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Morgan Stanley Brokers Use Treaty to Flee With Clients

(Bloomberg) -- Morgan Stanley could do little but watch as a team of advisers overseeing $2.2 billion in assets quit last month to start their own shop, the latest in a string of departures that have shifted billions of dollars in assets away from big Wall Street banks.

After months of secret and meticulous planning, 13 employees in Wichita, Kansas, left on a Friday with phone numbers and e-mail addresses for 800 clients, and then spent a frantic weekend on the phone trying to get them to switch to their upstart. It all depended on a gift from Morgan Stanley: Years earlier, the bank had signed away its right to sue.

The defectors who started the firm, 6 Meridian, were able to take clients with them thanks to an industry agreement called the Protocol for Broker Recruiting. The pact was devised in 2004 by three firms -- Merrill Lynch & Co., Citigroup Inc. and UBS Group AG -- in the name of reducing litigation and giving customers a choice when one big firm poached from another. Morgan Stanley, which declined to comment, joined the protocol two years later.

But over the years, the protocol has had an unanticipated effect by offering a blueprint to brokers with an entrepreneurial bent: have someone set up a shell company, have the company sign the protocol, and then take over the company without fear of a lawsuit.

Maneuvers like 6 Meridian’s explain why the legal peace treaty now has almost 1,500 members, even though the industry has only a handful of big national players. They also help explain a curious trend. In the years since the protocol was born, the old-school “wire houses” that started the pact have lost market share as small upstarts have gained.

Big defections have hit several large banks over the last two years, with Bank of America Corp. and Deutsche Bank AG each losing $3 billion teams to upstarts. Advisers are also being encouraged to leave banks by the expiration of multi-year employment contracts that many signed in the wake of the financial crisis, industry observers say. There are even websites that track the defections.

The unintended consequences are straining the agreement, with some big firms like JPMorgan Chase & Co. reinterpreting it or even partly opting out.

“Originally, the big boys formed the protocol and the smaller shops joined in,” said Jonathan Pollard, an employment attorney in Fort Lauderdale, Florida. “Now the ones pushing back are all big players.”

Brian Hamburger, a lawyer in Englewood, New Jersey, who specializes in helping brokerage employees go independent, figures he’s left his “fingerprints” on as many as one-third of protocol memberships, including 6 Meridian’s. “We’re working at varying stages with several multibillion-dollar teams. We expect more big deals this year,” Hamburger said.

Hamburger is part of a cottage industry of business consultants, technology vendors and law firms that has cropped up to help advisers make the leap to independence. A critical part of their playbook is the tricky task of invoking the industry protocol, without running afoul of regulations or employment contracts.

Client Data

These advisers take advantage of language in the protocol that releases them from non-solicitation agreements and other restrictions that might otherwise land departing brokers in court. Under the protocol, advisers who move among member firms receive a waiver from employment restrictions, as long as they take with them only five key pieces of client data: names, addresses, phone numbers, e-mail addresses and account titles. The three-page agreement includes what amounts to a legal loophole, allowing new firms to join simply by submitting a one-page letter of intent.

To invoke the protocol, departing advisers typically start planning months or years ahead. They hire an outside lawyer or consultant who sets up a shell company, sometimes in the name of a trusted proxy: “A college buddy or a crazy uncle,” Hamburger says.

That company then joins the protocol. Soon after, typically on a Friday, the advisers resign, take ownership of the protocol firm and work through the weekend schmoozing their clients while their former colleagues do the same, like the dueling sports agents in the film “Jerry Maguire.”

The Morgan Stanley advisers began talking seriously of breaking away two years ago and sped up preparations last fall as they zeroed in on software providers and office space, said 6 Meridian’s chief executive officer, Margaret Dechant. Because brokerage employees aren’t allowed to operate outside businesses without permission, the Wichita team turned to Hamburger to set up a company in advance and register it as a member of the protocol.

Then on Friday, Sept. 9, the group resigned from Morgan Stanley and re-registered ownership of Hamburger’s protocol-member company in their own names.

Within a couple of hours, 6 Meridian was up and running, calls were going out to clients. “The protocol was very important” to establishing 6 Meridian, Dechant says. “We knew if we followed it to the letter, it allowed us to reach out to our clients once we left Morgan Stanley.”


To avoid alerting their former employer, the group had insisted on strict secrecy throughout the breakaway process. “I got a tongue-lashing from my mother because she didn’t know,” Dechant says.

Even under the protocol, leaving a big brokerage with the intention to take along a large chunk of client assets is a bare-knuckled undertaking in which the slightest slip-up can spell disaster.

Hamburger recalls a case in which a graphic designer posted online a mock-up of a business card for an adviser who was planning to go independent. The adviser was promptly called into a meeting with lawyers at his brokerage firm, where he immediately quit. Even afterward, he was dragged into a costly two-year regulatory dispute over whether he’d violated the prohibition against operating an undisclosed business before leaving his job. Regulators took no action against the adviser.

Financial Incentive

Advisers have a strong financial incentive to leave big brokerages and go independent. Wire houses pay advisers 40 percent of the fees and commissions they generate. Independents keep 100 percent of revenue, after covering their overhead.

Wealth managers who leave traditional wire houses usually succeed in bringing well over 90 percent of client assets with them, says John Phoenix, who’s worked on hundreds of breakaways at Envestnet, which provides services to independent wealth managers.

“Advisers have seen colleagues with smaller books than them do this and have astounding success,” Hamburger said. “They think ‘If this idiot can to it, I can too.’ ”

The defections have helped reshape the industry. So-called independent Registered Investment Advisers more than doubled their assets under management in the eight years through 2015, to $2.8 trillion, according to the consultancy Aite Group LLC. At the wire houses, by contrast, assets grew 12 percent during that time, to $6.4 trillion, as their market share fell steadily to one-third of the $19 trillion U.S. asset-management business. Internet brokerages have also contributed to the shift.

Big firms often gripe at industry conferences about how breakaways are using the protocol, but it’s unclear what, if anything, they can do about it. Even if they came up with an alternative, there is no governing body to appeal to. Besides, any renegotiation would pit them against hundreds of firms that have benefited from the rules as they are.

To contact the reporter on this story: Neil Weinberg in New York at [email protected] To contact the editors responsible for this story: Jeffrey D Grocott at [email protected] David S. Joachim

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