Morgan Stanley's broker protocol exit: How did we get here?

As the number of signatories to the protocol has swelled over the years, so too has the gamesmanship Morgan Stanley cites as its reason for leaving, according to experts

Nov 2, 2017 @ 10:00 am

By Greg Iacurci

Morgan Stanley dropped an industry bombshell this week upon announcing it would leave the broker protocol, a 13-year-old agreement that governs how financial advisers could leave one brokerage firm for another without getting in legal trouble.

Some observers are hypothesizing this is the first of many dominos to fall, with an exodus of other big brokerage firms leading to an environment harking back to the '90s and early 2000s — one that's more contentious and litigious — when an adviser jumps ship.

How did we get to this point?

Merrill Lynch, UBS PaineWebber and Smith Barney were the founding signatories of the agreement, the Protocol for Broker Recruiting, in 2004. Morgan Stanley and Wachovia Securities (now Wells Fargo Advisors), the remaining wirehouse firms, followed in 2006.

Now, more than 1,500 firms voluntarily participate.

Prior to its establishment, big brokerage houses would seek to prevent clients (and their assets) from walking out the door by taking legal action against the departing adviser. Typically, that took the form of a temporary restraining order preventing the adviser from contacting, and soliciting, his or her clients pending a negotiation.

"The [temporary restraining order] was almost becoming commoditized," said Danny Sarch, founder and owner of Leitner Sarch Consultants, an adviser recruiting firm.

The broker protocol was the industry's answer to tamping down on litigation and issues that emerged around privacy of client data.


Mindy Diamond, president and CEO at recruiting firm Diamond Consultants, equates the agreement to a "mutual truce" — advisers who were part of signatory firms could leave without being sued if they followed certain rules, such as only taking a limited amount of client information.

The protocol's language hasn't changed over the years, but the way firms have operated within its boundaries has, straining the protocol amid allegations of gamesmanship by some participants.

"This has really cropped up over the past five or six years. It's become a lot more evident," Thomas B. Lewis, a partner at the law firm Stevens & Lee, said. Firms didn't initially use loopholes when the "large mainstream broker-dealers" were the only members, he added.

Some observers point to JPMorgan Chase & Co. and Bank of America Merrill Lynch as examples of firms gaming the rules via certain exclusions. In other words, they and other firms are partly in and partly out of the protocol, leading to circumstances where they may poach brokers at liberty but punish those trying to leave, the observers said.

"There's a lot of confusion right now with certain firms, and certain small firms that could be using the protocol to their advantage when it is advantageous, and taking the position the protocol doesn't apply in other situations," Mr. Lewis said.

JPMorgan holds that registered representatives at the firm's brokerage — a legacy of Bear Stearns, which JPMorgan acquired — are covered by the protocol, but says reps in JPMorgan's private bank aren't covered by the agreement. JPMorgan sees the protocol as pertaining only to commission-based brokers, not the employees in the private bank who receive a salary and bonus to service clients.

Similarly, Merrill Lynch distinguishes between brokers who build their books of businesses on their own, and those who use in-house referrals to do so. The former group is covered by the protocol. The firm has said brokers have a choice between the two classifications.

"They were able to have their cake and eat it too," Mr. Sarch said of the firms. He added, though, that there's logic in the dichotomy, because "but for the bank's introduction they would not know that client."

Merrill Lynch spokeswoman Susan McCabe and JPMorgan spokesman Robert Carosella declined comment.


But it's not only the big brokerage firms that have gamed the rules to a certain extent, observers said. Some small independent shops recruiting from larger firms join the protocol to make it easier to hire an adviser, but then exit the protocol shortly after hiring to make it difficult to leave.

Further, inherited accounts, or those an adviser inherits from a retiring or departing broker, also typically fall outside the protections of the rules. So, the inheriting adviser wouldn't subsequently be able to solicit those accounts upon departure from the firm.

Take a case involving Morgan Stanley and Connecticut-based brokers leaving for Janney Montgomery Scott as a recent example. Morgan Stanley sued for, and this year won, a permanent injunction against advisers Shane O'Brien and June Strunk preventing them from soliciting accounts inherited from a retiring Morgan Stanley broker.

Which all brings us back to the present. Morgan Stanley cited such so-called loopholes as a primary reason for leaving the broker protocol on Nov. 3, subsequently subjecting employees to a one-year non-solicit agreement if they leave.

But some observers don't buy it, and suspect the argument is an excuse to try to stem attrition at the firm.

"If you're a net loser of advisers, and have been for years, the protocol is just making the door out easier," Mr. Sarch said.

When asked for comment, a Morgan Stanley spokeswoman referred to the company's original announcement about the protocol departure, which says the firm will now be able to "invest more heavily in its world class advisers and their teams" to drive growth.


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