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UPDATE: Ir-Rationale FINRA Merrill Lynch EFL Arbitration Decision Cited By Tax Court
August 10, 2020
This is an UPDATE of Ir-Rationale FINRA Merrill Lynch EFL Arbitration Decision Cited By Tax Court
(BrokeAndBroker.com Blog / December 31, 2018)
(BrokeAndBroker.com Blog / December 31, 2018)
http://www.brokeandbroker.com/4367/merrill-lynch-efl-finra/
In my private law practice, I frequently receive telephone calls from registered representatives who have an Employee Forgivable Loan (also known as a "Promissory Note" or "EFL") and are contemplating quitting or anticipate being fired from their employer broker-dealer. Inevitably, our conversation involves some discussion as to the "unaccrued balance" remaining on the EFL -- which prompts the client to ask if I can negotiate some discount off any repayment. In some cases, the client volunteers that there's no way in hell that he can come up with the bucks needed to repay anything (often including my legal fees). In other cases, we got "mitigating circumstances" involving discrimination, harassment, wrongful discharge, hostile workplace, racism, sexism, ageism, which might entitle the rep to keep every penny of any unaccrued EFL balance and perhaps demand damages to boot. In such EFL discussion, I inevitably admonish my potential client with a quote from George Bernard Shaw: "There are two tragedies in life. One is to lose your heart's desire. The other is to gain it." Point being that the rep might refuse to repay the unaccrued balance, get sued by his former broker-dealer, get slammed by a FINRA Arbitration Panel with compensatory damages, interest, costs, and fees. That would be the "loss." As to Shaw's referenced "gain," that would be the rep winning a smashing victory, not have to repay any of the unaccrued EFL balance, but then winding up with the now-forgiven loan balance converted to income, which then gets taxed, which then requires payments to local, state, and federal taxing authorities. If you don't have the money to repay a broker-dealer, imagine what it will be like pleading poverty to a state or federal tax authority. With that preamble, let's embark upon a fascinating journey of one rep's apparent victory in an EFL battle with Merrill Lynch.
By Way of Background and Dramatic Foreshadowing
According to online FINRA BrokerCheck records as of December 31, 2018, Robert Alan Connell was first registered in 1975 with Bache & Co., and during his career he was registered with such firms as Lehman Brothers from 1980 to 1993, Citigroup Global Markets Inc. from 1993 to 2009 (with an overlap from June to July 2009 at Morgan Stanley Smith Barney following the launch of the joint venture between Morgan Stanley and Citigroup), and finally from June 2009 to August 2010 with Merrill Lynch, Pierce, Fenner & Smith Incorporated.
By 2009, Connell was working with a five-person team of brokers and assistants servicing about 200 clients with over $350 million in assets under management, of which Connell directly managed about $292 million. To some extent, Connell was viewed as the head of the group notwithstanding he lacked the ultimate authority to fire a team member absent management's approval. Connell's group was producing over $3.15 million in revenue with his clients alone accounting for about $2.6 million of that figure. Unquestionably, Connell was one of Smith Barney's top advisors and ranked first in his office and the North Atlantic region -- and was in the top 20 producers nationally.
2009 Merrill Lynch Employment Agreement
In early 2009, during the depths of the Great Recession, Connell learned of Morgan Stanley's intention to acquire Smith Barney (where he was working) and he explored employment elsewhere -- eventually accepting the best offer, which came from Merrill Lynch. On June 26, 2009, Connell signed both a Merrill Lynch Employment Agreement and a Promissory Note. The Merrill Lynch Employment Agreement provided in Paragraph 3(c)(i):
(a) Connell shall be entitled to monthly transition compensation payments of Forty-Two Thousand Nine Hundred Eighty and 07/100 Dollars ($42,980.07) during each month from October 2009 through June 2017. The transition compensation payments described in this paragraph are not eligible for computation of benefits (usually known as "non eligible compensation"). Connell shall cease to be entitled to the above-described transition compensation upon the termination of his employment for any reason.(b) In the event that Connell's employment is terminated by Merrill Lynch and/or Bank of America, other than for Cause (as defined below) or in the event that Connell's employment is terminated by reason of death or disability (as defined in the Merrill Lynch & Co. Long Term Disability Plan), Connell will no longer be entitled to monthly transition compensation payments under this Agreement. Instead, Merrill Lynch agrees to pay Connell or his estate a lump sum payment equal to the remaining transition compensation payments through June 2017, less any outstanding debts Connell owes Merrill Lynch. Subject to paragraph 3(c)(v), such lump sum shall be paid as soon as practicable after the close of the calendar year after the calendar year in which the termination occurs, but in no event later than March 15 of the year after the calendar year in which the termination occurs. In the event that Connell resigns or his employment is terminated by Merrill Lynch and/or Bank of America for Cause, Connell shall cease to be entitled to the above-described transition compensation payments and will not receive any lump sum payment as described in this paragraph.
