Jacko Law Group, PC (“JLG”) continues to see a high volume of financial advisors transitioning from one broker-dealer or registered investment advisory firm to another. Making this type of change in the heavily regulated financial industry requires an understanding of federal and state laws, as well as contractual limitations and how those items will shape the process. Both the onboarding firm and the transitioning advisor[1] must pay close attention to laws that govern this area as well as any additional applicable restrictions to reduce risks and decrease the likelihood of potential liability. The transition process is an exercise in coordination, timing and execution of various steps that need to be done, largely in a particular order, to achieve a smooth and uneventful process.
This month’s legal risk management tip summarizes[2] some of the primary focus areas for advisor transitions and discusses some additional considerations which do not always receive significant attention, but which are material to achieve an efficient transition process.
1. Primary Transition Considerations
- Does the Broker Protocol Apply?
The Protocol for Broker Recruiting (“Broker Protocol”) is an agreement among participants in the securities industry that permits the taking and use of certain confidential client information when an advisor moves between firms that are both signatories to the Broker Protocol. The initial intent of the Broker Protocol was to help reduce the likelihood for litigation between the firms, assist in the facilitation of advisors moving from one firm to another, and to minimize client impact. To that end, the Broker Protocol also specifies the type of client information that can be taken by the departing advisor to a new firm, so long as the advisor adheres to the expressed requirements of the Broker Protocol.
If the onboarding firm and the advisor’s former employer are both members of the Broker Protocol at the time of a breakaway, the risks associated with the transition are minimized by adhering to the conditions set forth in the Broker Protocol. [3]
- Do Advisor Contracts Restrict Activities or Approach?
An advisor’s contracts with his or her prior firm often limit the number of available options in connection with a transition.
The employment or contractor agreement[4] between an advisor and the advisor’s prior company typically contains rights triggered upon termination of the relationship, including robust non-solicit and, in jurisdictions where they are permitted, non-compete provisions,[5] that directly impact how an advisor may bring clients to a new firm. Importantly, some advisor contracts contain detailed confidentiality provisions restricting any communications with a prior firm’s clients or prospects, while other contracts allocate “ownership” of client accounts and carve those accounts out of non-solicit restrictions.[6]
Both the advisor and the onboarding firm should have a precise understanding of the applicable agreements so that a mutually agreeable transition strategy can be identified and implemented.
- What Should I Consider in Regard to Client Privacy?
Whether it is Regulation S-P[7] or a state privacy law,[8] there are numerous rules and regulations that govern whether and when a third-party, such an onboarding firm, can receive information about an advisor’s clients. Regulation S-P requires financial institutions to safeguard consumer information, and, among other things, provide such consumers a notice describing the conditions under which they may disclose the consumer’s information to nonaffiliated third parties. In addition, Regulation S-P requires a company to provide a method for consumers to prevent such disclosure by “opting out” of that disclosure.[9]
As a value-added service, many Transition Teams at financial firms are set up to assist transitioning advisors with completing the onboarding firm’s new client paperwork to make the process as easy as possible for both the advisor and clients. Such a step, when done incorrectly or hastily, increases client-facing and regulatory risk for both the onboarding firm and advisor.
2. Additional Transition Considerations
In addition to the more familiar topics discussed above, a variety of other fundamental and logistical matters arise when an advisor moves from one firm to another.
- What are Some Details to Consider During the Negotiation of a New Contract?
Clearly, no advisor is expected to change jobs without a detailed understanding of his or her new compensation and employment arrangement. The initial and ongoing discussions on this subject are a natural part of the process, but they often lose momentum at the “Term Sheet” or “Letter of Intent” phase. This stage of the transition is where major terms are written down, but no binding contract is prepared or signed by the parties. Additionally, to add complication to an already complex process, Legal Departments and/or Compliance Departments usually review a new advisor contract after the business-side details are agreed upon. This additional analysis can take time and may result in additional due diligence during which new issues can be identified (esp. if the advisor has a disciplinary history). To avoid surprises or an unanticipated delay, both parties benefit from defining business relationship terms and having a final advisor contract in-hand before formal transition steps (such as giving resignation notice) are commenced.
- What Should Timing of Resignation and Onboarding Look Like?
Transition teams that recruit individual advisors are critical to many larger firm’s operations and are typically enthusiastic to compete the onboarding process as quickly as possible. However, moving too fast can create issues for both the onboarding firm and the advisor. Client privacy issues (discussed above) need to be navigated thoughtfully and deliberately at this stage of a transition to avoid potential liability.
