Overview of Broker Protocol Rules
The Broker Protocol was formed in 2004 when Smith Barney, UBS, and Citigroup Global Markets (now part of Morgan Stanley) recognized that competition between firms had led to an increase in the number of employment disputes. Compounding this were the costs associated with litigation, including legal costs, discovery costs, and time lost by advisors. The Protocol’s founders were concerned that costs were raising client fees, creating problems for investors, and hindering the ability of financial advisors to meet the needs of their clients. In 2005, the Protocol was formalized as the Protocol for Broker Recruiting or the Protocol. The original firms signing the Protocol were: A.G Edwards, Ameriprise Financial, Banc of America Investment Services, CitiGroup Global Markets, Edward Jones, Fidelity Investments, Goldman Sachs, Legg Mason Wood Walker, Legg Mason Investment Counsel, Merrill Lynch, National Planning Corporation, Raymond James Financial, Smith Barney, Stifel, UBS PaineWebber, and Wachovia Securities. These 15 firms collectively represented more than 50 percent of all registered financial advisors at the time. In 2016 , a total of 608 financial firms belonged to the Broker Protocol. Joining the Protocol means that in the event of a "protocol break" where an advisor leaves one firm and goes to another the brokers’ sanctioned information is not the property to be divulged by the ex-employee. The departure must be specifically listed under the rules and parameters of the Protocol. List is as follows: These definitions can be broken down even further. Trailing documents refers to the documents that would typically be generated by an advisor. Examples include: account statements, performance reports, confirmations, trade tickets, etc. Transitory documents refers to the documents that would usually pass through and advisor’s hands in the course of doing business. Examples of these are: firm generated document such as cost basis reports, prospectuses, internal reports, fee schedules or the like. Marketing materials refer to documents used to communicate with potential or current clients. The final category is other which includes clustered or grouped information such as notes or thoughts about a current or prospective client’s ability to invest.
What are the Main Principles of Broker Protocol?
The overall findings of The Protocol for Broker Recruiting and Index Model Protocols, Inc. (collectively known as the "Broker Protocol") are that both departing brokers and their new firms have rules to follow during a transition. These rules seek to create a measure of fairness in the way they plan to compete with each other for clients. The Broker Protocol identifies certain information that is permissible to take, and other information that is off-limits.
Self-generation vs. Firm Affiliation Information
First, it is important to note that the Broker Protocol only governs the transition of a departing broker who proactively "self-generates" the clients with whom he or she will be immediately competing after the transition. In other words, it does not apply to mass-mailing lists of former clients, or lists containing a departing broker’s statement of assets under management.
Second, the Broker Protocol identifies what information is acceptable to take when moving from one firm to another and when a broker must leave behind his or her assets under management. In general, the information that is acceptable to take falls under the umbrella heading of "self-generated information," such as client contact information, assets under management, and specific account information. Any information that a broker generated himself or herself, using no company information – such as office visits or client meetings – is acceptable.
Conversely, the following types of information are not acceptable to take: phone book lists, office meeting lists, client lists using information provided by the firm such as contact information, account information, assets under management, etc., current staff contact information, etc. This information is considered to be company information, and by taking it the broker would be in violation of the Broker Protocol.
Client Interactions and Asking Questions
In general, when a broker transitions from one firm to another, he or she should engage in certain behavior that is consistent with the Broker Protocol:
Whether a broker has sufficiently complied with these rules will be determined on a case-by-case basis, and therefore, a broker should consult an attorney before making a transition.
In terms of asking clients questions about information remaining at the transferring broker, such as assets under management, there are rules to keep in mind. As described above, a broker may ask this information directly if it is self-generated, and he or she has specific information on the client. Alternatively, if the broker knows only a small amount of information, and the information is already present at the new firm, then a broker may ask questions of the client to assess that information.
Documentation
A broker must remember that in keeping documentation for the transition, he or she can only retain self-generation information, or information resulting from office visits and contact with the clients. If there is further documentation, the broker may keep it in a "locked box" format. This means that while the client information may be used internally within the new firm, it must remain secure as it will be disabled for use in other contexts.
Advantages for Financial Advisors
One of the most important benefits of the Protocol for Broker Recruiting is the retention and protection of existing clients. For an advisor who moves to a new firm, potential clients are generally not going to go with them if they have to start over from scratch because their prior firm has sued the advisor for moving a client or two.