As further defined in the Merrill Lynch Employment Agreement under Paragraph 4, "Cause" was described as a:
i. violation of Federal securities laws, rules, or regulations;ii. violation of any rules or regulations of any regulatory or self-regulatory organization;iii. violation, as reasonably determined by Merrill Lynch management, of Merrill Lynch's rules, regulations, policies, practices, directions, and/or procedures;iv. criminal conduct that could either result in Mr. Connell's statutory disqualification or could reasonably result in harm to Merrill Lynch's reputation, as reasonably determined by Merrill Lynch management;v. a suspension, bar, or limitation on Mr. Connell's activities for Merrill Lynch by any regulatory or self-regulatory organization;vi. violation of Merrill Lynch's policies against discrimination and harassment;vii. failure to maintain licenses and required registrations;viii. dishonesty in connection with Mr. Connell's employment; orix. failure to fulfill or to meet any financial obligations that exist between Mr. Connell and Merrill Lynch for a period of four consecutive months that occur outside the first six months of employment.
$3.6 Million EFL
Pursuant to the Promissory Note, Merrill Lynch lent Connell $3,637,217, of which $42,980.07 was due and payable to the firm from Connell each month; however, said amount was to be deducted from his monthly compensation from October 2009 through June 2017. This seemingly oddball arrangement is fairly common on Wall Street and its purpose was to allow Connell to receive the full upfront payment while only recognizing income as each monthly payment became due. In reality, monthly payment actually occurred from Connell to his employer. All outstanding principal and accrued but unpaid interest under the Promissory Note were to become due and immediately payable only if Connell's employment with Merrill Lynch terminated for any specified "reason," or he became insolvent or filed for bankruptcy.
The Broker Protocol Provision
Pursuant to his efforts to migrate his clients from Smith Barney to Merrill Lynch, Connell's conduct was governed by the Protocol for Broker Recruiting, which both his former and current employers had signed on to. In an effort to remain compliant with the conditions of the Protocol, Connell consulted with Merrill Lynch's attorneys and purportedly followed their advice as to how to properly contact his clients, inform them of his relocation, and invite them to transfer their accounts. In the event that Connell resigned or was discharged by Merrill Lynch, he negotiated a somewhat unique provision in his Merrill Lynch Employment Agreement carving out his transferred-in clients from the one-year non-solicit provision:
For a period of one year following the termination of Connell's employment with Merrill Lynch for any reason, Connell agrees not to solicit, or initiate contact or communication with, either directly or indirectly, any account, customer, client, customer lead, prospect, or referral whom Connell served or whose name became known to Connell during his employment at Merrill Lynch. This restriction will not apply to clients whom Connell served as a registered representative at his prior employer or who became clients of Merrill Lynch within one year after he begins employment with Merrill Lynch. In addition, if Connell terminates his employment and joins a firm that is part of the Protocol for Broker Recruiting ("Protocol") and Merrill Lynch is part of the Protocol at the time, Connell will be entitled to follow the Protocol.
Microsoft Word Spreadsheets
Connell transitioned his entire team from Smith Barney to Merrill Lynch and negotiated for each member a higher compensation package than was paid at the former firm. As part of ensuring a smooth transfer of clients, Connell utilized various Microsoft Word documents containing spreadsheets that he had developed over the years and were used by his group. Those documents included records of client conversations and meetings, and Smith Barney purported conceded that they were his personal property subject to express terms in his employment agreement with that firm.
