Broker protocol for recruiting a boon for clients

New research finds advisers whose firms have joined the agreement take better care of customers.

Turns out the broker protocol for recruiting among securities firms not only helps advisers more easily relocate where they work, it also has unexpected benefits for clients.

The protocol, first agreed to by a handful of large firms more than a decade ago, allows an adviser to take a limited amount of client information when leaving a firm for a new shop, and essentially eases that transition. It prevents lawsuits and restraining orders that harm clients, and has been widely accepted, with more than 1,500 firms working under its rules.

It also directly helps the customers of brokerage firms that are part of the agreement, according to a new report. It curbs customer disputes against brokers because the rep feels a sense of ownership in the relationship with the client and wants to watch over that relationship, according to a report published this month by two professors of finance at the University of Kentucky, Chris P. Clifford and William C. Gerken.

“We find strong evidence that advisers take better care of relationships after the firm enters the protocol,” representing a 42% reduction in customer disputes relative to the industry’s baseline, according to Mr. Clifford and Mr. Gerken.

Combing through records of 1.3 million financial advisers and over 50,000 firms from 1999 to 2016, the professors used three data points to create their analysis: the adviser’s own treatment of customers before entering the protocol, other advisers at the firm before entering the protocol, and contemporary behavior by other advisers within the same county.

The agreement creates greater broker movement, one of the key reasons Morgan Stanley said at the end of last month it was pulling out of the pact. But it also has certain advantages, according to the report, titled “Investment in Human Capital and Labor Mobility: Evidence from a Shock to Property Rights.”

“While inclusion in the protocol hastens employee departures from the firm, it also increases the employees’ investment in their human capital,” according to the report. “We find that advisers take better care of their client relationships as evidenced by a drop in customer dispute rates upon their employer joining the protocol. Advisers increase their number of industry licenses and shift their business to a longer-term fee-based model.”

Firms gain from the protocol, too.

“We find within firm evidence that revenues, assets under management and number of accounts increase after joining the protocol; these increases remain even after accounting for the increase in number of employees,” according to the report.

The state of the broker protocol is one of the biggest issues facing the retail securities industry today, and the report raises the issue that haunts the brokerage industry to its core. Who owns the client, the firm or the adviser?

That balancing act is at the heart of broker protocol. The large wirehouses clearly believe the clients belong to them and are reassessing whether to stay in the agreement. Smaller firms like Raymond James Financial and RBC Wealth Management have benefited from the agreement and have seen over the past couple of years significant amounts of advisers leave the wirehouses to join their ranks.

This report is another problem for large firms like Morgan Stanley. How can another such firm, think of Merrill Lynch or UBS Wealth Management Americas now justify leaving the protocol when there appears to be academic research showing such a move would not be in the best interest of its customers?

“As patients trust their doctor and do not want to go to a random doctor, even if equally qualified, clients of financial advisers are similarly attached,” the professors write. “While clients are legally the property of the firm, the individual adviser is the de facto face of the relationship.”

The report also cites current or forthcoming academic research that focuses on the argument that bad brokers tend to bunch together at firms that tolerate such behavior.

In other words, cockroach brokers cluster at retail firms that turn a blind eye or cater to dirty business.

“A significant fraction of advisers have disputes with their clients and suggest that certain firms specialize in [such] misconduct and cater to unsophisticated consumers,” according to the report. “Advisers learn from their peers, and misconduct is contagious among co-workers.”

Allowing brokers easier movement, it appears, improves the relationship with clients. Advisers have a greater sense of control and ownership of the relationship with the client, even though the client legally is under the firm’s control. There is also no doubt that the protocol makes business tougher for big firms like Morgan Stanley, who are seeing a drain of some of their largest, most accomplished advisers, who are becoming independent RIAs or setting up their own businesses with an independent broker-dealer functioning as a back office.

With more choices than ever, retail clients in the end will come out on top, working with their chosen adviser regardless of his or her location, firm or way of doing business. It will be a struggle for large firms to hang on to customers when an adviser’s ability to move easily to a new firm is acknowledged to be a boon for the client.