The Protocol for Broker-Dealer recruiting was adopted in 2004 by Merrill Lynch, UBS PaineWebber and Smith Barney and quickly developed into an almost industry-wide agreement between firms, with more than 1,800 current signatories. The Protocol was designed to ease the legal burdens behind an advisor moving firms by spelling out the steps one could follow to communicate with clients, take certain client information, move business to new firms, and avoid being sued in the process.
There has been a recent shift away from the Protocol, with three of the largest investment firms pulling out since late 2017. Morgan Stanley, UBS, and Citibank have all withdrawn from the Protocol, which means advisors with these firms may no longer rely on the provisions of the Protocol that permit advisors to take certain client data and solicit clients when transitioning from one Protocol firm to another. Advisors looking to leave these firms, as well as any other non-signatory to the Protocol, will now be faced with an increased litigation risk. Lawsuits arising out of these issues typically start with the filing of a lawsuit in federal or state court and typically involved a request by the former firm that the advisor be temporarily stopped from speaking with any clients or taking any client information. Courts are often presented with evidence showing what the advisors did leading up to their departure, whether they downloaded client information, whether they emailed client information to themselves or others, and whether they made any attempts to solicit clients. In the modern age of technology, much of this activity can be easily traced through analysis of computer systems and other forms of information technology. And for cases with FINRA Broker-Dealers, there will likely be a companion FINRA arbitration matter to decide the issues.
The timing of these changes is interesting for a few reasons. First, the percentage of revenue generated from commissions — the traditional source of revenue for Broker-Dealers — has decreased in recent years as the percentage of fee-based revenue has increased. With this trend toward fee-based or advisory business, there is a potential incentive for Broker-Dealers to create structural impediments to advisors looking to take their business to a small Registered Investment Advisor (RIA). Second, the independent-broker dealer model has continued to grow in popularity in recent years, with independent broker-dealers seeing a compound annual growth rate in assets of 11%, nearly double that of wirehouses, according to recent research from industry consultant Cerulli report. Some of the more well-known independent broker-dealers — notably, most of which are signatories to the Protocol — are part of a group that has traditionally relied on recruiting efforts to attract high-producing advisors to drive growth. This growth model is at odds with the traditional wirehouse model or bank broker-dealer model, which often relies on name-recognition and talent retention. The timing of Morgan Stanley, UBS, and Citibank withdrawing from the Protocol is also interesting because it comes at a time when the investment industry is hyper-focused on putting clients’ best interests first. Starting with the Dodd-Frank Act, then the Department of Labor’s fiduciary rule, and now with the Securities and Exchange Commission’s proposed Regulation Best Interest (Reg. BI), the industry has been grappling with how to best define rules that require all professionals — whether classified as a registered representative providing advice for a commission or as an advisory providing advisory services for a fee — to place their client’s interests ahead of the firm’s and the advisor’s. This “client-first” mantra is hard to reconcile with firms withdrawing from the Protocol — creating legal hurdles that make it harder for clients to communicate with their advisors or follow advisors to new firms.
With the changing landscape surrounding advisor recruitment, it is more important than ever for advisors to understand the following:
- Do I have written agreements with my firm (e.g., employment agreements, rep. agreements, production agreements, etc.)?
- Do my agreements contain confidentiality provisions, restrictions on client solicitation, restrictions on competition, or other restrictions that define what may or may not be done with documents and/or information upon my departure from the firm?
- Is my current firm/potential new firm a signatory to the Protocol?
Change is inevitable, and advisors will undoubtedly change firms throughout their careers. Engaging experienced counsel is vital to understanding how to properly navigate those changes and minimize risk and uncertainty.
Originally published in Crain’s Cleveland Business, February 17, 2019.
Brian P. Nally is a shareholder in the Cleveland office of Reminger Co., L.P.A. His national litigation practice focuses on securities litigation and arbitration, securities regulatory defense, business and commercial litigation, and directors and officers liability. He has been a CMBA member since 2010. He can be reached at (216) 687-1311 or email@example.com.