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Kitces: Is the Broker Protocol being undermined?

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Advisers at broker-dealers typically think of their clients as their very own, but the legal reality is that they’re clients of the broker-dealer. It’s not difficult to see how this misperception might lead to lawsuits when an adviser leaves, and wants to take clients along.

In the early 2000s, litigation related to broker-dealer personnel moves — and perceived client poaching — reached such a fever pitch that several of the major wirehouses of the time, Smith Barney, Merrill Lynch and UBS, executed the Protocol for Broker Recruiting. This agreement stipulated the terms under which a broker could depart a BD and take limited client information, without spurring the litigation and temporary restraining orders that were common at the time.

That doesn't mean the dust has completely settled, though. Over a decade after the protocol’s adoption, there are now signs that the agreement’s protections are being undermined, or rolled back altogether. Here, we look at what brokers must do to comply with the protocol’s terms and requirements, and the sometimes questionable ways that firms are attempting to shield themselves from the breakaway broker phenomenon.

The so-called Broker Protocol, originally signed in August 2004, was a form of cease fire between the major wirehouses of the time, who litigated when brokers were suspected of siphoning off client business when switching firms or going independent. Prior to the protocol, it was common for brokers to announce their departure in the final minutes of a Friday afternoon, and then spend the weekend racing to contact and convert as many clients as possible to their new firm.

At the same time, lawyers from the prior broker-dealer would try to find a weekend judge with whom they could file for a temporary restraining order against the departing broker to stop him/her from soliciting clients, followed the subsequent Monday by a more substantive injunction to further inhibit the broker from transitioning to a new firm. And after that, the broker-dealer would likely start litigation against the departing broker for a deemed breach of contract to not violate non-solicit or non-compete terms.

The matter was further complicated by the SEC’s 2003 implementation of Regulation S-P, which placed substantial obligations on financial services firms, including broker-dealers, to protect the privacy of client information. This greatly amplified the stakes, because a broker who changed firms and took client information along was not only acting in potential breach of an employment contract with the prior broker-dealer, but causing a privacy breach under Reg S-P — which introduced the potential of FINRA sanctions against all involved parties (including the broker-dealer for “failing to protect” client data from the departing broker).

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The Broker Protocol provided a clear process for how a registered representative could change to another firm, without being deemed in violation of any firm’s non-solicitation clause in their employment agreement, and in a manner that would not violate Reg S-P.

Notably, there were also questions at the time of whether broker-dealers were being too restrictive about brokers changing firms, in a manner that could unfairly bind clients to the firm and cause consumer harm. The implementation of the Broker Protocol reduced this regulatory risk for the firms involved.

Ironically, nearly 12 years later, the tide has shifted significantly on the protocol. What started originally as a means to facilitate intra-wirehouse recruiting and the occasional independent broker-dealer transition, may have unwittingly helped open the door to the rapid growth of the IBD and the independent RIA — particularly as the breakaway-broker trend accelerated after the financial crisis.

As a result, concerns have now begun to arise that large broker-dealers are chipping away at the protections of the Broker Protocol. Some examples could include: JP Morgan being accused of using the protocol to recruit brokers but working to inhibit them from using it when leaving, and Merrill Lynch applying pressure on brokers who try to leave and take clients that were internally referred from Bank of America’s retail branches.

Nonetheless, while the Broker Protocol started out as a closed-system agreement for broker recruiting among broker-dealers and has now led to some leakage out of the broker-dealer system altogether, it’s not clear that there’s any way to close the doors. Limiting the protocol would shatter the ability of broker-dealers to recruit in today’s environment, even as they struggle with being recruited against.

And the onset of the Broker Protocol was rumored to occur, in part, because there were concerns among regulators about the fairness to both brokers and consumers of binding brokers too closely to a particular firm. Furthermore, narrowing the Broker Protocol (e.g., to be applicable only to changes between broker-dealers) may not withstand antitrust scrutiny.

