It is all too common for a broker-dealer to recruit a registered representative (“RR”), who has built a thriving book of business, only to leave the RR  “high and dry” when the previous brokerage firm (“old firm”) brings an injunction and/or sues for damages for allegedly taking trade secrets from the old firm.  The RR’s defense is the recruiting broker-dealer’s (“new firm”) transition was aware and authorized the alleged taking of trade secrets and confidential information.

This article deals with the extent a new firm has to an RR’s best interest in transitioning from an old firm.  At first glance, it seems logical the new firm and the RR’s interests be aligned, but this is not always the case.  For example, a recruiting firm typically has the RR sign an indemnification agreement.

An indemnity agreement is a contract where those involved agree that the other be ‘held harmless’ for losses or damages, or where the parties agree that the other is legally exempt from losses or damages incurred.  In essence, many indemnity agreements require the RR to pay the new firm’s attorneys’ fees, settlements, FINRA arbitration awards, jury awards, etc. relating to an RR’s conduct transitioning to the recruiting firm. The new firm may not consult or obtain approval from the RR when settling a matter. 

When an old firm sues an RR for alleged transitioning violations, not only could this trigger a reporting for CRD purposes, but the emotional and financial stress involved may cause an RR to question the merits of switching firms, even despite any upfront bonus by the new firm.

I have seen cases where the old firm sued both the new firm and RR for transition violations.  In an attempt to hide the new firm’s knowledge and approval in transition violations, it fires the RR alleging that it did not know of the RR’s alleged wrongdoing.  Most, if not all RRs are employees-at-will or independent contractors.  This means that the firm may fire or cease a working relationship with an RR for just about any reason.

Now, imagine a RRdecided to switch to a new firm.  The RR worked 24/7 cultivating client relationships transitioning to the new firm.  However, there is always an attrition rate, especially with large producers and wire-houses because customers may be satisfied with the old firm.  Customers may have non-securities related matters, such as mortgages, helocs, credit cards, loans, etc. at the old firm.  Customers may also enjoy the overall customer service and dealing with other individuals at the old firm.  Customers, especially fiduciaries, who handle multiple accounts may elect to remain at the old firm because the transferring paperwork could be voluminous.

To continue with the example, after the RR is up and running at the new firm, it terminates the RR in response to a lawsuit filed by the old firm, alleging facilitating the RR in taking trade secrets and confidential information.  Not only is the RR stunned, he now has to hustle to associate himself with another broker-dealer and once again reach out to customers to transfer to a different firm. The attrition rate of losing customers increases.  To make matters worse, a broker-dealer has 30 days from terminating an RR to file a Form U-5, disclosing the reasons for termination.  From a compliance perspective, a prospective firm would not hire a RR until the Form U-5 is reported to FINRA.  A hiring firm wants to know why a RRwas terminated before making the decision to establish a relationship. 

In the meantime, the new firm/firing firm reassigns the RR’s accounts to other brokers.  Customer accounts still need to be serviced, especially if a customer wants to make a trade or receive a distribution. This only leads to further headache to the fired RR, who has to explain to customers why he no longer works for the firm he recently raved about and why brokers are calling his clients, saying they are the newly assigned advisor.

Only a few months prior, all looked good, but now, the RR has been sued, paying legal bills, terminated, has negative language on his CRD, and is unemployed.  How did things go so wrong, so quickly?

It is important to take away that a firm’s transition team at the new firm is skilled in helping RRs transfer as much business as possible away from the old firm. Transition teams are typically not attorneys, and many of whom are unlicensed.  They are administrative in nature.  Many transition representatives turn a blind eye when an RR unknowingly brings over inappropriate information from old frim to the new firm. Many times, transition representatives are quickly assigned to a new recruiting prospect and are unaware of the legal consequences of their actions.

How does one protect oneself in transitioning to a new firm?  It is always prudent to check with an independent attorney experienced in this area.  No one wants to be involved in a legal matter, even if he or she will prevail.  Lawsuits are stressful and expensive.  An attorney who represents registered representatives in FINRA arbitration could provide invaluable advice on how to avoid a lawsuit when transitioning.

Another avenue in protecting oneself when transitioning from an old firm to a new firm is obtaining written approval by the new firm regarding any questions of impropriety.  For example, the content of laptops, day-timers, calendars, notes, etc. should be reviewed by the recruiting firm and signed off that the materials are permissible and not the property or confidential information of the old firm.  This could immunize the RR in the event of legal action for allegations of taking inappropriate information.