WealthManagement Magazine

Sob Story

When brokerage firms ask judges to enjoin departing brokers, emotions run high. Like a bitter divorce, the issue involves custody as well as egos. Firms cite theft of trade secrets, confidentiality breaches, violations of non-compete and non-solicitation agreements, and a host of other legal arguments. They seek to retain client accounts by temporarily and quickly blocking their former employee from

When brokerage firms ask judges to enjoin departing brokers, emotions run high. Like a bitter divorce, the issue involves custody as well as egos. Firms cite theft of trade secrets, confidentiality breaches, violations of non-compete and non-solicitation agreements, and a host of other legal arguments. They seek to retain client accounts by temporarily and quickly blocking their former employee from contacting the client.

But the urgent relief firms claim is so critical may be overstated. Statistics and court records show that firms' request for relief is a sob-story tactic of questionable legality, designed to impede brokers at the same time firms continue to recruit from each other.

Just about once every business day of the year, a brokerage firm requests some form of an injunction to prevent a departing broker from contacting clients they serviced while with the firm. Often these occur at temporary restraining order (TRO) hearings where neither brokers nor their counsel are present--an ex parte proceeding. From January 1996 through October 1997, firms filed 463 suits seeking injunctions against departing brokers, according to the NASDR. In 1996 alone, 236 injunctive cases were reported to the NASD, and at the end of October 1997, the regulator counted 227 cases from 1997--an apparent increase in the number of TRO cases, although the growth could be due to more complete reporting by firms last year, the second year they were required to follow up a TRO by filing for an expedited hearing with the NASDR. Recently, however, firms have expressed more willingness to sue reps who leave (see "Free At Last? Not Quite ... " February '97, Page 59).

But once the initial shouting is over and the restraining order or injunction is in place, some 96% of these cases settle for fairly predictable amounts, usually a percentage of the brokers' trailing 12-month production, though details of these settlements are rarely available to the public. Of the 463 cases reported to the NASDR, only 3% (14 cases) proceeded to a full-arbitration hearing, according to statistics provided by Deborah Masucci, director of arbitration at the NASDR. The rest settled or hadn't been resolved yet.

The bottom line: The first few weeks following a broker's move is what counts, industry experts say. Everyone involved in these cases understands this.

"The fact that very few of these controversies have been concluded by a full hearing and final award is not surprising given the fact that employers and employees seek their quick resolution," the NASDR's Masucci said in a speech given to a New York City securities industry conference on raiding last November.

An injunction facilitates a quick settlement because the broker is essentially prevented from earning a living or contacting clients. "If you're on the losing side [of a TRO battle], you should seriously consider folding your cards," says Larry Carnevale, a securities attorney with Carter Ledyard & Milburn, in New York City, which sponsored the raiding conference. "If you win, you're in a much better leveraging position."

Legally Questionable But according to the law, the purpose of a TRO, or any injunction, is not to aid in settlement or to be a tactical leveraging tool. An injunction aims to prevent harm that cannot be compensated for later. And that's why the fact that these cases settle so readily does seem surprising.

At a TRO hearing, firms typically argue that irreparable harm is about to be done and no monetary award can rectify it. Irreparable harm is one of four legal standards that must be present for an injunction to be granted. The other standards: a lesser likelihood of irreparable harm to the enjoined party if a TRO is granted, a likelihood that applicant will succeed on the merits, and a salutary effect on the public interest.

A judge must agree that there is an overriding need to preserve the "status quo," and that any remedy available at a later date will not entirely compensate for the alleged loss. A good example would be an injunction against the slaughter of a dairy herd--a tough outcome to reverse.

"The legal theory of irreparable harm is that money damages won't be sufficient," says plaintiffs' attorney Jeffrey Liddle, of Liddle & Robinson in New York City, who handles securities industry disputes. "In most states, if I can otherwise know what the money damages are, they will tell you, you can't get a preliminary injunction."

That's why when a firm sues for an injunction, they usually don't simultaneously ask for damages, Liddle says. "If I'm Merrill Lynch suing somebody, and I know the damage is $100,000, it's not appropriate for me to seek an injunction. It's appropriate for me to sue for $100,000."

Firms often are successful in obtaining injunctions because they argue that damages from a broker departing with clients are unclear and not ascertainable at the time they request relief, says Rick Ryder, publisher of Securities Arbitration Commentator in Maplewood, N.J., and judges usually agree with this.