For the broker-dealers who initiated it, the Broker Protocol, or something substantively similar, appears likely to remain for the foreseeable future, for better or worse.

Specifically, the Broker Protocol permits the registered representative to bring along the following five pieces of client information:

(1) Names
(2) Addresses
(3) Phone numbers
(4) Email addresses
(5) Account titles of clients they serviced at the [former] firm

Notably, while the relocating broker can take this information along, only this exact information may be taken. Additional information, from copies of account statements and account numbers to any portion of client files or other client data, falls beyond the scope of the Broker Protocol — and its protections would not extend to a broker who collected such data, thereby opening him/her up to Reg S-P violations, breach of employment contract, or other litigation.

In fact, to fully substantiate that the departing broker took only the permitted client information, he/she must actually provide a full list of the exact client information being taken when submitting a letter of resignation to the now-prior firm. Furthermore, the Broker Protocol requires that the registered representative provide a list to the former firm of all account numbers associated with those client accounts, so the firm can ascertain which accounts are protected by the agreement.

Notably, the requirement to provide the former firm a list of all account numbers also effectively provides them a list of specific clients and related accounts, which the firm may in turn solicit to get the clients to stay. This is not necessarily advantageous to the departing broker, but providing the account number information is a requirement nonetheless.

After switching firms, the Broker Protocol permits the broker to use the transferred client contact information to request that clients sign an authorization to release account-specific information to the departed broker. This can facilitate the subsequent transfer of accounts — presuming the clients wish to transfer their accounts, of course.

A key requirement of the Broker Protocol is that in order for the broker to be permitted to take the specified client information, both the broker-dealer he/she is leaving and the new firm must be present in the Broker Protocol directory.

Fortunately, a website aptly named TheBrokerProtocol.com, maintained by the law firm Carlile, Patchen & Murphy, houses a directory of all firms that have signed the protocol agreement. The list is updated regularly, and as of this writing includes a whopping 1,446 firms — up from the founding three firms of just 12 years ago.

There is no fee to join the protocol’s member list; firms simply must submit a simple Joinder Agreement to become part of the Protocol for Broker Recruiting, which is handled by the law firm Bressler, Amery & Ross — an outgrowth of SIFMA transitioning administration of the list in May 2015. Notably, firms can also leave the Broker Protocol at any time, and withdrawals are also handled by Bressler, Amery & Ross.

In its early days, the Broker Protocol list was essentially a broker-dealer list, as the Broker Protocol by its very name is focused on brokers at broker-dealers, and was originated among the wirehouses. However, in today’s environment, the list of Broker Protocol members includes a number of independent RIAs and other wealth management firms as well.

Why the broadening? As noted earlier, in order for the Broker Protocol to apply for a moving broker, both the departing and receiving firms must have signed the Broker Protocol agreement. In fact, given this dynamic, so-called breakaway brokers who are leaving their broker-dealer to go entirely independent and form their own RIA should have their new RIA entity join the Broker Protocol before they leave their existing firm.

Of course, the timing is sensitive, as new firms that get added to the list are circulated as part of the ongoing updates to the existing member firms. Therefore, adding a new firm can tip off the departing broker-dealer. On the other hand, it’s crucial that the new firm be added by the time the moving broker actually hands in his/her resignation letter, or it won’t be permissible to actually take the aforementioned five items of client information on that day of departure. And if you’re joining a hybrid RIA and broker-dealer arrangement, be certain that both the new RIA and the new broker-dealer are Broker Protocol members.

On the other hand, while a departing broker can add his/her firm to the Broker Protocol list, there is no way to force an existing broker-dealer to join the list if it hasn’t already. While the explosive growth of the member list signifies that most firms have decided it’s an appealing trade-off — the opportunity to recruit brokers without fear of litigation, in exchange for the risk that brokers will more easily be recruited away — the firms that aren’t necessarily looking to recruit heavily in the first place may not join the list. That means a broker at such a firm is stuck with the terms of the firm’s existing employment agreement, including non-solicit and non-compete clauses, to the extent they are otherwise enforceable under state law, and has no path to use the Broker Protocol.

