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Handcuffs Made of Gold

It's a familiar occurrence these days brokers fighting their former employers over money held in deferred-compensation plans. A group of former Smith Barney advisors recently won a judgment that would return over $8 million in forfeited wages held in the company's Capital Appreciation Plan (CAP). Meanwhile, a former rep from the former Prudential Securities is challenging that firm's deferred-comp

It's a familiar occurrence these days — brokers fighting their former employers over money held in deferred-compensation plans.

A group of former Smith Barney advisors recently won a judgment that would return over $8 million in forfeited wages held in the company's Capital Appreciation Plan (CAP). Meanwhile, a former rep from the former Prudential Securities is challenging that firm's deferred-comp vehicle, MasterShare, on the grounds that it violates his rights under the Employee Retirement Income Security Act (ERISA).

Given these legal attacks, a casual observer might well deduce that deferred-comp plans are the enemy of the retail broker. In fact, say recruiters, brokers and industry legal experts, the plans can be an advisor's lucrative friend. That said, before signing onto a plan, advisors must be sure they don't intend to leave — or get fired for cause — for a few years. And even if you're optimistic about your firm, work great with your branch manager and have confidence in the stability of your own branch, you must still understand exactly what you are signing.

Deferred Comp on Trial

What you are signing is an employee-retention document, as the recent spate of legal challenges casts in stark relief. And, obviously, employee-retention tools are designed to discourage brokers from moving to greener pastures. They do this by holding some of an employee's “green” in an escrowlike account.

Typically the plans let reps channel a portion of their paychecks into discounted stock that grows tax-deferred over a defined vesting period. The plans frequently feature performance incentives that will bump up a firm's matching contributions for advisors who exhibit outsized asset growth or for those who move a high percentage of clients into fee-based arrangements, for example. After the expiration of the vesting period — usually around five years — the broker can renew the account or cash in the shares and pay the income tax on the balance.

However, if the broker leaves or is fired with cause before the vesting period, things can get complicated. Most firms will take back the reps' accrued company-funded benefits in the accounts — the matching funds and the gains that resulted from them. Others take more severe action: in Prudential's MasterShare and Smith Barney's CAP, departing brokers forfeit all the money in the account, deferred salary included.

Not surprisingly, these hard-line programs have endured their fair share of challenges. According to an attorney for the Smith Barney brokers who won (for now) the $8 million award, their case was “the biggest victory yet for brokers.” The attorney, Bruce Nagel, a partner with Nagel Rice & Mazie, in Livingston, N.J., has good reason to be excited: The award is the first, he says, that requires Smith Barney to repay employees earnings connected to CAP. (Smith Barney will likely appeal.)

The attacks on CAP have largely centered on violations of state wage laws, which in general prohibit employers from paying wages in any form other than dollars. (The CAP plan offers participants discounted Citigroup stock.) In the New Jersey case, the judge ruled, “forfeiture of earned wages invested in the CAP plan contradicts [New Jersey] public policy, which requires that employees receive that earned compensation.”

A lawyer familiar with the defense's viewpoint says the ruling on the forfeiture clause “is ridiculous.” In past cases, Smith Barney has defended itself by showing that it's a clearly defined and described agreement, signed voluntarily by the plaintiffs.

“It may be a handcuff, but the brokers are knowingly putting it on themselves,” says the lawyer.

Illustrating the difference in the state-level rulings, in July 2003 a California judge ruled for the CAP plan, and against the previous “wage” arguments. “When class members voluntarily terminated their employment, they were not forfeiting unpaid wages. Rather, it was a forfeiture of restricted shares purchased with wages,” the judge wrote, referring to the plan's use of Citigroup restricted stock in its plan.

Likewise, the Prudential case is probing new cracks in the historically impenetrable defense of the deferred-comp plans. Yaakov Holansky, the former broker bringing the case, has won an early battle to have it cast under ERISA, which strictly prohibits forfeiture of employee contributions. Holansky's favorable ruling in Illinois found that MasterShare may have qualified as an employee benefit pension plan, in which case it should have been governed under ERISA. (Holansky left $10,000 behind when he left the firm.)

A source close to the matter says the ruling is off base, and that MasterShare, like the other plans, is “specifically designed” so it will not fall under ERISA regulation and is very clearly a multiyear handcuff — an argument that several previous court decisions have also agreed with.

The Winds of Change

Though it's anyone's guess what the outcome will be of these cases, many within the industry see the programs as perfectly legal and point to the preponderance of court rulings upholding the legality of the plans as a solid benchmark for what to expect when the appeal process gets under way.

Popular opinion, however, is another matter. The publicity garnered by these cases highlights the fact that the Smith Barney and Prudential plans require the forfeit of more deferred funds, and that could prove a negative on the recruiting trail.

“It will probably change. Otherwise, I can see the other firms using it as a selling point for their own firm,” says Mike Herman, head of the financial services unit for Deloitte & Touche's human capital advisory practice in New York.

In the meantime, compensation experts and recruiters remind brokers of something that could well get lost in the noise surrounding these cases: Deferred-comp plans are designed to be mutually beneficial to the firm and broker. Andrew Tasnady, a Port Washington, N.Y.-based compensation consultant and designer of many of the plans in use at brokerage firms today, illustrates just how lucrative a typical plan can be for a successful broker.

