Good Move – The Legal Non-Protocol Exit

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Good Moves Bad Moves Legal storiesJohn Lockedin was at the end of his rope. He was the top producer in his branch and had been so for five years. His clients had outgrown the proprietary products his branch manager wanted him to push. His compensation grid was good, but far below industry standards. He could make a lot more if he left his firm, Edward Stanley. Adding to his stress, was the fact that he had signed an agreement not to solicit his clients if he made a move. He also had a promissory note that was awarded to him for his outstanding performance. The note also contained a covenant not to solicit his clients. Even worse, he had been granted an equity buy back with strings attached. He knew all of these devices were designed to inhibit his upward mobility by stopping him from moving for a better opportunity. He thought his career was finished. Frustrated and anxious, he called his best friend, Knewt Freeman. Knewt had just been through a move and suggested that John talk to his lawyer. 

The lawyer told him that there were many financial advisors who would like to move but are not employed by a protocol-member firm. Likewise, he told him that there are advisors that have an excellent opportunity to move to a non-protocol firm. These financial advisors are not frozen in career purgatory. These financial advisors can move if they manage their movement risks. The lawyer reminded John that before the year 2004, there was no Protocol for Broker Recruiting and financial advisors moved all the time. They and their lawyers managed the litigation risk through good advice and planning. Advisers need to have an appreciation of the risks and legal climate that surrounds movement.

To his surprise, the lawyer told John that, by and large, the law favored movement and despised injunctions. John and his lawyer then discussed some of the risks and legal factors that favor a move. 

THE RISK AND COST OF AN INJUNCTION

The risk is not that an action for an injunction will be filed, but that an injunction will be entered. When you leave your old firm, you want to call all of your clients and have all of your clients move with you. The first two weeks are critical. Your old firm will want to stop or interfere with your solicitation efforts during this crucial time by filing for a temporary injunction. 

The first thing to do is find out from your new employer if they will pay your legal costs. Many will. Find out. If they won’t, find a very competent industry savvy lawyer and get an estimate. Use the estimate to determine if the move will be profitable by considering the probable percent of your clients that will come with you and stay for a reasonable time. Some folks use 80% for five years for example. If the numbers make sense, have your lawyer familiarize you with the process and your chances of avoiding an injunction. 

THE PROCESS FAVORS YOU

The process cuts in your favor. Your old firm can’t file an action against you for an injunction unless they simultaneously file a FINRA arbitration, FINRA Rule 13804 (a) (2). This lets your lawyer argue that the court should not act at all because FINRA will figure out if anything is wrong. Many courts are hesitant to act when there is an industry body like FINRA that has special expertise. If you draw a judge that takes this approach, you win. Even if you lose a temporary injunction hearing, FINRA must convene a panel to review the court’s order within 15 days, FINRA Rule 13804(b). This is helpful because FINRA panels usually dissolve the court injunction.

SOME INJUNCTIONS ARE PROHIBITED BY FINRA RULES

FINRA rule 2140 specifically precludes the following:

No member or person associated with the member shall interfere with a customer’s request to transfer his or her account in connection with the change in employee of the customer’s registered representative… Prohibited interference includes, but is not limited to, seeking a judicial order or decree that would bar or restrict the submission, delivery or acceptance of a written request from a customer to transfer his or her account.

The SEC adopted FINRA Rule 2140 after determining that seeking injunctive relief when an employee changes employment is an unfair practice that causes unnecessary delay in transferring customer accounts. See SEC Release #34-59495. Furthermore, the SEC found that the practice of seeking injunctive relief is inconsistent with the just and equitable principles of trade. The SEC’s reason for adopting this rule is the recognition that it is the customer who should have the choice who their financial advisor is and not the wire house that employs the financial advisor. Lawyers argue and courts agree that customer relationships are uniquely personal in the brokerage business. A special, intimate character of the relationship arises out of the client’s detailed sharing of his or her financial situation and objectives, and out of the broker’s conscientious servicing and protection of the client’s particular needs. The recognition of the special relationship is routinely cited by courts when denying injunctions being sought by former employers. 

“A broker/client relationship like a lawyer/client or doctor/patient relationship is a personal relationship dependent on personal trust. Clients should be free to deal with the broker of their choosing and not subjected to turnover of their accounts to brokers associated with the firm but unfamiliar to the client unless the client gives full informed consent to the turnover. As the district court in De Liniere, 572 F. Supp. 249 noted “the public has a greater interest in being able to choose whether to follow its broker to a new firm or remain at the old firm with a new broker. The public has little interest in having its choice restricted to brokers other than the one that has served them…’” Prudential Securities, Inc. v. Plunket, 8 F. Supp. 514-520 (E.D. Va. 1998) (denying a preliminary injunction to the brokerage house). 

Courts give the fiduciary nature of the relationship between an advisor and client great weight in denying injunctions. 

“A stock broker stands at a different relationship to his customer from that of other kinds of salesmen, and fiduciary duties of a broker are recognized in law because of the important role of the broker in protecting the financial welfare of his clients. The public’s ability to choose the professional services it prefers is central to this criteria of injunctive relief.” Merrill Lynch, Pierce, Fenner & Smith v. De Liniere, 572 F. Supp. 246, 249 (N. D. Ga. 1983) (denying an injunction to the brokerage house). 

