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Ready to Punch the Clock?

Most registered reps compare themselves to professionals, such as doctors and lawyers. But, in fact, it seems that, financial advisors may be held to the same labor law standards as an hourly employee

Most registered reps compare themselves to professionals, such as doctors and lawyers. But, in fact, it seems that, according to an interpretation of federal law, financial advisors may be held to the same labor law standards as an hourly employee of, say, Wal-Mart.

Accordingly, registered rep employers in the near future “will be required to treat brokers like hourly workers and control the hours they work,” say lawyers hired by the Securities Industry Association, the influential lobby group for Wall Street firms.

Put another way: Imagine arriving to your branch office and punching a clock (or, more likely, swiping your ID). Or how about being forced by the company to take breaks, including a lunch break, instead of working, as may be your present go-get-‘em habit? Instead you may have to take all the allotted time for the break and prove it by swiping out and swiping back in. But, hey, look at the bright side: You would be paid overtime for each hour worked; and, sales assistant salaries and other payroll deductions (for bad trades, for example) would be paid for by the broker/dealer.

Welcome to the world of the wirehouse rep if class-action overtime suits prove successful — or so say lawyers for the SIA. Are these just scare tactics? Or a reasonable guess as to how the compensation debate now embroiling contingency fee lawyers and management might shake out? The SIA says, “It is inconceivable that this would be in the best interest of the vast majority of brokers who enjoy the flexibility of setting their own hours and who would not want to fill out time cards or be paid by the hour. Nor would it be in the best interest of clients whose needs are better served by a professional who is not bound to the clock.”

Fair Labor

Think it's some weird fantasy, that there's no way this will ever happen? “Hourly employee? C'mon, I'm a financial advisor,” you might say. Consider that plaintiffs' attorneys have been successful in settling overtime class-action lawsuits with four top firms totaling over $265 million in restitution and damages since 2005 — two of them national settlements. At this point, the suits have not been tested before a judge. Merrill Lynch and Morgan Stanley settled with brokers in California for $37 million and $42.5 million, respectively. UBS and Citigroup have both settled nationally with their reps for $89 million and $98 million, respectively.

And it's just the beginning. There are now dozens of copycat suits filed by reps from coast to coast, with brokers claiming that they were illegally denied overtime pay and suffered illegal pay deductions on trading errors and sales assistants' salaries. (Brokerage firms deny they are doing anything illegal, and were not forced to say otherwise in the settlements.)

The argument from plaintiffs' lawyers, including lead attorney Mark Thierman of Reno, Nev., who pioneered the legal strategy (see “Wall Street Wage Fight” in Registered Rep.'s May 2006 issue), is actually simple: Reps are being misclassified as “administratively” exempt under the Fair Labor Standards Act of 1938. This exemption says that employees who regularly exercise “discretion and judgment” in their work and are guaranteed a weekly salary of $455 are exempt from receiving overtime. Thierman argues that since most reps work on a draw and a commission, they cannot be listed as exempt. The law, all agree, was intended to protect blue-collar workers in the Depression from abusive work practices, but has stayed on the books and been revised over the years to adapt to jobs that didn't exist 60 years ago. Yet, until Thierman came along, no one thought to apply it to the financial-services industry.

Interestingly, investment advisor representatives (IARs) — fee-only advisors who work for registered investment advisors (and there are many at wirehouse brokerages, which all have RIA units, too) — “are probably exempt” from the FLSA, since they are paid on a “constant” rate based on the assets they've gathered, says Thierman. In short, IAR comp is much like a salary.

Overhauling FA Compensation?

By and large, most firms declined to discuss the issues in any detail, since they appear to be trying to figure out how to tweak compensation. (Most financial advisors are very much against any change in comp.)

But, Walter Olson, a fellow at the Manhattan Institute, says, “Revamping the compensation system is at the top of the firms' agendas.” And no wonder. Do the math: Paying 11,000 reps a salary of about $23,660 a year (or $455 a week) would cost Smith Barney, for example, over $283 million each year. If you tack on sales assistants' salaries, firms will be on the hook for plenty more. According to data from the industry consultant, The CBM Group, reps at regional brokerages typically pay sales assistants salaries of between $24,000 and $36,000 before bonus. Wirehouse sales assistants' salaries range from $48,000 to $60,000 pre-bonus. (Of course, some top producers may already have gotten their firms to pay for sales assistants.)

Publicly, the wirehouses and regional firms party to the suits are standing behind their decisions to classify reps as exempt from overtime. The SIA legal team is even calling plaintiffs' lawyers “opportunistic,” but is also saying that it is not currently pursuing the overtime issue as part of its legislative efforts in Washington. Still, lawyers and industry experts acknowledge privately that the firms are looking to change the way they compensate brokers, possibly as soon as 2007 when new compensation packages are promulgated.

Developing and implementing a new compensation system will not be easy, obviously. The big question for firms, according to a lawyer familiar with the overtime suits, is, “How do we equitably pay out reps, motivate them to perform well, allow the company to generate a return and comply with the law?”

Smith Barney may be the only firm that has come up with a solution so far, although there seems to be some confusion on this point. In an April 28 memo to branch managers, the firm announced it would be paying all of its reps the minimum salary per week beginning on May 10. Alexander Samuelson, a spokesman for Smith Barney, confirmed the existence of the memo but declined to comment further. Yet, not one Smith Barney rep or branch manager (over two dozen) contacted by Registered Rep. was familiar with the new payout system supposedly implemented by the firm. In fact, one advisor logged into his payroll account and verified there was no change to his May and June paychecks.

