James McCarthy was more than just a model Smith Barney broker. He was something special. A 20-year veteran of the firm and a million-dollar producer in the prime of his career, McCarthy was the top rep in New Hampshire, his home state, and among the 20 best in New England. As part of Smith Barney's elite Director's Council, which is limited to brokers in the firm's top 5 percent in production, he was invited to an annual conference with top brass and given access to special investing programs.
All that now seems so long ago. Seven months after leaving the firm in May 2003, he went after his former employer in what has become a tangled legal battle over a lot of money he says belongs to him.
The 48-year-old McCarthy says he felt he had to leave the brokerage unit of Citigroup — and the whole Wall Street way of doing business — after the research scandal centering on Smith Barney analyst Jack Grubman in 2002. The incredible revolving arbitrations and courtroom dramas that have tied him in knots for over two years speaks to another ugly Wall Street story: the lengths to which firms go to keep top talent from walking out the door.
Roughly 10 percent of Wall Street's brokers change jobs or leave the business annually, according to widely accepted industry figures. A much smaller percent — about 1 percent to 2 percent — leave specifically to work as independent reps. Wall Street's success in keeping both numbers so low has a lot to do with deferred compensation or, as it has been nicknamed, golden handcuffs. As the term implies, it's a promise to “reward people who stay,” says Andy Tasnady of Tasnady & Associates, a Port Washington, N.Y., compensation consultant.
At the same time, there's a penalty for leaving. McCarthy's experience with the Smith Barney plan, which has been mired in controversy, offers a cautionary tale on the consequences of fighting it.
The Big Whack
When McCarthy made up his mind to quit, he faced a particularly big loss. The voluntary Smith Barney deferred-compensation plan he contributed his earnings vests every two years. That's the carrot and, as it's a shorter stretch than at most firms, a big one. On the other hand, anyone who leaves before that time loses every cent put in.
For the superstar McCarthy, it meant being whacked for $287,000. Had a broker of his caliber moved to another Wall Street house, he very likely would have been reimbursed the money by his new firm. As it is, he was sure to lose it all by opening up a two-man shop, Seascape Capital Management in coastal North Hampton, N.H. — unless he fought for it. Then, McCarthy thought, he at least had a chance.
“It's my money,” he explains succinctly. Yes, he says, he knew he'd have to forfeit the money if he left before his two years were up, but he felt brokers were pressured into contributing to the plan and the research scandal put him in a fighting mood.
“The firm sold out its retail brokers, period,” he says. “It's ironic that people who were fined and barred from the industry get generous severance packages, but a top producer who gave his career to the firm has to fight for what he already earned.”
William Jacobson, a Providence, R.I., securities lawyer, who McCarthy enlisted to take his case, gave him hope that he could win. New Hampshire law stated that employees could not waive their rights to their money and a class-action suit in New Jersey, which has a similar law, was already being waged to recover voluntary contributions to Smith Barney's Capital Appreciation Plan (CAP). “A lot of cases turn on credibility,” says Jacobson, “but that's not an issue in James' case. This is pure and clear an issue of legality.”
Still, McCarthy was taking on an extremely powerful firm that had already proven it had no intention of giving back any money if it could help it. The fight in New Jersey had already been going on for four years and McCarthy would have to prove he had the stomach for fighting a firm where he had spent nearly half his life.
The Good Soldier
McCarthy came in to the advice business through the insurance side, working at Prudential Life and then E.F. Hutton Life for several years before joining Hutton's consulting arm in North Hampton, N.H., in 1985. By that time, Smith Barney had acquired the firm. And, in 1993, he was the top producer in his office and one of the best in the firm.
McCarthy signed up for CAP, which had been started four years earlier. It allowed reps to defer up to 25 percent of their pretax earnings towards the purchase of Citigroup stock, discounted 25 percent. Every two years, the stock would vest and reps could cash out and defer again, or, since it's voluntary, discontinue participation indefinitely.
Stopping, though, wasn't an easy option. There was pressure to stay in, as well as to join, McCarthy says. Citigroup Chairman Sandy Weill strongly supported the plan, and branch managers, McCarthy says, “strongly encouraged” brokers to participate — a claim that is supported by the testimony of a branch manager during McCarthy's arbitration.
As part of a branch manager's evaluation, firm brass compared levels of CAP participation at the different branches. Low participation meant a lack of leadership and an absence of team spirit, which reflected badly on the boss. Smith Barney says this is no longer part of the branch evaluation process and the program is truly voluntary. McCarthy says he strongly doubts the pressure is no longer there merely because the official policy has changed.
Change of Heart
When the research scandal hit, McCarthy saw no reason to spend the rest of his career working for Wall Street firms. Other firms, not just Smith Barney, were also tainted by the scandal. He wanted no part of them.
“I didn't want to jump from the frying pan into the fire,” he says. “So I looked out five to 10 years and asked myself where'd I'd be better off, financially and in terms of happiness.”
He became a registered independent advisor, opened Seascape with a partner and, in December 2003, hired Jacobson to represent him through the arbitration process. Eleven months later, in November 2004, McCarthy had a hearing and seemed to be in a good position to win. That year, the Smith Barney brokers in New Jersey won $8 million and Wachovia dropped a (Prudential) plan that was almost identical to Smith Barney's CAP, which is now virtually the only one of its kind left. Tellingly, Wachovia dropped the Pru plan, even though it had fared well in court challenges by reps.
It was agreed by both McCarthy and Citigroup that New Hampshire laws governed the case. Nevertheless, the panel sided with Citigroup, calling the wage laws “irrelevant” and emphasizing McCarthy's voluntary participation, knowledge of the consequences and common use of the plans in the industry. McCarthy appealed and, in January 2005, won a decision from Judge Joseph DiClerico of the U.S. District Court of New Hampshire, who vacated the decision and remanded it to arbitration a second time. In his written opinion, the judge slammed the panel's decision, saying it “was made in manifest disregard of the law [New Hampshire wage law.]”
Both parties chose to enter into a second arbitration hearing with a different panel. Citigroup prevailed again. This time the panel responded to Judge DiClerico's instructions to apply the state wage law, saying in its August 2005 report that it had considered the “applicability” of the New Hampshire wage law in making its decision. But the panel didn't further explain how it reached its decision. Jacobson and other lawyers say this kind of behavior from two separate panels is almost unheard of: “The first panel, perhaps, you could understand,” he says. “But the second panel had a prior decision by a judge in favor of the broker and they just ignored it.”
McCarthy appealed again, and, in December 2005, DiClerico vacated the second panel's decision, too, registering frustration with the panel's lack of an explanation given his prior orders: “In the absence of any explanation, there appears to be no arguable or plausible basis for the panel to have ruled either that the New Hampshire wage laws did not apply to McCarthy's claims or that [Citigroup's] failure to pay McCarthy earned compensation, based on the forfeiture provision in the CAP, was lawful.”
Citigroup, which declined to talk about the CAP plan, issued this statement: “We have tried and won this case twice and we are appealing the latest court decision vacating our latest victory and are confident we will prevail in this matter.”
McCarthy now waits for a third arbitration date, and, not surprisingly, he wishes the whole mess would end. But there's no time limit on principle, he says. “I think in the long run I made the right decision,” he says. “And you know, 18 years of a stellar career should have stood for something with them.”