July 27, 2010 "Resignation"
Less than a year after Connell joined Merrill Lynch, that firm retained outside counsel to investigate the manner in which Connell transitioned his Smith Barney clients with an apparent focus on potential violations of the Protocol and his Merrill Lynch Employment Agreement. Connell fully cooperated in Merrill Lynch's investigation, and retained the highly-regarded industry employment lawyer Thomas Bradford Lewis, Esq. Upon the purported conclusion of the investigation, Merrill Lynch's outside counsel recommended that the firm only issue a letter of reprimand to Connell; however, the firm did not follow that recommendation. Only four days before Connell's one-year anniversary (at which time he would have been entitled to a bonus), on July 27, 2010, Connell was told by his manager and a compliance officer that he was "going to be resigning." Connell's lawyer Lewis recommended that he voluntarily resign in the face of the employer's apparent ultimatum, and he did so that day.
August 3, 2010 Litigation by Merrill Lynch
In response to Connell's resignation, Merrill Lynch froze his firm account and on August 3, 2010, filed a Complaint and an Emergency Motion for a Temporary Restraining Order and Preliminary Injunction in the United States District Court for the Eastern District of Pennsylvania. Pursuant to an August 3rd Consent Order, Connell agreed to an injunction governing his solicitation of clients and returned certain property to his former firm -- with the Order to remain in force and effect until a FINRA Arbitration Panel rendered a decision on Merrill Lynch request for injunctive relief. Oddly, Connell's former team members were not pressured into leaving and, in fact, Merrill Lynch gave his junior partner a raise and offered reduced management fees to clients who remained with the firm.
August 3, 2010 FINRA Arbitration Complaint
In a Financial Industry Regulatory Authority ("FINRA") Arbitration Statement of Claim filed on August 3, 2010, and as amended on August 9, 2010, Claimant Merrill Lynch asserted
- breaches of contract, contract-employment agreement, contract-promissory note, and duty of loyalty;
- misappropriation of trade secrets;
- conversion of confidential business information;
- unfair competition; and
- unjust enrichment.
Claimant Merrill Lynch sought a Permanent Injunction enjoining Respondent Connell from using client contact information and other data, and destroying certain records and documents purportedly in his possession. Claimant also sought an Order for the return of certain cited documents, particularly data stored on computers and storage devices.In addition to unspecified compensatory damages and attorneys' fees, Claimant sought payment of an outstanding Promissory Note executed by Respondent Connell in the amount of at least $3.285 million plus interest accumulating at the rate of $220.52 per day since July 27, 2010. In the Matter of the FINRA Arbitration Between Merrill Lynch, Pierce, Fenner & Smith Incorporated, Claimant, vs. Robert Connell Respondent (FINRA Arbitration 10-03486, May 6, 2011).
http://www.finra.org/sites/default/files/aao_documents/10-03486-Award-FINRA-20110506.pdf
August 18, 2010 Form U5
Merrill Lynch filed a Uniform Termination Notice of Securities Industry Registration ("Form U5") on August 18, 2010, indicating that Connell had been "Permitted to Resign" for:
Conduct resulting in loss of management's confidence, including conduct relating to the handling of customer information and lack of cooperation in the firm's review of the matter.
Connell Arbitration Answer and Counterclaim
Respondent Connell generally denied the allegations, asserted various affirmative defenses, and filed a Counterclaim in which, among other causes of action, he asserted breach of contract, fraud in the inducement, defamation, and tortious interference with contracts and/or business relationships. In his Counterclaim, Connell requested $3.2 million in transition compensation; $950,000 that represented the first-year back-end compensation; and $4.6 million in back-end compensation that would have been due during years two through five; $26 million in lost commission for the next 14 years of intended employment. Moreover, Respondent sought interest on all amounts, expungement of his Form U5, punitive damages, attorneys' fee, and costs.
January 10, 2011 FINRA Arbitration Panel Order
In response to a December 17, 2010, motion filed by Claimant Merrill Lynch for the Panel to make a determination as to the assets to be retained by Claimant in Respondent Connell's account(s), on January 10, 2011, the Panel ordered that Claimant may retain not more than $1,200,000.00 in cash in Respondent's account(s). The identity of the assets comprising the remaining $2,550,000.00 to be withheld by Claimant will be determined by Claimant after consultation with Respondent's counsel.
May 6, 2011, FINRA Arbitration Decision
The FINRA Arbitration Panel denied Merrill Lynch's claims "in their entirety."
