Recently I have been offered a “forgivable loan” as part of a transition package. I've taken loans before, but I've never seen one of the requirements in this one: forgiveness tied to production. It's a four-year loan, one-quarter of the loan forgivable each year. But, the company will only forgive year one if I do 50 percent of my trailing 12. In year two, that number increases to 70 percent. In year three, it's 100 percent. Year four doesn't have any production tied to it. Is this a new standard? I've never seen this and am seriously considering not accepting.
Welcome to the recruiting world of the 21st century: hard production bogeys, cashless transition compensation and eight-year deals!
All firms are much more careful with the deals they now strike with recruits, no matter how badly they want the recruit. Recruiting managers take much more seriously their jobs of due diligence regarding recruits, in terms of verifying production, customer complaints and style of doing business.
The days of getting a fat check from a new firm upfront and then settling in, learning the computer system and essentially coasting are long gone. Like payout grids, the formula for doling out transition compensation has been tweaked and tightened dramatically in favor of firms.
The deal you have on the table is a perfectly reasonable one because if you cannot do half of the production you promised, you should not be moving, and the recruiting firm has made a terrible mistake in hiring you. The harsher version of what we see now is “cliff” transition compensation, which requires the broker to hit the production targets (typically 75 percent of on-board trailing 12) or get nothing.
But the real issue for you is to ask yourself: Why am I concerned that I would lose half of my business in moving? Why does the general rule — that clients who like, trust and respect their financial advisors follow their financial advisors — not apply to me?
Paduano & Weintraub
New York City
You're on the right track if you're considering not accepting. Tying forgiveness to production is, first and foremost, a way to shift risk from the employer to the employee. While there might be legal arguments available to you, if you were to find yourself in a battle over unforgiven debt, that's not a battle you ever want to fight.
First, promissory note cases are an uphill battle for the registered rep. Second, your attorney will be working on an hourly basis. You will be financing that potentially expensive fight yourself. Third, if you lose, the note may make you liable for the employer's legal fees, as well as your own.
Tying loan forgiveness to production is neither commonplace nor unprecedented. From the hiring firm's perspective, such a compensation scheme reduces risk in at least two ways. It may reduce the risk of an unproductive hire by keeping the prospective representative more honest about his or her past production and more realistic about his or her projected future production. It also provides the firm with a contingent savings (essentially “insurance” in the amount of the potential unforgiven debt) in the event that post-hiring production, for any reason, is less than the agreed targets.
The extent to which it keeps a prospective hire more honest and realistic might not hurt the employee. But each dollar of risk that the employer avoids through such an arrangement lands squarely on the employee's shoulders. As an employee whose income depends almost exclusively on production anyway, you don't need still more risk in your life.
Such an arrangement creates incentives that can be highly nonlinear, as well. Suppose you have a $200,000 loan and are approaching your employment anniversary just a few thousand dollars shy of your target for that year. In those final weeks of your year, you'll have an enormous incentive to do whatever it takes to generate the necessary additional production. The $50,000 you stand to save in the form of forgiven debt could be larger than the transactions themselves, let alone being vastly greater than the commissions you generate. And if you make a questionable recommendation during that time, imagine how easy it will be for arbitrators or regulators to assume your judgment was clouded by the tremendous financial pressure under which you were operating. Why would you subject yourself to that kind of pressure and stress if there were any alternative at all?
Nonlinear incentives created by such arrangements might work their ugly magic on the employer as well. In the example above, the employer would stand to save $50,000 if you failed to make your goal. That undoubtedly would dwarf the additional earnings the employer would receive if you were to generate the additional few thousand dollars of production necessary to hit your target — particularly since you might well make those additional sales the following year anyway.
Thus, an employer with a stable of employees laboring under arrangements of this kind will have an incentive to be very efficient about supporting the superstars who easily will surpass their targets and to be far less supportive of anyone who is close to the target. That may be a great strategy for the employer, but it seems a correspondingly poor one for you. Positive thinking is great, but remember that you don't have a crystal ball, you don't know what the economy or the markets will do and you can't know with any certainty how you will perform relative to the annual targets.
Law Offices of Scot Bernstein
Ethical Rep is a monthly feature in which more than 30 prominent securities attorneys, experts and law school professors help Rep. readers deal with work-related ethical quandaries. Have you encountered a situation at work that makes you uncomfortable? Are you confused about how your responsibilities to clients might change as regulations continue to evolve? Drop a line to Rep.'s contributing editor, Ann Therese Palmer, and our group of experts will help you work through the problem.
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