Financial Advisers Back In Court and Customers Get Caught In The Middle

By William K. Flynn
Broker-Dealers Turn Up The Heat On Departing Advisers.

Late last year, Morgan Stanley and UBS withdrew from the Protocol for Broker Recruiting, followed closely by Citigroup in January. Morgan Stanley and UBS together account for almost half of the approximate 50,000 registered securities representatives (stock brokers) employed by the four major wire houses (Morgan Stanley, UBS, Merrill Lynch, and Wells Fargo). Industry observers are divided about what this portends for the Protocol, especially if it means more broker-dealers returning to court in order to keep departing brokers from soliciting clients. Others see little change going forward with approximately 1,600 firms still signed on to the Protocol. Raymond James, for example, says it still considers participation in the Protocol as a positive for its broker recruitment efforts. Morgan Stanley takes a dimmer view, claiming there were too many ways to “game the system” and it has already filed lawsuits to shut down (at least temporarily) departing advisers in Florida, Indiana and Illinois. One Texas court, however, rejected arguments to keep a transferring broker from calling his clients at Morgan Stanley.

Changing industry demographics are one likely reason for broker-dealers resigning the Protocol. It used to be that the only place a departing broker with a book could go was another wire house. Now, with the proliferation of technology, third-party portfolio platforms and fee based advisors, there are many more independents competing for that same book of business, making the potential payoff from aggressive recruiting and lucrative signing bonuses by the wire houses much less certain. What is certain, however, is that any Morgan Stanley, UBS or Citigroup broker intending to make a move is going to face heightened uncertainty on the way out the door, especially if they are expecting clients to follow with them.

What Is The Broker Protocol And How Does It Work?

When a broker leaves and transfers registration to a different broker-dealer, the expectation is that clients will follow. Brokers like to think of their “book” as something they cultivated over the years and that it should naturally belong to them. The harsh legal reality is much different and often comes as a surprise to the departing broker. For the most part, employers and broker-dealers are going to have the stronger claim. Making matters more complicated is that brokers are typically made to sign a non-solicitation agreement when everyone is happy at the beginning of the relationship. But when that relationship sours, or the next best deal comes along and a broker transfers, litigation frequently follows. For years, broker-dealers enforced their claims to “ownership” of clients and for violation of non-solicitation clauses with aggressive litigation that is universally expensive, stressful and frequently upsetting to clients who have no interest in being caught in the middle.

The Broker Protocol came into existence in 2004 as a contractual “cease fire” negotiated by Merrill Lynch, Smith Barney (now Morgan Stanley) and UBS. Since then, signers have expanded from the three founding firms to nearly 1,600 and the Protocol has become the industry playbook for any broker hoping to leave on Friday afternoon and call clients on Saturday, without getting hauled into court on Monday morning.

The substance of the Protocol permits a broker to leave with a list of names and contact information and then solicit those clients, provided the former broker-dealer gets advance notice and the broker takes absolutely no other customer-related information. One school of thought driving Protocol participation is that it is better to minimize disruption and allow brokers to leave and solicit customers under strictly controlled conditions, knowing that the broker-dealer can also aggressively recruit brokers from Protocol competitors while avoiding the litigation trap. There is no guarantee there will not be a lawsuit because there are plenty of traps for the unschooled departing broker and any misstep could open the court house doors. Neither the common law nor the Protocol, for example, allows a broker to solicit clients in advance of resigning, yet it is surprising how frequently brokers give in to the temptation. More often than not, they are caught.

What Is A Departing Broker To Do?

Any broker expecting to leave a non-Protocol firm and call clients announcing the big move, should expect to find themselves on the expensive end of a temporary injunction and a lawsuit claiming breach of contract and theft of trade secrets. Most states, including Ohio, consider a list of customers to be a protectable trade secret owned by the employer. This is a powerful argument for wire house broker-dealers and other employers. But departing brokers are not entirely without support. Some courts have said that customer names and contact information alone, entirely divorced from any internal compilation and any other customer related information, do not qualify for trade secret protection because that very same information can be found in public sources. Other courts, however, give a list of customer names created only from memory trade secret protection. Given this conflict in the courts, a compelling argument against trade secret protection is that for 13 years Protocol firms permitted departing brokers to take a list of names and use it to solicit clients. For former Protocol firms to reverse course and now claim after all this time that the same names are a highly-guarded trade secret, would be contradictory at best and disingenuous at worst. Other support favoring the broker is that federal consumer privacy rules (Reg. S-P) does not consider names and addresses available from public sources to be private information.

Legislation Would Make Sense.

It is unlikely that the Protocol will disappear completely, but more defections cannot be ruled out. Merrill Lynch and Wells Fargo are still in, at least for now. Unfortunately, clients also get caught up in the fog of litigation. Logic and experience suggest that customers typically value the personal relationship over the firm and that they just want to be able to choose their own adviser without being dragged into court as a witness. A sensible solution would be legislation following the Protocol framework allowing a departing broker a list of names and contact information and the freedom to inform clients when a broker changes employers. That is what happens with doctors. In 2013, Ohio adopted rules (R.C. §4731.228) protecting patients by requiring medical employers to tell them if their doctor leaves for a new employer. This was a policy choice by legislators that a patient’s interest in continuity of care takes precedence over any financial interest of the former employer. A similar ethical rule applies to law firms and attorneys. It can be argued that brokerage customers have no less of an interest in continuity of care over their financial health, but the recent Protocol defections suggest that at least some broker-dealers are willing to sacrifice the interest of clients in favor of revenues. Absent legislation, it will be left to courts to decide if financial customers have any protectable interest in knowing how to find their broker. Achieving that kind of customer-centered approach in the courts will not be easy, but it would be worth the effort.
Mr. Flynn has more than 30 years’ experience representing customers, broker-dealers, registered securities representatives, and advisers in financial services related litigation and other regulatory concerns.