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Standardizing Methods of Allocating Attrition Can Help Manage Discrimination Suits from Brokers

The information contained in this article is intended for informational purposes only and should not be construed as legal advice or a substitution for obtaining legal advice from an attorney licensed in your state. Reading this article is not intended to create an attorney-client relationship. For personal legal advice, please consult an attorney of your choice. Because of the possible unanticipated changes in industry regulations and applicable state and federal laws, the authors and creators and any and all persons or entities involved in any way in the preparation of this article disclaim all responsibility for the legal effects or consequences of the interpretation of the information provided.

If one was to search for the origins of the adage “Lion’s get fed” they would most likely discover that it was spawned somewhere ions ago at some brokerage firm by the stereotypical slick, rhino-skinned sales manager as he distributed an ex-brokers account cards to his top-producing registered reps. Visions of Alec Baldwin from “Glengarry Glen Ross” are conjured as we hearken back to the dark days of retail stock brokering.

But these are modern times and brokerage firms are under more scrutiny than ever before, and not for just the way they treat clients; for the way they treat their brokers as well.

The securities industry boasts one of the highest turnover rates of personnel of any professional field. In some cases it has been calculated that as many as 97% of the people that start in “the business” never make it three years. Because of this fact, hundreds of millions of dollars of clients’ equity go up for grabs as 97 out of 100 brokers hit the door, either seeking greener pastures at a firm across the street or simply leaving the business for the sanity of a low-stress, salaried position in a slower-paced environment. Regardless, the practice of distributing house accounts is a tremendous part of the business that brokers rarely speak about and that the investment public hears about to even a lesser extent.

Most standard employment contracts issued by brokerage firms today include language specifying that the firm owns the brokers work product, including any and all client accounts. Whether the broker is termed for cause or simply resigns, these accounts then become “house accounts’ or simply stated, the property of the employing firm. Moreover, most such employment contracts contain a “non-competition” agreement preventing the broker who is leaving from soliciting their clients when and if he or she joins another firm. NASD rules and regulations also require that any disputes between a registered rep and employing firm will be settled by arbitration procedures.

Customarily, these accounts are distributed by the first in the chain of command, the sales manager, affectionately known as the “24.” In addition to nominal salaries, sales managers are customarily compensated in two ways: if they are a “producing manager” with their own “book”, they receive the pick of the litter of attrition when a broker leaves the firm. They also receive an override (anywhere from 1%-5%) on the brokers they manage. Their motivation is of course to first reallocate house accounts to top-producing agents who have the ability to generate the greatest amount of commission dollars for the firm while servicing their new-found client base. Secondly, managers will distribute accounts to their familiars or “buddies” in the firm, brokers they not only have to satisfy in a professional but social capacity as well.

This “buddy system” is truly one of the last bastions of unchecked nepotism in the industry today.

This dynamic brings us to the ‘chicken and the egg” scenario. Does a registered rep become a top producer because he inherits accounts, or does he inherit accounts because he is a top-producer? Regardless, the simple fact that this practice exists means that hundreds of millions of commission dollars are directed into the pockets of a handful of the firm’s brokers, without any formal industry or internal guidelines in place. The NASD rules do not provide any guidelines and do not require the firm’s written supervisory procedures to address this issue. The lack of industry procedures or guidelines not only permits this type of abuse and indiscretion by the firm’s principals, but actually encourages it. Branch managers may commit outright discrimination on a regular basis and this spells L-I-A-B-I-L-I-T-Y for the employing firm.

With any accepted practice that is unregulated, where millions of dollars changes hands, there is more than just a “potential” for abuse. Abuse becomes inherent in the system. More unfortunately is the reality that these abuses are so broadly prevalent and accepted that they become part of the institution itself and accepted by the participants as “just the way things are.”

Female registered representatives and minorities feel the sting of these arbitrary policies more severely than their white, male counterparts. Women and minorities have made tremendous strides in the securities industry since the early 1970’s and Muriel “Mickie” Siebert is living proof of this. Ms. Siebert is the first woman to own a seat on the New York Stock Exchange and the first to head one of its member firms -- Muriel Siebert & Co.

For the most part though, women and minorities comprise less than 20% of the securities industry but receive few, if any, of the house accounts traditionally distributed to their white, male associates. In related fields discrimination suits have resulted in multi-million dollar settlements to established companies that possess an otherwise unblemished track record. Most brokerage firms are constantly on the lookout for potential lawsuits from clients and regulatory bodies when in actuality they should be more wary of the liability that is growing in their own backyards.

As is the nature of regulatory and compliance law, it is typically cheaper to avoid a problem than to fix one.

It is recommended that one or more of the following four guidelines be adhered to by employing firms when allocating these house accounts. These guidelines will not only strengthen the firm’s defense in the event of an arbitration filed by a disgruntled broker, but will also strengthen the firm’s sales force in the process. Ideally, more revenues will be generated and ultimately retained since big-ticket settlements with former brokers are eliminated.