Note: You can check the Broker Protocol member list to see if your firm is represented, but it’s recommended you not do so from your company computers, where your browsing activity can be tracked. In addition, it is not advisable to ask your firm directly if they’re a member of the Broker Protocol, as it can tip off the firm that you’re considering a departure, which may lead the firm to take preemptive action. Look it up online directly instead.

While the Broker Protocol does provide a clear pathway for a registered representative to change broker-dealers, or break away entirely to become an independent RIA and still take a limited amount of client information, it’s crucial to fully comply with all the requirements of the protocol. Failing to comply can invalidate its protections altogether, and the courts have looked unfavorably on brokers who have not acted in good faith.

The first key issue to consider when complying with the Broker Protocol is this: Don’t tell anyone you’re planning to leave until the day comes.

Tipping off your colleagues may lead to one accidentally — or deliberately — leaking the information to your firm, which could lead them to take preemptive action. In the extreme, this could include terminating you before you have an opportunity to complete an orderly departure.

Note: You can check the Broker Protocol member list to see if your firm is represented, but it’s recommended you not do so from your company computers, where your browsing activity can be tracked.

Additionally, it’s important not to incite your colleagues to come with you, as doing so may be construed as raiding — where a recruiting firm takes a large volume of advisers and staff members all at once, which goes beyond just recruiting a broker and transcends into damaging the prior firm itself.

Although the exact definition of raiding is somewhat fuzzy and should be a non-issue when a single broker departs, a departing manager/leader who recruits away multiple advisers — or in the extreme, an entire branch or a critical mass of the entirety of a small broker-dealer’s advisers — may constitute raiding, and is not protected under the Broker Protocol. To be safe, some attorneys even advise not even telling your employees until the transition occurs, and then making offers to join you at the new firm after the fact, to avoid any risk that your departure will be seen as raiding.

It’s especially important not to announce in advance to clients that you plan to leave and solicit them to come with you. The reason is that, despite what you may think as an adviser, technically and legally the client relationship is with the broker-dealer firm, not with you. Consequently, soliciting to consider a move to your new firm before you’ve left your existing firm is a breach of your employment agreement, and can lead to immediate termination.

Only contact your clients to ask them to come to your new firm after you have submitted your resignation to the existing firm.

And bear in mind that even telling family members before the move can lead to having the information unwittingly leaked early. It’s not so hard to imagine a family member accidentally tipping off the firm by calling the office and saying, “I’m trying to reach John. Does he still work there?”

The bottom line: Be very, very cautious regarding who you ever disclose your prospective departure to before you actually submit your resignation.

When the time comes to make the transition, a crucial step is executing a clean and proper resignation.

The act of resignation should be done in writing, generally delivered in person to the local branch manager. The resignation letter itself can be relatively short and simply state the decision to resign and the immediate effective date; the longer the letter, the more you may unwittingly say something that opens the door to legal troubles.

Per the requirements of the Broker Protocol, the resignation letter should also include a copy of the exact client information/documentation that you are taking with you — which should be limited to the five specified client-information details permitted under the protocol and nothing else. This helps to substantiate that you did in fact take exactly and only the permitted information.

When the time comes to make the transition, a crucial step is executing a clean and proper resignation.

In addition, along with your resignation letter, you must include a list of all the account numbers associated with your client accounts. This list must not be taken with you beyond the resignation, as it is solely to be provided to the broker-dealer to notify them of the related clients and accounts to which the protocol applies.

Upon submitting the resignation and exiting the building, do not take any other information with you. Be certain to return everything else that is business-related back to the firm, such as any company computer, flash drives, client files, and statements.

