Merrill Lynch faces 'significant hurdles' to convince judge to restrain its former $129 billion team from pursuing life as Schwab RIA, attorney says

Merrill Lynch's 48-page demand to shut down a $129-billion breakaway startup RIA just met its match in defense counsel's blistering, 168-page retort from that comes out swinging.

The $3-trillion wirehouse's claims the mass exit by its Barron's No.1 Atlanta team -- now known as OpenArc -- is a “raid” against its business interests.  

But OpenArc lead counsel Joseph Alonso fired off a searing response – setting up an unprecedented showdown in an Atlanta courtroom on Tuesday (Sept. 30). 

“This case is shaping up to be one of the most consequential RIA breakaway litigations in recent memory, involving about $129 billion in AUM,” says  Ari Sonneberg, partner with Wagner Law Group in Boston.

Merrill Lynch filed a lawsuit in federal court in Georgia seeking a temporary restraining order (TRO) the same day (Sept. 24) OpenArc announced its formation. Charles Schwab and Dynasty Financial Partners and 12 OpenArc employees were named as co-defendants.  See: Charles Schwab and Dynasty pull off record-shattering -- and previously unthinkable -- lift-out of $129-billion AUA Merrill Lynch team, but the thundering herd has furiously stampeded to court to block the move

In the formal response filed today (Sept. 26), lawyers for the employees challenged every assertion in the Merril Lynch suit and leveled their own charges of underhanded dealings by the wirehouse. 

Speculation, innuendo

The defense basically stands on four legs – the industry's Protocol for Broker Recruiting, the Financial Industry Regulatory Authority's (FINRA) dispute resolution process, the so-called “lifeboat defense” and case law, including a ruling just this past August on what constitutes “raiding” in the financial services industry. 

“Merrill offers no credible, admissible evidence…” Alonso writes in the TRO response. 

“The sole ‘evidence provided in support of the motion for TRO is an affidavit from an interested manager that contains no single shred of actual admissible evidence, is solely based on speculation and innuendo, replete with statements like ’I believe' or ‘I understand’ and completely devoid of factual basis or first-hand knowledge.”

The defendants also charge Merrill has “unclean hands.” 

“Not only did Merrill ‘set up’ defendants to attempt to terminate them, it also dragged their reputations through the mud via the press to unfairly compete,” the response states. 

Leader to laggard

Alonso seems to be employing a savvy strategy – especially for a TRO hearing, Sonneberg says.

“I think the TRO faces some significant hurdles. Courts typically impose a high burden of proof for injunctive relief,” he explains.

The OpenArc response reframes Merrill Lynch arguments and paints a portrait of a corporation that made no meaningful investment over five years in the division, known as Global Corporate & Institutional Advisory Services, or GCIAS. . 

The result was the “staggering losses of clients that was not sustainable,” and an “estimated $45 million” in revenue losses  “that even hundreds of millions in investments could not stop.”

“The [Merrill] division’s technology and platform became so outdated due to Merrill’s failure to invest that it went from industry leader to laggard in past five years,” Alonso writes. “Not surprisingly, Defendants, who were employees-at-will, started looking elsewhere and decided to open their own business as a Plan B.”

Such a narrative could be effective, says Sonneberg.

“OpenArc’s framing of their departure as a legitimate business move could sway the judge,” he says.

Central claim

Merrill Lynch declined to respond to most of the litany of issues and counter-allegations raised by ex-staffers.

But a spokeswoman directly fired back at a central claim by disaffected employees that they paid $22.5 million to buy the unit's book of business. Merrill asserts that it owns the clients.

“Consistent with industry practice and contrary to these false [Merrill] claims, clients from retiring financial advisors were transitioned to other members of the team and they were compensated as a result. The advisors actively participated in the program, resulting in increased compensation over time,” the response states.

A Dynasty-sympathetic source with knowledge of broker recruiting said the payment transitioned ownership to the advisor's book.

“The wires can allow a senior advisor to sell business to junior advisor,” the source explains. " But once it’s paid for, it’s the advisor’s book, and they should be able to leave under the protocol which Merrill is in.  