For example, if an advisor moves to a new firm, and a client decides to go with the advisor, the client would become subject to a Broker Protocol lawsuit by the former firm. When a firm files a lawsuit against an advisor, that information is made public on Bloomberg, etc., and clients are generally reticent to move with the advisor if it appears to be contentious or if the client has to take sides against their former firm to follow the advisor to the new firm. Also, if the client is part of the lawsuit, they could be subject to a subpoena, and many advisors will tell you that would be the tipping point at which the client would say "enough of this."
Furthermore, even if the prior firm does file a lawsuit against the migrating advisor, a firm that is a signatory to the Protocol for Broker Recruiting agrees it will not sue for any conduct authorized under the Protocol. That means no lawsuits, no injunctions, no non-solicitation of any employees or clients of the former firm. This greatly reduces the risk associated with leaving for an advisor.
How to Handle a Broker Change
For many brokers, starting out with a firm, after 20 years they choose another firm, and the cycle continues. As brokers move from firm to firm with greater frequency, the need for awareness of the particulars of broker transitions under the protocol becomes necessary and simply practical. Here are some tips to consider:
- Choose a firm that is a signatory to the Protocol. For firms to have signed the broker protocol, they must have adhered to certain measures set forth in the protocol. If you choose a broker non-signatory firm, you have to be careful not to reveal your non-public information as it may give rise to claims against you for violation of confidentiality.
- Check the broker non-compete provisions. Even if you are a member of the broker protocol, you may have a non-compete in place that prevents you from transitioning. Carefully review your employment agreement before moving to make sure you have sufficient leeway to change firms absent a non-compete violation.
- Prepare a list of contacts. A list of "clients" is necessary to take with you when you leave your current firm and join the new one. The creation of the broker protocol means that in most cases this is limited to the "clients" you have serviced and worked with over the "last twelve months." It is important to know who your firm considers a "client" and what the "last twelve months" means. It may mean the last calendar year or the last twelve months over any given date. But, to be safe, you should consider "clients" to include everybody you have a relationship with at the firm.
- Prepare for a transition of two months. This is sometimes the hardest thing to do. Your current firm will likely put a hold up on your ability to transition for the first seven to up to 90 days after notification of your desire to transition. You need to think about this when timing your move to a new firm.
Potential Drawbacks or Limitations
While the Broker Protocol offers a range of advantages and a relatively straightforward process for individual brokers, it is far from perfect. For starters, not every firm is a participant in the Protocol. In addition, even for those that are, many firms impose limitations on the methods of solicitation that departing brokers can use. Particularly at risk are the bulge bracket firms that participate in the Protocol. By the very fact that they are sizable participants in the Protocol, firms such as these risk ending up on the wrong side of a protocol fight. If these firms were to leave, it would only take one or two comings and goings for there to be significant wealth and expertise outside the Protocol . Similarly, some firms simply choose to leave the Protocol (such as Morgan Stanley). In those cases, it is often because they are facing repeated Protocol walkouts. In addition, not all firms interpret Protocol rules the same way. What’s more, the rules themselves can sometimes be vague. These challenges can lead to a heightened risk of litigation, leaving broker-dealers in a difficult situation where they are constantly worrying about Rule 7.3 violations, even when they are compliant. The rules can be especially problematic for departing advisors, who often find it difficult to know the specific limitations that a particular firm might have put on their ability to solicit former customers.
Latest Modifications or Updates
We understand that staying abreast of developments in the industry can be difficult. There are significant developments to the SEC Investment Advisor registration rules, FINRA market impact studies and broker protocol to name a few. It can be overwhelming, to lawyers included, in trying to follow the changes in all of these areas. That is why we like to provide readers of this blog with updates in these areas every few months. Below is the most recent update we have for you.
Updates and changes to broker protocol rules are few and far between; however, last year UBS and Morgan Stanley left the protocol. Some years prior, Wachovia Security also left the protocol. Those departures are currently the only ones affecting the protocol rule. In the meantime, the protocol has held strong with over 600 signatory firms. We have seen several large wirehouses expand their protocol signing by opening new offices with their own employees (practices they had been acquiring) claiming their departure from the protocol was wholly attributable to being larger than necessary for a wirehouse firm. Toward the end of 2014 Baird and RBC signed up for the protocol. These were the first firms to join since February 2013 when J.P. Morgan also signed up for the protocol. The protocol rule changes will affect a financial advisor’s decision making in determining whether to leave his/her firm. If the protocol rule changes to allow departing financial advisors more time to migrate their clients into a new affiliated practice under a different employer, it will make it easier for the advisory to jump firm; however, the amount of time an advisor can establish his/her practice will likely be dictated by the associate agreement between the advisor and his/her current employer. Different states have passed data retention laws that would impact the ability of financial advisors to obtain their stored email and documents located on their employers’ servers. New York City has a whole host of new rules concerning non-compete clauses that now apply to most contracts executed after May 15, 2014. These two recent updates may cause some financial advisors to leave their current firm as well. A change in a protocol rule will not affect the current protocol signatory’s decisions to leave. The protocol rule only applies to the firms that join the protocol. If a financial advisor leaves a signatory firm, he/she will have the benefit of the protocol rule at his/her new employer firm, but a financial advisor that moves to a non-signatory firm is not entitled to the benefits of the protocol rule. We look forward to providing readers of this blog with future updates and changes to the broker protocol rule.
