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Advice For Registered Representatives: Six Lessons From Cases Implicating The Protocol For Broker Recruiting

The Protocol for Broker Recruiting governs the employment transitions of registered representatives of financial firms, broker-dealers, and wire-houses. Signed with the stated goal of ensuring client privacy while enabling client freedom of choice, the Protocol allows a departing representative to take certain limited client information to his or her new firm. The departing representative can then immediately solicit past clients so long as both the former and hiring firm are signatories to the Protocol, the departing representative does not begin to solicit his or her clients before resigning, and the departing representative leaves behind a list of the information he or she has taken.

Because the Protocol, to which over 900 entities are signatories, trumps non-solicitation covenants, it has enabled smooth transitions for registered representatives while substantially reducing litigation. However, lawsuits between a former firm and its departing employee and/or its hiring firm may implicate the Protocol. Questions might arise about whether the employee or its new firm has breached the Protocol and about whether the Protocol should apply at all. Here are six lessons we’ve learned from those cases.

1. Courts look favorably on those departing employees who act in good faith.

When a Protocol-signatory firm wants to enjoin a departing employee who has left for another signatory firm from retaining information about or soliciting former clients, a court will ask whether it is likely that the departing employee breached the Protocol. Those employees who have acted in good faith are likely to be able to continue to solicit their former clients while those who have clearly exceeded the scope of the Protocol are likely to be enjoined by the court.

In one case, the representatives took a list of mutual fund ticker symbols, the names of three hedge funds and the aggregate amount of assets that their clients had invested in each one. Credit Suisse Securities (USA) LLC v. Lee, No. 11 Civ. 08566(RJH), 2011 WL 6153108 at *5 (S.D.N.Y. Dec. 9, 2011). But this did not violate the Protocol because the defendants only took a vague set of information that did not reveal any single client’s personal information, and because the limited scope of the information would not put the defendants at “any distinct competitive advantage.” Id. at *5. Also, even though there was a file containing client information on a defendant’s personal computer, the defendant acted in good faith by deleting the file upon discovering it. Id.

Courts will not tolerate those who act in bad faith or violate the letter or spirit of the Protocol. One departing employee emailed to his personal email address clients’ financial plans and other confidential information when he resigned. He sent many of those emails “in the course of three minutes, on a Friday night, approximately one week before he attempted to resign.” The court decided his actions suggested he took confidential client information and then tried to use the Protocol to avoid the terms of his other restrictive covenants. His actions went “against the terms and spirit of the Protocol.” American Financial Services, Inc. v. Koenig, Civil Action No. 11-6140-NLH-JS, 2012 WL 379940 (D.N.J. Feb 6, 2012).

2. Do not take the information regarding or attempt to solicit clients that you did not personally acquire, develop, or bring to the firm.

Courts are more likely to allow a departing broker to contact and solicit those clients that that broker earned when working at the former firm as opposed to those clients that the broker acquired via a coworker or the firm’s goodwill. For example, a financial advisor who left a team with whom he had worked and signed a restrictive covenant could not solicit any clients other team members had acquired. UBS Financial Services, Inc. v. Christenson, Civil No. 13-1081 (MJD/JSM), 2013 WL 2145703 at *4 (D. Minn. May 15, 2013). However, the advisor was still allowed to reach out to the disputed clients to inform them of his departure because “there is a difference between soliciting and contacting.” Id at *5.

3. Courts have refused to recognize the Protocol as an “industry standard”

Since the Protocol is a contract, it cannot bind a nonparty. Therefore, non-signatories can sue departing representatives who violate non-solicitation agreements. See Hilliard v. Clark, No. 1:07-cv-911, 2007 WL 2589956 at *8 (W.D. Mich. Aug. 31, 2007).

4. Firms that have signed the Protocol may fail to obtain a preliminary injunction even when the employee has transitioned to a non-Protocol firm.

Signatory firms have struggled to show that a departing employee who complies with the Protocol creates an extreme risk of irreparable harm, even when that employee has gone to a non-signatory firm. The Protocol demonstrates that financial firms implicitly accept that “brokers will leave and take client lists with them.” Merril Lynch, Pierce, Fenner & Smith, Inc. v. Brennan, No.1:07CV475, 2007 WL 632904 at *3 (N.D. Ohio, Feb. 23, 2007). Because the former firm will be in the same position as if the departing advisor had moved to another Protocol firm it will surely survive the transition. Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Baxter, No. 1:09CV45DAK, 2009 WL 960773, at *6 (D. Utah Apr. 8, 2009).

Also, a non-solicitation agreement can have a potentially devastating effect on a departing employee. Individual advisors often spend their whole careers building a client base. An injunction “barring them with any contact with their clients would effectively cripple their careers.” Id at *7.

However, it may be inequitable to allow parties that have not signed to incur the benefits of the Protocol—an incoming financial advisor being allowed to solicit his clients from his former firm—without incurring the risks of a departing financial advisor taking her clients with her. There is, in essence, no reciprocity when one signatory and one non-signatory are involved in the dispute. See Wachovia Securities, L.L.C. v. Stanton, 571 F. Supp.2d 1014, 1040 (N.D. Iowa 2008).

Though a court will not always grant a preliminary injunction when an employee leaves a Protocol firm for a non-Protocol firm, the departing advisor and the hiring firm will still likely be liable for damages to the former firm in FINRA arbitration. After all, the Protocol only governs an employee’s transitions between two signatories.

5. Compliance with the Protocol does not imply total immunity.

Courts are quick to stress that even when they do not find that it is likely a departing employee who has breached the Protocol, the Protocol only replaces non-solicitation agreements. A departing representative “could invoke the protections of the Protocol to avoid liability to his prior firm arising out of his solicitation of his former firm’s clients but nonetheless remain liable to his former employer for other wrongful conduct” such as breaching a covenant not to raid coworkers. Lee, 2011 WL 6153108 at *3.

6. Courts respect and enforce the goals of the Protocol.

The Protocol aims to further clients’ privacy interests and maximize their choices in connection with the movement of their representatives between firms. Courts consistently refer to these goals in determining whether or how to apply the Protocol in a given case.

Courts will not look fondly upon those departing brokers who take more information than permitted. The disclosure of confidential information, such as a client’s credit card and social security numbers not only violates client privacy, it also harms a firm who may lose the trust they had built with that client. As the one court explained, “[t]he fact that the Protocol does not permit disclosure of such information suggests that it is to remain highly protected.” Koenig, 2012 WL 379940 at *7.

The best way to maximize client choice is to give both the departing broker and the broker’s original firm an equal chance to solicit and win the client’s business. When both parties are on equal footing, the client can make the most informed choice possible. But if a “financial advisor one day simply disappears without warning” and cannot inform her clients of her departure because of restrictive covenants, a client’s range of choices becomes more restricted. Smith Barney Div. of Citigroup Global Markets Inc. v. Griffin, CIV.A. 08-0022-BLS1, 2008 WL 325269 at *3 (Mass. Super. Jan 23, 2008).

Thus, both employers and brokers should always make sure that their actions benefit the client first and foremost. They should not take actions that violate a client’s privacy or prevent clients from making informed decisions regarding their representation.

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