Introduction
In 2004, three financial services firms devised a way to ease the transition of financial advisers from one firm to another. The three firms – Citigroup Global Markets (Smith Barney), Merrill Lynch, and UBS Financial Services – signed an agreement called the Protocol for Broker Recruiting (the “Protocol”). Since then, at least 153 financial services firms have signed the Protocol. The result has been a profound increase in the number of transitions and an equally profound decrease in the number of litigation filings in which firms have sought to obtain Temporary Restraining Orders (TROs) or other injunctive relief against their departing employees! By its express language, the Protocol protects transitioning financial advisers only when they comply with the terms of the Protocol in transitioning from one Protocol signatory firm to another. If one firm (or both firms) is not a Protocol signatory firm, then temporary restraining orders and other injunctive relief, as well as monetary damages for loss of business, continue to be remedies available to firms who elect to pursue their departing advisers. That said, recently several courts of equity have refused to grant injunctive relief to financial services firms that are Protocol signatories. That trend perhaps best is characterized as an unintended consequence of the Protocol that binds.
Protocol Basics
When the three original signatory fi rms created the Protocol, there was a great deal of speculation as to whether it would last. Th e thinking, at the time, was that each fi rm would need to refl ect on whether, in the months and years ahead, it would be a “net hirer” or a “net target” of employee defections. A “net target” fi rm would not accept the deal because the Protocol, in eff ect, was a litigation forbearance agreement. Giving up the right to enjoin transitioning fi nancial advisers leaving with “the fi rm’s customers” and to seek damages was not a decision to be made lightly. Nonetheless, and despite some early delays in signing on, most major fi nancial services fi rms, including all of the “wirehouse” fi rms (such as Merrill Lynch and Morgan Stanley), signed the Protocol. Since then, several (but clearly not all) other fi rms of all sizes have signed on. Th e result has been an employment transition expressway! Why? Th e principal goal of the Protocol, as noted in the opinions of numerous courts, is client choice. Th e Protocol expressly provides: Th e principal goal of the following protocol is to further the clients’ interests of privacy and freedom of choice in connection with the movement of their Registered Representatives (“RRs”) between fi rms. If departing RRs and their new fi rm follow this Protocol, neither the departing RR nor the fi rm that he or she joins would have any monetary or other liability to the fi rm that the RR left by reason of the RR taking the information identifi ed below or the solicitation of the clients serviced by the RR at his or her prior fi rm. When RRs move from one fi rm to another and both fi rms are signatories to this protocol, they may take only the following account information: client name, address, phone number, email address, and account title of the clients that they serviced while at the fi rm (the “Client Information”) and are prohibited from taking any other documents or information. Resignations will be in writing and delivered to local branch management and shall include a copy of the Client Information that the RR is taking with him or her. Th e RR list delivered to the branch also shall include the account numbers for the clients serviced by the RR…. As stated, transitioning fi nancial advisers may take their client names, addresses, telephone numbers, email addresses and client account names/titles. Likewise, transitioning fi nancial advisers may share their personal sales production information with their new fi rm. On the other hand, transitioning fi nancial advisers may not take other account data, such as client account numbers, account statements or tax identifi cation numbers. Similarly, fi nancial advisers may not share with their new fi rms any client information prior to resignation. Of course, it is worth noting that nothing in the Protocol alters the common law duty of loyalty as it relates to prohibiting a fi nancial adviser from soliciting clients (to move their accounts) and staff (to join the new fi rm) before the adviser resigns. Financial advisers must resign in writing and attach copies of any client information that they are taking. While the fi – nancial adviser can and will bring a list of client account names/titles, he or she also will provide that list to the former employer but will add to it the client account numbers.1
Protocol Litigation Surrounding Non-Compliance