“A $1 million producer on a 40 percent payout, deferring the maximum [usually] 25 percent of his gross [$100,000] who then hits all the buttons — employer matches, bonuses for assets, etc. — can ostensibly get a $200,000 match if he's really good,” says Tasnady. “After a five-year vest, that's $300,000,” he says. The alternative, he adds, would have been the $100,000 minus taxes, or roughly $50,000 for his pocket.

“You can see why the plans are good,” he says.

If you stick around long enough, that is. One broker says that decision is ultimately about the culture and the atmosphere at the firm. “The manager, the services, the other FAs — those are going to be strong influences in whether you'll want to stick it out,” says one Smith Barney broker. “It says a lot for doing research on each firm's personality,” before jumping into a deferred-comp plan.

What can you expect from a recruiting firm if you do decide to jump? Chances are, not a lot, unless you're the big fella in the corner office. “What a broker is going to lose is typically greater than what they're getting in upfront money from an interested firm,” says Mark Elzweig, a recruiter in New York. “If you want to attract people with $500,000 in production and 15 years of experience, these people have big deferred-comp problems.”

But if you happen to be a true heavy hitter, recruiting firms are sometimes willing to make up for portions of the deferred comp left behind. For instance, UBS is currently offering big producers up to 100 percent of unvested deferred compensation in order to bring them over, according to recruiters.

Smith Barney is also selectively aggressive in making recruited brokers whole. One former Prudential broker quit the firm in the wake of the Wachovia transition, leaving more than $150,000 in deferred comp behind. Smith Barney gave him 100 percent of his trailing 12-month production and a 25 percent discount on Citi stock to vest over seven years.

“All in all, they covered about 80 percent of my unvested portion,” says the broker.

Looking back, he says the Pru deferred plan represented a golden opportunity to increase his negotiating leverage: “It was a really good deal, especially for above-average producers.”

At Pru, he and his fellow brokers could contribute up to 25 percent of gross commissions into the plan and the firm would match up to one-third of that amount. Performance bonuses increased the matching: Brokers in the top 20 percent of the firm would receive an additional 67 percent bonus, thus making it a dollar-for-dollar match. The next 20 percent would get an additional 33 percent and the third quintile got 17 percent. Since these were production bonuses, those in the bottom two quintiles got nothing. A third determinant — a broker's “compound annual growth rate” (CAGR) — could push matching contributions up another 100 percent. The resulting match for these top performers could be as high as $2 to the broker's $1, a very good deal for “stayers.”

Amazingly, the broker says, a lot of people didn't participate. “Everyone who I spoke to said they opted out of it because they didn't want to be tied to the firm,” he said. “But I liked the branch, I knew I'd be around for a while, so it made sense.”

Here to Stay

Brokers cheering for the courts to rule in a precedent-setting way against the brand of plans employed by Smith Barney and the former Pru might do well to save their energy.

The firms have faced down numerous challenges over the years — many of which included superior court overturns of lower court victories by brokers. If history is any guide, deferred-comp plans are likely to be around for some time to come.

Danny Sarch, a recruiter and founder of Leitner Sarch Consultants in White Plains, N.Y., says deferred-comp programs can be a good deal — for the right advisor.

“I don't see any downside, as long as brokers know going in that it's a golden handcuff,” he says. “It's additional compensation and that's always good.”


Firm Smith Barney Merrill Lynch Morgan Stanley Prudential UBS Wachovia
Investment Vehicle Stock Stock + Cash + Fund (FA's>$1m) Stock/Option Blend Multiple Funds Cash Multiple Funds
Annual Award Basis Production + Product Mix Production Production + LOS Production + LOS Production + LOS + AUM + Credit Lines Production
Vesting 5 yrs. Cash- 4yrs. Stock-8yrs. Fund-retirement 5 yrs. 5 yrs. 6-10 yrs. 5 yrs.
Additional Deferral Option Additional at risk Vountary stock purchase plan, (“CAP”), up to 25% employee contribution, at 25% discount) No Additional FA specific voluntary option. Additional Voluntary deferred plan available for 3-year deferral Voluntary at risk plan, (“MasterShare”), up to 25% FA contribution, with company match of at least 33% + multiplier based on LOS and FA production growth Add'tl Voluntary element. Also, add'tl asset-based award of 50bps Additional Voluntary plan available (5% to 85% FA contribution) is fully vested and provides same choices as bonus plan

Should I Stay or Should I Go?

Factors that favor “Stay”:

  • Your manager is trustworthy and supportive of your efforts to expand your book. This is important for two reasons: First, a good manager can help a broker earn more; second, a good relationship with a manager reduces the likelihood that you'll need to seek a position at another new firm, leaving deferred comp behind in the process.

  • The firm's culture is a good fit. If everyone else is in the office at 6 a.m. everyday, listening to a conference call while reading the Journal — and you are too, that's a good sign. But if you're a night person, you're unlikely to stick with the firm long enough to vest the deferred-comp plan.

  • You're a short-timer, vestingwise. If you've got a year left in an “at risk” plan before your money vests, odds are that the best bet is to stick out a current situation and wait for the money to become yours.

Factors that argue “Go”:

  • Gold in them hills. If you happen to be part of that rarified class of advisor who can demand to be made whole during a firm switch, feel free to look around at any time, because you're likely to be able to recoup most of what you might leave behind in deferred comp.

  • Your manager is a drag. A bad relationship with a manager can be a drag in every sense of the word, and it could mean that you're not long for the current firm. Avoid committing to the deferred-comp plan, if possible.

  • Resource issues. If you're firm's technological resources do not support your practice amply, you're unlikely to be able to sustain a productive career there.
    John Churchill

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