When Morgan Stanley recently announced it was withdrawing from the Broker Protocol — a system installed 13 years ago to lay out clear rules for advisors who leave one firm for another — the decision came as quite the shock to the financial advisory community.
The protocol had ended legal wrangling and in the process, eliminated an expensive kink in the recruitment process. Now, in rejecting those rules, Morgan Stanley is essentially walling in its advisors in an attempt to thwart them from defecting to other firms.
Morgan Stanley has a problem, after all: The firm has been steadily losing top advisors. Withdrawing from the protocol may seem to them like a shrewd move under these circumstances. This step essentially says the firm believes that advisors are employees and any work product (including new clients) belongs to the firm. It's a defensible position but not a winning one. Here's why:
1. MORGAN STANLEY RECRUITING IS EFFECTIVELY OVER
No self-respecting advisor will join a firm that promises to sue them if they ever leave. Even if Morgan Stanley promises that it won't go after clients that an advisor brings into the firm, most advisors are unlikely to feel it's worth the hassle of joining a firm with a No Exit sign posted over the entryway.
2. THE BIGGEST ADVISORS WILL BOLT FIRST
Advisors will chafe at the new rules and are more likely now to test the legal waters of leaving. Advisors with larger practices will have a clear advantage, as rival wirehouses and regional firms will be eager to lure them to their side. Large firms with deep-pocketed legal resources will probably step up to the plate first, with a willingness to handle any legal difficulties that may arise when they transfer client accounts to their firm.
The exodus has already begun. Morgan Stanley announced its decision to withdraw from the Broker Protocol on October 30, and within three days, nine teams that managed more than $6 billion had announced their departures to competitors.
Independent firms with skinny profit margins are likely to wait out the legal battles, leaving Morgan Stanley advisors who want to go independent in the lurch.
Prior to the Protocol, many firms typically had stipulations in their agreements that prohibited departing advisors from soliciting their accounts.
"Once you take the Protocol away, any non-solicitation clause comes back to life," explains David Harmon, a partner at the law firm of Norris McLaughlin & Marcus.
Over time, legal precedent will determine the new rules of the road for departing Morgan Stanley advisors.
3. THE VALUE OF A MORGAN STANLEY ADVISOR WILL SHRINK
Recruiting packages will likely decline by about 10% if the past serves as a guide. In the past, the hiring firm paid approximately 10% of the advisor's trailing 12 month’s gross commissions to settle with the old firm. Another negative: The advisor couldn't hit the road running. In the bad old pre-Protocol days, major wirehouses routinely petitioned courts to issue temporary restraining orders against their brokers who left.
The 10% scenario is the best-case view. If the courts opt for a stringent interpretation of the non-solicitation clauses, advisors would be worth a lot less to prospective firms. They'd be more like bank brokers who mostly mine in-house relationships and who typically sign prohibitive trade secret agreements that limit their ability to solicit clients. Bank brokers usually get relatively little upfront. Back-end performance payments are the most important part of their recruitment packages. If Morgan Stanley advisors get demoted to the level of bank brokers for recruitment purposes, all bets are off.
4. RETIREMENT VALUE OF BOOKS WILL DECLINE
Michael Kitces, publisher of Kitces.com and partner at Pinnacle Advisory Group, says retiring advisors at non-protocol firms will be paid less for their books because their employers will feel that they can't move them anyway.
5. EVERY FRIDAY WILL BE FRIDAY THE 13TH
Friday afternoon is about to become the worst day of the week for Morgan Stanley branch managers. The protocol facilitated a smooth transition of assets and gave advisors the confidence to resign anytime during the week that made sense. Now that Morgan Stanley has moved its advisors back to the pre-protocol era, advisors will once again resign late on Friday when other advisors are not available to prospect their accounts and when the old firm may find courts less available to petition to issue TRO's.
6. THE PRESS WILL LOVE COVERING UGLY SPLITS
Morgan Stanley advisor departures will generate ugly disputes that the press will gleefully broadcast. This unseemly publicity will be a black eye for all Wall Street firms.
7. FIRMS THAT VALUE ADVISORS WILL BE THE BIG WINNERS
Protocol firms that respect customer choice and recognize the advisor's importance in the advisor-client relationship will attract top-drawer advisors. These firms will triumph in recruiting.