The Panel found Claimant Merrill Lynch liable to and ordered it to pay to Respondent Connell:
- $476,500 in "compensatory damages;"
- $288,734 in attorneys' fees pursuant to the parties' contractual agreements; and
- $22,408.67 in costs.
Also, the Panel removed the January 10, 2011 restrictions imposed by its order allowing Claimant Merrill Lynch to retain not more than $1.2 million in cash and a further $2.55 million in assets pending the Award; and, accordingly, Respondent Connell was entitled to retain $3.285,228.26 paid to him by Claimant. Further, Respondent's request for expungement was denied. Finally, the August 26, 2010, Permanent Injunction entered by the FINRA Arbitration Panel in favor of Claimant Merrill Lynch was modified as follows:
(a) Claimant shall deliver to Respondent within thirty (30) calendar days from the date of this award, the "Connell Proprietary Excel Spreadsheet and MS Word templates" without any data.
(b) Upon delivery of the "Connell Proprietary Excel Spread Sheets and MS Word templates" without any data to Respondent, Claimant shall cease using the "Connell Proprietary Excel Spreadsheet and MS Word template" and provide to Respondent a certification signed by an authorized representative of Claimant that it has removed the "Connell Proprietary Excel Spreadsheet and MS Word template" from all Claimant's computers and portable electronic storage devices.
(c) Within ten (10) business days from the date of this award. Claimant shall deliver to Respondent his personal computer(s) and any and all portable electronic devices with all data removed on the computer(s) and removed on all portable electronic devices, including, but not limited to: (1) SanDisk Cruzer, serial number: 173801143142BF50 (2) SanDisk Enterprise, serial number: OE104A7151C288D9 (3) SanDisk Cruzer, serial number: 3954011618C1AE35 (4) SanDisk Enterprise, serial number: 1078920759E33A9E
(d) The restrictions on Respondent's personal account(s) with Claimant are stricken. Respondent is entitled to retain the $3,285,228.26 paid by Claimant to Respondent.
(e) Except as amended herein, the balance of the Permanent Injunction shall remain in effect.
Bill Singer's Comment on the FINRA Arbitration Decision
Without question, the FINRA Arbitration Panel's Award was a rare -- I would argue "extraordinary" -- result in the annals of such EFL disputes. Connell's lawyer Tom Lewis did a magnificent job.
In reading the FINRA Arbitration Panel's Decision, we are initially struck by the substantial rendition of the parties' allegations and the detailed presentation of the relief requested. Similarly, there is an extensive statement of the various issues considered by the arbitrators leading up to their ultimate deliberation that includes mechanics of the several motions and orders prior to the Award.
And then we are struck by a striking absence.
At first, that absence is not apparent but we soon realize that there is absolutely no rationale set forth in the Decision. We have Point A in the form of the parties' allegations. We have Point C in the form of the FINRA Arbitration Panel's Award. Missing is Point B -- what did the arbitrators actually decide and why? Yes, Connell was"entitled to retain the $3,285,228.26 paid" by Merrill Lynch; and, further, Merrill Lynch was also found "liable" and ordered to pay to Connell $787,642.67 in compensatory damages, fees, and costs-- but based upon a finding of what exactly? As set forth in the FINRA Arbitration Decision:
In his Counterclaim, Respondent asserted the following causes of action: breach of contract demanding repayment of transition compensation, breach of contract nonpayment of back end compensation, breach of the implied covenant of good faith and fair dealing, common law fraud and fraud in the inducement, Form U5 defamation, quantum merit, unjust enrichment, conversion of client accounts, conversion of personal accounts, tortious interference with contracts and/or business relationships, misappropriation of trade secrets, and unfair competition.
Respondent Connell was entitled to retain some $3.2 million paid to him under the Merrill Lynch Employment Agreement / Promissory Note -- but why?
Respondent Connell was awarded some $787,000 in compensatory damages, fees, and costs -- but based upon what misconduct by Merrill Lynch?
Some might say that Connell should not look a gift-horse in the mouth. Some might say that he should just run as quickly and as far as he can and be thankful that his lawyer, Tom Lewis, pulled off the nearly unthinkable and kicked Merrill Lynch's ass. There are very, very few such disputes in which a former employee not only wins the right to retain the unpaid balance on an EFL but also is awarded damages, costs, and fees.
