Your Book or Your Life!

Without it, you are nothing. How to keep your book in this dangerous market.

What would you do if you lost your book? Where would you turn for new customers? Where could you be hired?

Those are questions that keep many advisors up at night — and beavering away during the day to make sure their production does not fall to the level where they will be laid off. Victims of a layoff can wind up losing their entire customer base, because it can take months for them to get set up in a new shop. Even top producers — the ones who are still being wooed for their books — have to weigh the prospect of losing 10 percent to 25 percent of their clients against whatever blandishments the hiring firm has to offer. And that's if they don't wind up in a legal tangle, an increasingly likely possibility given how desperate firms are for assets.

The worst-case scenario, however, is for brokers who leave a firm involuntarily in this market. Just ask Lisa Neuman, a former Morgan Stanley rep. She left the firm amidst a gender discrimination dispute in 2001. In better times and under better circumstances, she held onto most of her book as she moved through three different wirehouses. But leaving Morgan Stanley without a new job, (she has since started her own advisory practice) she had no way to hold onto her clients. “I said, ‘I am taking my files, because these are my clients,” she says. Morgan Stanley disagreed and, Neuman says, “My clients were told I had left the industry completely.”

Could this happen to you? The easiest way to lose your book is through layoffs. And, unfortunately, the prognosis is not good. While some firms are recruiting proven producers, they are simultaneously whacking brokers who don't meet rising performance standards. Brokerage firms have already cut the ranks of reps by 11.5 percent over two years, according to the Securities Industry Association, and more cutbacks are expected. As firms eliminate small producers they usually wind up keeping their assets, reassigning accounts to other reps or to call centers. The broker, if he can even get a new job, is left cold calling somewhere else, in the chilliest environment in decades.

Some brokers who might be at risk are moving their books, often to regional firms, or to independents or bank brokerages. “The fact is, the lower-end producers should be moving, because the wirehouses don't want them,” says New York-based recruiter Michael King. But it can be tricky for these brokers to convince clients to follow them. “The market is so far down — how do you tell clients you're moving when you've been losing them money for three years?” he says.

Back in the good old days — three years ago — brokers with good books could count on a smooth transition. After all, the firms were all poaching each other's top producers. So, after some legal saber rattling, a broker usually left with his book intact — to start over with a juicy upfront payment.

Now, firms are going after just about every producer who leaves. David Lerner Associates, a small Syosset, N.Y.-based brokerage firm, recently won a couple of arbitration awards, one for over $1 million, from Smith Barney and Prudential for poaching producers.

And, clearly, customer loyalty is not what it was. The team approach to financial advisory services has made many customers feel more connected to the firm than to an individual broker. Also, the bear market has made clients less loyal in general. “I had about 300 clients,” says a Janney Montgomery Scott producer who switched firms twice in the last three years. But because of market conditions, he says, the last time he probably lost 70 clients. “I can't really call those people and get them back,” he adds.

Whose Clients Are They?

Except for instances when top producers switch firms, taking entire teams with them, there is usually some kind of tussle over the clients these days. The top brokers get less grief because the big firms recognize that clients of those advisors are less interested in the broker's firm affiliation than his track record. Also, the firms are busy looking for ways to lure other huge books from their rivals.

But for nearly everybody else, when the relationship ends, the tug of war begins. How much of a fight depends on many factors, including how the client came to the firm. Reps can usually lay claim to clients that they recruited, especially those they brought with them. “If they came in with the clients its, ‘God bless you and good luck,’ but if they're trainees it's another story,” says Craig Stein, a Miami-based attorney who represents reps and broker/dealers. “It really turns on a case-by-case basis.”

Neuman, who now runs Neuman Capital Management in Sussex, N.J., had little trouble moving her book among wirehouses. “When I left PaineWebber, I took my big corporate accounts. But when I left Smith Barney they attempted to put an injunction on my corporate accounts,” she says. “But that didn't work — all I had to do was provide the PaineWebber statements showing they were my clients prior to Smith Barney, and that undid it right there.”

Firms keep track of what they own, too. For example, a broker who leaves can't expect to walk away with accounts that management recently assigned to him. Also, firms tend to look harshly upon the departure of a neophyte broker who has not yet generated the commissions to cover what can be hundreds of thousands of dollars of training and career startup costs.

“The standard is, the broker works to develop the relationship. He's not getting paid a salary, and he only starts making money when he starts selling, so most of the investment in that relationship is his,” says Tom Campbell, an attorney at Smith Campbell in New York. “The firm is entitled to get their training costs back — but when you're suing someone who graduated from the training program 19 years ago, saying they're not entitled to contact their client base, well, the residual value of the training is not so great.”