As one would expect, there has been litigation addressing whether transitioning financial advisers have complied with the Protocol, and what the consequences should be in the event that they have not so complied. Courts indeed have issued injunctive relief under these circumstances. E.g., A.G. Edwards & Sons, Inc. v. McCreanor, 2007 WL 2696570 (M.D. Florida) (temporary restraining order issued against advisers transitioning to Morgan Stanley). However, the terms of the Protocol deem advisers to be in compliance with the Protocol so long as the adviser “exercised good faith in assembling the list” of customers delivered to branch office management, and “substantially complied” with the requirement that only certain customer information be taken. Accordingly, other courts have not granted such relief – even in situations where, perhaps, it would have been warranted. For instance, in Merrill Lynch v. Reidy, 477 F.Supp.2d 472 (D.Connecticut 2007) the court was faced with deciding whether fi nancial adviser Brendan Reidy and his team should be enjoined in transitioning from Merrill Lynch to Morgan Stanley. Merrill Lynch cried foul and sued Reidy and his team, arguing that because they had not followed the Protocol, they were exposed to liability for breach of contract, as well as statutory and common law obligations. Merrill Lynch requested that the court issue a temporary restraining order and preliminary injunction. Th e court noted that such equitable relief is an “extraordinary and drastic remedy, one that should not be granted unless the movant, by a clear showing, carries the burden of persuasion.” Turning to the facts, Merrill Lynch argued that Reidy and his team had breached the Protocol by failing to provide adequate customer information to it upon resigning, by taking more client information than permitted, including account numbers, and by accessing and/or taking prohibited documents with them upon resignation, pointing to computer access records and printing histories. For example, one set of documents at issue included annual performance reviews. Reidy and his team had prepared them for 50 clients in the month prior to their resignation, without Merrill Lynch compliance approval as client correspondence. Th e court addressed each of the purported Protocol defi ciencies. Th e court determined that Reidy and his team substantially had complied with the Protocol. Additionally, the court concluded that there was a “legitimate dispute” about the scope of the client information that Reidy and his team had retained upon resignation. Notably, with respect to the annual performance reviews, the court stated that while such activity might have violated Merrill Lynch’s compliance policies, it did not rise to the level of a Protocol violation. Finally, the court found Merrill Lynch’s claim that Reidy and his team had retained client account numbers as “largely speculative.” Accordingly, the court held that Merrill Lynch had failed to meet its burden of proof for injunctive relief. Similarly, the court in A.G. Edwards v. Martin, 2007 WL 4180943 (N.D.Florida), based its decision to deny a request for a preliminary injunction on the fact that the document and information taking was “inadvertent” and quickly remedied by its return. In that case, adviser Frank Martin and his team transitioned to Raymond James & Associates. In doing so, they unquestionably took records and impermissible client information not permitted under the Protocol. However, the court stated: Here, the Defendants moved from one firm to another, both of which are signatories to the Broker Protocol. Thus, the Broker Protocol governs and Defendants are allowed to take certain account information. The Defendants admit to inadvertently taking documents that contain additional information, but have returned all documents containing the additional information. The Plaintiff has not shown that the Defendants still have in their possession any additional information. The Defendants have substantially complied with the Broker Protocol. Thus, the Plaintiff has not shown there is a substantial likelihood that the Plaintiff will prevail on the merits. Although the court opinion does not address it, presumably A.G. Edwards retained the right to seek damages (in arbitration).
Creative Applications of the Protocol Agreement
As one may expect, parties in litigation have argued that the Protocol eff ectively has become an industry standard. Consequently, parties argue that transitions in accordance with the Protocol should not be subject to injunctive relief, regardless of whether the parties’ contractual agreements provide for injunctive relief – and, more signifi cantly, even where both of the parties involved are not signatories to the Protocol. Th is creative argument has had moderate success. In Merrill Lynch v. Brennan, 2007 WL 632904 (N.D.Ohio), fi nancial advisers transitioned from Merrill Lynch (a signatory fi rm) to Bear Stearns (a non-signatory fi rm). Merrill Lynch sought a temporary restraining order for breach of contract, misappropriation and misuse of trade secrets, conversion of confi dential business information, breach of the duty of loyalty, and unfair competition. Merrill Lynch cited to its Financial Consultant Training Agreement with the defendants, in which they agreed, among other things, to document confi dentiality, non-solicitation and the issuance of a TRO or a preliminary or permanent injunction. To justify a temporary restraining order, the court stated that Merrill Lynch had to demonstrate: (1) a likelihood of success on the merits; (2) that it would be irreparably harmed in the absence of injunctive relief; (3) that greater harm would result to Merrill Lynch from the denial of injunctive relief than to the defendants where injunctive relief is granted; and (4) that the public interest would be better served by issuing a preliminary injunction. Merrill Lynch argued that it met each of those four elements. Th e court, however, found that Merrill Lynch could not demonstrate irreparable harm. 2 Damages are calculable, the court concluded, reasoning: