Morgan Stanley, Merrill Lynch Pay Plans Land in Legal Spotlight

Morgan Stanley, Merrill Lynch, and the US Labor Department are aligned in an emerging legal battle that is poised to shift the landscape governing lucrative financial adviser compensation agreements.

Deferred incentive compensation programs require employees to receive part of their pay on a delay—usually after several years of continuous employment—with immediate payouts possible upon death, disability, or retirement.

The programs, which grew in popularity following the 2008 financial crisis and are common in the financial and professional services industries, typically require employees to forfeit deferred compensation if they resign before the applicable payment date—a feature proponents have championed as promoting stability in the broader economy.

These forfeiture rules are now driving a sprawling legal battle playing out in federal courts, dozens of private arbitration proceedings, and the halls of the US Department of Labor. The money at stake can be massive: Morgan Stanley has paid financial advisers billions of dollars under these programs over the past decade, according to court filings, and individual disputes over forfeited compensation often seek hundreds of thousands of dollars apiece.

Pending litigation over both Merrill Lynch’s program and the Labor Department’s support of Morgan Stanley’s arrangement could spur a major shakeup in the world of incentive compensation.

If the appeal against Merrill Lynch is successful, it would have “far-reaching implications to employers in lots of industries,” as it would likely force them to consider significantly restructuring their own programs or eliminating them altogether, Tiffany Downs, a Barnes & Thornburg LLP partner, said.

Legal Question

The central dispute turns on whether deferred incentive compensation programs qualify as pension plans governed by the Employee Retirement Income Security Act. If they do, they’re subject to—and likely violate—rules governing how quickly benefits must vest.

The debate tends to focus on the extent to which the programs distribute money during an employee’s tenure, or, like traditional retirement plans, after they’ve left the company. The Merrill Lynch and Morgan Stanley programs make the vast majority of their payments to current employees, according to the companies’ court filings.

These programs historically haven’t been considered ERISA-covered plans, and rethinking that status quo could be a major and expensive change, Downs said.

Employers could be required to change how their programs are funded—a potentially huge increase in costs that could force companies to stop offering the arrangements altogether, she said.

“There’s millions of dollars at stake,” Scott E. Galbreath, an attorney with Trucker Huss APC, said. “That’s why there’s so much litigation and arbitration involving the Morgan Stanley and Merrill Lynch plans, because the stakes are so high.”

Morgan Stanley Saga

In 2020, a financial adviser sued Morgan Stanley on behalf of a proposed class of thousands, saying he personally forfeited more than $500,000 in compensation. A federal judge granted the company’s request for arbitration, but added that the program is subject to ERISA because it allows compensation to be deferred after employment ends.

Morgan Stanley objected, saying the judge improperly decided a legal question that should have been left for the arbitrator, and the company unsuccessfully sought to have this analysis vacated on appeal.

Meanwhile, hundreds of former Morgan Stanley advisers have sought forfeited compensation through arbitration. The company has secured several arbitration victories with many disputes pending.

The Labor Department recently threw cold water on these advisers’ efforts, announcing in an advisory opinion that Morgan Stanley’s program isn’t an ERISA-covered pension plan because it incentivizes performance and doesn’t systematically defer compensation beyond termination of employment.

A new lawsuit challenged the opinion letter, saying it was improperly obtained and legally wrong. The company’s lawyers “extensively” lobbied for the letter as a “sword” to use during ongoing legal battles, which runs afoul of the department’s pledge not to issue advisory opinions aimed at preexisting disputes, three former Morgan Stanley employees alleged in the suit.

“The Department of Labor violated its own procedures, ignored ERISA’s language and case law, and accepted Morgan Stanley’s position about inapplicable proposed rules and regulations when it issued the advisory opinion,” Doug Needham, a Motley Rice LLC attorney representing the employees, said in an Oct. 29 emailed statement.

Morgan Stanley declined to comment.

Merrill Lynch Appeal

The first court to pass judgment on the department’s opinion may be an appeals court hearing an unrelated—but similar—lawsuit against Merrill Lynch. A federal judge ruled in March that the program sponsored by the Bank of America Corp. unit isn’t governed by ERISA, and employees appealed to the US Court of Appeals for the Fourth Circuit, which tentatively scheduled oral arguments for late January.

Merrill Lynch, which declined to comment, recently submitted the department’s opinion letter to the appeals court as supplemental authority, and the employees replied by urging the court to reject the department’s “flawed analysis.”

The Fourth Circuit isn’t required to follow the DOL’s opinion, but it may nevertheless deem it persuasive, Downs said.

Courts have sometimes hesitated to put too much weight on advisory opinions, and that trend has intensified after the US Supreme Court overturned the decades-old Chevron doctrine of deferring to administrative agencies’ interpretations of unclear laws, said Stephen D. Rosenberg, a partner with Wagner Law Group.

If the Fourth Circuit declines to follow the DOL’s analysis, anyone attempting to rely on the letter will face an uphill battle of arguing against the analysis of a federal appeals court, according to Rosenberg. Such a move may also strengthen the Morgan Stanley advisers’ case seeking to invalidate the letter, Galbreath said.

But a decision agreeing with the DOL would bolster the advisory opinion’s persuasive value in future cases, Rosenberg said.

It could also provide a roadmap for employers hoping to design programs with an eye toward avoiding ERISA coverage, according to Galbreath.