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Avoiding Legal Nightmares and Pitfalls When On-Boarding New Advisors

It’s easy to obsess over expanding your practice but don’t let that stop you from taking the simple legal steps necessary to protect all your hard work.

Most registered investment advisory firms are constantly in recruitment mode.

Once they find that great “fit” in a new advisor and hammer out a deal that works for both parties, it’s time to bust out the champagne and cigars. Or is it?

This period is often when the proverbial ball gets dropped, and resulting problems can manifest both immediately and later. Neither is good, and both can be expensive. How do we avoid these painful legal outcomes? First, you have to learn about the potential problems with RIA recruitment and then the steps to take to avoid them.

Your Recruit Has a Contract with the Old Firm

You are recruiting a young, hard-charging advisor who can bring solid AUM and give you the type of high-level support with client service and portfolio that you have been looking for. She has a clean compliance record and expects no pushback from clients when she asks them to transfer their business. She resigns one Friday afternoon, joins your RIA and the clients start rolling in just like she said they would. The only problem is that her former employer, RIA, is not so keen on this development. The former employer’s attorney sends her and you a nasty letter, along with a copy of the no-solicitation agreement she signed eight years ago when she joined the firm. They claim she is violating her agreement and that your firm is tortiously interfering with that same contract. Although you suspected she had some agreement with them, you didn’t press the issue when she said she didn’t remember signing anything. Now what do you do? You call your lawyer, of course.  But what could you have done to avoid this crisis entirely, or at least get ahead of it? 

You can avoid this problem by having “that” discussion with the advisor early in the recruitment process. Ignorance, in this context, is not bliss. The former employer will allege that you “knew or should have known” about the no-solicitation or non-competition agreement, so you may as well face reality. Sit down with the recruit and get a firm answer on what kind of agreement she may have signed. If she no longer has a copy, it is understandable that she is not going to want to alert her employer by requesting one. After all, that would be a huge red flag that the advisor is thinking about heading out the door. Instead, get as much information as you can from the advisor. Even if you don’t have all the relevant information, you should have at least a sense of what you are dealing with, and you can now plan. Get legal advice on the likely enforceability of the agreement and evaluate how you can work with the advisor to weigh the legal risks of different solicitation approaches. In some circumstances, direct solicitation may be advisable. In others, a published notice or other less direct communication might be better. Either way, get good counsel and then get on the same page with the advisor so there are no “surprises” to deal with. The key is having the plan in place well before the advisor’s resignation. This is true regardless of whether the broker is coming from a wirehouse or another RIA.

You Want the New Recruited Advisor to Sign Your Own Agreement 

Whether you need to deal with the advisor’s former employment agreement, you may want her to enter a no-solicitation agreement with you before you give her access to your existing clients. That process needs to be done very early in the employment relationship.  Each state has its own law on the enforceability of such agreements. As a result, you do not want to download one from the internet, use the one you had when you were at a wirehouse 20 years ago, or ask ChatGPT to draft you one. These agreements are enforceable only to the extent that they are crafted in accordance with your state’s laws. Also, some states require additional consideration (for example, additional pay or benefits) in order to be enforceable. As a result, you may think you are protected when, in reality, you are not. Get a good no-solicitation/non-compete agreement in place at the beginning of the employment relationship. You will not regret it. 

I’m Safe Since I Locked in the New Advisor by Giving Them Equity

Some RIAs offer (or demand a buy-in) of units in the limited liability corporation, the most common corporate form for RIAs, to recruit advisors in the hopes of “locking them in” to the business. This strategy makes a certain amount of sense because the LLC agreement governing the units generally contains a non-competition and non-solicitation agreement. But the real “kicker” is that the advisor is now also an owner, so anything she does to harm the business is not only a breach of the employment agreement, its also a breach of her fiduciary agreement to the LLC. And there is another problem: She is also an owner, and regardless of what else happens in the relationship, you can’t just get rid of her. As a result, if you go down this route, you may want to be certain that the LLC agreement gives you a clear path to divest the advisor of equity if the advisor breaches her employment agreements and heads out the door with firm clients. Having this in place at the outset of the relationship will go a long way in avoiding the expense and headaches associated with litigation.

My Back-Office Guy Just Stole a Third of My Clients!

Remember that young kid you hired who had no book of business because he was going to support you and work the back office as needed? He got older and noticed that he had unfettered access to your clients, whom he has interacted with frequently while you have been out getting new business. He sends you an email late one Friday afternoon while you are starting your vacation in The Bahamas. He has resigned and is now soliciting half of your clients to transfer to your direct competitor. In a cold sweat, you leave the guacamole and chips at the tiki bar and pull up his personnel file on your laptop. Nope, there is no non-solicitation or non-competition agreement in there. Why not? Well, you hired him as a back-office sales assistant and promptly forgot about him. You were busy building your practice, and it never occurred to you that this unassuming guy would have the gall to challenge you for your hard-earned clientele. What to do now? Well, your options will be limited according to the law of your state, but you surely wish you had a real agreement to enforce. To avoid this problem, you don’t need to have everyone (including the plant lady) sign an employment agreement. Instead, you need to self-audit this issue every few years. Write it on your calendar so that you can at least consider what real-life changes have occurred in your office. Are certain back-office people or small producers getting closer to your clients? This is the time to act, not while you are desperately trying to book a flight back from The Bahamas.     

Sensing a theme here? It’s easy and commendable to obsess over your advisory practice, but don’t let that stop you from taking the simple legal steps necessary to protect all your hard work.  It may be easier than dealing with other compliance issues, and it can be just as valuable.


John MacDonald is the managing partner of the Princeton office at Constangy, Brooks, Smith & Prophete, LLP. He focuses his practice on employment litigation, employment counseling, restrictive covenant litigation, FINRA securities arbitration, securities industry litigation and support of "start-up" businesses. 

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