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California DFPI Securities Regulator Censures Morgan Stanley for Acting as Unlicensed Lender

By George C. Miller, Partner of Shustak Reynolds & Partners, P.C. posted on Thursday, June 15, 2023.

George C. Miller

George C. Miller


Location: San Diego, California
Phone: (619) 696-9500 (Ext. 105)
Direct: (619) 501-8270
Email[email protected]

The California Department of Financial Protection and Innovation (“DFPI”) has censured a subsidiary entity of Morgan Stanley, Morgan Stanley Smith Barney FA Notes Holdings, LLC (“MSSBFA”) and issued a $1 million fine for acting as an unlicensed, unregistered lender within the State of California. According to the DFPI’s October 2020 consent order, the regulator concluded MSSBFA made loans to certain Morgan Stanley employees as part of a comprehensive employee benefit program primarily to recruit and retain those employees. Morgan Stanley would then seek to collect the alleged unpaid balance due on those notes if the advisor left the firm before the loans had been fully forgiven or repaid. As a result, the DFPI found that MSSBFA had “engaged in the business of a finance lender without obtaining a license from the Commissioner and without an applicable exemption from the CFL in violation of Financial Code section 22100….”

Broker-dealers have long used large, up-front recruitment bonuses as a recruiting incentive. Those loans are usually tied to promissory notes scheduled to be forgiven, or repaid with additional bonus monies, over 7-10 years. Years ago, Merrill Lynch, Morgan Stanley, UBS, and other large broker-dealers announced sweeping changes to their compensation policies, including a move away from the large, up-front recruiting “transition” bonuses that dominated the industry. Those “bonuses,” often paid in the form of forgivable promissory notes with back- and front-end payouts regularly exceeding 300% of the advisors’ trailing-12 revenue, resulted in firms holding billions of dollars in outstanding loans on their balance sheets. Litigation over promissory note payouts was common, as firms sought to collect the alleged outstanding balance due in the event an advisor left the firm. The change also came as firms prepared for the rollout of the Department of Labor’s (DOL) fiduciary rule, which would have required financial firms and their representatives only to act in the best interests of their clients and limit certain transaction-based compensation. DOL guidance suggested that up-front bonuses, which historically were tied to revenue production hurdles, could run afoul of the rule. Both the proposed DOL rule, and a desire to reduce their carried debt and related promissory note litigation, contributed to the change.

But sooner or later, everything old becomes new again. In 2017, as these changes were announced, we predicted that high-dollar recruiting bonuses were likely to return. And by 2019, concerns over the DOL rule had waned due to changes to the rule and delays in its implementation. As advisor transition activity continued—indeed, during the pandemic, accelerated quickly—competition for the same pool of experienced advisors and their valuable client assets increased.

By mid-2020, with that increased competition, firms turned back to a familiar tool—up-front recruiting bonuses—to entice stable, top-producing financial advisors to consider a move from one firm to another. While some firms—notably UBS—are focusing less on up-front money and instead offering recruits increased payouts or a guaranteed income over a period of time—most firms, including Morgan Stanley and Wells Fargo, have resumed offering substantial transition packages to recruits—sometimes in excess of 320% of the advisor’s trailing-12 month revenue production.

This time around, the big boys of Wall Street are not alone. Once reticent to jump into the up-front bonus game, or at least to the same extent as Wall Street, both independent broker-dealers and regional firms have dramatically increased their recruitment spending. Ameriprise, Stifel, Wedbush, Kestra, Avantax and others also have reportedly increased the amount offered to entice experienced advisors to move. If history serves as a guide, increased litigation involving up-front transition bonuses is likely to follow the surge in recruitment activity and outstanding promissory notes—at least until what’s new once again becomes old, and the retail securities industry moves away from the up-front bonus recruiting model once again. 

Shustak Reynolds & Partners, P.C.’s experienced California FINRA, securities and financial services lawyers are well versed in the financial services industry.
We routinely represent brokerage firms, registered representatives, registered investment advisory firms (RIAs) and others employed in the securities and financial services industry in transition disputes, employment and trade secret litigation, and other FINRA arbitration and securities disputes.
Attorney George C. Miller can be reached in the firm’s San Diego office at (619) 696-9500.



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