Do not make duplicate electronic copies of this information, either saved or emailed to yourself, as taking any of this information can violate client-data privacy and open you to potential SEC and FINRA fines and regulatory discipline, in addition to breaching the Broker Protocol itself and rendering its protections invalid, and further exposing you to litigation from the departed broker-dealer — along with a potential temporary restraining order to further halt the transition and solicitation of now-former clients.

Once your resignation has been submitted, it’s time to finally solicit your now-prior clients to join you. However, you still may not actually solicit clients until you are formally employed at your new firm. In practice, many recruiting transitions or breakaways are deliberately coordinated to make the new firm’s registration live the same day that the resignation occurs to allow for an immediate switchover. But this must be planned in advance for proper execution.

When soliciting clients to make the switch, it’s also crucial to recognize that only the actual departing adviser who resigned under the Protocol for Broker Recruiting has the right to solicit those clients. Other employees or adviser colleagues at the new firm do not have the right to contact and solicit those clients. All points of contact must initially come directly from the moving broker, until clients have agreed to make a transition. Then, and only then, can supporting staff be involved.

In addition, departing brokers should be cautious when soliciting clients not to disparage the prior firm, lest they risk exposing themselves to litigation for libel or slander. The discussion with those clients should focus instead on the virtues of the new firm, or the benefits of going independent, or whatever other benefits there are for working with the new firm.

When soliciting clients to make the switch, it’s also crucial to recognize that only the actual departing adviser who resigned under the Protocol for Broker Recruiting has the right to solicit those clients.

Also, remember that the prior firm can and almost certainly will begin immediately to contact your now-former clients and solicit them to stay. While the Broker Protocol permits the departing broker to take specified client information in order to solicit the clients to make a change, it does nothing to limit the departed firm from also contacting those clients and asking them to work with a new broker in-house. And of course, the firm will know exactly which clients those are, as the list must be provided along with the broker’s resignation letter.

While the Broker Protocol does allow moving brokers to take specified client information with them and solicit those clients, it’s worth recognizing that there is occasionally some debate about which clients are subject to the rules.

In general, clients that the registered representative developed and brought to the firm in the first place are recognized as being protected under the protocol. But clients that weren’t actually brought in by the broker themselves are often subject to more scrutiny.

For instance, when the broker is part of a team — an increasingly popular structure at wirehouses — the situation is more complicated, as many brokers are often involved in supporting the combined client base. Accordingly, there may be a team agreement that stipulates additional rules as to whose clients are whose, in the event that one member of the team chooses to depart. Some of these team agreements are very restrictive if/when an adviser does want to break away on his/her own.

In the absence of any specifications in the team agreement, the Broker Protocol states that by default, once a broker participates in a producing capacity with a team for four or more years, all the team’s clients are fair game. If the broker had been participating in the team in a producing capacity for fewer than four years, the Broker Protocol only protects information for clients that the particular broker brought into the team.

Another complicating situation: where the firm itself introduced the clients to the broker. This may take the form of an internal referral program from another division of the firm — for example, referring a retiring client from the 401(k) division to the broker for an IRA rollover — or an arrangement where the broker is paid to service the client of another broker who retired. In those situations, additional agreements between the broker and the firm may apply, dictating the terms of those internal referrals, and potentially limiting those clients from being eligible for Broker Protocol treatment.

Beyond the process of complying with the Broker Protocol itself, there’s far more involved in executing a clean transition away from a broker-dealer, whether it’s to be recruited to a new broker-dealer or breaking away to form or join an independent RIA.

Perhaps the biggest issue is simply the sheer business disruption involved: learning new software and systems, the race to solicit and transition former clients, the massive income gap that can occur while waiting for clients to get up and running — and be billed — at the new firm, to name just a few potential challenges.

Even in the best of circumstances, income can dip precipitously for several months while clients are being solicited and client assets are transitioning, which means the adviser’s new practice needs to be certain to have enough working capital to manage business expenses and employee salaries until revenue picks back up again. Fortunately, there are lenders now available to help finance the working capital for those transitions.