In addition, numerous functional areas within a firm need to authorize/approve the hiring of a new advisor. Cross-functional diligence and approvals should be verified to ensure that both the onboarding firm and advisor have the same understanding about whether open issues exist or whether parties are ready to move forward. In particular, Legal, Compliance and Licensing/ Registration (in lager firms) need to have ample time to review and approve advisor details, especially if an advisor has past disciplinary issues, before major transition steps should begin. Advisors should consider how to communicate with the functional areas of the onboarding firm to verify that all are comfortable with the new relationship and synchronized regarding transition steps.
- What Notice Provisions Should be Considered in Advisor Contracts?
Generally, advisor transitions occur quickly after resignation, but each firm has its own unique protocols and procedures that apply to this situation. In many cases (primarily with investment advisory firms), an advisor’s contract with a prior firm requires a certain amount of notice before a resignation or termination of an employment relationship becomes effective (a 30-day period is the most common). Logically, parties wonder whether the prior firm will actually require the stated amount of time or allow the termination to proceed more rapidly. Understanding your firm’s practices and historical approach will assist in setting expectations for the advisor and the onboarding firm on this particular and important point.
3. Professional Advisors Can Mitigate Transition Risks
Like many things in the regulatory environment, the rules and regulations that apply to transitions are complex and nuanced. It is strongly recommended for advisor recruits to obtain legal counsel about how to properly leave one firm and join another; the engagement also may serve to significantly lower the risks to the onboarding firm through the transition process. If an advisor breaches a contract or an applicable statute, the onboarding firm and advisor should expect a “cease and desist” communication from the prior company, especially if an advisor is too aggressive – or uniformed – about how to transition and how he or she is permitted to contact former clients. Working with a qualified professional should increase the efficiency and protections available to the advisor and onboarding firm alike.
Conclusion
If an advisor transition is on your or your firm’s agenda, understanding the regulatory and legal details is critical to identifying and managing potential risks and to make the transition process as smooth and efficient as possible.
JLG assists firms and individuals through the numerous complicated and nuanced considerations relating to investment adviser or registered representative transitions. For more information on this topic, please contact us at (619) 298-2880 or at info@jackolg.com.
JLG works extensively with investment advisers, broker-dealers, investment companies, private equity and hedge funds, banks and corporate clients on securities and corporate counsel matters.
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[1] The term “advisor” used in this article refers to a transitioning registered representative or investment adviser representative.
[2] We have discussed in greater detail transition considerations from both the onboarding firm’s and transitioning advisor’s perspective in JLG Risk Management Tips, available at https://www.jackolg.com/tip-What-To-Consider-When-Onboarding-New-Advisors and https://www.jackolg.com/tip-Strategic-Considerations-For-The-Transitioning-Advisor, respectively.
[3] For additional information regarding, including discussion of the criteria of the Broker Protocol, see recent JLG Legal Risk Management Tip, available at: https://www.jackolg.com/tip-Strategic-Considerations-For-The-Transitioning-Advisor.
[4] Many advisers receive promissory notes from institutional employers that need attention at the time of a transition. Discussion of Promissory Notes is outside the scope of this article, but was discussed in a prior Legal Risk Management Tip, available at https://www.jackolg.com/tip-Breaking-Away-Vital-Considerations-For-The-Transitioning-Advisor.
[5] Employment and contract laws vary across the United States and the validity of non-compete provisions will depend on factors including governing law and case precedent.
[6] The protection of a firm’s trade secrets is another critical area that may bear on how an advisor transitions to an onboarding firm. Trade secrets are governed at the federal level by the Defend Trade Secrets Act of 2016, and by state laws (see, e.g. the California Uniform Trade Secrets Act, Cal. Civil Code § 3426 et seq.).
[7] Pursuant to the mandate in the Gramm-Leach Bliley Act, the SEC promulgated Privacy of Consumer Financial Information (Regulation S-P) (“Regulation S-P”), which governs the treatment of nonpublic personal information about consumers by brokers, dealers, investment companies and SEC registered investment advisers.
[8] The California Consumer Protection Act (“CCPA”) is one example of a newly enacted state law focused on privacy issues. JLG recently discussed the CCPA in a Legal Risk Management Tip, available at https://www.jackolg.com/tip-The-California-Consumer-Privacy-Act-CCPA-What-You-Should-Do-Now-to-Prepare.
[9] See 17 C.F.R. § 248. As noted below, some states, such as California, have more stringent regulations and require an “opt-in” by the consumer; see Cal. Fin. Code §§ 4050-4060 for more information relating to the California Financial Information Privacy Act, commonly referred to as SB-1.