Although this court found such arguments persuasive in 1998, the changed circumstances in the securities industry convinces the court that such arguments no longer merit such weight. Merrill Lynch v. Martin, No. 98 CV 1408 (N.D. Ohio 1998). To wit, in 2001 [sic 2004], Merrill, along with industry peers, signed the Protocol For Broker Recruiting (“the Protocol”). In essence, the Protocol allows brokers, under certain conditions, to bring client lists with them when transferring fi rms. Although Bear Stearns is not a signatory to this agreement, Merrill’s signature indicates that they understand the fl uid nature of the industry; brokers routinely switch fi rms and take their client lists with them. By setting up such a procedure for departing brokers to take client lists, Merrill tacitly accepts that such an occurrence does not cause irreparable harm. Merrill Lynch also argued that the loss of goodwill was a source of irreparable harm; specifi cally, “allegedly suff ering a loss of customer trust and goodwill once it becomes clear that such confi – dential information was given to others (i.e. Bear Stearns).” Nonetheless, the court rejected that argument, commenting that the existence of the Protocol “signifi cantly undercuts the notion that such behavior destroys customer goodwill.” Th e court ordered the matter to proceed in arbitration where, if appropriate, Merrill Lynch could seek monetary damages for its alleged loss of business. Likewise, the court rejected Merrill Lynch’s eff ort to obtain a temporary restraining order in Merrill Lynch v. Brinkman, 2008 WL 4534299 (D.Arizona). Th ere defendants had transitioned to a non-Protocol fi rm, Robert W. Baird & Co. Merrill Lynch contended that it simply wanted to enforce its contractual agreement with the defendants, and that the Protocol was irrelevant. In an interesting twist, the court observed that even though Robert W. Baird was not a signatory to the Protocol, the defendants “would have been wise to have followed it and taken with them only the information allowed under the protocol.” In view of the fact that the defendants did more than what the Protocol allowed, among other reasons, the court found that Merrill Lynch indeed had shown the fi rst element of a temporary restraining order, probable success on the merits (“or at least that serious questions are raised”). Still, the court denied the issuance of a TRO, determining that Merrill Lynch had failed to show two other elements — irreparable harm as well as balance of hardship — notably without reference to the Protocol. As to irreparable harm, the court believed that “the identifi cation of lost clients and the determination of associated damages would not be diffi cult within the scope of the parties’ arbitration agreement. As to balance of hardship, the court noted that the loss of Merrill Lynch’s customers (the harm) already had occurred, whereas, “the harm to the defendants is that they likely would not be able to earn a living in their chosen fi eld for up to a year.” Observing that covenants not to compete are frowned upon, the court found that the balance of hardship did not “tip sharply” in Merrill Lynch’s favor. In Smith Barney v. Griffi n, 2008 WL 325269 (Mass.Super.), the court again was faced with a situation where a fi nancial advisor had transitioned from a signatory fi rm, Smith Barney, to a non-signatory fi rm, N.Y. Life. Th e court was faced with the usual arguments and responded that it had “struggled for many years with various motions, such as this, brought by fi nancial services companies seeking preliminary injunctions that would prohibit their departing fi nancial advisors from taking any client information with them and from soliciting their former clients to transfer their accounts to the new fi rm.” Th e court described fi ve reasons for this diffi culty. First, the enforcement of the confi dentiality and non-solicitation provisions “punishes the clients of the departing fi nancial advisors” as the clients’ fi nancial advisor “one day simply disappears without warning.” Second, citing the movie “Casablanca”, fi rms seeking injunctive relief simply are “shocked, shocked” that another fi rm would induce their new fi nancial advisor to breach his or her agreements with the former firm, yet “they are themselves engaged in precisely the same ‘shocking’ conduct.” Th ird, the non-solicitation agreements typically have been presented to fi nancial advisors when they fi rst commence employment, without separate consideration beyond continued employment, and without any choice apart from termination. Fourth, the legal justifi cation for such restrictions is to preserve the company’s goodwill, yet a company is not entitled to preserve the goodwill earned by its employee that fairly belongs to the employee. Fifth, and fi nally, there is a real question as to whether clients’ names, addresses and telephone numbers are confi dential. In addition to those fi ve generic reasons, the court wrote that in the case before it, another, sixth reason was present: Smith Barney was a signatory to the Protocol. While Smith Barney argued that the Protocol was “irrelevant to this motion for preliminary injunction because it is simply a forbearance agreement that does not apply here, since N.Y. Life is not a signatory”, the court nonetheless states that it does not agree that the Protocol is “inconsequential to the decision of whether preliminary injunctive