Advisor Transitions: 5 Critical Questions to Answer Before Changing Firms
Taking a job with a new firm can be a stressful and challenging experience for any professional. In the investment advisory and brokerage industries, accepting a new job involves added complexities because industry norms and advisor contracts tend to favor the registered investment adviser (“RIA”) and broker-dealer (“BD”) firms.
Recent industry data shows that investment advisor representatives and registered representatives (together, “Advisors”) are transitioning at a record pace in 2021, with thousands of individuals switching firms so far this year.[1]
Whether you are an Advisor about to change jobs, or a firm hiring those Advisors, here is a list of critical questions to consider before acting:
1. Is the Advisor Ready to Make a Change?
Changing firms in the investment and brokerage space is an exercise that typically takes weeks or months to plan. There are many steps that need to be synchronized to ensure an orderly transition, some of which can include: (i) completion of onboarding diligence by the hiring firm, (ii) finalizing the Advisor’s new contract terms, (iii) if an Advisor will be creating an entity (e.g., a personal corporation or limited liability company), the valid establishment of that entity, and (iv) the amount of notice the Advisor must give before leaving their current firm. Each of these steps can influence an Advisor’s transition timetable.
2. Restrictive Covenants: Does the Advisor’s Contract Limit Transition Steps?
An Advisor’s contract with their current firm is the most common place to find restrictions that limit the steps permissible when changing firms. Ideally, an Advisor will have a copy of any employment letter or independent contractor agreement in hand long before thinking about a transition (because requesting a copy of such a document can be viewed as a “red flag” by RIAs and BDs). Non-solicitation[2] provisions prohibiting an Advisor from inducing clients to move their business are commonplace; provisions requiring an Advisor to pay the prior firm for any clients that transition with the Advisor often appear in Advisory contracts as well. Confidentiality clauses typically state that an Advisor cannot transport any client information to the new firm and restrict an Advisor from using a firm’s trade secrets (which usually include client lists and information) to compete against the prior firm.[3] As a result, an Advisor has to be prepared to start with no data at the new firm (subject to application of the Broker Protocol, discussed below), and to address contract-specific issues as part of the transition process.
3. Will the Broker Protocol Allow an Easier Transition?
The Protocol for Broker Recruiting (the “Protocol”) was created and adopted by three major wirehouses in 2004 - Citigroup Global Markets (then Smith Barney), UBS, and Merrill Lynch - to facilitate a more efficient and less litigious transition of Advisors. Since the three founding members created the Protocol, nearly 2,000 firms have now signed and adopted it.
The Protocol states that if the Advisor’s prior firm and the new firm are signatories to the Protocol at the time of transition, then the Advisor may retain five pieces of client information and to take that information to the new firm. Those five specified pieces of information include only the client names, addresses, phone numbers, email addresses and account titles of clients that the Advisor serviced at the prior firm. There are additional steps that must be followed if seeking reliance on the Protocol when making a transition, so Advisors should carefully review all relevant requirements.
4. Are Form U5 Issues a Valid Concern?
Form U5 is the Uniform Termination Notice for Securities Industry Registration used by RIAs and BDs to report information about an Advisor, including the departure of an Advisor for any reason from a firm.[4] Information reported on Form U5 is reviewed by industry regulators, and certain data is available to the public via the FINRA and IAPD websites.[5]
If an Advisor resigns, the prior firm would be expected to select “voluntary resignation” on the Advisor’s Form U5 as the reason for departure. However, if the Advisor experienced any compliance or human resources issues or was involved in a violation of firm policy before the Advisor’s resignation, the prior firm could elect to report the Advisor as being “under internal review” at the time of separation. This approach would require the firm to add disclosures to Form U5 explaining the circumstances, which could result in a negative reporting event in the disciplinary history of the Advisor.
Adding a disclosure to an Advisor’s Form U5 is the equivalent of delivering a regulatory “gift that keeps on giving.” The disclosure is certain to be reviewed by the governing regulatory body overseeing the Advisor’s activities, and may elect to open an inquiry into the matter. Additionally, a new regulatory disclosure may chill the new firm’s interest in hiring the Advisor, provide the new firm a basis to reopen employment discussions, or cause clients not to retain/maintain relationships with the Advisor.
Options to remove or modify a negative Form U5 disclosure are extremely limited[6], so a transitioning Advisor should properly grasp whether U5 issues are likely so that they can be factored into the Advisor’s overall transition plan.
5. Is the Right Professional Adviser Involved?
Changing firms in the investment advisory or broker-dealer space is complicated. Finding the right professional adviser is an important step in creating a smartly designed transition plan. Advisors are urged to work with knowledgeable counsel with deep experience in securities industry matters to identify important regulatory and legal issues, and to formulate a detailed transition strategy.
Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes.
We represent many broker-dealers, registered representatives, investment advisors, investors and businesses.
Attorney Robert D. Conca can be reached in the firm’s San Diego office at (619) 696-9500.
[1] See this recent blog by my colleague George Miller, citing 2021 transition statistics: https://www.shufirm.com/financial-advisor-update-more-advisors-moving-firms-in-2021.
[2] Note that non-compete clauses comprise a complex area of law that varies by state and are different from non-solicitation clauses. California Courts will generally not enforce non-compete provisions in an Advisor employment agreement, but other states may permit such clauses (e.g., prohibiting an Advisor from providing investment advice within 120 miles of their former place of employment).
[3] Trade secrets are governed at the state level (California Uniform Trade Secrets Act, Cal. Civil Code § 3426 et seq.) and at the federal level. Detailed discussion on this topic is outside the scope of this article.
[4] See Form U5 Instructions: https://www.finra.org/sites/default/files/AppSupportDoc/p015113.pdf.
[5] See https://brokercheck.finra.org/ and https://adviserinfo.sec.gov/ respectively.
[6] The primary option here is expungement, which is conducted through a formal FINRA arbitration proceeding, and relief is awarded if a U5 disclosure is fundamentally flawed or incorrect. A detailed discussion is outside the scope of this article.