Examples and Case Studies
Understanding the nuances of Broker Protocol rules can be difficult without real-life examples. A financial advisor who was proficient in the protocol probably would not have been compelled to file a temporary restraining order in the case Thompson v. Morgan Stanley (N.C. Super. Ct. Nov. 29, 2013). The plaintiff, who had traded at Thomson and McKinnon Securities Inc., was able to brush aside his former employer’s efforts to enforce a noncompete agreement prevented him from practicing in through broker-dealers based in San Francisco or, "indeed, within the city limits of San Francisco," and win a temporary restraining order (a preliminary injunction was granted later).
Or look at MOMO Financial, LLC v. Yelp Inc., No. 15-10435(N.D. Ill. 2015), where a salesperson left Yelp to join a start-up called MOMO. Yelp, which was based in San Francisco, believed it had been put at a competitive disadvantage because a number of its Yelp Vendors Specialists had joined MOMO, along with their client lists and other confidential information.
In response, Yelp went after MOMO. It threatened to sue not only MOMO itself but also the individual YVS employees who had left the company to join the start-up. Yelp argued that these employees had violated the protocol by bringing over client relationships and other confidential information.
But the court sided with the defendants. It noted that the protocol’s dispute resolution provision called for confidential arbitration and that the agreement did not provide or contemplate public adjudication in a state or federal court. "It just didn’t happen in this case," the court added.
The Yelp example shows exactly how quickly legal proceedings can unravel when the dispute resolution rules set forth in the protocol are ignored. But the publicity surrounding the case demonstrates that litigation can be avoided if protocol rules are adhered to.
Future of Broker Protocol
The Broker Protocol is always evolving and its future may look different than its current form. These changes could come about through various means, including the entry of private equity firms into the wealth management space. Private equity firms have made their mark on an array of industries throughout the nation. In the wealth management industry, they are increasingly becoming players by acquiring large-sized wealth management firms that are ripe for consolidation. This influx of new buyers may endeavor to make their arbitrable assets more secure through the federal courts. That is, private equity firms may try to assert that Rule 12 of the Broker Protocol is broad enough to protect all of a firm’s accounts, regardless of whether they are held at another Protocol firm. However, based on the language of Rule 12, this assertion would likely fail. Broker-dealers can almost certainly rely on Circuit Court precedent to shore up their state court pleadings when seeking to compel compliance with the Protocol. As private equity firms continue to grow their wealth management businesses, it is also possible that they will seek to wind down the policy in favor of non-binding guidelines that resemble FINRA’s rules. These types of rules would be binding on members, essentially replacing the Broker Protocol and reestablishing a right of agreement. With many member broker-dealers violating the Protocol, such a transition may be seen as cutting losses so as to vindicate legal claims against breaking firms . Whether the increased entry of private equity firms will lead to the demise of a robust Broker Protocol is unclear. The financial industry will have to wait and see how the private equity wave will affect the Protocol. Changes in national employment trends could be another way that the Broker Protocol might come to an end. More and more workers are entering the gig economy in which individuals are employed on a temporary basis. As millennials continue to enter the working world, it is likely that they will continue to change employers at a high rate of frequency. As a result, the data from these individuals will travel with them, which, in turn, means the Protocol’s rule on transitioning client data may become unenforceable over time. Any transitional arrangement (including the Broker Protocol) must be compatible with how employees will naturally behave. When the Protocol was adopted it was observed that "once a customer has been serviced by a financial advisor at a firm, he or she tend[s] to want to remain with that advisor as long as possible." If financial advisors are employed at a high rate of turnover, there may be no incentive for clients to stay with that advisor for months or years on end. In addition to private equity and the gig economy, changes in federal regulation could also alter the Broker Protocol. If an administration were to change the rules regarding non-compete and non-solicitation contracts, the Broker Protocol could also be on the chopping block.