Fight over promissory notes intensifies with Morgan Stanley's $5M clawback

Morgan Stanley is the latest wirehouse to recoup a big recruiting loan before a FINRA arbitration panel, clawing back more than $5 million from a former advisor.

Morgan Stanley won a nearly $5.2 million award on Friday from Federico Cardona, who left the Wall Street giant barely a year and a half after joining to go to the hybrid firm Stonecrest Partners in Puerto Rico in October 2022. The amount includes roughly $5 million owed on a promissory note, plus $30,634 in interest, $126,658 in attorney's fees and $3,000 in other fees. Cardona also owes nearly $700 in interest every day until the award is paid in full.

Promissory notes are one of many ways firms try to prevent wealth managers from leaving to go to work for rivals. The notes come in the form of loans made to advisors when they join a firm like Morgan Stanley. 

As long as they stay for a set amount of time — often seven to 10 years — the loan amount is forgiven. But if they leave earlier, their former employer can turn to FINRA arbitration to try to recoup at least part of the note.

Other firms

Disputes like the one between Morgan Stanley and Cardona have been common in recent months. Morgan Stanley clawed back nearly $650,000 in April from James Czerniak, who left the firm after six years in 2023 to join Osaic Wealth in Warrenville, Illinois.

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Wells Fargo has also been on a tear in recouping recruiting loans. Earlier this month, a three-member FINRA arbitration panel awarded Wells roughly $4.2 million from an unpaid promissory note issued to Joseph Siedler, who left after a stint of slightly more than a year to go to RBC Capital Markets in mid-2021. Just a few days before that, a FINRA arbitrator ordered Robert Boyer, who left Wells after six years, to pay back $1.1 million on three promissory notes. And in April, Wells secured a $734,000 award against Howard Okeefe Graham, who was discharged in July 2023 for "not receiving client authorization to place trades and exercised time and price discretion," according to FINRA's BrokerCheck database.

A Morgan Stanley spokesperson declined to comment on the firm's latest promissory notes case. A Wells Fargo spokesperson said, "Our strategy in these matters has not changed."

Elsewhere, JPMorgan is seeking to claw back roughly $92 million in promissory loans made to 16 advisors formerly employed at the failed regional bank First Republic. The advisors left JPMorgan around the time it bought First Republic out of government receivership in May last year.

Bigger deals, more aggressive clawbacks

Rick Rummage, an industry recruiter and the CEO of The Rummage Group, said the frequency of the cases is likely a reflection of how big recruiting deals have become in recent years. There was a time not long ago when firms were willing to avoid arbitration and litigation and try to reach settlements over outstanding promissory notes.

And that's still the case, Rummage said, for disputes over relatively small sums of money. But when the amount owed starts stretching into the millions, the amount a firm has to spend on legal expenses to recoup it begins to look pretty reasonable.

"And over the years, as they've gotten more aggressive and spent more on legal costs, they've tended to win more awards," Rummage said. "And they've finally learned it usually pays, especially if it's a bigger sum, to be more aggressive."

Rummage said advisors who are leaving one firm will often try to get their new employer to help them pay off any outstanding debts on promissory notes.

"The deals are so large nowadays, and there is a lot of capital riding on it," he said. "So the tide has shifted from advisors feeling like they can walk away without owing anything back to now knowing they have to pay it off."

Sharon Ash, the chief litigation counsel at Hamburger Law Firm, said the cases are reminders that advisors should pay attention to collection notices from their former firms. Wealth managers who are hit with large FINRA awards can either hand over the amount in full, try to negotiate a lower amount or declare bankruptcy or otherwise an inability to pay.

But those who simply refuse to pay could end up seeing FINRA pull their brokerage licenses.

"One way or another, they force the representative to take some action so the firm gets some form of relief or payment," Ash said.

Carrots and sticks

Promissory notes are just one among several legal carrots and sticks firms use in attempts to bind wealth managers to their jobs. Others include various types of noncompete and nonsolicitation clauses, which temporarily bar advisors from working for competitors or reaching out to former clients, and deferred compensation, which lets advisors collect a portion of their pay only if they stick around for a set period of time.

Almost all of these contract provisions have given rise to litigation in some form or another in recent years, while also attracting regulatory scrutiny. The Federal Trade Commission has approved an outright ban on noncompete clauses scheduled to take effect this summer, if it isn't first derailed by lawsuits. And Morgan Stanley and Merrill are both caught up in court and arbitration battles over whether their deferred compensation policies violate federal retirement law. 

The heightened scrutiny of these methods hasn't stopped firms from relying on them. If anything, pressure to recruit and retain top advisory teams is likely to make firms only more litigious as time goes on.

Short timer

In Morgan Stanley's most recent case involving promissory notes, a deciding factor was likely the relatively small amount of time Cardona spent at the firm before moving on. Cardona, who couldn't be reached for this article, was at Morgan Stanley from March 2021 to October 2022 after an eight-year run at Merrill.

Rummage said that even if an advisor like Cardona gets a generous recruiting deal at a new firm, most of the money may be needed to pay off an old promissory note. Unfortunately, he said, a lot of advisors find other uses for their sign-on cash before learning they have outstanding obligations to a former employer.

"Where they get themselves into trouble is when they spend the money," Rummage said. "They buy a second home or pay their mortgage, and now the money is gone."