Imagine you're a broker who's just signed on with a new firm, based in large part on the half-a-million dollar signing bonus you've been promised, as well as assurances of future production bonuses to come. It feels great to be on the receiving end of all that cash, right? But wait a minute - before you sign anything, consider what you're getting yourself into. That bonus is probably structured as an Employee Forgivable Loan, which is a very different thing from a true bonus payment. Read on to learn about the significant downside to these loans, and what your options may be if you find yourself a party to one.
What's an Employee Forgivable Loan?
Employee Forgivable Loans, also known as EFLs, are a favorite technique among brokerage firms to offer so-called "bonuses" to their broker employees. Used as signing bonuses for new employees, as a reward to lure a broker and her book of business from another firm, or as production bonuses for meeting sales or "assets under management" targets, EFLs can seem like a fair deal but often function as a trap for the unwary. At the same time you collect your "bonus," you are also required to sign a promissory note agreeing to pay the money back to the firm over time. The firm forgives the loan on a set repayment schedule, but if you leave or are fired before the entire amount is repaid, the remaining outstanding principal and interest are accelerated and due immediately upon your departure. Even worse, the promissory note likely contains a covenant not to compete, or a covenant not to contact any of your clients for as long as you still owe the firm any money. In reality, EFLs can effectively establish a form of indentured servitude for brokers - you must continue working for the firm until you pay off your debt, and the various covenants you've agreed to prevent you from being able to take a job with another firm.
Potential EFL Downsides
Here's what can happen if things go sideways with your brokerage firm:
- Under the provisions of the promissory note, if you leave your job before your EFL is paid back, the remaining payments will be accelerated, and the entire outstanding amount will be due immediately. This can be true whether your departure is voluntary or not. Depending on what the note says, if you are not fired "for cause" the firm may forgive the remaining amount you owe, but in this case the total amount forgiven would be counted as taxable income to you all at once, and you would be taxed on it as though you had just been handed all that cash (which, of course, you haven't).
- Unless you've planned more carefully than most people, you likely won't have the cash on hand to pay off the firm all at once. If you take the head-in-the-sand approach as some brokers do and ignore the repayment obligation, you can expect your former firm to file a FINRA arbitration to compel repayment. Now you'll have to hire an attorney to represent you in the arbitration, which can be another financial hit.
- FINRA arbitrators are used to brokerage firms winning these kinds of arbitrations, absent exceptional circumstances. (Of course, when our firm handles one of these cases on your behalf, we present a variety of defenses and counterclaims, discussed in greater depth here.) Statistically, the best result you can hope for would be a settlement requiring payback over three to five years, with a higher interest rate, and backed by an agreed award or a judgment. And if there is a judgment against you, keep in mind that most promissory notes will also contain a provision requiring you to pay the firm's attorneys fees and costs arising from the arbitration they filed to compel your payment. Arbitrators aren't shy about enforcing these provisions in a judgment, even when those costs and fees run to the hundreds of thousands of dollars.
- If you can't make the payments in the settlement, or if you lose the arbitration, you will have a judgment against you that must now be disclosed on your Form U-4.
- All of this happens against the backdrop of the covenant not to compete that is likely included in the promissory note as well, which may impact your ability to take a job with a new firm and earn the salary you'll need to pay off your snowballing obligations.
How Can You Protect Yourself?
If you already have one or more outstanding EFLs, don't panic. Consult an attorney with any questions you have about what you may have already agreed to. If you are considering making a change from one firm to another, be sure to consult a lawyer before you make any commitments, and certainly before you sign any more promissory notes. An experienced attorney can help you negotiate the terms of your departure from your existing firm, possibly setting up a manageable repayment schedule without your being dragged into arbitration. Alternatively, it may be possible to negotiate an EFL from your potential new employer that will provide you the means to pay off existing ones. If you're offered a new EFL, either from your current employer or a potential new one, don't sign a promissory note before you have an attorney representing your interests review it on your behalf. And if you are currently facing a FINRA arbitration, call a lawyer without delay.
The Forman Law Firm represents brokers and investment advisers in all kinds of FINRA arbitrations and employment negotiations. We can help you with whatever part of the bonus trap you may find yourself in. Contact us at 866-597-2221 for a confidential consultation today.