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Nov 12, 2010 3:32 pm

Nov 11, 2010 7:05 PM, By Kristen French

</p> <!--begin paragraph--><p>New

rules governing broker recruiting bonuses? The idea, floated by Mary
Schapiro at the SIFMA annual conference in New York on Monday, met with
skepticism this week from securities industry attorneys, compensation
experts and recruiters.

Schapiro told Charlie Rose in an
interview during the SIFMA conference that the regulator is planning to
write rules in the next few months that reign in compensation programs.
Schapiro said she doesn’t like incentive pay that encourages
individuals to take short-term risks at the expense of the long-term
stability of the franchise and at the expense of investors—among other
things, she mentioned the “big upfront bonuses” paid to “brokers who
deal with retail customers.”

But this would be a very slippery
and difficult issue to regulate, said industry insiders, because
incentives are built into almost every broker compensation program,
including typical payout grids and retention agreements. Where would
the SEC draw the line?

“How far do you go?” asks attorney
Michael Taaffe, with Shumaker, Loop & Kendrick in Sarasota, Fla.
“Some brokers get greater compensation for certain kinds of products, A
shares, B Shares, all that stuff. They could consider telling clients,
‘Your broker is being compensated for the transition of your account,’
but they’d have to send a similar notice if accounts stayed at the
former firm, because sometimes brokers are compensated for taking
departing brokers’ accounts,” he said. “Sometimes they also offer
fee-waivers to clients who stay in place. Is that fair to all the other
clients who aren’t getting free service and have their accounts there?”

Regulators are most concerned that the bonuses, which are as
high as 300 percent of trailing 12-months production in some cases,
provide outsized incentives for brokers to try to reach certain
production goals by churning client accounts—whether that’s the $1
million in 12-month production required to get certain deals or the
production growth hurdles a broker needs to meet to get additional
bonus money on the back end.

I think the SEC might be worried
about someone who moves, only brings half of their clients, and then
tries to quadruple the sales numbers to hit growth goals by selling
them a bunch of new products,” said Andy Tasnady, CEO of compensation
consultant Tasnady & Associates. “I’m more worried about people at
existing firms churning,” he said.

Further, the guys who move
for the big checks are not the ones who are a big churning risk, he
said. “The advisors that are getting the largest offers are advisors
that are fee-based, have average or below revenue to asset ratios. Now
they want long-term successful people because they’re going to keep
them around for 9 years or more, guys who will continue to grow. And
you don’t do that by short-term jerking your clients around for 3
months.” Firms already monitor advisors that have high revenue to asset
ratios, exceeding 2 or 3 percent, he said. There just aren’t that many
guys left who have, say, $50 million in assets and $1 million in
revenues, he explained. “If someone is a risk for churning, then
they’re probably already churning. The sales deal might heighten the
opportunity, but not that much.”

Brian Hamburger, a securities
industry attorney with Hamburger Law, said he doesn’t expect any
regulatory action at all on broker pay in spite of Schapiro’s comments
Monday. “The betting men will tell you, nothing at all [will happen],”
he said. “There are so many challenges out there and this is an issue
they haven’t been able to tackle in the past.”

publications have made reference to a memo New York law firm Ropes
& Gray sent to clients in July on the subject of compensation rules
for broker/dealer firms, as evidence that rules on broker pay are
imminent. The memo,
which analyzes the impact of Dodd-Frank legislation on broker/dealers
and other firms and has been available on the firm’s website since the
summer, says only that regulators will write rules by April 21 that
“prohibit any type of incentive-based payment arrangement” that could
“lead to a material financial loss to the institution.” No mention is
made of broker bonuses, which are not generally thought to have the
potential to lead to a “material financial loss” to a brokerage firm.
Regulators are worried about the impact of broker bonuses on investors’
pocketbooks, not those of firms.

Disclose It

course, new rules could be in the cards. The SEC declined to talk
further about Schapiro’s comments, and FINRA also declined to address
them. But attorneys and compensation consultants said regulators would
be highly unlikely to prohibit the bonuses all together. Instead, they
might require firms and brokers to disclose the upfront bonuses to
clients, or to base the rewards on assets instead of sales numbers. Or
they might require heightened supervision of brokers who are on big
recruiting deals.

Brian Hamburger, an attorney with Hamburger
law firm in New Jersey, said that if the SEC does in fact, write new
rules, disclosure is the most likely option. “We’ve gotten away from
regulators imposing specific types of compensation,” said Hamburger.
“The trend has been to increase transparency with disclosures about
those compensation practices. I suspect that’s going to continue.”

Disclosures about upfront bonuses could fit within the new broker/dealer ADV type disclosure form
that was recently proposed by Finra, he said. “FINRA themselves have
tipped their hands that they may be willing to disclose their executive
compensation,” said Hamburger. “I suspect they are making this move in
anticipation of calling upon the industry to do the same thing.”

Sarch, a recruiter with Leitner Sarch Consultants said he thinks
disclosure is the most likely option, as well.“I’ve been saying for a
while that full disclosure about the deals is going to be mandated,”
said Sarch. “A broker is going to be required to tell his or her
client, look I’m getting this inducement and this is the reason why.”
In fact, he thinks it could be a good thing for brokers, because branch
managers at the former firm often tell a broker’s clients that he is
getting a big bonus to go to another firm, in an effort to convince the
client not to follow him. “I’ve been recommending this to brokers for

Greater disclosure could also provide firms with legal
protection in the event that a new recruit does behave badly, said

Old School

The idea of
regulating upfront bonuses is not a new issue. Back in August, Schapiro
sent a warning to brokerage firm executives, asking them to watch for
sales practice problems caused by the “large upfront bonuses and
enhanced commissions” that firms are giving to new recruits.

bonus numbers have surged to over 300 percent as recruiting competition
intensified following the financial crisis. But they have been climbing
steadily for years, even as the amount of time required to cash in on
the full deal has risen to nine years. Most recently, Merrill extended
its own deal to 14 years.

in 1995, when recruiting bonuses maxed out at 60 percent, the Tully
Commission was convened to study broker compensation practices. At the
time, it issued a report that recommended eliminating upfront bonuses,
or paying them over several years to encourage longer tenure by
registered reps, and eliminating accelerated payouts—higher payouts
paid to new recruits during the first 6 months or year after they have
joined a firm. As a result of that report and investigation, firms
stopped offering recruits accelerated payouts and began building
deferrals into these recruiting bonus contracts, extending paymen