Why RIAs who left deferred comp on the table back at the wirehouse may yet make a claim for what might be, rightfully, their money
Clauses written by lawyers under duress of wide-ranging defections may have over-reached, creating an opportunity to challenge in court.
Brooke's Note: Haste makes waste. If you leave a wirehouse without preparation, you're likely to end up on the wrong end of a lawsuit. But what if you're a wirehouse that crafts a retention scheme under duress as your staff brokers depart en masse in the wake of a financial crisis? This column by Jack Edwards Jr. suggests Merrill, Morgan, Wells and UBS may have made haste in a way that exposes them to legal disadvantage. His primer could be an eye opener for wirehouse brokers currently deterred from a breakaway by deferred comp concerns. Yet it may also be a windfall for existing RIAs who bit their tongue and walked away from compensatory treasure where they had more rights than they knew.
Wall Street firms have fought for years to keep brokers from leaving by deploying a variety of golden handcuffs and other restraints to cut attrition. Deferred compensation is a favorite of the Big Four wirehouses.
Although deferred compensation is not new, it became more prevalent and punitive after the 2008-2009 financial crisis, as firms sought to stem the exodus of advisors who wanted greener pastures and distance from big brokerages’ damaged reputations.
In theory, deferred comp is a simple matter. If a broker leaves for a new firm, they forfeit their unvested compensation awards.
But the law is not so clear and deferred compensation agreements may not be as iron-clad as brokerages claim.
Because wirehouse lawyers wrote many deferred compensation contracts with punitive strings attached, their legality comes into question.
With the exception of recent lawsuits against Wells Fargo and RBC, advisors have generally been reluctant to fight for the deferred money they may be owed.
In some cases, they may not pursue legal action because they are unaware of their legal rights. In other cases, fear of retribution, such as a counterclaim or an unjustified mark on their Form U5 may keep advisors from taking action.
Regardless, it raises questions: Are these tactics justified, and are these forfeitures legal?
Like so much else, the devil is in the details, but there are a few basic things to look for.
Advisors should first gather their plan documents, award documents and account statements. They should then look for provisions on vesting, forfeiture, and choice of law (state or ERISA).
Because this analysis can be complicated, you may want to contact an attorney who specializes in recovering deferred compensation.
There are two key questions to ask:
1. Is your plan a bonus plan or a pension plan?
Your plan is either a “pension” plan or a “bonus” plan. Pension plans are governed by ERISA; bonus plans are governed by state law. There is no bright line dividing these two types of plans. It is a gray area that depends on many variables, including how the plan is administered, the demographics of the plan and the vesting period. In general, the longer the vesting period, the more likely the plan is to be considered an ERISA pension plan, which may work to your advantage.
2. If your plan is a pension plan, is it a “top hat” plan?
There’s a big difference. A top hat plan is a special type of pension plan intended for executives and high-level employees. In Congress’s view, such employees are capable of protecting their own pension interests and do not need ERISA protections. Top hat plans must be “unfunded” and limited to a “select group” of management or highly compensated employees.
Usually, this does not include your typical rank-and-file advisor, and by law, participation in a top hat plan must be limited to 15% or 16% of a company’s total workforce.
If your plan is an ERISA top hat plan, then the forfeiture provision is likely valid because top hat plans are exempt from ERISA’s substantive provisions on accrual, vesting, and anti-forfeiture.
But some purported top hat plans include too many advisors or rank and file advisors with insufficient income—and thus do not qualify as top hat plans.
If yours does, and if it is an ERISA pension plan, then the forfeiture clause is likely invalid under ERISA, if you have the required minimum years of service. This means you may be able to recover money from your prior employer.
Beat goes on
For example, let’s say you are a 48-year-old advisor at a brokerage firm where you’ve worked for six years. You’ve earned awards of deferred compensation that vest 100% after eight years of employment.
Your compensation is mid-range, so you’re more of a rank-and-file advisor, and the plan is open to all advisors. Thus, the plan is likely not a top hat plan and you may be successful in recouping any monies withheld because you left prior to eight years on the job.
Top hat cases are fact-intensive and therefore tricky.
In two cases against RBC, plaintiffs alleged that RBC’s deferred-compensation plan was not a top hat plan because it included too many people.
Courts in both cases concluded that the plan was an ERISA pension plan, but did not rule on whether it qualified as a top hat plan. Each case settled for a confidential amount.
In a similar case against Wells Fargo, the court certified a class action and approved a precedent-setting $79 million settlement in 2020. (Full Disclosure: My firm handled that case.)
Despite the settlement, Wells Fargo says they have no plans to alter or remove the forfeiture clause in its deferred compensation plan. So, the beat goes on.
Bonus vs. pension
It is important to know if your plan qualifies as a pension plan but not a top hat plan, then the forfeiture of your deferred compensation may be invalid and you may be eligible to recover money.
Under ERISA, awards of deferred compensation fully vest after three years of service under a cliff-vesting schedule or partially vest 20% per year after two to six years of service under a graduated-vesting schedule.
If you have these minimum years of service, then your deferred compensation is partially, or fully, vested and cannot be forfeited.
In contrast, if your plan is not a pension plan, it is “bonus” plan.
Federal regulations exempt from ERISA coverage “bonuses for work performed,” unless such payments are “systematically deferred to the termination of covered employment or beyond, or so as to provide retirement income to employees.”
Bonus plans are therefore governed by state law and typically have a shorter vesting period than pension plans.
If your plan is a bonus plan, then the forfeiture of your deferred compensation may be illegal under your state’s law. To hard-working advisors, this is just not right.
Cases involving bonus plans have had mixed results. In Wakefield v. Wells Fargo & Co., plaintiffs sued Wells Fargo under California and North Dakota law. The case settled as a class action for $7.4 million.
In contrast, in Connell v. Wells Fargo & Co., plaintiffs sued Wells Fargo under Texas law, but the court enforced a North Carolina choice-of-law provision and dismissed plaintiffs’ claims. So, you see, these cases can go either way.
Often, these cases become class action lawsuits. Class members receive an amount of their respective forfeitures, depending on the date of their forfeitures and the number of years the class member worked for the firm.
The bottom line: Whether you have a case hinges on a variety of factors related to the type of compensation plan you are in and how the firm has administered it.
These plans may defer awards for too long, include too many advisors, or include advisors with insufficient income.
Or they may violate state law on restraints of trade. To determine whether the forfeiture of your deferred compensation was legal or whether monies that were rightfully yours were wrongfully withheld, you should consult with an attorney.
Jack Edwards is a commercial litigator with Ajamie LLP in Houston, Texas. He handles commercial disputes before state and federal courts, including antitrust, contracts, copyright, ERISA, fraud, insurance coverage, product liability, securities, trade secrets, toxic tort, and wrongful death cases.