relief equitably is warranted.” In fact, the Griffin court found that New York law (which governed the parties’ contract), like Massachusetts law, recognizes that a nonsolicitation agreement is an “ancillary employee anti-competitive agreement that will be carefully scrutinized by the courts.” As such, the court stated that – in determining whether to grant Smith Barney’s request for a preliminary injunction – it must examine not only whether the non-solicitation provision of the adviser’s employment contract was a reasonable restraint on the adviser’s ability to compete with Smith Barney, but also whether the court’s equitable power should be used to preliminarily enjoin violation of the adviser’s employment contract. In rejecting Smith Barney’s request for a preliminary injunction, the Griffi n court found that the Protocol indeed did shed light on three critically important questions: (1) Does Smith Barney regard Client Information, as defi ned in the Protocol, truly to be confi dential? (2) Is the non-solicitation agreement in the [employment] Contract truly necessary to protect the goodwill of Smith Barney? and (3) Is a preliminary injunction truly necessary to prevent a substantial risk of irreparable harm? Signifi cantly, the Griffi n court held that, in view of the Protocol, the answer to each of the aforementioned questions is a “no.” For example, with respect to Question No. 1, the court found that, by allowing its departing fi nancial advisers to leave freely with client information (pursuant to the Protocol), Smith Barney eff ectively has declared that it does not consider this client information to be “nonpublic personal information.” Hence, such client information cannot be characterized as “confi dential.” In sum, the court found that Smith Barney cannot have it both ways – declaring this information to be confi dential and, at the same time, permitting it freely to be taken to other fi nancial institutions by advisers departing for Protocol signatory fi rms. In Smith Barney v. Burrow, 558 F.Supp.2d 1066 (E.D. California 2008), the defendants resigned from Smith Barney (a Protocol signatory fi rm) on March 7, 2008 to become SEC-registered investment advisers doing business as Valley Wealth Incorporated (“Valley Wealth”). In arguing against the motion for preliminary injunction, defendants claimed that the Protocol was an “industry standard collective bargaining agreement” to govern “fi nancial fi rms in dealing with the modern trends of fi nancial advisors who change fi nancial fi rms and bring with them their clients.” Indeed, on the day that defendants had resigned from Smith Barney they had signed a Joinder Agreement to the Protocol for Broker Recruiting. Whether or not the defendants were signatories to the Protocol, Smith Barney argued that the defendants failed to abide by the terms of the Protocol. Nonetheless, the court found that Smith Barney failed to demonstrate suffi cient successes on the merits to satisfy that element for a preliminary injunction. First, citing Smith Barney v. Griffi n, supra, the court rejected Smith Barney’s argument that defendants had removed confi dential trade secrets. Th e court stated, “Given the Protocol, Smith Barney is hard pressed to convince this Court that information regarding clients whom [defendants] serviced qualify as Smith Barney’s confi dential trade secrets.” Elaborating, the court observed that defendants built up their clientele through their eff orts, and that one of the defendants brought (and was encouraged to bring) his clients with them initially when he transitioned to Smith Barney. Th e court also noted that Smith Barney had failed to pinpoint that it had spent substantial sums of money to develop defendants’ clients and, in any event, noted that Smith Barney had acknowledged that it purchases mailing lists – “i.e., public information to develop clientele.” Additionally, relying on the Protocol, the court determined that Smith Barney had failed to prove its claims of unfair competition as well as breach of fi duciary duty. Regarding unfair competition, the court states: Th e record before us indicates that [defendants] pursued clients whom they had serviced and developed while at Smith Barney. Smith Barney’s signing the Protocol indicates that it expected outgoing financial advisors to continue to service their clients and that such continuing service is not unfair competition. Smith Barney overplays its claims of deception. Regarding breach of fiduciary duty, the court wrote: Smith Barney’s participation in the Protocol diminishes its claims that [defendants] breached duties of loyalty, especially given that Smith Barney presumably benefi tted from [one of defendant’s] transfer of his Morgan Stanley clients to Smith Barney. At most, defendants and Smith Barney compete on a limited scale in a limited market. Defendants do not compete with Smith Barney in the national market to which it is privy. Clients are free to come and go among defendants, Smith Barney, and a myriad of other fi nancial advisors. Likewise, the court relied upon the Protocol to fi nd that there was no irreparable harm. Citing Merrill Lynch v. Brennan, supra, the court commented that, “Courts have become disinclined to fi nd irreparable, incalculable harm from fi nancial advisors’ departures.” In lieu of an injunction, the court off er invited Smith Barney “to seek compensation for proven economic harm” – in arbitration.
