COMPLY-Commission-sharing snafus can trip up U.S. brokers

Tue Nov 13, 2012 2:23pm EST

Nov 13 (Reuters) - Nuances and twists in commission sharing rules can turn into traps for securities brokers who, in an effort to boost their bottom lines, turn to the arrangements without paying close attention to fine-print restrictions, say industry lawyers.

Commission sharing is widespread and generally allowed. The practice could gain even more traction as a generation of aging brokers recruit junior partners to, ev entually, take over their practice. Those sharing arrangements can vary from as little as 10-percent of total commissions for a junior partner, to a 50-50 split for commissions from new clients, say recruiters.

Such agreements are also a good workaround for advisory teams that, say, include someone who excels at bringing in accounts - a rainmaker - but who is not skilled at day-to-day money management, said Danny Sarch, founder of Leitner Sarch Consultants Ltd, a wealth management recruiting firm in White Plains, New York.

But among the potential problems that nuanced industry rules can lead to: brokers aren't allowed to profit from securities they aren't licensed to sell.

Brokers and teams that share commissions must be licensed to sell the same products through the Financial Industry Regulatory Authority (FINRA), Wall Street's industry-funded watchdog. But commission sharing is not allowed, for example, on a team in which one broker is licensed to sell only mutual funds and the other only to sell stocks and bonds.

While improper commission sharing does not appear to be widespread, according to Ivan Knauer, a lawyer for Pepper Hamilton LLP in Washington, who represents brokerages and brokers, he said it is not surprising when problems do crop up.

"Some people can cross the line inadvertently," Knauer said.

Brokerages typically have compliance procedures in place to prevent brokers who aren't licensed to sell the same things from entering sharing agreements, but mishaps can occur amid mounds of paperwork and thousands of brokers.

Issues can also crop up when all brokers on a team are not all licensed in the same states, said Benette Zivley, a lawyer at Munsch Hardt Kopf & Harr, P.C. in Austin, Texas.

If, say, four brokers on a team are licensed to sell securities in Texas, but only one is licensed in another state where a client places an order, state regulators could raise questions as to whether the three other brokers may legally share in the transaction proceeds, said Zivley, who is also a former Texas Securities Commissioner.

The answer, he said, would vary by state. Some state regulators may take an aggressive approach by restricting commission-sharing to only brokers licensed in their states, Zivley said.

CROSSING THE LINE

There are other obvious commission-sharing prohibitions that are more difficult to track. Among them: giving kickbacks to barred individuals who continue to work with clients in an unofficial capacity - such as an independent, unregistered adviser - and rely on former colleagues to process their trades.

Those helpful colleagues can suffer the same fate - being barred from the industry. Commissions at large brokerages typically go into the firm's account first, before being paid out to brokers - a roadblock to improper sharing. B ut some brokers, nonetheless, still find ways to take the risk, often to earn extra cash.

In early November, Ryan P. Miller was barred. He allegedly transferred about $300,000 to a barred individual between 2007 and 2010, according to a settlement between Miller and FINRA. Miller, during most of that time, was a broker for Securities America Inc, which fired him in 2010 for a previous "unauthorized affiliation" with the barred person.

A spokeswoman for Nebraska-based Securities America declined to comment. Efforts to locate Miller were unsuccessful. Miller did not admit nor deny FINRA's findings.

Such schemes probably occur "more than any firm would like but not as much as some cynics may think," said one brokerage executive who is not authorized to speak to the press. "The risk of getting caught just simply outweighs the potential benefit."

A sales assistant who was barred in March earned $4,000 from a commission-sharing infraction after paying $65,000 to his former boss, for instance, according to regulatory documents. A sales assistant starting out at a small brokerage doesn't take home a big paycheck, making such a proposition more tempting.

Monitoring for such activity is difficult for brokerages, which would, for starters, need to analyze brokers' bank statements to even begin to spot a potential problem. Even then, pinning down misconduct can be difficult, especially if a broker pays the outside person in cash. One reason the sales assistant who blew his career over $4,000 was caught: he made payments by check to a company set up by his former boss.