The recent acquisitions of Legg Mason's retail brokerage by Citigroup and Advest by Merrill Lynch brought an interesting recruiting problem into high relief: Raiding. Simply put, there are some brokers who are too hot to touch: groups or teams who together generate 40 percent or more of a branch office's revenues. If groups of that magnitude move together to a new firm, the recruiting firm can face millions of dollars in “raiding” settlements or arbitration fines.
When the acquisition plans were announced, many Legg and Advest reps said they were uneasy about switching from a cozy regional to a Wall Street behemoth. Some jumped ship rather than be acquired by a firm not of their choosing. But some teams of strong advisors were trapped because the firms recruiting them were afraid of suffering monetary penalties for raiding, according to recruiters.
“I was approached by many different groups that said, ‘Aren't we more attractive as a group of 10 doing $4 million to $5 million in production?’” says recruiter Danny Sarch of Leitner Sarch Consultants in White Plains, N.Y. “But that kind of group would definitely be nailed for pirating. I told them to break up and go separate ways,” he says.
Breaking up the group is an alternative, but not one brokers want to embrace. “In many cases, two brokers or more have joined together to complement one another's strengths,” says Mindy Diamond of Diamond Consultants in Chester, N.J. “Their clients rely on them for different things,” she says. Indeed, most teams would rather stay together as a unit at Merrill Lynch than move elsewhere separately, she says. “Splitting up was just not an option.”
It's hard to say exactly how many brokers are staying at either Merrill Lynch or Smith Barney because of fears of raiding charges. As of late December, an estimated 225, or 44 percent, of a total of 515 advisors at Advest had left. And about 175 Legg Mason reps, or about 12 percent of the brokerage force, had decamped.
Raiding claims often follow mergers and acquisitions for the simple reason that large numbers of brokers often decide they don't like their new masters. But recruiters say Legg and Advest reps were particularly affected because a number of the branch offices at the two firms were small two- to 10-person shops, making it more likely that a recruiting sweep would end up looking like a raid. Another factor is that so many brokers today rely on a team approach.
Diamond cites two partnerships in an Advest office in the Northeast that wanted to move together to Ryan Beck. “They loved Ryan Beck and would have gone there in a minute,” she says. “But Ryan Beck pulled out, because they didn't want to even touch it.” Why? The two teams generated just $2.5 million in revenues between them, but they represented the entire office.
Even when splitting up is an option, it still means some of the brokers in the group won't get their first choice of a new home. “If Dain Rauscher was looking to hire five different reps from one office, they had to choose between the five and be selective, so a lot of them found themselves stuck,” says Diamond.
Raiding is actually shorthand for a variety of legal infractions, including violation of nonsolicit or confidentiality agreements and statutes governing unfair competition and antitrust, says Howard Iwrey, a securities lawyer with Dykema Gossett in Detroit. But broker/dealers are much more likely to file and win claims when rival firms poach enough brokers to do substantial harm to a business unit — typically defined as any unit with its own profit-and-loss statement, he says. The rule is rather informal, but it's backed up with 20 years of arbitration rulings, he adds.
That financial threshold starts when around 40 percent (although sometimes it's been as low as 30 percent) of a unit's revenue is at stake. The bar may be lower if a branch manager is involved, because he has a fiduciary responsibility to his firm, securities lawyers and recruiters agree. “The underlying concept is what harm have you done to the branch? If you have done substantial harm then the employer should be compensated for that,” says securities lawyer Mike McCallister, a partner in Satterlee Stephens & Burke in Manhattan. The raiding firm can be forced to pay the lost profits of the departing producer. “Though not every penny of lost revenue is usually replaced,” he says. “I've been involved in cases where the award was as high as $22 million, others where the award was zero.”
Most claims are settled before they go to trial, say securities lawyers, so there aren't many arbitration awards on the records. But one of the biggest raiding awards ever went to Minneapolis-based b/d John G. Kinnard in an NASD arbitration against Dain Rauscher in 1999. The arbitration committee awarded Kinnard in excess of $16.5 million after Dain lured away 52 percent of a Kinnard branch. The two firms eventually settled for $13.3 million.