Courts routinely deny injunctions against financial advisors who have covenants not to solicit because the clients look to the advisor as their personal financial consultant and those clients should not be denied expertise regarding their investments.  See, Wells v. Merrill Lynch, 1919 F. Supp. 1047, 1053 (E.D. Ky. 1994).

MANY COURTS DENY INJUNCTIONS AGAINST ADVISERS BECAUSE THE PUBLIC INTEREST WILL BE DISSERVED

As one court said, 

“Each member of the affected public has right to learn that the broker with whom he entrusted his accounts is no longer servicing her accounts because the broker has gone to another firm. It is in the best interest of the public, therefore, that these affected clients be informed of Ms. McCullen’s move so that they might decide on their own whether to follow her to Prudential or to stay with Merrill Lynch to be serviced by another broker there. Merrill Lynch is not restricted in any to way from in good faith attempting to convince the clients to keep their accounts at Merrill Lynch but ultimately it is each client’s own informed decision to make. Therefore the court cannot find that the denial of Merrill Lynch’s request for IR against the broker would be contrary to the public interest.” Merrill Lynch v. McCullen, 1995 WL799537 (S.D. Fla. 1995).

THE GENERAL LAW OF COVENANTS NOT TO SOLICIT FAVORS THE ADVISER IN MOST STATES

The typical adviser nonsolicit agreement is extremely disfavored in most states. Most courts and legislatures believe that their citizens should be free to compete unhampered by restrictive covenants or covenants not to solicit. Many states have found that covenants not to solicit are a particularly pernicious form of anti-competitive activity. Accordingly, a majority of the states have passed statutes which prohibit or severely curtail the enforcement of covenants not to solicit. California for instance bars them entirely,” Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” Cal. Bus. & Prof. Code § 16600. Other states severely curtail their enforcement. See: e.g., C.R.S. 8-2-113.

THE DISTINCTION BETWEEN AN ANNOUNCEMENT AND A SOLICITATION IS FREQUENTLY HELPFUL

Even in the states which do permit non-solicit agreements, there are exceptions for announcements that can be taken advantage of by the departing advisor. In most states, it’s possible for financial advisors to announce that they have moved to a different firm and give their new contact information. Lawyers call these states “Announcement States”. The courts in Announcement States hold “merely informing customers of one’s former employer of a change of employment, without more, is not a solicitation.” See: e.g., Alpha Tax Services, Inc. v. Stuart, 761 P.2d 1073 (Ariz. Ct. App. 1988) or Aerotek, Inc. v. Johnson Grp. Staffing Co., 2013 Cal. App. Unpub. LEXIS 5424, 2013 WL 3947750 opining:

Our Supreme Court has recognized that “[m]erely  [*22] informing customers of one’s former employer of a change of employment, without more, is not solicitation. Neither does the willingness to discuss business upon invitation of another party constitute solicitation on the part of the invitee.” (Aetna Bldg. Maintenance Co. v. West, (1952) 39 Cal.2d 198, 204, 246 P.2d 11 (Aetna).) Aetna explained that ” ‘Solicit’ is defined as: ‘To ask for with earnestness, to make petition to, to endeavor to obtain, to awake or excite to action, to appeal to, or to invite.’ (Black’s Law Dictionary, 3rd ed., p. 1639.) ‘It implies personal petition and importunity addressed to a particular individual to do some particular thing . . .’ (Golden & Co. v. Justice’s Court, 23 Cal.App. 778, 798, 140 P. 49.) It means: ‘To appeal to (for something); to apply to for obtaining something; to ask earnestly; to ask for the purpose of receiving; to endeavor to obtain by asking or pleading; to entreat, implore, or importune; to make petition to; to plead for; to try to obtain.’ (People v. Phillips, 70 Cal.App.2d 449, 453, 160 P.2d 872.)” (Aetna, supra, at pp. 203-204.)

A strong argument can be made that each Adviser has a duty to tell his or her clients that he has moved and where he is. In Announcement States the adviser can mail an announcement to his former clients, informing them of his new contact information. He can also call clients by telephone for the limited purpose of providing them with his new contact information. This is not considered a solicitation that can trigger an injunction. 

WHAT YOU NEED TO KNOW

There are many financial advisers who would like to move who are not employed by a Protocol member firm. Likewise, there are advisers that have an excellent opportunity to move to a non-protocol firm. These financial advisers are not frozen in a career purgatory. These financial advisers can move if they manage the movement risks through good advice. After all, before the Protocol for Broker Recruiting, financial advisers moved all the time! They simply managed the risk of moving through good advice. This article is not legal advice. You should hire the best lawyer you can find. 

The author, James R. Miller, has been a practicing trial lawyer for 45 years. He has assisted financial advisers for a majority of those years. He is the founder of James R. Miller Movement Lawyers, LLC.

JAMES R. MILLER
www.jamesrmillerconsultants.com
JamesMiller@JamesRMillerConsultants.com
720-893-4747

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