I frequently chastise FINRA for failing to ensure that its various arbitration decisions and regulatory settlements and decisions contain sufficient content and context so as to render them intelligible. Although the FINRA Arbitration Decision at issue provided an excellent presentation of the underlying dispute between Merrill Lynch and Connell, there was no rationale set forth in the published document. Based on what? Why? How come? Too many FINRA Arbitration Decisions invoke an unwarranted and dubious cone of silence and cloak of secrecy, which tend to benefit FINRA's member firms to the detriment of the industry's customers and employees. Generally, this lack of explanation is of no further consequence because most disputes die a death (tortured or otherwise) with the issuance of the decision. But not always . . .
IRS Tax Dispute
Robert A. Connell and Ann P. Connell divorced in 2010 but had filed a 2009 joint Federal income tax return and Robert Connell filed a 2011 single individual Federal income tax return. The Internal Revenue Service determined a deficiency of $169,552 in their joint 2009 return with a penalty of $36,701; and further cited Connell's 2010 and 2011 taxes respectively for $147,198 and $1,312,943 with penalties of $29,440 and $262,589. Robert A. Connell and Ann P. Connell, Petitioners, v. Commissioner of Internal Revenue, Respondent -- and -- Robert A. Connell, Petitioner, v. Commissioner of Internal Revenue, Respondent (United States Tax Court Memorandum 2018-213, Docket Nos 14947-16 and 14948-16 / December 26, 2018) http://brokeandbroker.com/PDF/ConnellsTaxCtMemo.pdf
(NOTE: Connell was not represented before the Tax Court by Thomas B. Lewis, Esq. but by Barry H. Frank, Gordon Fairle Moore II, and Tiffany W. Donio, Esqs.). The issue before the Tax Court was
(NOTE: Connell was not represented before the Tax Court by Thomas B. Lewis, Esq. but by Barry H. Frank, Gordon Fairle Moore II, and Tiffany W. Donio, Esqs.). The issue before the Tax Court was
[T[he character of the balance of the Merrill Lynch upfront forgivable loan, $3,242,248, which was extinguished as a result of the award determination of the FINRA Panel. Specifically, we must determine whether that award constitutes capital gain, as Mr. Connell maintains, or ordinary income, as respondent maintains. . .
Page 16 of the Tax Court Memorandum
In large part, what had prompted this tax dispute was the apparent fruits of what seemed like an amazing victory for Robert Connell during his FINRA arbitration with Merrill Lynch. As set forth in pertinent part in the Tax Court Memorandum [Ed: footnotes omitted]:
Merrill Lynch issued Mr. Connell a Form 1099-C, Cancellation of Debt, reporting debt cancellation income of $3,285,228. The parties stipulated that the amount on Form 1099-C was wrong and that the proper amount of cancellation of indebtedness income should be $3,242,248.16Mr. Connell timely filed his 2011 Federal income tax return wherein he reported adjusted gross income of negative $112,635. Mr. Connell attached to his income tax return a document entitled "Form 8582 and Schedule E 2011", wherein he reported the cancellation of indebtedness income as "deferred compensation" ordinary income. He offset this amount with two ordinary loss items: (1) a "Merrill Lynch Reduction for 1099C Reported on W-2" of $42,980 17 and (2) "Smith Barney Citi Group Deferred Compensation Loss" of $2,495,732, resulting in $782,516 in total (net) deferred compensation. This amount, combined with Mr. Connell's other reported business losses, was reported on line 17 of Mr. Connell's Form 1040, U.S. Individual Income Tax Return, as a total loss of $577,363. Combining this total with deductions of $65,999 claimed on Schedule A, Itemized Deductions, Mr. Connell requested a refund of $129,911.The IRS examined Mr. Connell's 2011 tax return and determined that the Smith Barney Citi Group deferred compensation loss was a loss from the sale of stock and could not be used to offset ordinary income. Mr. Connell has conceded this recharacterization.On October 10, 2013, Mr. Connell filed an amended 2011 income tax return wherein he reported adjusted gross income of $1,047,365. On line 17 of the amended tax return Mr. Connell reported positive income of $582,637. Also on the amended return Mr. Connell reported itemized deductions totaling $1,930,999. As a result, Mr. Connell again claimed entitlement to a refund of $129,911. In essence, Mr. Connell recharacterized the extinguishment of the balance of the Merrill Lynch upfront forgivable loan, $3,242,248, from ordinary income to capital gain.
