July 26, 2002

To Err is Human, To Forgive Divine

By Bill Singer

Bill Singer is a partner with the broker-dealer law firm of Gusrae, Kaplan & Bruno, PLLC  and may be contacted at  917-520-2836 or by e-mail at bsinger@rrbdlaw.com .  He expresses special thanks to his partner David Gehn, Esq. for his thoughtful contributions to this article.

In recent months, a number of RRs have called me for legal advice about employee forgivable loans (EFL). For example, BDs may offer you a $100,000 EFL that is 20% forgivable on each employment anniversary for a period of five years.  From the BD’s perspective, EFLs serve two functions: 1) induce prospects to join the firm; and 2) convince unhappy employees to complete their employment term in order to avoid repayment of any unearned balances.   

The headhunter and all the senior people who interviewed you stressed that BD2 was reputable, reliable, and a paragon of virtue.  Hell, the marketing and recruiting materials say it in black and white.  In retrospect, you weren’t really dissatisfied with BD1; you had built a sound book, developed excellent client relations, and were on track for management - - - but this was the golden opportunity.  Join us! We’re bigger . . . more opportunities . . . more earning power .. .we’ve got the best research department on the Street . . . we cover everything . . .sterling reputation --- and we’ll give you a $100,000 five-year EFL to boot! 

So, you signed on the dotted line and happily took the $100,000.  To be honest, you never really considered it a loan - - - no, you thought of it as a bonus. I mean they were going to have to dynamite you out of this place. Your career was made.  Then came the shock. The research wasn’t exactly pristine. The analysts weren’t acting on the up-and-up.  Worse,everyday there’s another disturbing and embarrassing revelation in the press. You look at your once promising client book and it’s devastated. Customers are leaving in droves. BD2’s once golden name now gets the phone slammed down, rather than serves as an entrée to opening new accounts. None of this is your fault. They lied to the public and to you. Would you have left BD1 had all this been disclosed? 

Unfortunately, you’ve already been called into the boss’ office. Get your numbers up or you’re fired.  Some of you have already been terminated and now, to add insult to injury, they want you to repay the last three years of the $100,000 EFL. Where am I going to come up with $60,000, you nervously wonder.  Your wife is home with the kids and she lost her job last year.  You’re hardly covering the mortgage. 

It’s in times such as these that the guys in your firm’s credit department step into the moonlight and become ravenous werewolves.  You get the demand letter. Sure, they’re willing to give you some reduction if you make full payment.  They’ll take $48,000 rather than $60,000; and if they’re being particularly charitable, they may even agree to take $50,000 over 12 months (but they want a promissory note with a confession of judgment).  If you don’t agree or can’t come up with the cash, the next step is a collection agency or an attorney who files an arbitration complaint.   

Arbitration Panels are inclined to honor  EFL agreements and require repayment.  Somewhere out there is an attorney who will preliminarily explain the standard defenses that you will raise against full payment.  However, he then tells you about an interesting defense . . . he thinks you may have been fraudulently induced into employment with the major firm --- even fraudulently induced into entering into the EFL agreement.  He suggests that this defense should be valid if you can prove that the BDused deceit or trickery as to essential facts upon which you based your employment decision in order to cause you to act to your disadvantage, such as in leaving your former employer, signing an employment agreement, or accepting an EFL. 

The lawyer makes many convincing arguments about his idea to use the fraud in the inducement defense.  But you wonder.  Ultimately, it sounds as if he's making a big deal about honesty and integrity.  You're just not sure if those two virtues have much meaning on Wall Street anymore.  The lawyer then shows you a copy of the NASD's Rules of Conduct which says:

2110. Standards of Commercial Honor and Principles of Trade

A member, in the conduct of his business, shall observe high standards of commercial honor and just and equitable principles of trade.

 

Intrigued by the free, initial consultation with this personable attorney, you come home that night and surf the Internet. You’re curious as to what types of representations major firms routinely make to consumers and job candidates.  Do they stress their honesty?  Do they claim to be trustworthy and professional?  Do they state that integrity really matters?  Do they refer to demanding professional standards? Do they point with pride to their highly-regarded research?    As you click through various websites,you come to Merrill Lynch’s  and find a press release in which the firm states  

We believe strongly in the integrity of our Research . . .The e-mails that have come to light are very distressing and disappointing to us. They fall far short of our professional standards, and some are inconsistent with our policies. We regret that, and we further regret that the perception of our Research integrity has clearly been affected . . We have failed to live up to the high standards that are our tradition,and I want to take this opportunity to publicly apologize to our clients, our shareholders and our employees. [i]    

You begin to understand your lawyer’s point.  Merril admits that they "failed to live up to the[ir] high standards . . ."  Wow, that's pretty damning, you think. You remember during your interviews with your employer, BD2, that they made a major point about their pristine research as something that set them apart from the pack.  That emphasis meant a lot to you because BD1’s research capacity was a bit limited and not nationally known. BD2’s recruiter reminded you about how many times their famous analysts were on television.  

Intrigued by what you're finding,you then log on to Smith Barney’s website and find a statement in which they note that “Our firm is distinguished by its strong work ethic and its commitment to building relationships based on trust and professionalism.”[ii] . You then note a recent newspaper article about the growing Worldcom scandal and "Embattled Salomon Smith Barney telecom analyst Jack Grubman."  You wonder what it would mean if it's determined that SSB and Grubman knew or should have known the ramifications of their actions.  

Now it dawns on you, yes, the lawyer was right, BD2 gave you similar brochures and also told you about the importance of trust, professionalism, and integrity. Your curiosity having been piqued, you continue to surf through the website of other leading BDs and find the same promotional materials.  Interesting. Public investors are crying foul and suing for their losses because they were deceived by dishonest research.  State and federal prosecutors are investigating criminal allegations.  Many of your once loyal clients are blaming you --- maybe even suing you.  And your BD wants you to repay the balance of the EFL? Now you feel victimized and cheated. They sold you a bill of goods when they recruited you.  They didn't tell you the truth during the interviews. Food for thought?