Automaton? Or Skilled Investment Pro?

But will a minimum salary be enough to win an administrative exemption from the federal labor law? For once on Wall Street, it isn't entirely about money. It's also about how one classifies the duties of a registered rep in 2006. Is he a salesman or not? Do reps actually use their own discretion and judgment? No, says Thierman, most reps are nothing more than glorified salespeople, and should be considered hourly employees. Reps, in this view, are automatons that fill out “if-then” suitability questionnaires for clients — and then offer firm-approved, prefabricated investment solutions accordingly. (That's the trend, anyway.)

Of course, many reps aren't going to like being thusly categorized. One top-producing Smith Barney rep — who like many other FAs had no idea about any of the overtime pay issues despite the memo — said he wouldn't think many top producers would stick with a firm offering a salary. “There is no way it would be received well. If they did that at Smith Barney, any broker that has confidence would leave and go to UBS or Merrill or any competitor that has something better to offer,” he says. A source familiar with Smith Barney's proceedings points out that this is not a problem unique to any one particular firm; it's an industrywide problem that needs an industrywide answer.

Who Is It Good for?

It seems anything but the current system will dissatisfy reps — and perhaps with good reason. It is the only universally accepted compensation system that has existed in the retail brokerage industry. Andy Tasnady, compensation consultant with Tasnady & Associates in Port Washington, N.Y., says, “Any system that doesn't reward you on your performance heavily is not going to be very attractive.” He also adds that brokers would interpret the introduction of a base salary as the first step towards a 100 percent salary compensation system, and in response, would panic and go independent.

One possible solution that firms are currently considering may mean no change for top producers, according to Dale Hudson, a lawyer with Nixon Peabody in Irvine, Calif. The system would look at each rep individually and decide on a case-by-case basis how he or she would be classified: highly-compensated exemption, administrative exemption or hourly wage earner. The first would be ideal for top producers, according to Hudson, who typically earn more than $100,000 under the current system. Reps under the highly-compensated exemption must be guaranteed $455 per week; the remainder of the compensation, according to the FLSA, can be paid through commissions, nondiscretionary bonuses and other nondiscretionary compensation.

Advisors who typically do not earn $100,000 would be either administratively exempt or paid by the hour, depending on their responsibilities. If the advisor's primary duty includes the exercise of discretion and independent judgment and he is guaranteed a weekly salary of $455, then an administrative exemption can apply. “The bottom line is that there are going to be employees that don't fall under either of those exemptions. Then the only option is to treat them as hourly wagers,” Hudson says. Generally, rookie advisors would be filed as hourly workers.

Some argue that any compensation change will have to occur unanimously among the wirehouses, but then the question of collusion is raised. Hudson says although the firms can't get together in a room and decide on a new payout system, they can respond to one another's changes. “It's the same way the airlines have done it. One airline would raise prices and then five others would follow suit. Eventually, in about three to four years, there will probably be a fair amount of uniformity among the firms after they figure out what works,” he explains.

Besides Smith Barney's alleged compensation change, there has been little certainty on any specific changes in compensation, but employment lawyers from both sides predict, at the least, that deductions from advisors' pay will eventually be phased out. “The issue of paying sales assistants' salaries will probably have to stop,” says Hudson. Thierman adds, “What annoys brokers the most are these deductions.” But he says reps will feel a direct impact when they look at their paychecks and the deductions have been phased out.

Ironically, the overtime suits were started by brokers complaining about the deductions they faced for trading errors and sales assistant salaries. Plaintiffs' lawyers coupled the reps' original complaints with their own newly founded argument for overtime. Somehow, deduction complaints have taken a backseat to the overtime claims, which most advisors don't believe they're even entitled to. Nonetheless, the overtime claims may well be turning the industry's current compensation system on its head, because as Olson puts it, “No one wants their compensation system to be a punching bag for lawyers.”

Thierman's Math

How much will your firm owe you in back pay? Thierman estimates each rep is personally owed $30,600 in overtime, or a firm with 10,000 brokers would owe a cumulative $306 million. Here is his calculation for Federal and the state of California, where he has settled with two firms based on this method.

Federal Calculation Method California Calculation Method
Annual compensation/total hours work $153K/2400 = $63.75 per hour Annual compensation/2080 (or 40 hours per week × 52 weeks) $153K/2080 = $73.56 per hour
(Federal law requires overtime rate to $63.75/2=$31.87 1/2 an hour per hour overtime California law requires overtime equal half the hourly rate) rate to equal “time × one-half,” or $73.56 × 1.5 = $110.34 an hour per hour of overtime
Rate of overtime × annual overtime hours × statute of limitations (2, 3 if willful) $31.87 1/2 × 10 × 4 8 × 2 = $30,600 per broker for overtime back pay Rate of overtime × annual overtime hours × statute of limitations (4, in California) $110.34 × 10 × 48 × 4 = $211,852.80 per broker for overtime back pay
Assuming the major wire house employs 10,000 brokers: Assuming the firm employs 1,600 brokers in California:
$30,600 × 10,000 = $306,000,000 in damages $211,852.80 × 1,600 = $338,964,480 in damages
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