Page 30 of the Tax Court Memorandum
As he had argued to the FINRA Arbitration Panel, Connell asserted, in part, that Merrill Lynch should not be awarded the balance of the forgivable loan because it would essentially bestow his book of business upon the firm at no cost; and that the former employer had weaponized the subject Form U5 in an effort to suppress (if not extinguish) his ability to compete for his customers' business. In his prehearing brief to the arbitrators, Connell pointed out that:
Interestingly, none of Mr. Connell's team, including his partner and the four sales assistants who transitioned with him, seem to have faced any repercussions for the actions in which they all engaged and which allegedly constituted violations of the Protocol. The rest of Mr. Connell's team remains at Merrill Lynch servicing Mr. Connell's entire book of business. Forcing Mr. Connell's resignation and retaining his entire book of business was not enough for Merrill Lynch, though; instead, Merrill Lynch saw fit to seek repayment of compensation paid to Mr. Connell and to file actions against him in Federal Court and with FINRA, all in an effort to ensure that Merrill Lynch would have total, unrestricted access to Mr. Connell's book of business free from competition and to prevent Mr. Connell from securing competitive employment at a comparable financial services firm.
Pages 20 - 21 of the Tax Court Memorandum
Connell argued to the FINRA Panel that Merrill Lynch had lured him and his book of business to that firm, and then not only forced him to resign but did whatever it could to inhibit his ability to find future industry work:
Merrill Lynch has thereby secured for itself exclusive access to Mr. Connell's book of business, including the revenue generated by and the assets held in Mr. Connell's clients' accounts. It has done so by forcing his resignation--manufacturing an alleged violation of the Protocol for Broker Recruiting as its reason for doing so--and then filing a Form U5 Notice of Termination regarding Mr. Connell's separation with an intentionally false statement explaining the circumstances of Mr. Connell's resignation. The statement made on Mr. Connell's Form U5, which is meritless and was made without justification, render [sic] Mr. Connell virtually unemployable with the major financial services firms in the securities industry. Additionally, as if this were not enough, Merrill Lynch, since Mr. Connell's resignation, has sought the return of the very compensation paid to Mr. Connell in return for his decision to transfer his book of business to Merrill Lynch. Moreover, the manner in which Merrill Lynch has handled Mr. Connell's resignation from the firm may have irreparably damaged his relationship with his clients, who, after Mr. Connell's resignation, were left to speculate as to the true nature of Mr. Connell's abrupt departure from Merrill Lynch.
Page 21 of the Tax Court Memorandum
Burden of Proof on Taxpayer
In tackling whether the determinations in the IRS Notice of Deficiency were correct, the Tax Court restated the long-standing principle that a taxpayer has the burden of proving error, and that it is incumbent upon Connell to prove that the proceeds he received in the FINRA Arbitration Decision did not constitute taxable income because they fell under a recognized exclusion. Respondent IRS argued that Connell was:
[B]ound by his employment agreement and promissory note. The promissory note was made as part of Mr. Connell's compensation package with Merrill Lynch (i.e., the monthly transition compensation). The note makes no mention of Mr. Connell's book of business. Moreover, as respondent points out, Mr. Connell treated the monthly transition compensation he received during his tenure at Merrill Lynch as ordinary income, which is consistent with the terms of the employment agreement and promissory note. Respondent also draws our attention to the fact that Mr. Connell did not assert that the income was capital gain income until the IRS determined that he erroneously characterized the Smith Barney stock loss as an ordinary loss.
