Client Portability Through The Looking Glass

Client Portability Through The Looking Glass

October 28, 2024

There is much confusion about what restrictions apply to asset, or client portability, and what the rules are for advisors should their clients choose to follow them when they depart for another firm. In an industry going through change, such as M&A and breakaways, these issues are particularly acute.

The following article considers?“client?portability” – how easily, or not, it is for clients' assets to move with advisors when advisors move from one firm to another. An important term is “solicitation” – a practice that comes with a number of restrictions. With so much change, including M&A and breakaway activity?taking place, and with generational upheavals to wealth management, this topic of client?portability is particularly important. To discuss this topic is Allan Starkie, (main picture) partner, at Knightsbridge Advisors, a consulting and executive search firm. See a previous article by Starkie here. (Barry P Kaltenbach, principal at law firm Miller Canfield also contributed to the article.)

Within the wealth management industry there is considerable confusion about what restrictions exist on asset portability, and how enforceable they may be. As a result, I have undertaken to write this article, with a well-known attorney experienced in these types of disputes, in the hope?of alleviating some of the angst around moving assets from one firm to another.

Let us begin by listing the type of restrictions that commonly exist:

1. The non-solicitation is the most commonly used, and typically restricts a departing advisor from soliciting the clients to follow, for a specified period of time – typically one year. It prevents direct as well as third-party solicitation. Of all the types of restrictions, the non-solicitation is the one which is most often enforced. The dispute often comes down to what constitutes a solicitation and whether an advisor may solicit clients with whom the advisor already had a relationship prior to the advisor’s current employment. See, e.g., Edward D?Jones & Co?v?Kerr, 415 F?Supp. 3d 861, 873 (S D?Ind?2019) (“The issue of when a communication becomes a solicitation is in a sense a `metaphysical’ question, the answer to which turns out to be highly contextual.”).
2. The non-compete is less frequently used, and is subject to increasing scrutiny by various states and the FTC that might eliminate it completely, as it is sometimes considered to create unlawful “restraints of trade.” The non-compete prevents a departing employee from working for a competitor for a specified period of time. Although the restrictive period is usually one year, we have seen examples as high as five years. In many cases, there is a geographic element which prevents the employee from working, for example, within a particular radius of the firm that they departed, or any of its branch offices. It may be enforceable when the advisor has received contemporaneous, additional compensation in return for accepting this restriction. As a result, we see it most commonly used within the RIA community when an employee is awarded partnership and equity. Even then, however, overly severe restrictions might be invalidated.
3. The third is the non-accept or non-service, which prohibits the departing advisor from accepting the account of a former client, even if that client directly approaches the advisor and requests to open?an account at the new firm. This form of restriction is rarely used, but still exists among some of the aggregators and a handful of RIAs. Some courts have refused to enforce these types of restrictions on the basis that they unfairly restrict client choice. See, e.g., Aon PLC v?Alliant Ins?Servs, Inc, No?23-cv-03044, 2023 WL 3914886, at *10 (ND?Ill?June 9, 2023) (“Non-servicing and non-acceptance restrictions that purport to bar employees from responding to unsolicited inquiries from customers pose unwarranted hardships on both the former employee and customers and are therefore contrary to Illinois public policy.”).
4. Garden leave. In the case of garden leave, the departing advisor is still paid by the firm he has left for a period of between 30 days and 90 days, depending on corporate rank. During this period, the departing advisor is still an employee of the firm and may owe a fiduciary duty of loyalty to the employer throughout the garden leave. The garden leave allows the employer to create a communication hiatus between the departing advisor and their clients, allowing an undisturbed transition of the book of business to a newly-appointed advisor. This can create significant tension, particularly when clients demand to continue working with their existing advisor. Often, we advise departing advisors to try to negotiate a reduction of time on their garden leaves. Many RIAs are loath to pay three months of salary and are willing to reduce the period in return for other concessions.?

Let us look at enforceability and how to navigate potential portability within the constraints of these restrictions. It is important to note that there are significant variables in enforceability depending on the applicable state law, the location of the employee, and the experience and thinking of the particular court presiding over the case. Some firms choose binding arbitration as the form of resolving the violation of restrictive covenants. In such cases, one is subject to the often-limited expertise of an arbitrator unfamiliar with our industry and unschooled on legal precedent around such cases. FINRA, however, will often accept arbitration of RIA disputes if all parties agree to use its services.