In some ways, the situation for brokers has improved. Before 2001, it was not uncommon for a firm to seek a temporary restraining order to prevent a departing broker from taking his clients or soliciting them from his new firm. That practice was curtailed after the NASD, in December 2001, enacted rules to prevent firms from obtaining TROs to block transfers — unless, of course, the contract contains a non-solicitation agreement (which many do). The NASD says it is also considering greater efforts to enforce rules against delaying account transfers — another method firms have used to hold onto accounts.

That's not to say that firms don't have other means of holding onto clients of departing brokers, including getting other brokers to talk clients into staying. One Prudential rep says that she has joined the hunt when management handed out the names of a departing broker's clients to solicit. However, she says, she draws the line at bad-mouthing those who have left. “I've heard advisors say things like, ‘Your broker didn't know anything to begin with,’ but I think that's deadly,” she says. “That's a karmic thing — if I'm mean, it's going to come back to me.”

Enforcing Contracts

Another increasingly effective tool for firms is planting legal traps in employment agreements. For instance, some firms have written contracts that include language that can hold a rep's book hostage to paying off a “forgivable” loan made at sign-up. No repayment, no book. “I've seen two agreements where if a rep leaves, unless they pay the promissory notes back, the firms have said all customers would be held up,” says Chicago-based attorney James Eccleston, who represents producers in employment disputes.

The most common legal lever is the non-solicitation clause that prevents brokers from contacting old clients for a period of time after they leave the firm. (A row erupted in March among Pru producers when the firm attempted to insert a non-solicitation clause into a routine document brokers sign annually).

Several employee attorneys say that among the firms, Merrill Lynch has been among the most aggressive in this respect. How serious is Merrill? It has retained Paoli, Pa.-based Rubin & Assoc., (with the ominous Web address: www.injunction.com) to handle these cases. “A broker who has left our firm and has a one-year non-solicitation agreement, we will continue to enforce that agreement,” says a Rubin spokesman. “They're Merrill clients if somebody leaves Merrill.”

Attorneys say the non-solicitation agreements, while sometimes enforced, generally just end up as an obstacle for brokers to get around. Here's the typical scenario: A broker, who has been operating in stealth mode for weeks or months as he or she makes the deal with a new employer, walks into the branch manager's office on Friday, after the close, and resigns. The broker then high-tails it to his new office and starts overnighting ACATs (account transfer forms) to his clients. Then, he spends the weekend phoning clients to try to bring them along — before the old firm can get a court-issued injunction to enforce the non-solicitation clause, which usually comes by Monday afternoon or Tuesday morning.

By then — if this is a broker worth recruiting — the largest clients have already started their transfers. And then the negotiations begin. The object of this legal pas de deux is to get the new employer to pay the old b/d a certain percentage of the broker's trailing-12 month production, in return for dropping its claim and in compensation for losing the clients. “I became like a commodity that just gets sold,” says a Prudential producer who switched firms in early 2002.

Richard Ryder, editor of Securities Arbitration Commentator, says between 500 and 1,000 such injunctive proceedings are heard through arbitrations every year. In a late 2001 NASD ruling Merrill won a $350,000 award from Smith Barney, because the arbitrators found that the broker had violated his employment agreement. But an injunction forbidding the broker from soliciting clients in his $120 million book was immediately lifted. Another late 2001 ruling between Charles Schwab and A.G. Edwards upheld an injunction against the broker who had moved, disallowing him from doing any solicitation.

Several securities attorneys say the most imperative part of the contract language concerns whether the customer list is considered a trade secret belonging to the firm.

“The practice is that client statements get turned over,” says William Jacobsen, an attorney on employment matters based in Providence, R.I., and also a columnist for Registered Rep. “But the same firms that engage in that practice cry bloody murder when one of their brokers does it to them.” Some producers have countered this by keeping names and addresses in a personal digital assistant under headings like “birthday list.”

But when a broker is let go outright and doesn't have another job lined up, the ability to shield or protect his book goes out the window. Then, the rebuilding process is painful. It's a fact Neuman knows all too well. She started her own company in late 2001 and is still trying to rebuild her book, currently managing a few million dollars — much less than the $100 million-plus she once had. She now plans to hire several other independent producers to affiliate with her.

“I felt that it would be in the best interest of my clients to set up my own company,” she says.

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