Broker-Dealer Breaches Contract With Investment Firm

    stock chartThis case takes place in Wisconsin and involves the loss of commissions due to an indirect purchase of a small independent broker. The plaintiff is a capital market investment firm that deals primarily with public school districts, offering public employee pensions and deferred services. They also provide teachers with access to mutual funds and earn a percentage in overrides or commissions. Since the plaintiff was not a broker-dealer they were required to work through another entity, paying them approximately 5% of gross dealer commissions. Another entity purchased this broker-dealer and displaced the plaintiff in receiving overrides. This entity was not a broker-dealer and was given a loan by the defendant of approximately $7 million. The defendant is one of the largest independent brokers and they offered loan forgiveness if the cash flow of the lendee hit a certain target. The plaintiff alleges that the defendant forced the plaintiff out of the prearranged deal and captured their override.


    Question(s) For Expert Witness

    • 1. Can you explain the structure of a broker dealer's relationship to registered representatives and the value of commissions and overrides to the broker?
    • 2. What is standard procedure when switching broker-dealers under FINRA?
    • 3. Can you explain the reasoning behind a large independent brokerage firm willing to lend $7 million which is forgivable?

    Expert Witness Response

    The broker-dealer license and its obligations are specific to the entity. Change of ownership does not impact the broker-dealer’s obligations. The broker-dealer, by regulations, can only pay registered staff and entities. However, its contractual obligations fall under common law and the law of contracts with the exception that any provision that violates the SEC Act of 1934 will be deemed unenforceable. Under Rule 1014, any ownership change must be approved by FINRA. Any change in the firm’s membership agreement must comply with FINRA Rule 1017. It is not an uncommon event for a brokerage firm to lend a large forgivable amount, and the reasoning depends upon the treatment of the loan for regulatory capital purpose. Based upon the time of the loan, the rules have changed to make any loan deemed to be forgiven to be treated as a capital infusion, which will trigger the provisions of Rule 1014.

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