It feels as if I spend much of my time like the mythical Don Quixote, tilting at windmills—with one very important distinction. The opposition I joust with is far from imaginary and is armed with seemingly limitless resources. One of my passions is to protect financial advisors trying to break away from the deep pockets of wirehouses and go to independent investment advisors or broker-dealers.

So I took note when I saw the latest proposed rule by the Financial Industry Regulatory Authority (Regulatory Notice 13-02) requiring “disclosure of conflicts of interest relating to recruitment compensation practices.” This proposed rule says any transitioning broker who has been offered or received “enhanced compensation” of more than $50,000 to join another firm must give a written disclosure of it to any clients before moving his or her accounts to that new firm. The proposed language even mandates that the specific “details” of the compensation must be clearly articulated, and the disclosure must be delivered to the client together with any account transfer approval documentation.

I thought it odd that the wirehouses were not vociferous in their opposition to this proposed rule. I mean, it’s their recruits that would most likely have to make disclosures. But upon closer examination of what is missing, I now realize the Finra proposed rule has the fingerprints of the big wirehouses all over it. Because the rule would erect a considerable barrier to stem the ongoing tide of advisor and client departures away from those wirehouses.

Just to be perfectly clear, I strongly believe investors deserve full disclosure of any material conflict of interest, including compensation arrangements between brokers and their firms, especially deals that encourage certain types of behavior. I take umbrage not with the stated intent of the proposed rule, but rather with much of the vague and, at times, seemingly arbitrary provisions, the excessive specificity of the required disclosure, and, most important, its subtle but inherent inequity. Independent broker-dealers and investment advisors have been making steady gains on the traditional wirehouses, and this proposal looks a lot like the wirehouses are trying to stem that flow by making it more attractive to stay than go.

All Recruitment Compensation Is NOT Alike
My first issue has been highlighted in many of the 60-plus comment letters submitted to Finra by interested parties. There is no rationale or justification for why $50,000 was chosen as the threshold for disclosure; it appears to have been plucked from thin air with no connection to the real world. Many of today’s signing bonuses are not windfalls for the financial advisor. The recruitment compensation packages are instead meant to defray the often excessive costs associated with transitions—from transferring accounts from one broker-dealer to another, to compensating the financial advisor for lost revenue during the transition and offsetting various out-of-pocket costs for things such as office space, equipment purchases, etc. Furthermore, the compensation may be split among several staff members who are part of the transitioning team.

Depending on the size of the business, these costs alone can easily exceed $50,000, and hardly should be lumped under the “enhanced compensation” banner that requires disclosure.

Thus, compensation that could sound like a staggering amount to clients might actually be reasonable and customary under the circumstances. In addition, financial advisors forced to show all the specific details of their compensation package would have no practical way to explain the justification, allocation, duration of service or other information to show the reasonableness of the compensation package. Such explanations would probably just raise clients’ suspicions and apprehensions.

Finra should simplify yet broaden the disclosure requirements—asking brokers to disclose any and all potential conflicts of interest, including the reasons they are getting “enhanced compensation” and the conflicts this might bring about. This will be much more meaningful and useful to clients, who can always ask their advisors for more details about the ways they are being paid. The broker is obliged to respond in a manner consistent with his or her duty of good faith and fair dealing.

A Year In The Life
The proposed rule also arbitrarily requires brokers to make the disclosure to any former customers who want to move their accounts to the new firm for an entire year. Even though the most complex transitions are usually completed within 90-day windows. The only plausible reason I can think of for such an excessive requirement is that the wirehouses have soured on the “Protocol for Broker Recruiting,” which basically voids restrictive covenants (non-solicitation or non-compete provisions in employment agreements) for financial advisors joining other Protocol firms. The one-year disclosure requirement resembles the typical one-year non-solicitation lockup that many reps sign when they join a brokerage. Though the protocol still effectively voids the non-solicitation provision in financial advisors’ employment agreements, the rules proposed by Finra would discourage moving.

The Elephant In The Room
Meanwhile, another obvious kind of compensation is being blatantly overlooked—the amount wirehouses are paying to retain advisors. Clearly, if Finra’s intent is to protect the best interests of investors, then it should ask for similar disclosures when a broker gets a large retention bonus from a wirehouse. These deals are often indistinguishable from the bonuses paid to advisors to join a new firm, both in their dollar value and in their structure.

Wirehouses have been successfully locking up their top producers for years with generous retention packages (some offering bonuses that exceed three times annual production) in the form of large “loans” that are gradually forgiven the longer the rep remains with the firm. This activity obviously encourages one sort of behavior over another, which makes it of material importance to investors. After all, a client’s interests might be best served if his or her broker moved to a different firm offering better pricing, more product diversity, a superior technology platform or more financial stability. In many cases, the rep may be reluctant to do so simply because of his or her retention package. Yet nowhere within the language of the proposed Finra rule is there a single mention of retention compensation disclosure.

The regulator’s singular focus on recruiting while it ignores retention is akin to its scrutiny of securities transactions while it ignores dormancy in brokerage accounts. Investors’ thirst for transparency has advanced beyond merely looking at transactions. The savvy public has come to realize that the decision not to make a transaction is as important as the decision to make one. Investors deserve more credit than Finra is giving them with this proposal.

The silver lining of this proposed rule is that the recruitment “playing field” for smaller broker-dealers may be somewhat leveled. Traditionally, these firms have lacked the necessary resources to join the recruiting arms race perfected by wirehouses paying exorbitant compensation to top producers. Should the rule pass as currently written, these firms may find themselves on equal footing by convincing reps that a large recruitment package that a bigger firm might offer to pay isn’t worth the disclosure requirements to the broker.

It seems that something more than just investor protection and transparency is behind Finra’s rule proposal. What that may be, I’ll leave to you to determine. In the meantime, I will continue my quest to champion the interests of the independent investment advisors. 

Brian Hamburger, JD, CRCP, AIFA, is the founder and managing director of MarketCounsel, the leading business and regulatory compliance consulting firm to the country’s pre-eminent entrepreneurial investment advisors. He is also the founder and managing member of the Hamburger Law Firm.