What to Do After End of Broker Protocol Truce

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They were the end-of-year shots heard round the financial advisory world.

The withdrawal of Morgan Stanley, UBS Financial Services and Citigroup from the Broker Protocol signals the end of peace between warring brokerage firms over control of customer assets and financial advisor recruitment.

As in the not-too-distant past, financial advisor resignations will induce their former firms to rush to court to obtain emergency temporary restraining orders and to file for recompense through FINRA arbitration claims.

The hundreds of firms still in the pact are now in their strategy rooms determining whether to back away from the big-book brokers at those firms or to stay in the game. If they do, based on recent history, they will have to give potential recruits guidance on how to move within the letter of their employment contracts while realistically calculating litigation budgets for the inevitable court and arbitration battles.

Reviewing the history of Protocol is good preparation for both sides.

In 2004, Merrill Lynch, Smith Barney (then a unit of Citigroup and now part of Morgan Stanley) and UBS Financial drafted a truce for the industry. The Protocol for Broker Recruiting promoted advisor mobility and fair competition by allowing advisors to solicit the customers they serviced when joining competing brokerage firms, provided they adhered to certain requirements.

By 2017, approximately 1,700 firms were in the pact, providing advisors (and, arguably, their customers) with more mobility, and drastically reducing litigation between firms.

But like any truce, the value of the Broker Protocol depended entirely on the honor of its members. Human nature and fierce competition spawned sharp practices.

With the threat of big legal bills gone, the big firms pumped up “transition” packages to entice financial advisors to defect (even if the result was a zero-sum game as no one firm emerged with a distinct customer-asset advantage).

In terms of respect for the governing Protocol, there were many snubs.

Departing advisors in some cases shuffled, shredded, stole or deleted their former firms’ customer files and computer data. (In an arbitration decided in August 2017, advisors who left one regional firm were ordered to pay $500,000 of compensatory and punitive damages and attorneys’ fees and costs for destroying, stealing and deleting what arbitrators agreed was non-public customer information.)

It was even more common for advisors to prematurely solicit customers before departing, with quiet encouragement of the treachery from the firms that they were about to join.

Advisors implicitly understood what they had to do to justify their fat recruiting packages: Move with speed and ensure that a sufficient volume of customer business tags along. Advisors, of course, did not inform the customers that they defected primarily for recruitment bonuses.

Recruiting firms routinely overlooked the fact that many of their recruits falsely checked the “no” box on forms asking if they were bound by non-solicit clauses, confidentiality and privacy terms with the prior firms.

The firms may have presumed the Broker Protocol trumped these contract terms, but this discrepancy was not clearly addressed in the Protocol and went largely untested in courtrooms and arbitrations during the truce. (In the new Protocol-exit era, that is about to change.)

On the flip side, the jilted firms chased advisors in arbitration for failing to fulfill terms of the promissory notes they signed to get “forgivable” signing-bonus loans. The firms pressed inventive arguments that solicitations of former customers were forbidden until the notes were paid, and often won. (Again, the Protocol did not address the issue.)

Firms also routinely “lost” account transfer forms, claimed the transfer forms were incomplete, and reassigned customer account numbers—tactics designed to delay the exodus of customer assets.

The deserted firms, for their part, coaxed customers to stay, offering free or discounted services for their loyalty. And to no one’s surprise, former colleagues routinely disparaged fleeing advisors to their former customers with exaggerated or false reasons for the departure.

And the losing firms often issued the coup de grace by “weaponizing” Form U5s, saying brokers were guided out because of alleged company and regulatory rule violations that sometimes led to FINRA investigations.

All that being said, under the Protocol there was some peace of mind for those who followed the rules. Even though more than a thousand firms remain in the pact, that sense of security may be gone forever.

It seems clear that Morgan Stanley and others who pulled the trigger were fed up with the bad-faith retaliatory tactics and the expenses of recruiting at a time that their parent banks have been ordering compensation and litigation expense cuts. (Morgan Stanley’s withdrawal coincided with an arbitration award of $1.2 million in damages to Charles Schwab, which claimed unfair recruiting tactics and misappropriation of confidential data.)

Is it a coincidence that Morgan Stanley and UBS Financial’s withdrawals come as they substantially cut its recruiting of experienced advisors, greatly limiting the value of the Protocol to the firms? (Merrill Lynch has similarly cut recruiting, although it for now remains in the Protocol.)

While it is impossible to predict whether the Broker Protocol will collapse entirely, recent skirmishes do not bode well for its future.

Morgan Stanley in December prevailed in obtaining temporary restraining orders preventing financial advisors in three separate cases from contacting former customers they claimed to have developed and serviced on their own. The rulings upheld the enforceability of the non- solicit and confidentiality contract terms in brokers’ employment contracts, a sobering sign for future mobility of advisors.

How can advisors protect themselves in such uncertain times? They should first assume that it will be much more difficult to jump-start their books at a new firm. But they shouldn’t feel stuck.

Anyone contemplating a move should diligently organize their employment contracts, promissory note agreements and workplace manuals into  package. If they are dually-licensed as registered investment advisors and insurance agents, they should gather those contracts too for presentation to their legal advisors.

Most importantly, advisors must recognize that soliciting customers before departing is never permitted.

Post-departure, the extent of customer solicitation behavior will be case-specific. Sending announcements about a new location and firm and leveraging social media with approved scripts is generally permitted, but such well-known platforms as LinkedIn and Facebook may pose risks.

It would be a mistake to presume that a move puts an advisor in customer communication seclusion, but it would also be a mistake to presume that the deserted firm is not monitoring every communication pre- and post-departure.

Advisors should keep in mind that their prior firm can trace their workplace behavior for at least 30 days. They need to restrain the temptation to copy their workplace emails, to forward or download nonpublic information about customers and to exploit data that might be stored on cellular phones, tablets and other devices.

Perhaps most importantly, advisors should not attempt to navigate these minefields alone. Work closely with your new firms’ lawyers and with your own counselors to evaluate contract terms and develop a strategy pre- and post-departure for client contact.

As the adage goes, if you want peace, prepare for war.

Reif is the managing partner of the Los Angeles office of Winget Spadafora & Schwartzberg LLP.

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