How to deal with adviser clawback debt

Adviser commission clawback debt is not something many brokerages like to talk about, but it is something that most have to deal with on a fairly regular basis.

Clawback debt arises when an adviser writes a policy or a loan, receives commission, but the client either cancels or pays the debt off early. The commission is then clawed back from the brokerage, which will usually recover it from the adviser – but if this process isn’t properly handled, it can lead to complex and drawn-out debt recovery cases in court, and thousands of dollars’ worth of debt for small businesses.

Though the figure will vary from brokerage to brokerage, Crestone Compliance co-founder Charles Laing estimates that approximately 10-15% of deals are clawed back per year. Having seen a number of tricky cases through court, he says there are ten key steps that can really help a brokerage avoid writing off adviser clawback debt.

“It’s fairly common for a few clawbacks to come through after an adviser leaves a business,” Laing told NZ Adviser.

“Most brokerages deal with this by deducting something like 10% from each adviser’s commission. Then if they leave and some clawbacks come through, the brokerage can use that fund to pay for it.”

“But it does happen that there will be more clawbacks than that fund can pay for, and some brokerages can be a bit hot-headed in collecting that debt,” Laing explained. “We have taken some tricky cases through the courts, and so off the back of that we’ve come up with the following tips for adviser businesses, especially those who engage other advisers as part of their operations.”

Charles Laing and co-founder Andrew Wilkinson’s tips to avoid writing off adviser clawback debt are as follows:

1. Always have a copy of the signed adviser agreement on file
   This is a crucial basic first step that will set out the brokerages expectations and processes upfront.

2. Have a clause in the adviser agreement which states that the adviser must repay commission if the insurance provider makes a clawback claim on the brokerage
   This step is always important. Laing says Crestone Compliance has handled cases where there was no agreement, however the judge ruled that there is always an implicit clawback clause, regardless of whether or not it is explicitly stated in the contract. This step is a way of ensuring that everyone is on the same page from the start, and that there is a set period of time where the clawback debt can follow the adviser.

3. Make sure debt recovery costs and interest can be added to the debt if it is not settled immediately
   This is a way of helping cases to settle quickly, and ensuring that the brokerage suffers no financial losses as a result of recovering its debt.

4. Ensure the clawback clause survives termination of the adviser agreement
   This prevents advisers from leaving a brokerage after having written bad business which isn’t likely to last, and allows brokerages to recover debts for a period of time after advisers have left their company. Laing says taking this step makes it clear to advisers that clawbacks will follow them, regardless of whether or not they leave the brokerage.

5. If the brokerage puts aside commission for clawback risk, make sure the adviser agreement makes it clear when it will be used and/or returned
   If a brokerage deducts a percentage of commission for a clawback fund, this makes it clear to the adviser what this deduction is being used for. It also makes it clear that if there is no clawback risk after two years, the balance of the fund will be returned to them.

6. If the adviser agreement is with a company rather than the adviser as an individual, make sure that company is incorporated before executing the contract
   Laing says that brokerages will often sign their adviser agreement with a company, as a business-to-business contract. However, this can become a problem if a debt-related case goes to court and the adviser’s company isn’t incorporated.

7. Have both parties initial each page
   A minor detail, but nonetheless important in expediting lengthy court cases.

8. Keep good records of how much the adviser is paid for each deal
   Again, solid record keeping can vastly speed up the process of a long court case, and also makes it clear that you are only after the amount that the adviser was paid for the clawed back deal.

9. Consider having the adviser sign a personal guarantee granting the brokerage a general security interest
   This may be a good idea because adviser commission is almost like a loan. Laing says he’s seen some brokerages employ advisers who deliberately wrote bad deals with friends and family, and once those policies were cancelled, the brokerage had to pay back all of that commission. One small business ended up $30,000 in debt following the departure of two advisers, and this is where having a security interest can come in useful.

10. If all else fails, as long as the brokerage can prove the following, they should have a good case:

• The provider paid the brokerage
• The adviser was paid
• The provider has clawed back the commission

Andrew Wilkinson says these tips should be especially useful to small-to-medium sized brokerages, which are more likely to come up against cash hurdles.

 “Clawback debt is potentially less of a problem for the larger brokerages because a lot of the time, it’s a cash flow issue,” Wilkinson said.

“Smaller businesses are typically more  impacted by those cash flow issues than larger businesses – and that’s not limited to financial services. If you’ve suddenly got tens of thousands of dollars that you have to outlay and you weren’t expecting it, that’ll be a bigger problem if there are only four or five people in the business.

“Clawback debt can pose a problem for the larger brokerages too, but the smaller businesses are the ones who will really feel the effects of this kind of debt,” he concluded. “That’s why having all of these procedures in place can be really useful.”