Six Broker-Dealer Red Flags

April, 2011
by Jonathan Henschen, CFS and featured in Advisorbiz.com:

Five years ago the due diligence conducted on reps looking to join a broker dealer was more lax than what you see today. Pre-hire screening by broker dealers is more rigorous–even when it’s just for the privilege of a home office visit. When you decide you want to join a firm, the background checks are much more in-depth and detailed. As Bob Dylan would say, “The times they are a changing” Here are six red flags to consider when thinking about changing broker dealer:

1. Frequent broker dealer change history – It’s one thing to have your firm sold out from under you or closed down. However, for those reps who stay at firms for one or two years and then move on to another firm on a repeated basis, you are likely to be rejected by top tier firms. And, even lesser firms are steering clear of job hoppers. If you can stay put for three to four years at a firm, that longevity is likely to enhance your appeal to a new firm.
2. Poor Credit – Five years ago it was rare that a broker dealer checked your credit score. Today, it is commonplace. In fact, if your score with any of the three credit rating agencies is under 600, you are likely to be rejected by upper tier firms. You’ll be able to find a home at lesser tier firms if you have enough production: $100,000 or more is a typical level that makes it worthwhile for the firm.
3. Bankruptcy – Outside businesses closing, medical expenses and divorce are legitimate reasons for a representative declaring bankruptcy in the eyes of most firms today. If you mismanaged your finances and/or have open, unresolved tax liens, finding a broker dealer willing to bring you on can be very difficult. Best advice is to pay off tax liens before considering a switch.
4. Multiple Compliance Marks – If your compliance history shows one or two customer complaints where fines were paid, you still have numerous choices in broker dealers. If you get to three marks that have occurred within the last five years, it gets much more difficult to find a firm that is willing to hire you. It’s at this magic number of three that the new broker dealer will, in most cases, be required to have you under special supervision for a period of six months to a year or more. The added administration required for broker dealers to do special supervision can be burdensome to the point that few firms are willing to bother with it. If you look at broker dealers based in your home state, the likelihood of a firm willing to do special supervision will improve greatly since your close proximity reduces their costs related to the extra supervision. Compliance marks for forging signatures, terminations for serious infractions, multiple compliance complaints that show a repeating pattern and criminal histories are death knells at most firms unless you have substantial production to offset the risk. Even then, your chances of acceptance are shaky.
5. Open Arbitration – If you have an open arbitration, ideally you should play through it with your current firm, which is more likely to help you through it in a positive manner while you are with them, than if you were to leave and join a new firm. If you have been terminated with an open arbitration, realize that your choices will be few. Still, you will have choices, especially if you have high production. The new broker dealer’s primary concern will be to ensure it has a wall of liability protection between itself and the liability your arbitration case presents. A real-time example is the many reps today who have open arbitrations from the fraudulent alternative investments Provident Royalties and Medical Capital. Typically, these cases would be handled by your old firm. But what happens when your old firm goes bankrupt and closes? It’s likely that securities attorneys will try to recover the money by going after your new firm. If the new firm had selling agreements with these problematic products, they very well may be on the hook for paying off the arbitration. Problematic Alternative Investments have made broker dealers extremely cautious of bringing on reps with legacy alternative products that have the potential for future arbitrations.
6. Trust Level – Trust is the most significant issue for broker dealers when talking to prospective reps. When you are forthright and upfront about things you’ve done wrong, a foundation of trust is established. When you don’t disclose everything to compliance, tell a different story from what is on your compliance record or minimize what you’ve done, you can be assured you’re burning your relationship bridge with that firm as the trust level evaporates.

One broker dealer president I know recently shared a story of a rep that the firm brought on who had a compliance mark for forging a signature. For this firm, a compliance mark for forging a signature would usually have signaled a definite “no” for consideration. However, in this particular case they made an exception. When asked about the mark for forgery, the rep responded, “Oh, you mean the mark for the most stupid thing I ever did in my life?” The rep was extremely upfront and had such a high level of regret that the firm discussed the matter and made an exception to its usual policy, accepting the rep to join. Being honest and forthright is always the best path when a checkered past is in the picture.

If you’re looking to change broker dealers, do yourself a favor: clean up the problems that you can and be upfront about those you cannot. This approach is the best way to enhance your appeal to a firm as it considers bringing you onboard.