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The Legal Risks of Failing to Disclose Up-Front Bonuses

Advisors who take an up-front transition check without disclosing it to clients face potential legal and regulatory downside risks.

As the recruiting wars between independent broker/dealers intensify, firms in this space are offering ever-larger up-front recruiting bonuses to top-producing financial advisors to get them to jump firms. In certain cases, larger independent firms have been known to offer 100% or more of an advisor’s trailing 12-month revenues to attract their business.

For the advisors who get such an offer, adopting a “take the money and run” approach might seem attractive at first blush. But there are potential legal and regulatory downside risks.

Unfortunately, advisor transitions are not always in the best interests of clients, who could face higher fees and inferior service when their advisors make a switch to a different b/d platform.

And if an advisor transition results in clients feeling that their service experience or costs have negatively changed, what happens if they learn the shake-up was set in motion by their advisor being offered a large up-front check? 

That not only could put that relationship at risk, but it also increases the likelihood that lawsuits and arbitration hearings could be in the advisor's future. 

The Worst-Case Scenario

Admittedly, many clients are unlikely to pursue legal action over fee hikes alone. The attorney fees would far outweigh any sum they'd be trying to recover.

But those fee hikes could lead some clients to question whether they are getting real value out of the relationship.

And if other negatives come up in the transition, that would likely strain the relationship even further, perhaps prompting clients to scrutinize the recruiting bonus given to the advisor that brought about this move in the first place.

At that point, even if it doesn't quite make financial sense to mount a legal challenge, clients in such a situation could choose to do so out of spite. Crazier things have happened.

Weigh the Pros and Cons

There’s no law against taking up-front recruiting checks, nor should there be. Independent advisors who have built a strong business deserve to optimize the value they have created in multiple ways.

But it is incumbent on advisors being wooed with large up-front payments from firms to take a long, hard look at whether client service and fees will move decisively in a superior direction following a transition.

Advisors should decline any recruiting bonus—and stay where they are—if there is any reasonable uncertainty as to whether a transition would meaningfully hinder their clients' ability to reach their financial goals. To do anything else would potentially invite legal and regulatory troubles. 

Equally important, just because a client may face higher fees or experience a rocky transition doesn't necessarily mean they won't benefit from their advisor switching to a new b/d. And paying more for better service is a fact of life. Most clients are level-headed enough to accept that reality.

What they don't like is a surprise that speaks to hidden agendas and a lack of alignment on interests. That's why transparency is crucial. If client fees will increase, tell them. Be equally clear that the transition will almost certainly involve a few hiccups. Finally, be open and honest about any up-front recruiting bonuses.

This way, clients will be secure in the knowledge that they know all the pros and cons, which will quash what could otherwise be unpleasant shocks. Above all, it's a signal to all clients that their advisor is worthy of their trust. Trustworthy advisors tend to have loyal clients, which means attrition should be less of a concern.

Question Your Actions

Advisors mulling whether to accept a large bonus in exchange for moving to a new firm need to put themselves in their clients' shoes. Wouldn't they want to know all the factors that went into that decision?

There is a lot of lip service in our industry about building long-term, trusting relationships with clients. Hiding information from them is rarely in their best interests, if ever.

And if you feel you couldn’t justify the up-front check you are taking to switch firms, that might be a sign that you shouldn’t take the money and run.

Sander J. Ressler is founder and managing director of Essential Edge Compliance Outsourcing Services LLC, a Delray Beach, Fla.-based regulatory and compliance supervision consultancy.

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