.

“I think the SEC might be worried about someone who moves, only brings half of their clients, and then tries to quadruple the sales numbers to hit growth goals by selling them a bunch of new products,” said Andy Tasnady, CEO of compensation consultant Tasnady & Associates. “I’m more worried about people at existing firms churning,” he said.

Further, the guys who move for the big checks are not the ones who are a big churning risk, he said. “The advisors that are getting the largest offers are advisors that are fee-based, have average or below revenue to asset ratios. Now they want long-term successful people because they’re going to keep them around for 9 years or more, guys who will continue to grow. And you don’t do that by short-term jerking your clients around for 3 months.” Firms already monitor advisors that have high revenue to asset ratios, exceeding 2 or 3 percent, he said. There just aren’t that many guys left who have, say, $50 million in assets and $1 million in revenues, he explained. “If someone is a risk for churning, then they’re probably already churning. The sales deal might heighten the opportunity, but not that much.”

Brian Hamburger, a securities industry attorney with Hamburger Law, said he doesn’t expect any regulatory action at all on broker pay in spite of Schapiro’s comments Monday. “The betting men will tell you, nothing at all [will happen],” he said. “There are so many challenges out there and this is an issue they haven’t been able to tackle in the past.”

Other publications have made reference to a memo New York law firm Ropes & Gray sent to clients in July on the subject of compensation rules for broker/dealer firms, as evidence that rules on broker pay are imminent. The memo analyzes the impact of Dodd-Frank legislation on broker/dealers and other firms and has been available on the firm’s website since the summer. But it says only that regulators will write rules by April 21 that “prohibit any type of incentive-based payment arrangement” that could “lead to a material financial loss to the institution.” No mention is made of broker bonuses, which are not generally thought to have the potential to lead to a “material financial loss” to a brokerage firm. Regulators are worried about the impact of broker bonuses on investors’ pocketbooks, not those of firms.

Disclose It

Of course, new rules could be in the cards. The SEC declined to talk further about Schapiro’s comments, and FINRA also declined to address them. But attorneys and compensation consultants said regulators would be highly unlikely to prohibit the bonuses all together. Instead, they might require firms and brokers to disclose the upfront bonuses to clients, or to base the rewards on assets instead of sales numbers. Or they might require heightened supervision of brokers who are on big recruiting deals.

“If they say we aren’t going to allow any upfront bonus, that doesn’t sound to me like it’s going to work. You’re not going to allow anyone to sell their book?” asks Tasnday. “The companies would find other ways to get around the issue. The firms wouldn’t be doing it if it didn’t make sense economically. If I were a firm and they said you can’t offer a bonus, I would just offer a new comp plan, with the bonus added on to it each year.”

Brian Hamburger, an attorney with Hamburger law firm in New Jersey, said that if the SEC does in fact, write new rules, disclosure is the most likely option. “We’ve gotten away from regulators imposing specific types of compensation,” said Hamburger. “The trend has been to increase transparency with disclosures about those compensation practices. I suspect that’s going to continue.”

Disclosures about upfront bonuses could fit within the new broker/dealer ADV type disclosure form that was recently proposed by Finra, he said. “FINRA themselves have tipped their hands that they may be willing to disclose their executive compensation,” said Hamburger. “I suspect they are making this move in anticipation of calling upon the industry to do the same thing.”

Danny Sarch, a recruiter with Leitner Sarch Consultants said he thinks disclosure is the most likely option, as well. “I’ve been saying for a while that full disclosure about the deals is going to be mandated,” said Sarch. “A broker is going to be required to tell his or her client, look I’m getting this inducement and this is the reason why.” In fact, he thinks it could be a good thing for brokers, because it would make it harder for his former firm to use the bonus against him. Branch managers often tell the client's of a departing broker that he is getting a big bonus in an effort to convince the client to stay. “I’ve been recommending this to brokers for years,” says Sarch.

Greater disclosure could also provide firms with legal protection in the event that a new recruit does behave badly, said Tasnady.

Old School

The idea of regulating upfront bonuses is not a new issue. Back in August, Schapiro sent a warning to brokerage firm executives, asking them to watch for sales practice problems caused by the “large upfront bonuses and enhanced commissions” that firms are giving to new recruits.

The bonus numbers have surged to over 300 percent as recruiting competition intensified following the financial crisis. But they have been climbing steadily for years, even as the amount of time required to cash in on the full deal has risen to nine years. Most recently, Merrill extended its own deal to 14 years.

Back in 1995, when recruiting bonuses maxed out at 60 percent, the Tully Commission was convened to study broker compensation practices. At the time, it issued a report that recommended eliminating upfront bonuses, or paying them over several years to encourage longer tenure by registered reps, and eliminating accelerated payouts—higher payouts for new recruits during the first 6 months or year after they have joined a firm. As a result of that report and investigation, firms stopped offering recruits accelerated payouts and began building deferrals into these recruiting bonus contracts, extending payments over 5, then 9 and now, in some cases, 14 years.