“They are trying to paint a picture to say the clients were ‘owned’ by Merrill, not the advisors who paid to inherit the book.”

Protocol precedent

Though Merrill Lynch declined to further elaborate, it sent an excerpt from its original complaint to address the claim that OpenArc is shielded by the Broker Protocol – a widespread no-fault divorce provision for wealth managers signed by many RIAs and broker-dealers. 

"Individual Defendants may attempt to invoke the protections of the Protocol by contending that Merrill and Dynasty (and possibly OpenArc) are Protocol signatory firms, and/or that they themselves are the intended third-party beneficiaries of this agreement. (paragraph 179)

Merrill argues that Individual Defendants forfeited their eligibility to invoke the safe harbor protections of the Protocol by allegedly “misappropriating, misusing, and sharing confidential, trade secret, and proprietary information in violation of their legal obligations,”

The suit also charges the defendants with “soliciting other Merrill employees, diverting business opportunities, soliciting clients, and otherwise breaching their duties of loyalty to Merrill.”

Negotiated settlement

It'll still take proof – and there is still plenty of precedent for the protocol's application, Sonneberg says.

“The TRO may be denied or significantly narrowed, especially if the court agrees that OpenArc adhered to protocol and did not pre-solicit clients,” he says.

“This is not the first RIA to depart a financial institution- the question really boils down to whether OpenArc used tactics that departed from the norm in their efforts to break off from Merrill.”

“Given the reputations at stake and the complexity of the issues involved, a negotiated settlement—possibly involving financial compensation and some limited restrictions—seems probable.”

Anchors aweigh

The so-called “lifeboat defense” revolves around whether the departure of the Merrill employees constitutes a “raid” on Merrill's staff under the Broker Protocol. 

Raiding in the financial services industry generally means “malice, predation, or improper means” were involvled in luring away employees from one firm by another firm." 

However, the industry authorities have also recognized the “life boat defense," the response states.  

It applies if the defendant can establish that producers hired from plaintiff were intent on leaving for “honestly held and objectively verifiable and substantial reasons.”

"The producers also approached defendant and made their intent and reasons for leaving clear, and the defendant, in good faith, determined that producers would accept employment elsewhere if defendant did not hire them."

“In this case, defendants were one team who decided to leave Merrill to start their own business rather than a competitor seeking to hire from Merrill.”

Hoodwinked

“Critically, a very recent decision by the United States Court of Appeals for the Fourth Circuit has determined that raiding cannot apply when the employees depart to form their own competing firm,” the response adds.

"As stated by the Court of Appeals, the Protocol for Broker Recruiting contemplates liability for raiding “when an outside firm preys upon another firm, not when individuals leave a firm.”

Futhermore, the defendants argue that Merrill can not seek “equitable relief” in court "because it comes with unclear hands." 

In the days leading up to Defendants’ termination, Greg McGauley, head of Private Wealth Management, had learned of the planned departure and “begged for an opportunity for Merrill to retain Defendants.”

But "Merrill hoodwinked defendants and for over a week delayed good-faith negotiations. Merrill clearly utilized this period of time to develop a scheme to harm defendants. 

“Then, after a full week of waiting,” the employees were "placed on immediate administrative leave and were prohibited from contacting fellow employees or clients.

"It is clear that not only did Merrill ‘set up’ defendants to attempt to terminate them, it also dragged their reputations through the mud via the press to unfairly compete.

Outrageously, Merrill provided this lawsuit to the press and articles were published before defendants were given notice, despite multiple requests for same and only hours after their forced resignation."

(Full discosure: RIABiz was not on Merrill's handout list to the media and obtained its copy of the lawsuit through other sources.)

FINRA redress

The OpenArc response concedes that an arbitrated “money” settlement is the appropriate objective.

“To the extent that Plaintiff seeks damages it may be adequately redressed with money damages in [FINRA] arbitration before a panel familiar with industry standards and the Protocol,” the OpenArc response says.

Some big firms, like UBS and Morgan Stanley, exited the protocol but Merrill stayed in. Schwab never signed on.