In Footnote 18 on page 32 of the Tax Court Memorandum
Ir-Rationale
It is well established that IRS determinations in a notice of deficiency are presumed correct and taxpayers bear the burden of proving error. In Connell's case, he was charged with proving that the proceeds of the FINRA Award constituted capital gain income rather than ordinary income. If, in fact, the FINRA arbitrators had found that Merrill Lynch purchased Connell's book of business and then fraudulently attempted to retain that business through wrongly forcing him to resign and demanding repayment of the consideration for said acquisition, then Connell should have been able to quote the arbitrators' rationale in the FINRA Arbitration Decision. If the arbitrators simply concluded that Merrill Lynch had acquired Connell's service in exchange for the EFL and comp package, then the Decision should have so stated. It may well be that the FINRA arbitrators did not find that Merrill Lynch engaged in any fraud, conversion, or tort but had engaged in a form of breach of contract. Whatever the arbitrators' findings and their attendant rationale, Connell should have been able to direct the Tax Court's attention to specific explanations and guidance set forth in the FINRA Arbitration Decision. But FINRA's penchant for publishing merely serviceable Decisions lacking substantive rationale reared its ugly head yet again, and deprived Connell, the IRS, and the Tax Court the ability to discern the arbitrators' rationale and relevant findings. As the Tax Court itself lamented the:
FINRA Panel did not explain the basis of its award; hence, we are left to infer its reasoning
Page 33 of the Tax Court Memorandum)
record herein does not reveal the specific argument the FINRA Panel found most persuasive when it extinguished the balance of the upfront forgivable loan
Page 34 of the Tax Court Memorandum).
In the absence of an expression of rationale in the FINRA Arbitration Decision, the Tax Court's lopsided inquiry did not work out in Connell's favor, as the Court noted that:
[A]dmittedly, the filings heavily emphasize Mr. Connell's argument that Merrill Lynch lured Mr. Connell to Merrill Lynch in order to acquire his book of business and that thereafter it set out to ruin his professional reputation so as to keep him from working at a competing financial services firm. But this argument was not the only one Mr. Connell presented to the FINRA Panel. Mr. Connell's attorney, Mr. Lewis, an experienced and successful litigator, made certain of that. Mr. Connell's filings forcefully argue that the FINRA Panel should reject Merrill Lynch's position and conclude that Mr. Connell need not pay the balance of the upfront forgivable loan. Indeed, Mr. Connell's filings emphasized that Merrill Lynch breached the terms of the employment contract, not Mr. Connell, causing Mr. Connell to suffer damages. This argument, by itself, would relieve Mr. Connell of his obligation to pay the outstanding balance of the promissory note to Merrill Lynch.
Pages 33-34 of the Tax Court Memorandum
Ultimately, the Tax Court found that Connell failed to establish that the amount at issue was solely earmarked for the acquisition of his book of business:
[C]onsequently, we sustain respondent's determination that the extinguishment of Mr. Connell's debt to Merrill Lynch constitutes cancellation of debt income and that the amount of the extinguishment is taxable as ordinary income.
Pages 34 of the Tax Court Memorandum
UPDATE: 3Cir August 2020
On June 16, 2020, Connell appealed the Tax Court ruling. In Robert A. Connell, Appellant, v. Commissioner of Internal Revenue (Opinion, United States Court of Appeals for the Third Circuit, No. 19-2668 / August 6, 2020)
http://brokeandbroker.com/PDF/ConnellOpinion3Cir200806.pdf In affirming the Tax Court, the 3Cir noted in pertinent part [Ed: footnotes omitted]:
[T]he Tax Court reviewed in depth Connell's recruitment to Merrill Lynch; the employment agreement and promissory note at the heart of this litigation; the circumstances surrounding Connell's departure from Merrill Lynch; and the arbitration, including the filings and the award.
With this thorough factual backdrop firmly in hand, the Tax Court determined that Connell did not carry his burden to show that the arbitration award was compensation for his book of business. This conclusion was not clearly erroneous. The Tax Court found that the $3.6 million loan, the balance of which the arbitration panel extinguished, was part of Connell's compensation package. Connell's "monthly transition compensation" was $42,980, and his monthly loan payment was also $42,980. The Tax Court found that "[t]his arrangement, common to the industry, allowed Mr. Connell to receive the full amount of his transition compensation up[ ]front, while recognizing income only as each monthly payment came due." Neither Connell's employment agreement nor the promissory note state or imply that the compensation was the price paid for Connell's book of business. Moreover, Connell did not introduce evidence that would have shown that the value of his book was the same as the outstanding balance of the loan.Nor did the Tax Court err in interpreting Connell's filings before the arbitration panel. The Tax Court stated that, aside from arguing that Merrill Lynch offered the loan to obtain Connell's book of business, Connell's arbitration "filings [also] emphasized that Merrill Lynch breached the terms of the employment contract." . . .
at Pages 3 - 4 of the 3Cir Opinion