This story is the third in a series Financial Planning Chief Correspondent Tobias Salinger is writing on how to build a successful RIA. Click here to read the first story on when advisors should consider starting an RIA and follow this link to get the second piece on the right timing to leave a wirehouse. Also, find the series by following Salinger on LinkedIn.
Of all the factors that influence financial advisors' decisions about whether to change firms or break away to start their own, few carry as much weight as a potential lawsuit.
Temporary restraining orders, FINRA arbitration cases and proceedings over the terms of an employment contract or an M&A deal could put advisors' transitions on hold. Such legal actions could also cost them tens or hundreds of thousands of dollars in attorney fees or even millions in damages. And the legal risks, once generally contained to the traditional wirehouse filings against their ex-brokers, have expanded to lawsuits involving advisor exits from independent wealth management firms.
The shift in possible legal ramifications reminds Brian Hamburger, founder of wealth management business and regulatory compliance consulting firm MarketCounsel and the Hamburger Law Firm, of how "we used to travel Route 1 and 9 and now, all of a sudden, we're on the New Jersey Turnpike with 12 lanes," he said. Advisors who allow themselves "the luxury of objective advice" well in advance of their move will avoid the mistakes made by those who "just went and did this, without understanding the real risks that are inherent," he said.
"If you look at all of those transitions, what they have in common is that there's been an underlying objective, there's been a plan and there's been a focus on precision in executing that plan," Hamburger said. "At this point in where we are in the development of this industry, I think we can do better than avoiding disaster. I think we can optimize transitions."
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What's in the contract?
Advisors should take preventative action to avoid legal entanglements by reaching out to a qualified lawyer early — "if you have even a leading thought that, maybe you should run this by an attorney now, before you've taken an action," said Doc Kennedy, the president and founder of the AdvisorLaw law firm. If they are served with a subpoena after an M&A deal or a move to a different firm, then it's "better late than never" to consult with an attorney, he said.
"You'll reach a deal — it's not going to be what they come out of the gate with on day one, but it's also not going to be as low as you might hope it will be," Kennedy said.
An advisor's opinion that such filings are unfair is "totally understandable," he added, "but, ultimately the obligations under the contract make that irrelevant. … At the end of the day, you're still going to have to pay a price."
The available data on "intra-industry" arbitrations involving parties that are either FINRA member brokerages or registered representatives indicate a constant stream of legal filings that can take years to resolve. In the past four years alone, there have been nearly 2,000 claims involving the three most common types of allegations at issue in those cases: compensation owed to either party, promissory notes for recruiting bonuses that are typically due back to brokerages when advisors leave prior to their agreed-upon tenures with the firms, and breaches of contract by one of the sides in an employment agreement or M&A deal.
Yet that data from FINRA omits some key metrics. Those important details include the size of the sometimes-hefty payouts in those cases, whether the firm or a rep filed the lawsuit, and the volume of court filings that may precede or follow the arbitration case. There are also many other advisor moves that go through careful negotiations or mediation, Hamburger noted.
"We'll often work to avoid any type of publicity in these transitions by coordinating departures between firms that are losing talent and firms that are picking up talent," he said. "Everyone but the lawyers are better off, and that's a good outcome for independence."
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Thousands of advisors and their circumstances
And since the thousands of advisors in motion across wealth management each year are forging their own paths from one firm to another, there is no single trail to follow to steer clear of litigation while retaining clients. Advisors and their counsel must navigate barriers related to laws in the home state of their business, the timing of their journey, the extent that their prior firm engages in litigation against departing teams and the rules about undisclosed outside business activities, selling away and private securities transactions, according to Hamburger. They must even consider whether they have texted clients or staff telegraphing their move ahead of time.
The finer points of topics like, say, the Broker Protocol or the obligations of various noncompete or nonsolicit clauses may prompt advisors to speak with an expert who's more in touch with that terrain. That makes sense "if you're moving over, and you want to be sure that you're not just crushed under the weight of a firm with giant resources," Kennedy said. If there is a period of economic downturn, firms may turn even more litigious in their race to hold on to assets and advisors.
"You try to claw back whatever things maybe wouldn't have been worth it before, you try to retrieve those things," he said, noting that such legal matters often extend beyond advisors' areas of expertise. "They know the industry, they know the clients, they know the job quite well. But what they don't know is there's a whole aspect of what you must do, what you can't do and how you can do it and all of those things, as far as the departure."
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Don't rush to the finish line
Advisors' valid fears about potential lawsuits may cause them to miss retention opportunities in their client base and operate on an orderly timeline, Hamburger said. However, they run into problems in cases where they "overplay their hand" with clients, team members or supervisors by notifying them of an impending move in the wrong manner, he noted. Their exit "is by design a very lonely endeavor," and "some advisors set themselves back two or three years in their careers" if they don't understand the requirements, Hamburger said.
"Getting caught in the middle of the street is probably one of the worst risks of all," he said. "Now they don't have the resources to fund their defense. That's a terrible scenario to be in, and we've seen that happen a lot."
Furthermore, in a time with so many M&A deals and intertwining relationships among RIAs and brokerages, the advisor selling a firm today "can very, very easily and seamlessly become the buyer tomorrow," Kennedy said. That means they should avoid any rush in locking themselves into a deal — whether out of concern for underlying economic conditions or the need for a succession plan someday.
"If you want to protect yourself, I always tell people it's like a marriage: You want to know as much as possible about the other person," Kennedy said. "You've got to figure out how much room you have to negotiate with and have all those agreements clear as day."
