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Regulation and Compliance > Litigation

The Big Mistake That Leaves Advisors Open to Lawsuits

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What You Need to Know

  • An increasing number of RIA firms have sued former advisors for allegedly breaking the terms of their contracts.
  • Too many advisors and brokers don’t read the terms of the contracts they sign when they join a firm.
  • One other big mistake: Not having a lawyer review the contract before signing it.

After Hightower sued a breakaway advisor in December on accusations he broke an agreement protecting client information, advisors and other industry leaders criticized the firm for using what they deemed a wirehouse tactic. But in recent years, an increasing number of RIA firms have filed similar suits, legal experts told ThinkAdvisor.

Across channels, too many advisors and brokers don’t read the terms of the contracts they sign or even know what the exact terms are when they join a firm, they said.

One big mistake is that advisors “almost never” have a lawyer review a contract from a financial services firm before signing it, according to Brian Hamburger, CEO and president of MarketCounsel and chief counsel of the Hamburger Law Firm.

Not Just for Wirehouses Anymore

It used to be the wirehouses that were responsible for most cases in which financial services firms sued brokers who left and attempted to take clients with them, Hamburger told ThinkAdvisor.

“But, as market share has shifted, I think we are seeing a commensurate number of cases within the independent side of the securities industry, and that makes sense,” he said.

Meanwhile, the specific terms of each financial services firm contract with an advisor or broker vary significantly, Hamburger said, adding there are always some restrictions placed on advisors. “Yet, way too often, advisors just sign what’s placed in front of them” and aren’t reviewing the business terms before accepting a job, he said.

The Hightower Case

Advisor/broker Michael Policar “stole Hightower’s confidential and proprietary information, trade secrets, and solicited Hightower clients for the benefit of his newly created competing company,” NGP Financial Planning, Hightower alleged in a recent complaint filed in U.S. District Court for the Northern District of Illinois.

As part of an agreement he signed with Hightower, Policar “promised to safeguard confidential information and take precautions to prevent the disclosure and improper use of confidential information,” the complaint said.

However, “Policar failed to safeguard Hightower’s confidential information; Policar violated Section 3(c) of the agreement when he used such confidential information for improper purposes and to his advantage, thereby harming Hightower,” according to the complaint.

The agreement restricted Policar from contacting Hightower clients for 12 months following his termination, according to the complaint, which said he contacted Hightower clients exclusively by phone “in order to avoid leaving a paper trail of his wrongful behavior.”

Policar denied that he breached his agreement with Hightower.

‘Restrictive Covenants’

This type of legal dispute is “extremely prevalent in the industry,” according to Max Schatzow, partner at RIA Lawyers.

“Most employers in this industry still try and protect their business and their clients through restrictive covenants and when employees violate those restrictive covenants, we oftentimes see litigation,” he told ThinkAdvisor.

If Policar was located in California instead of Illinois, “there is likely no case,” said Schatzow, noting California “doesn’t recognize agreements not to solicit clients and it is unlikely that Hightower brings the case based solely on the misappropriation of trade secrets (although I have seen these types of cases brought in desperation).”

“Typically, we see either 1- or 2-year restrictions against competition and contacting and soliciting former clients,” according to Schatzow.

But he pointed out: “Every business is different and there really isn’t any industry standard. Large firms and small firms alike take steps to protect their businesses. For firms that believe in using restrictive covenants to protect their business, they need to look to state law to see what the law permits.”

Although Hightower critics argued that such restrictive contracts should be abolished, Schatzow said it was more complicated.

The Broker Protocol

Schatzow and Dennis Concilla, a lawyer at Carlile Patchen & Murphy, where he heads the firm’s Securities Litigation and Regulation Practice Group, both pointed out that the Broker Protocol was designed to provide advisors more freedom, but not every firm is a member of it. If you’re not a member of the Broker Protocol, it can’t be used as a defense by you if a case goes to trial, they said.

Carlile Patchen & Murphy’s website features a Broker Protocol search engine. Hightower was listed as a member of the Protocol, according to a search, while Policar and NGP were not. However, Hightower left the Protocol in 2019, a company spokesperson told ThinkAdvisor on Tuesday.

The Protocol was intended to decrease the number of legal disputes just like this one, Concilla told ThinkAdvisor. It has achieved that but there are still many cases like this anyway, he noted.

In essence, the Protocol says, “if you promise not to do certain things [and/or] you only do certain things, regardless of what your contract says, we’re not going to sue you,” Concilla explained, adding advisors can join the Protocol in addition to brokers; in fact, most members are now advisory firms.

If an advisor or broker backs up a truck to the firm’s office back door and takes all the clients’ documents, like in a case he had several years ago, “that’s going to be illegal” regardless of what the contract says, with or without the Protocol, Concilla said. “Every company has a right to protect its property,” he said.

Isn’t It Ironic?

Recruiter Jon Henschen, president of Henschen & Associates, says he has discussed the Hightower case with other recruiters.

“We all agreed that this advisor likely skimmed over the contract, which is very common,” he told ThinkAdvisor. “Advisors will think, this is the last place I’m moving to, so they simply skim over the contract and not look at the details.”

In cases like this, therefore, it’s the advisor or broker who is at fault, he said.

However, “the irony of this of course is wirehouse representatives join a firm like Hightower,” which previously targeted wirehouse reps, “to gain greater freedoms in how they operate their business yet we see Hightower incorporating similar tactics to the firms their advisors left, wirehouses,” he told ThinkAdvisor.

Henschen argued it’s possible that “Hightower will cripple their recruiting efforts going forward because trying to sell an environment of business confinement is a tough sell.”

After all, “our industry is a small world and word gets around quickly with unintended consequences to those that try to impose limits on advisors independence,” he said. “Freedom, as in much of life, always attracts, while those that impose constraints on freedom eventually lose their audience.”

But, “instead of mandating rules or regulations on such matters, I prefer the free markets to let the best ways to operate a business rise to the top,” he said. “Let RIAs and broker-dealers do as they wish, such as Hightower hindering their advisors’ ability to leave, and let them experience the repercussions.”

A LinkedIn Loophole?

This issue is “why every financial advisor should make sure that they’re connected to their clients on LinkedIn,” Crystal Thies, a LinkedIn trainer, said recently on LinkedIn, in response to comments made by Penny Phillips, president and co-founder of Journey Strategic Wealth. Thies argued this would serve as a loophole for advisors.

But Concilla laughed at that argument, saying it may serve as a loophole in some cases, but “it’s not all that effective either.” For one thing, many people, like him, don’t like using LinkedIn (even when they are, like him, a member of the social network).

In many cases, companies have sued over this, alleging it was the equivalent of solicitation, he said.

Also, an advisor’s LinkedIn account and email are often controlled by the firm they are working for and can no longer be used after the advisor has left the company, he added.

(Pictured: Brian Hamburger)


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