Up-front bonus cases are probably the most arbitrated cases between stockbrokers and brokerage firms in FINRA Arbitration.

To recruit stockbrokers and their book of business, brokerage firms provide employee forgivable loans (“EFLs”).  The terms of the note usually provide that if the broker’s employment is terminated, whether voluntary or not, within a certain period the remaining balance of the loan must be returned to the firm.

For example, a broker receives $1,000,000 five-year forgivable note as a condition to coming to the new firm.  The company gives the entire $1,000,000 to the broker at the start of employment.  Each year of employment with the firm one-fifth of the note is forgiven as being “earned.”  By the end of year two, the broker made $400,000 and has a $600,000 balance remaining on the note.  If the broker leaves the firm after year three, according to the agreement, the broker would owe the firm $400,000 since he or she earned $200,000 (1/5 of the EFL) each of the three years.

Prudence dictates the broker escrow the entire proceeds of the loan and withdraws the pro rata amount as fees earned at the end of each year.  The reality is brokers rarely do this and instead spend the loan proceeds either investing in his or her business or for personal use.  The brokerage firm initiates FINRA Arbitration against the broker to collect the unearned loan amount.  Most promissory note contracts have a condition granting attorney fees to the prevailing party.

As a defense to the arbitration, the broker will counterclaim against the brokerage firm for untenable working conditions which forced him or her to quit the company.  If this defense has merit, it could reduce or eliminate the amount owed on the outstanding note.  Examples of counterclaims are defamation, discrimination, material misrepresentation, intentional infliction of emotional distress and constructive discharge.

Obviously, the more documentation and corroboration the broker has to substantiate his or her counterclaim, the better.  Contemporaneous notes, correspondence, witnesses, employee handbook, and policies may all help prove the counterclaim.

Many times a counterclaim is leverage to increase the chance of settlement.  If the broker loses the arbitration and is ordered to repay not only the balance on the note but also attorneys’ fees, it can force him or her into bankruptcy. Therefore it is crucial to consult with experienced attorneys.

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