Morgan Stanley Appeals Panel Chilly to Undoing Deferred Pay Rule

An attorney for Morgan Stanley on Tuesday encountered a Second Circuit panel that seemed unwilling to disturb an opinion in a case by former financial advisers who say they’ve wrongly forfeited compensation.

The judges uniformly challenged Morgan Stanley’s bid to undo language in a district court opinion sending the dispute to arbitration at the bank’s request. Morgan Stanley says the decision improperly resolved the merits of the parties’ dispute—whether the compensation program is subject to federal benefits law—instead of leaving that question for the arbitrator.

Judge Gerard E. Lynch said Morgan Stanley may actually be seeking a “boost in arbitration” that the appeals court was powerless to provide.

“You can’t appeal a case where you won just because you don’t like the reasoning that the district court gave,” Lynch said. “There’s no appellate jurisdiction over this at all.”

Morgan Stanley’s attorney, Meaghan VerGow of O’Melveny & Myers LLP, said that the district judge’s determination that the relevant compensation plan is subject to federal benefits law is tantamount to a “judge’s thumb on the scale,” which can be “incredibly influential in arbitration,” she said.

Pay Battle

The lawsuit, filed by former Morgan Stanley financial adviser Matthew Shafer and others, says the company requires advisers to contribute a portion of the revenue they earn from client investments to two deferred compensation plans that distribute benefits when the advisers retire, become disabled, are laid off, or leave to work for the government.

The plans also include a “cancellation rule,” which causes advisers to forfeit money earned within a certain time period—between four and eight years—of when they leave the company to work for a competitor or change careers, according to the lawsuit. Shafer, who says he lost out on more than $500,000 under this rule, says it violates Employee Retirement Income Security Act provisions governing the rate at which retirement benefits vest over time.

A New York federal judge granted Morgan Stanley’s request to send the dispute to arbitration in 2023, adding that the company’s plan is subject to ERISA because it provides payments based on the revenue generated by the advisers and allows those payments to be deferred past termination of employment in some instances. Morgan Stanley objects to the latter analysis, saying it improperly decided the dispute’s central question in favor of the advisers instead of allowing the issue to be resolved through arbitration.

Unfixable Problem

Morgan Stanley will have the same problem in arbitration regardless of how the Second Circuit rules, Judge Steven J. Menashi said. Whether the company wins or loses on appeal, it’s still left with a nonbinding statement from a district court judge that the advisers can cite in arbitration for its persuasive value, he said.

“We actually can’t fix the problem you’re describing,” he told O’Melveny’s VerGow.

Judge Richard J. Sullivan also appeared unpersuaded by Morgan Stanley’s position. The bank is asking the court to “critique the judge’s reasoning” rather than rule on an appeal from a judgment, he said.

Though the judges directed most of their questions at Morgan Stanley, Menashi pressed Shafer’s attorney, Mathew P. Jasinski of Motley Rice LLC, on whether he planned to argue in arbitration that the judge’s decision on ERISA coverage was binding. Jasinski responded that this is a question for the arbitrator to decide, with the parties free to argue for their respective positions.

Menashi also used the debate as an opportunity to critique the legal consensus surrounding arbitration of ERISA claims. Several federal circuit courts, including the Second, Third, Sixth, and Tenth circuits, have declined to send certain ERISA disputes to arbitration under what he called the “effective vindication” doctrine, in which arbitration provisions are deemed invalid when they prevent parties from asserting certain rights provided by statute.

Menashi believes there’s “no such thing” as an effective vindication doctrine, but he recognizes that it’s “the rule that’s prevailed,” he said.

The case is Shafer v. Morgan Stanley, 2d Cir., No. 24-3141, argued 6/10/25.