But the facts show otherwise.

In transcripts from an arbitration hearing a year ago, from a case Liddle is pursuing against Merrill Lynch, an outside attorney for Merrill gives a specific range for what the firm settles for. The attorney, Peter Cantwell, of Cantwell & Cantwell in Chicago, told an arbitration panel that he handles injunctive cases for the firm, and "one of the things that I will represent to the panel, and I can back it up with the hard dollar proof of the contract so to speak, is that these cases have settled between a range in our experience of probably 10% on a very low side to 40% on a highside, and typically settle in Chicago for around 25% of the trailing 12. ... "

Other attorneys cite similar figures, and also note that upfront bonus formulas and various methods used to buy a retiring broker's book indicate that the monetary value of a book of business can indeed be calculated.

One judge, apparently recognizing that such a formula or compensation standard existed, found that there was no "irreparable harm" in a preliminary injunction ruling in October 1993.

Judge George E. Woods, Eastern District of Michigan, Southern Division, dissolved a TRO obtained by Merrill Lynch against its former rep Anthony Manaia, ruling: "If there is a standard by which money damages may reasonably be calculated, with the fact finder giving its approval or disapproval, then an injunction is not an appropriate remedy. ... If the court does not issue an injunction, it certainly is going to become clear, and quickly so, how many clients follow Manaia to his new employer. It isn't going to take any magic solution for Merrill Lynch to figure that out."

Judge Woods also found a problem with Merrill's claims that Manaia's possession of client records represented a breach of confidentiality. Only clients have a right to assert that claim, he said. " ... any harm that will be done to Merrill Lynch by allowing Manaia to keep the client records is theoretical and speculative at best. The client was the one who gave all of this information contained in the records to Manaia himself within the context of their broker-client relationship. There is something to be said for the fact that the confidentiality issue is best raised by the clients as opposed to the brokerage house. ...

"Merrill Lynch can continue to service the clients' accounts because they retain the pertinent records. As for the fact that employees at PaineWebber [Manaia's new firm] now have access to the clients' financial records, this is not the sort of event that will result in certain harm to Merrill Lynch."

So why seek injunctions? To "extort settlement dollars," says David Jarvis, a securities attorney with Singer Zamansky in New York City who represented Manaia.

Court Still Preferred Over Arbitration But many judges aren't familiar with industry practices. "Firms rarely have to face the same judge more than once," says Phil Taylor, a rep with IM&R in Smithfield, N.C., who has been involved in arbitration with his former firm, Edward Jones. "If they do something in Nebraska, who is going to hear about it? They're never in the same jurisdiction twice."

Despite the new expedited arbitration pilot program begun in January 1996, whereby the NASDR set up its own injunctive-granting system, firms continue to turn predominantly to courts for injunctive relief, says Ryder. Of the 463 injunctive cases, only 19 or 4% have obtained interim awards in arbitration, and most of the interim awards went against the raided firm, denying the request for injunctive relief.

More so than arbitrators "judges tend to react to employers who come in and say, 'Judge, you have to protect us, he's got our confidential customer lists,'" says Jonathan Schwartz, a securities attorney in Marina del Rey, Calif., who represents brokers. "It sounds very convincing when you're representing the largest brokerage firm in the world, wearing a three-piece suit and a new pair of wing tip shoes."

Rampant Hypocrisy And while firms continue to take aggressive positions to prevent their own reps from moving and attempting to take their client books with them, those same firms maintain aggressive recruiting efforts.

"A lot of these TROs are brought just to keep the troops in line," Schwartz says. "If every time you pick up Registered Representative magazine or a newspaper, you read Merrill Lynch has sued someone, you're going to think twice about moving."

Revenge is also a motive when branch managers are confronted with defections.

"When you have highly skilled, successful brokers leaving, their managers left behind feel betrayed," says David Hankey, an attorney with Gohn Hankey and Stickel in Baltimore, who represents both employers and employees in non-competition and trade secrets litigation. "Nobody leaves a good job for a worse job," he says. "[Branch managers] see star performers leaving. ... There are personal hurt feelings and feelings of revenge: 'I don't care what you do, get him.'"

But the same branch managers complaining about reps leaving their firm also are active in luring reps from other firms, which makes their sob stories less credible.

