Morgan Stanley’s long-running fight over deferred compensation for former advisors has hit a new setback, with a federal appeals court refusing to revisit a key lower court decision that could carry major implications for wealth management firms relying on arbitration to resolve disputes.
The case centers on a group of former Morgan Stanley advisors who allege the firm improperly withheld tens of millions of dollars in deferred pay after they left for competitor firms. While Morgan Stanley successfully compelled the advisors to bring their claims through FINRA arbitration in a 2023 district court ruling, the firm has since challenged a crucial part of that decision: the judge’s finding that the firm’s deferred compensation plans are subject to the federal Employee Retirement Income Security Act (ERISA).
ERISA governs retirement and benefit plans, and treating these deferred comp plans under its framework could potentially bolster advisors’ legal arguments in arbitration by framing the compensation as protected benefits rather than discretionary bonuses. Morgan Stanley has argued that this interpretation unfairly tilts the playing field and should be left to FINRA arbitrators, not the courts.
But the U.S. Court of Appeals for the Second Circuit rejected that argument on July 9, declining Morgan Stanley’s request to revisit the lower court’s ERISA determination. The firm had claimed that the ruling effectively denied arbitration by improperly influencing the forum, but the appeals court dismissed that notion, calling the request an “unprecedented step.”
In its order, the court noted that Morgan Stanley failed to cite any legal precedent to support the idea that a court’s interpretation of ERISA amounted to a “constructive denial” of arbitration. The judges emphasized the clear statutory language governing appeals of arbitration orders and affirmed that courts can evaluate ERISA’s applicability when determining whether claims are arbitrable.
The appeals panel’s decision allows arbitration to proceed, while also making it clear that panels can consider the district court’s finding that the compensation plans are governed by ERISA.
For wealth managers, especially those who use deferred comp to retain talent, the implications are significant. The court’s refusal to walk back the ERISA ruling opens the door for broader interpretation of such plans as protected retirement benefits—potentially altering the risk calculus when advisors exit and seek unpaid deferred compensation.
Douglas Needham, a partner at Motley Rice and lead counsel for the advisors, hailed the ruling as a pivotal development. “It’s a major win for our clients and for advisors more broadly,” he said. “Morgan Stanley has leaned heavily on the idea that arbitrators shouldn’t rely on the district court’s ruling because it was under appeal. That argument is now off the table.”
Needham’s firm represents around 100 former Morgan Stanley advisors and had paused arbitration proceedings while awaiting the outcome of the appeal. With the appellate court’s decision now in hand, he says the cases will move forward with more clarity around legal standards and the role of ERISA. “This simplifies a lot for arbitrators,” he added. “We’re eager to pursue these cases and secure the compensation our clients are owed.”
Other groups of advisors, represented by different firms, have continued pursuing claims through FINRA arbitration during the appeals process, resulting in a mixed bag of outcomes for Morgan Stanley.
A spokesperson for Morgan Stanley reaffirmed the firm’s position that the deferred compensation plans do not qualify as ERISA-covered pensions. “These awards are not a pension, as multiple arbitration panels have now recognized,” the representative said. “We are confident that when arbitrators weigh the full evidence, they will reach the appropriate conclusion.”
The dispute originated in December 2020, when Needham’s clients filed a lawsuit in federal court in New York, arguing that Morgan Stanley’s decision to withhold deferred compensation after their resignations violated ERISA protections. Their complaint asserted that the plans met the legal definition of retirement benefits and could not be forfeited simply because an advisor left the firm.
In his November 2023 decision, U.S. District Judge Paul Gardephe sided with Morgan Stanley on the arbitration issue but made waves by concluding that the plans were in fact governed by ERISA. That determination, the judge explained, was necessary to decide whether the advisors’ claims were arbitrable.
Morgan Stanley’s legal team has spent the past 18 months trying to reverse that aspect of the ruling, arguing that the court overstepped by weighing in on ERISA before arbitration began. The firm insisted that arbitrators—not courts—should decide if ERISA applies.
But the Second Circuit’s recent ruling shuts that door. In addition to denying Morgan Stanley’s request for a rehearing, the appeals court rejected its bid to force the lower court to amend or withdraw its ERISA analysis. The panel emphasized that Judge Gardephe acted within his authority to evaluate whether ERISA applied, as part of assessing the enforceability of the arbitration clause.
In its opinion, the appeals court wrote, “We have held that ERISA may render unenforceable an arbitration agreement that covers certain types of claims. So we have suggested that it is sometimes necessary to consider the applicability of ERISA before ordering arbitration.”
The ruling reinforces the ability of courts to shape the legal backdrop of arbitration, even as they compel claims to be resolved in that forum. For advisors and their attorneys, that provides a powerful precedent.
While the decision doesn’t grant advisors the right to litigate in federal court, it does arm them with a favorable judicial interpretation of the deferred comp plans—an interpretation that could prove persuasive in future arbitration proceedings.
Needham said the firm is ready to ramp up its arbitration efforts now that the legal uncertainty has been resolved. “This brings clarity and momentum,” he said. “We’ll be moving forward with our cases immediately.”
Morgan Stanley, meanwhile, will continue defending its compensation policies in FINRA forums, where the firm has so far seen mixed outcomes. The arbitration results to date underscore the variability of decisions in a non-precedential forum and the potential stakes involved when ERISA interpretations are in play.
As firms increasingly rely on deferred comp to align advisor incentives and reinforce retention, this case serves as a reminder that the legal framework governing those benefits may be more contested—and consequential—than previously assumed.
