Industry insiders say they're stunned by a recent courthouse loss

January 11, 2011 — 2:53 PM UTC by Lisa Shidler


After a recent case in which the Charles Schwab & Co. Inc. aggressively pursued one of its own advisors who went independent, industry insiders are wondering if the company is taking a stronger stance against its own brokers breaking away – and perhaps damaging its reputation as a landing place for wirehouse breakaways in the process.

Schwab sued former broker Kristian Colvin, who left the company in September 2009 to become a solo practitioner with Emerson Equity LLC. Colvin, who says he had managed $200 million at Schwab, now has $25-$30 million in assets under management.

Schwab lost the case in both San Diego Superior Court and in a 4-day FINRA arbitration hearing in which the 3-person panel ordered the company to pay what may be an unprecedented $218,881.86 in legal fees to its former broker. Colvin received the money in November.

Looking like a bully

“This was an atrocious defeat for Schwab,” said New York securities attorney Bill Singer, of Gusrae Kaplan Bruno & Nusbaum PLLC. “Schwab has to be careful when they throw their weight around in courts. Even if they were correct, they come off looking like a bully. This was a huge gross miscalculation on Schwab.”

Lawyers said Schwab has fought against departing brokers for taking client information in the past, but said this case stands out because Schwab asserted so much muscle attacking Colvin – and then lost. The company had asked for $1.5 million in damages.

Mike Cianfrocca, spokesman for Schwab, says the company handles all of the cases of departing brokers the same way and is not pursing leaving advisors more aggressively. He said that if a Schwab employee leaves and violates the terms of an agreement with Schwab, the company will pursue the matter legally.

Cianfrocca said that Schwab gets customers through its marketing efforts and hands them to advisers. The Schwab retail advisors aren’t building a book of business themselves.

Fidelity will take legal steps that may be required

Fidelity Investments, the second largest custodian for independent advisors, declined to discuss the details of their policies, but did explain that the firm gets the customers and the customers are assigned to work with its retail advisors.

“These investors are the firm’s customers,” said Fidelity spokesman Adam Banker in a statement. “Our customers expect us to preserve and protect the privacy and confidentiality of their relationship with the firm and their personal information. We will take any legal steps that may be required to protect our customers and their information in this regard.”

Neither company is a member of the Which firms are joining the Broker Protocol, and how your firm gets on the list, the recruiting truce among wirehouses that enables brokers to take certain limited information with them. Both firms said the reason they’re not part of this protocol is because their advisors aren’t generating the clients themselves. Wirehouse advisors typically build their own books of business.

Even though Schwab nurtures advisors who are breaking away from wirehouses, Cianfrocca points out that as part of that advice, Schwab executives are helping ensure advisors are following the letter of the law and honoring the terms of their contract with the wirehouses.

Even if the company didn’t intend to do so, Schwab sent a message to brokers in the industry with the hard-fought battle with Colvin, said Timothy D. Welsh, principal of marketing firm Nexus Strategy LLC of Larkspur, Calif. He is also a former director of marketing for Schwab’s RIA custody business.

Irony lost?

“They did some brand damage with this one,” he said. “They cultivate this atmosphere that they’re all about independence except when it comes to one of our own. The irony is probably lost on them.” Schwab Advisor Services brought in $13 billion of assets from breakaways in 2009. (See: Both Schwab and TD Ameritrade smash breakaway recruiting marks from last year.)

Here’s what happened in Colvin’s case, according to Colvin and court records.

Colvin had worked for Schwab for 10 years. During that time he had seen significant changes, with the firm becoming more focused on sales. At the same time, he said, retention-driven compensation was also on the decline. He had been working mostly with high net worth private clients and offering them advice on their portfolios but the company wanted him to focus solely on new clients and sales.

“When they asked me to stop meeting regularly and helping clients manage their assets, that’s when I decided it was time to go,” he said. “I got into this business to be a personal advisor to clients.”

Eight days after his departure, Colvin was sued by Schwab, on Sept. 17, 2009, for breach of contract in San Diego Superior Court. The company alleged in court documents that he took personal and financial information from Schwab and made unauthorized use of Schwab information to lure Schwab customers to his firm.

Schwab was seeking injunctive relief from the court to prevent Colvin from transferring any clients to his new firm. The Superior Court denied Schwab’s request, finding Colvin’s actions were permissible under the law.

FINRA involvement

Meanwhile, Schwab also pursued Colvin with FINRA, arguing for 13 forms of relief including compensation damages, punitive damages, pre-aware and post-award interest and other damages estimated at around $1.5 million.

Colvin said 20 of his 200 Schwab clients joined him at his independent practice, which meant he took about $20 million of his then $200 million in assets from Schwab. He currently custodies with Pershing Advisor Solutions.

At the conclusion of the four-day trial, the three-person panel ruled unanimously in Colvin’s favor. Schwab sought to vacate the ruling claiming the arbitration panel was biased. FINRA denied Schwab’s request, ultimately ordering the firm to pay Colvin’s attorneys’ fees.

It’s quite unusual for a FINRA panel to issue attorneys’ fees in a ruling, Singer said.

“Normally, if you lose a case, you just lose a case. You rarely see an award for attorneys’ fees. I almost fell off my chair when I saw Schwab had to pay $200,000 in attorneys’ fees.”

Colvin said Schwab didn’t offer any witnesses that were previous clients who said he tried to steal or lure them away from Schwab.

“If I did solicit business wouldn’t one of those 180 people who stayed with Schwab have come out and said that I solicited their business. But they didn’t have anyone.”

Comfortable for clients

Colvin doesn’t know why more clients didn’t come with him, but said he was careful not to solicit any clients. “The Schwab name is comfortable for clients,” he said. “They like the marketing and the name recognition.”

Of the clients who came with him, he’s known most of them for about 7 years, and his average client has about $1 million in assets – which was the case when he was at Schwab. He said his investment management fees are similar to Schwab’s, though slightly higher in some cases.

Though he’s only earning 50% to 60% of what he made at Schwab, he says enjoys getting to work closely with clients again. He said he’s still surprised that Schwab chose to pursue him.

“I’m not sure why they made such a stink of me leaving. It just sucked. I think they were trying to set an example of me.”

Clinton Marrs, with Albuquerque, N.M.-based Tax Estate and Business Law LTD, says he believes that Schwab is trying to send a message to its existing brokers on staff.

“They know that the next guy who thinks about leaving will think twice after they hear these horror stories,” Marrs said.

Marrs represented former Schwab broker Lee Munson, who left to go independent in 2008.

“Everyone thinks that Schwab is this big wonderful place. But this side of the story doesn’t get told,” says Munson.

18-month battle

Schwab sued him federally and leveled FINRA charges at him for taking trade secrets. Munson also won, but it was an 18-month battle.

Munson, now an advisor with Portfolio LLC in Albuquerque, N.M. had managed about $200 million in assets at Schwab when he left there on Jan. 1, 2008. He estimates about $50 million in former Schwab client assets joined him at his new firm. Now, he currently manages about $125 million.

Each week, Munson says, he gets calls from Schwab brokers who thinking of leaving but are very nervous.

“I tell them you need to get legal advice because even if you do all of the right things, they’ll still question you. It really becomes a terrifying ordeal.”

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