Why MSSB's legal hardball in Idaho could bring overdue change to the Broker Protocol

Brooke’s Note: It’s quite an image: A big Wall Street firm is sending its alligator-shod lawyers deep into the Idaho woods (400 miles north of Boise) dodging elk and wolves to draw and quarter a branch manager who wanted to start a new life with a new firm. But the case has also drawn the attention of a legal expert who wonders whether Morgan Stanley is actually performing a classic legal overreach — while acknowledging it has the Court’s sympathy thus far. How, wonders Pat Burns, are branch managers, legally speaking, so different from brokers? And, if the Broker Protocol is designed to prevent lawsuits then why wouldn’t the wirehouses — never mind the 996 non-wirehouse firms who could out-vote them — agree to amend the agreement?

Morgan Stanley Smith Barney LLC’s plan to sue three defectors from its firm is probably not good news for those individuals but it may set off a chain reaction that could be a positive for other firms that depend on the Broker Protocol.

The plan by one of the wirehouses to throw down the legal gauntlet against Michael W. Armon, Donald B. Scharenberg and Guy E. Gerber could gain considerable scrutiny because there is a gap in the Protocol’s protections that probably shouldn’t be there.

The New York-based wirehouse is counting on getting legal traction because Armon is a branch manager who isn’t covered by the Protocol in his role as a manager. MSSB is alleging breach of contract and fiduciary duty, as well as conversion of trade secrets, customer lists and confidential business information. In other words, it alleges that the branch manager played a significant role in recruiting away brokers he managed. See: Casting a wider net for talent, HighTower poaches an MSSB branch manager.

Managers marginalized

The Broker Protocol, established almost a decade ago, is essentially a declared legal truce between the wirehouses so that defecting brokers make the breakaway without legal repercussions if they follow pre-set rules. The number of signatory member firms has since grown to almost 1,000 and the Protocol has significantly reduced the number of legal disputes over the last decade between firms and departing brokers. (See: Broker Protocol signings regain momentum amid new signs that the wirehouses could shut the breakaway portal.)

But through all that growth in members and usage, the Protocol itself has not evolved to reflect changing business conditions. One significant area that the Protocol does not address is breakaway managers who jump ship and later recruit financial advisors they supervised. It is possible that manager breakaways were never contemplated because their defections were relatively rare at the time. In fact, since 2008, branch managers’ salaries have often been viewed as costs to be cut and they have been. Or managers have been viewed as people to be slashed or whose influence has been dramatically reduced.

Despite how branch managers have been marginalized in an era of cost-cutting, they are typically prohibited from directly or indirectly soliciting people they managed to work for them or their new organization for a period of time, within a defined territory (geographical or just financial advisors within offices they managed). See: Former MSSB exec powers up Washington Wealth Management as branch-manager franchise.

Case in point

Last month, on May 17 a complaint was filed by MSSB against the defendants in the U.S. District Court for the District of Idaho seeking injunctive relief (a temporary restraining order). On May 20 after oral argument, the court granted MSSB’s motion for a temporary restraining order and preliminary injunction against Armon from soliciting away MSSB associates and denied MSSB’s motion in all other respects (e.g., against the brokers themselves). The takeaway from the court’s decision is that this case is really about the branch manager and not the breakaway brokers who departed with him.

A prime town for tourists, witness
protection and bass fishing but not
far enough to escape MSSB’s legal
tentacles.

Time for amendment

The Broker Protocol is now the de facto industry standard governing breakaway-broker transitions. There has never been an amendment to the Protocol and there are no procedures in place for how amendments would take place.

Perhaps this case will serve as a wake-up call that it is time for an amendment to be made to the Protocol allowing branch management to move on to new firms with their financial advisors free from fear of legal action. After all, there are nearly 1,000 Protocol member firms that could have freely recruited away defendants Scharenberg and Gerber, without fear of legal action. Is there really that much of difference between their branch manager’s encouraging them to join a new firm versus a recruiter at a Protocol member firm’s doing the same?

An amendment to the Protocol would benefit wirehouse firms and other types of organizations by reducing the fear of litigation when a branch manager chooses to move on to another Protocol firm with his or her team. As with brokers, certain criteria could be established which is allowable and compliant with the Protocol (i.e., a safe harbor) for branch managers seeking to move on to another firm with their team members.