Strict Interpretations of the Protocol Agreement
Not all courts are so willing to overlook the contractual agreements between the fi rms and their fi nancial advisors, however. For example, in Hilliard-Lyons v. Clark, 2007 WL 2589956 (W.D.Michigan), the plaintiff seeking injunctive relief, Hilliard-Lyons, was not a signatory to the Protocol. Defendants transitioned from Hilliard-Lyons to Raymond James & Associates, a signatory fi rm. Arguing against the issuance of an injunction, including the enforceability of non-solicitation provisions in trainee agreements, defendants contended that the Protocol was signed by a majority of fi rms and such non-solicitation provisions were inconsistent with the Protocol. Th e court disagreed. Th e court stated that the Protocol applies, by its own terms, only when both fi rms are Protocol signatories. Distinguishing Merrill Lynch v. Brennan, supra, the court concluded that, unlike Merrill Lynch, Hilliard-Lyons did not “tacitly accept” the terms of the Protocol because it never had signed it. Th e Protocol, the court wrote, “is not intended to bind those fi rms who opt not to sign it.” Moreover, in Wachovia Securities v. Stanton, 571 F.Supp.2d 1014 (N.D.Iowa 2008), the court found the Protocol arguments unpersuasive even though the plaintiff , Wachovia Securities, was a Protocol signatory. Recognizing that the ruling was contrary to the ruling in Merrill Lynch v. Brennan, supra, the court wrote: Where both parties are signatories, they have essentially agreed to reciprocal “poaching” of registered representatives and the registered representative’s clients from the former fi rm, apparently on the assumption that they will gain as much as they lose in the exchange. On the other hand, where the new fi rm is not a signatory, the old fi rm has no reciprocal benefi t to look forward to, and a prohibition on solicitation of clients by a departing registered representative is still reasonably necessary to protect the former fi rm’s client base from “poaching” by the new, non-Protocol fi rm. 3 Th e court did, however, fi nd that the Protocol was relevant to its fi nding with regard to prejudice to the public interest. Th e court highlighted the fact that the Protocol “does recognize that its ‘principal goal’ is ‘to further the clients’ interests of privacy and freedom of choice in connection with the movement of their Registered Representatives (‘RRs’) between fi rms.” Th is and other facts, the court said, were “suffi cient to call into serious question the enforceability of those covenants.”
Conclusion
While we cannot be certain what the future holds (or even whether the Protocol will exist ten years from now), there can be no doubt that the Protocol has been nothing less than a “sea change” for the fi nancial advisers who seek to transition their books of business from one fi rm to another, and the securities broker-dealers and investment advisory fi rms that employ them. Th e ease with which departing advisers can transition their books of business – and the eagerness of fi rms to race to the courthouse for a TRO – greatly have been impacted by this so-called “forebearance agreement.” One thing is clear, based on the foregoing review of court opinions from throughout the country: the Protocol indeed has caused unintended consequences. While several courts have sought to protect the interests of non-signatories seeking to enforce their rights as against departing advisers, a signifi cant number of courts have relied upon the Protocol to deny injunctive relief – even where one (or both) of the parties at issue is a non-signatory to the Protocol. Whether that trend will continue remains to be seen, but the existing case law, discussed above, no doubt will continue to shape this debate in the years ahead.