In addition, it’s important to remember that while following the Protocol for Broker Recruiting does reduce the moving broker’s exposure to liability for taking limited client information and soliciting those former clients, it does nothing to change the terms of any prior retention deals at the prior firm, including any forgivable loan terms. The latter is especially crucial to consider, as just walking away from a retention deal means income that won’t come in, but a forgivable loan means dollars will be due to the prior broker-dealer when walking away. Fortunately, again, lenders are available that will help finance the repayment of a forgivable loan, at least turning the obligation into a more manageable ongoing payment instead of a lump sum commitment.

It’s also helpful to recognize that when the time comes for a transition, some client assets and accounts are easier to transition than others. While the terms of the Broker Protocol require the broker-dealer to allow the moving broker to take certain client information and cooperate with subsequent ACAT transfer requests, proprietary funds that can only be held on the prior broker-dealer’s platform are still proprietary, and don’t have to be transferred.

It’s important to remember that while following the Protocol for Broker Recruiting does reduce the moving broker’s exposure to liability for taking limited client information and soliciting those former clients.

Similarly, not all third-party managers are available on all platforms, and may not be transferrable, either. Thus, while ultimately it’s still important to invest in solutions that are right for the client first, some solutions are more easily transitioned to a new broker-dealer than others, which is a consideration when evaluating which products to put client investment dollars into in the first place.

Perhaps the most important step of all, though, is simply to review the existing employment agreement with the broker-dealer — that document covering everything from compensation and retention bonuses to the crucial non-compete and non-solicit terms. Although the whole point of the Broker Protocol is that it effectively overrides the existing employment agreement’s non-solicit terms, that’s only true specifically for the non-solicit terms — and generally only for clients brought in or developed by the brokers themselves. The rest of the employment agreement still applies, and must still be honored.

And the consequences for noncompliance are substantial. Not only does failure to comply with the Broker Protocol open up the departing broker to potential litigation — including a temporary restraining order to prevent the solicitation of clients — it can also embroil the new firm in litigation, which it will certainly not appreciate, and may slow or damage the transition process such that few clients even come to the new firm.

This, in turn, may lead the departing broker to fail to qualify the terms of his/her recruitment with the new firm, leading the deal to fall through altogether, and leaving the broker with a potentially blemished U-4 and BrokerCheck record, presuming the departed firm reports the inappropriate departure and client privacy breaches on the U-5 termination form. And if the broker failed to act in good faith in at least trying to comply with the Broker Protocol, the courts may take a heavy hand as well.

In other words, while the Protocol for Broker Recruiting provides a path of safety, stepping off the path can have dire consequences for the broker’s business. As a result, it is highly advisable to engage a competent attorney to support the transition, and ensure that every requirement of the Broker Protocol is handled properly.

The list below includes a number of attorneys and law firms that work with brokers who are departing broker-dealers and want to ensure compliance with the Broker Protocol, or who otherwise want help navigating a transition to or from a firm that is not part of the protocol. Because the needs and issues are at least slightly different in execution depending on whether the moving broker is going from/to a wirehouse, an independent broker-dealer or an independent RIA, the specialties of each firm are noted where applicable.

Law firms that work with brokers to assist in Broker Protocol and broker recruiting compliance:

Stark & Stark (any transitions)
MatasarJacobs (transitioning to another broker-dealer)
Vernon Litigation Group (transitioning to another broker-dealer)
MarketCounsel (transitioning to independent RIA)
Patrick Burns Law Offices (transitioning to independent RIA)
AdvisorAssist (transitioning to independent RIA)

So what do you think? Have you ever gone through the process of breaking away from one broker-dealer to another, or to an independent RIA? Any tips you wish to add, or negative experiences as a warning to others? Please share your thoughts in the comments below.

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