Freedom from fear

Wirehouse firms fears about branch managers leaving and subsequently recruiting away financial advisors they previously managed should be outweighed by the legal certainty gained by knowing branch managers they recruit will be free from fear of legal action if a prescribed set of rules is followed during their onboarding to a new firm. The basis of this theory is similar to the reasons why the Protocol was set up back in 2004 for departing brokers.

This case will be closely watched by industry members to determine whether branch managers should be heavily restricted, in a Protocol transition, from engaging in post-wirehouse recruitment activity of people formerly under their command. So far, the court has been sympathetic to MSSB’s request to restrict their former branch manager.

This case may spark a discussion whether the Protocol needs to be amended to protect branch managers and if so, how an amendment to the Protocol occurs. It seems fair that the Protocol ought to be amended to allow branch managers to depart with their financial advisors to another Protocol firm and provided they follow the Protocol, these parties should be free from fear of legal action against themselves and brokers leaving with them.

One way forward

The problem with amending the Protocol is that is uncharted territory. There are no administrative procedures or guidelines for how amendments to the Protocol would work. Would each Protocol member firm have an equal vote? How would a proposed amendment be teed up for consideration by the members to begin with? Right now, no one knows for sure. One theory is that a member firm could contact SIFMA, the Protocol’s administrator, and request that an amendment be proposed to the Protocol members and be put to a vote. See: SIFMA will take over administration of Broker Protocol list.

The original wirehouse firms that created the Protocol would each have one vote among the many Protocol member firms if all members are given an equal vote. In fact, each member firm likely would need to have an equal vote so that anti-trust laws are not violated by large firms being deemed to have engaged in a market division or allocation scheme. Market division or allocation schemes are agreements in which competitors divide markets among themselves. If large Protocol member firms decide matters among themselves, take common positions and have an outsized say on Protocol amendments that could be problematic.

View a list of Protocol members here.

MSSB’s case

According to the complaint filed by MSSB:

• The defendants were employed by MSSB and/or its predecessor firm, Smith Barney, at its office located in Coeur d’Alene, Idaho, from June 2009 until May 9, 2013.
• On May 9, 2013, defendants provided written resignations to MSSB that indicated they were effective immediately; they were resigning from the MSSB Coeur d’Alene office to open a new office in Coeur d’Alene for Stifel Nicolas & Co., which is a direct competitor of MSSB.
• The Coeur d’Alene MSSB branch is relatively small, with only six financial advisors at the time defendants were still employed there. The departure of three financial advisors, including the branch manager (defendant Armon) has led the relatively small office to experience upset, anxiety, insecurity, uneasiness and concern.
• As a condition of his employment as branch manager, defendant Armon agreed that he would not for a period of 18 months from the date of this termination from the firm directly or indirectly solicit firm employees or induce any firm employee to resign from any firm branch at which he worked; or any other firm office located within a one hundred (100) mile radius of the competitor’s office at which he worked, in order for that employee to accept employment at such competitor.
• However, it is alleged that defendant Armon directly and indirectly solicited MSSB employees to resign from the MSSB branch in Coeur d’Alene and work instead at the Stifel branch in Coeur d’Alene.
• While still employed by MSSB, and continuing thereafter, MSSB reasonably believes and therefore alleges that defendant Armon conspired with the other defendants and others to wrongfully convert MSSB records and trade secrets to Stifel.
• Defendant Scharenberg allegedly engaged in actions violating the Protocol for broker recruiting.

Defense contends

According to the defendant’s opposition to MSSB’s Motion for a temporary restraining order:
• Defendants deny wrongdoing.
• Question the lack of specific, verified and attested to factual allegations made against the defendants.
• Claim adherence to the Protocol.
• Claim that MSSB cannot show irreparable harm because it has accepted the Protocol.

Patrick J. Burns Jr. is the managing attorney with The Law Offices of Patrick J. Burns Jr., PC, a securities law firm dedicated to assisting industry members with their legal needs. He is also the president and founder of Advanced Regulatory Compliance, Inc. Additionally, Mr. Burns is a member of the California, New Jersey, New York and Texas bars. He received his Juris Doctor degree from Southwestern University School of Law in Los Angeles and Bachelor’s in Business Administration from Pace University’s Lubin School of Business in Pleasantville, N.Y. Mr. Burns began his professional career with a New Jersey-based law firm and then worked in a legal/compliance capacity for several financial services firms located in New York and Los Angeles. During his financial services career, he acquired numerous FINRA and insurance licenses. Mr. Burns is a frequent industry speaker on breakaway-broker matters, investment advisory compliance and general regulatory issues.