"They all get terribly emotional," says Samantha Rabin, senior editor at Securities Arbitration Commentator. "I worked [in the legal department] at a big broker/dealer. We'd get called in [by a branch manager]. 'So and so left, and took all our brokers. Those bastards. Go in there and get them.' Two weeks later, the same branch manager would say, 'We just raided this branch.'"

"It gets very heated. Everybody thinks great injustices have been done. The truth is, everybody does it."

As the court concluded in the Manaia case: "The court is not so naive to believe that Merrill Lynch has never participated in such broker enticement themselves. In all likelihood, that is precisely why Merrill Lynch included the no-compete clause in their broker contracts in the first place. ..."

According to a 1997 Registered Representative reader study, brokers on average deal with 333 client accounts. With 236 injunctions against brokers in 1996, that means somewhere around 78,600 clients were affected when brokerage firms sued their former employees and prevented reps from contacting those customers for a limited period.

Whether they know it or not, clients are treated as "trade secret property" of the firms where they do business. Is that a valid classification?

"If a broker acquires clients over the years, as opposed to being the broker of the day, it's a personal relationship," says Robert Dyer, a plaintiffs' attorney with Allen Dyer Doippelt Franjolain in Orlando, Fla. "It's not a trade secret in the classic sense of the term, like something you could develop or exploit in Silicon Valley. If you start applying ordinary legal principles to something that may or may not be a pure trade secret, you're going to get some unjust results, and the customer is squeezed in the middle."

Consumer organizations have not pursued this yet, but see some potential for harm. "This seems to contradict how a lot of brokerage firms try to advertise their services [in terms of] caring for individuals and developing professional relationships," says Laura Polacheck, senior public policy analyst at the American Association for Retired Persons. In pursuing injunctions, firms are essentially telling their clients the exact opposite, she says. "'We won't allow you to remain with the person with whom you've developed a relationship.' A lot of times [clients are] put with a stranger who doesn't know anything about them. It can be fairly traumatic."

A recent study by the Securities Industry Association confirms that clients primarily value their relationship with their broker. Two-thirds of investors who use a broker said their main loyalty is with the individual broker, not the firm (see "It's the Broker, Not the Brokerage, Stupid," OddLots, Page 54).

Nearly four years after a TRO battle, which he finally won, Channing Schwartz is still waiting for his $750,000 award.

Channing Schwartz, a veteran broker in tiny Alliance, Neb., population 9,765, never expected to be hit with a temporary restraining order (TRO) when he left Edward Jones in 1994 for Linsco/Private Ledger. In 11 years with Jones, he never signed a non-solicitation or non-competition agreement, Schwartz claims, and he took care not to copy "confidential" customer lists when he left.

Still, three days after Schwartz's departure, Edward Jones obtained an ex parte TRO through a Nebraska state court that barred him from contacting his clients for more than three weeks. During that time, Schwartz says Jones rejected the ACATs transfer requests he had processed during the three days before the TRO, including one submitted by his sales assistant for her own account. All told, Schwartz figures he ended up losing at least 60% of his clients because of the TRO. He has since had to prospect outside his geographical area to rebuild his business.

"Jones sent my clients a letter that let them know we were in a legal battle. In a small town, word gets out on the street fast. In a small town, you're guilty until proven innocent," he says. "I had a tremendous number of clients wondering what was going on."

Thirty days later, however, the same judge that granted the TRO dissolved it, apparently miffed that Jones had failed to notify Schwartz of the initial TRO hearing. Schwartz reports that at that point, Jones offered to settle with him if he would agree to pay them some small sum for the loss of client accounts. He refused, and instead, took Jones to arbitration, where an arbitration panel in November '95 awarded him $750,000 in damages for defamation, tortious interference and malicious prosecution.

More than two years later, he's still waiting for the check. Meanwhile, he's spent an estimated $200,000 in attorneys' fees, Schwartz claims.

Jones continues to appeal the arbitration decision despite what most agree are dim chances of success--arbitration decisions are not appealable. In March '97, the Circuit Court of Jackson County, in Kansas City, Mo., rejected Jones' motion to vacate the $750,000 award.

Undaunted, however, the firm filed another appeal in the Court of Appeals for the Western District of Missouri. Oral arguments in the case are expected some time this month or in February. The next step would be the Missouri Supreme Court.

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