However, since for every action there is an equal and opposite reaction, it is imperative that these guidelines be imposed on a case-to-case basis. There are no absolutes. Every brokerage firm has its own particular structure, strengths and weaknesses and every sales force possesses its own particular dynamic as well.

Although “gross is king” other factors must be considered when distributing house accounts. Forcing a round peg into a square hole will only achieve production in the short term. If the receiving broker inherits an account with $50,000 in client equity and redistributes it in accordance with current company recommendations, this will result in a handful of trades and most likely, a dead end as far as the client-broker relationship is concerned. By matching the right broker to the appropriate client there is the distinct possibility that the relationship will foster a greater trust and understanding of the client’s financial needs and risk tolerance. Once this is achieved the client may be diversified into a greater variety of products by funding the account to a greater extent, or even by consolidating other brokerage accounts at the new brokers firm. The added benefit is that clients holding a variety of products do not experience the same swings in account value as clients holding equities exclusively, further diminishing the chances of a client complaint. The receiving broker is satisfied due to the fact that they have not merely inherited an account, they have received a client. In summary, a long-term perspective equals greater revenues with lower inherent liability from the broker as well as the client.

Document the reasons a specific account was handed to a particular broker, emphasizing the benefit to the client, not the firm.

Since every top-producing broker starts out as a non-producing entity it is only basic common sense that everyone must be given a chance to excel. If indeed you are assigning an account to a broker who does not possess a stellar record of production, be sure to keep a separate log detailing what accounts were handed to whom and on what date and, as stated, for what reason. Also print the account’s daily statement for that date and attach it to your log. The broker should be informed that the accounts are distributed on a trial basis and that indeed they are property of the firm. You are merely appointing him or her as your representative to serve the client’s needs.

After sixty days review the progress of the account with the broker and give the client a quick call to gauge their overall satisfaction with the way their account is being handled. This practice of handing out accounts with a “probationary period” attached serves several purposes:

Should it be established that after sixty days the broker has basically “dead-ended” with the client, detail this in your records in order to insulate the firm from potential liability. The account should then be reassigned to another broker who may be a better fit for the client.

Consistency is tantamount in avoiding liability suits from employees. For example, if three accounts are handed to a broker with an annual production of $750,000 gross; there is absolutely no defense for not applying the same treatment to “Broker 2” who possesses the same qualifications.

The best way to avoid this conflict is to codify the firm’s policy for distributing house accounts. Qualifications for receiving house accounts should be based on the following:

The easiest and most cost effective way to handle this thorny conundrum is to simply eliminate the practice entirely. Create one house book and assign one or a small group of brokers to handle the equity and service the client base.

Since these brokers are not raising equity for the most part or cold-calling in order to initiate the long and laborious practice of opening accounts, it can be justified that they receive a substantially lower payout percentage-wise. Since attrition is an ongoing occurrence the house book will eventually become considerably large, so the attending representatives will be well compensated from a dollar perspective.

Once again, this book and these brokers should be closely monitored and held to the highest industry and internal standards to minimize the potential for any abuse.

The benefits to this approach are obvious. It creates the simplest, most cost-effective scenario for handling attrition while eliminating any risk that the employing firm will be sued for bias in distributing accounts.

The downside to this practice is potentially two-fold is this policy is initiated in mid-stream. In other words, if your brokers are currently receiving attrition it is essential that you continue to provide it. If the practice of reallocating house accounts to producing agents is eradicated, your sales staff may perceive that the employing firm has become greedy by hoarding accounts for its own book. This may initiate a mass exodus that will cost the firm its top producers and may make recruiting a near impossibility once the firm’s reputation has been damaged.

The second downside is that the ability to supply incentives to superstar producers has been lost in the process.

In summary, if house are to be kept by the house it is necessary that this procedure be implemented at the inception of the branch.

Discrimination suits adversely affect the bottom line of a securities firm on two specific fronts. There is potentially the short-term catastrophic expense of paying the settlement itself in addition to the long-term damage to the company’s reputation as a fair and impartial employer. Brokers have more options than ever before when seeking employment and it is of vital importance to create and sustain a balanced working environment where pre-empting discrimination quagmires is viewed with the same importance as generating gross production.

However, regardless of the size and focus of the brokerage firm it goes without saying that it is typically cheaper to avoid a problem than to fix one.

Laura Anthony is the founding partner of Legal & Compliance, LLC, a corporate and securities law firm specializing in securities & regulatory matters, business transactions, commercial litigation and entity formation. She is also a member the NASD Dispute Resolution Board of Arbitrators and can be reached at 800-341-2684; by e-mail at LauraAnthonyPA@aol.com or contacted through the company’s web sites http://www.LegalAndCompliance.com and http://www.MyWebLawyer.com.

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Laura Anthony, Founding Partner e-mail: lanthony@legalandcompliance.com	800-341-2684 fax: 561-514-0832
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