Since the non-solicitation is by far the most prevalent, let us discuss it in detail. The non-solicitation may not only pertain to the potential solicitation of clients, but also employees. It is therefore essential that care be taken among departing advisors (particularly in team lift-outs) in how they communicate with each other prior to resignation. In all cases, one must regard written communication between advisors and their clients, and advisors and their teammates, as discoverable. Personality does not translate well into written communications and words said in jest may not be read that way after a dispute arises. It is usually better to avoid written communications for this reason.?

In the case of team lift-outs, the search firm orchestrating the lift-out should initiate direct communication with each team member and develop an email record that clearly indicates that the recruiter is approaching each member of the team as individual candidates. Considerable thought should be given, on a case-by-case basis, regarding the sequence of the resignation of each team member, and the purported reasons each member gives for resigning.

Whether the departing advisor is leaving alone, or with a team, the constraints of the non-solicitation of clients is the same and must be respected. The departing advisor is often permitted to notify his clients of his new employment after he has resigned, although this can vary depending on the jurisdiction. We colloquially refer to this as the “one knock rule.” ?It is here where coaching?the advisor is critical. That one knock is the one chance the advisor will get to talk with the client without violating the non-solicitation agreement. The advisor is usually permitted to tell the client he has resigned; indeed, one can argue that he has a fiduciary obligation to do so. The advisor can also usually tell the client to which firm he is moving and provide his new contact information, however he cannot ask the client to follow him. If the client then has questions, the advisor can provide the requested information, but should still take care to avoid pitching the client.

At this crucial point, it may be a good idea to provide very specific scripted instructions. The departing advisor should inform the client of where he is going and then state, “I want you to know that pursuant to my employment contract with my prior firm, I am not allowed to solicit your business, and so that is not the purpose of this call. Honoring my word is important to me.” The client then has an opportunity to ask questions if the client wishes, such as “am I permitted to follow you, even if you do not ask?”

And it is not a violation to allow the worried client the courtesy of accepting his account. If the client does not take have any questions, it is necessary to wait out the restrictive period and then approach the client after the period expires, unless the client re-engages on his own before that point in time. Some advisors, instead of calling, send out “tombstone” announcements of their new affiliation. This can also be a permissible in some jurisdictions, but great care must be taken when drafting the announcement.

We are often asked why some firms staunchly litigate against violations of the non-solicitation restrictions while others do not. There are four typical reasons that sway a firm to litigate.

• Egregious violations of restrictions simply cannot be ignored without creating precedent that negates their future viability.
• In the aftermath of a recent rash of defections, litigation sometimes has the effect of scaring other advisors from leaving.
• Sometimes the financial risk of losing significant revenues will justify the cost of litigation.
• Sometimes, an individual within the RIA might feel personally wounded by the departure; instead of treating the matter as a business dispute, they might take it personally. In such cases, the litigation is often merely an axe to grind in a punitive retaliation.

Many clients ask me if there is a silver bullet to mitigate these risks and necessary manipulations. The answer is yes. In 2004, the major wirehouses created the “Broker Protocol,”?which I long ago nicknamed the Geneva Convention of asset portability. Although the protocol was initially intended to eliminate the costly litigation among the wirehouses, over the decades it has changed its membership to become dominated by RIAs, with few of the original founders remaining members. There are over 1,000 members currently and the list grows weekly. The protocol allows for the orderly transfer of clients/assets along with the departing advisor, as long as the new firm and the old firm are members. It even allows for five pieces of data to follow the departing advisor.

• Client names
• Addresses
• Email addresses
• Phone numbers
• Account titles

An interesting feature of the protocol is that any member firm can withdraw at any time. At the moment of withdrawal, the current client-facing members of the firm are no longer permitted to join another member firm of the protocol with impunity. I have often advised RIA clients in a growth mode to join the protocol while they are actively recruiting, and then withdraw when they enter a protective period, in which they are more focused on asset retention. Ironically, of all the firms that heeded my advice not one has exited the protocol. Note that the protocol does have rules that must be followed or else its protections may not apply to a departing advisor and it will not apply in all situations.

Finally, it is very advisable to start a process in which legal counsel is provided to a targeted advisor or team early in the process. Many discoverable mistakes are made early in the process by uninformed advisors, that are unaware of the risk of poorly managed communication of their intentions. By following these fairly simple rules we have coached hundreds of individuals and teams to transition enormous percentages of their assets?(the highest being $7 billion, representing almost the entire book of business), without a single lawsuit.

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