We’ve often blogged about how brokers and investment advisors don’t always do business in a client’s best interest. In many cases, it’s the broker’s best interest that comes first, and the client pays the price.
First Republic Bank’s compensation system for its brokers—called “wealth managers” in their Form ADV brochure—offered them considerable bonuses for bringing in cash-flush customers. The incentives allowed First Republic to recruit Wall Street brokers and funded its deposit base for these customers. This initiative saw First Republic’s deposit rate increase by 21% over a five-year period. At the end of 2022, the bank had $176 billion, according to their SEC filings.
According to one source, the bank’s deposit funding was greatly helped by the substantial increase on the wealth management side of the house.
Brokers, investment advisors, and other wealth management professionals are frequently offered incentives for bringing in additional business to their bank or firm. In this case, they were offered considerable incentives.
Prior to its ending and buyout, First Republic’s incentive system was the highest in the industry and went as high as 1.15%, or 115 points, of the customer cash brought in by their brokers. Those incentives are typically 2 to 10 points. Their system was much more lucrative for the brokers than any other financial institution and paid out over two years. Customers who moved their cash over also received low-rate mortgages and discounted fees.
Was Their Disclosure Enough?
First Republic did disclose to customers that their deposit would be uninsured in their Form ADV brochure. However, it wasn’t prominently visible, and the accounts earned below-market interest rates. Did anyone explain this to First Republic’s customers?
First Republic filed their Form ADV brochure with the SEC in late March. The brochure includes a disclosure on page 33 of this 45-page document that its brokers (“wealth managers”) are:
“. . .directly compensated for referring clients to [First Republic Bank] for Bank products and services. “This compensation creates an incentive for Wealth Managers to refer Clients to Bank products or services so they can receive compensation and not necessarily because they are appropriate products or services for such Clients, which is a conflict of interest. Such compensation has in the past and likely will in the future comprise a meaningful part of the total compensation package for many Wealth Managers.”
Included is a notice that bank deposits may be uninsured, and states that the client is responsible to “monitor their total deposits” at the bank. The client is also responsible for determining the extent of their federal insurance coverage. BNY Mellon’s Pershing held the brokerage assets.
In a recent article for AdvisorHub, Silver Law Group founder Scott Silver said that in the past, courts have ruled that “. . .disclosures need to be meaningful and address the specific known risks. Simply stating that there may be a ‘crack in the sidewalk’ ahead when entering the Grand Canyon fails to disclose the known real risk.”
This idea comes from a concept in the law known as “bespeaks caution” highlighted in a 1996 case against Prudential for failing to disclose that which it already knew was a significant risk associated with one of its products. Specifically, the Court held that “[t]he doctrine of bespeaks caution provides no protection to someone who warns his hiking companion to walk slowly because there might be a ditch ahead when he knows with near certainty that the Grand Canyon lies one foot away. The bespeaks caution doctrine requires a contextual analysis and, in context, even apparently specific risk disclosures like those in Polaris’ prospectus are misleading if the risks are professionally stamped in internal undisclosed analyses (as they were here) as significantly greater or more certain than those portrayed in the prospectus.
For many depositors, the disclosure wasn’t prominent enough to take notice.
Did You Invest With First Republic Bank?
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