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The Rocky Road to Independence

When Holly Hunter decided to leave the wirehouse she'd been with for five years, she knew the going would be tough. But she had no idea exactly how tough. Just planning her escape everything from choosing a broker/dealer to creating a budget took a good nine months. Worse, fearing the headache and expense of waging a legal battle with her former employer she'd signed an agreement that forbade her

When Holly Hunter decided to leave the wirehouse she'd been with for five years, she knew the going would be tough. But she had no idea exactly how tough. Just planning her escape — everything from choosing a broker/dealer to creating a budget — took a good nine months. Worse, fearing the headache and expense of waging a legal battle with her former employer — she'd signed an agreement that forbade her from taking existing clients with her if she left the firm — she decided not to contact any of her clients before or after she quit. Result: When she opened Hunter Advisor in October 2003 in Portsmouth, N.H., she had zero business. On top of that, when customers called her old firm, she learned that a replacement was spreading nasty gossip about her past performance. As start-up costs mounted, Hunter had to borrow $20,000 from a relative. “It was a pretty scary situation,” she says. “I had no income and major outlays of money just to get started.”

However by the second year, Hunter had managed to start rebuilding her book. Four years later, with $75 million in assets under management, most of her revenues come from financial planning, and she's paid off her loan. She's also making more money in her new practice. Although she has half as many clients, she is managing three times more assets.

If you've been reading the financial press lately, you've already heard that more reps are going independent these days, or at least, thinking about it. The reps considering independence are seeking everything from higher payouts to more autonomy. Some think that the recent court decision which overturned the so-called Merrill Lynch rule and killed fee-based brokerage, may inspire more top wirehouse producers to go the independent route. “That's making the most qualified brokers decide enough is enough,” says Brian Hamburger, managing director of MarketCounsel, an Englewood, N.J., law firm that specializes in helping brokers leave wirehouse firms.

Unfortunately, however, the road to independence is also a veritable minefield. For one thing, wirehouses don't take these defections lying down. Yes, the five major wirehouses, as well as Raymond James & Associates, have signed onto the Broker Protocol for recruiting, which stipulates that participating firms will not take legal action against a rep who leaves for another participating firm (provided he only takes certain limited client information with him). Even so, these firms are still trying to slap temporary restraining orders (TROs) on reps who attempt to take clients with them, whether that rep is going to a protocol or non-protocol firm. What's more, they're also playing a new card, according to Hamburger, and trying to prevent advisors from contacting clients by charging them with violations of privacy. The SEC seems to be helping on that front, considering indications that it may investigate how independent b/ds handle client information (See our cover story on page 34). On top of all that, there are the hassles and unpleasant surprises that come along with running your own business.

Wrangling Over Clients

It doesn't mean you shouldn't take the plunge. In fact, if you have an entrepreneurial urge, going independent can be the best thing you've ever done. But you do have to get familiar with the obstacles you're likely to face and what, if anything, can be done about them. Remember: The actions you should take depend on the specifics of your situation; it's a good idea to consult a lawyer.

The first big decision you will have to make is whether to bring existing clients with you and if so, how. “How” will depend in large part on whether you've signed a non-solicitation agreement with the firm, as well as the wording of that document. If you have one, then your ex-employer may ask for a TRO from the court to stop you from contacting your clients.

Considering recent legal developments, you might think that wirehouses would be more hesitant to take such action. For example, earlier this year, a United States Court of Appeals judge ruled against Merrill Lynch when it tried to impose a TRO against three top producers who were departing for a firm that hadn't signed the broker protocol. In reality, however, TROs are by no means a thing of the past. “Mostly, I see a change in which firms are doing it,” says Hamburger. Some of the protocol firms have gotten a little less “trigger-happy,” he says, while some of the non-protocol firms that “wouldn't have thought to engage in any dispute are now stepping in.”

You can always choose to follow Hunter's lead, and simply say goodbye to your current clients. She rebuilt her account base by contacting attorneys, accountants and others who had referred people to her in the past, and by placing an ad in the local newspaper. But, if you decide you can't let go of your clients, then you'll need to consider following the tried-and-true path of other advisors: Resign at the end of the day on a Friday, and spend the weekend calling your clients before your ex-employer can ask for a TRO on Monday morning.

Of course, different wirehouses are likely to take different approaches to the TRO. Take Joshua Itzoe and Patrick Collins. Three years ago, Collins left his wirehouse to start his own practice, Greenspring Wealth Management in Towson, Md. He'd signed a non-solicitation agreement, but intended to retain a small number of his most valuable clients. To make this happen he hired an attorney to help him deal with whatever legal challenge his firm might make. The wirehouse ended up asking for a TRO, but it was thrown out of court, because the firm waited a few days to ask for it. Still, the firm threatened to go to arbitration, a process that can take two years and cost up to $25,000 in legal fees. So Collins settled, agreed to pay the firm for so-called damages (he won't say how much these damages amounted to) and promised not to contact his clients for around four weeks. On the other hand, when Itzoe left a different wirehouse a year later to join Collins, his prior firm took no action.

In any case, both Itzoe and Collins were very careful about what they said when they called their former clients; that's an essential step to take. What you can say depends on such issues as the wording of your non-solicitation agreement, the jurisdiction you're in and your employer's past litigation history. In Itzoe and Collins' case, following their lawyer's advice, they used a script, outlining what language they could and could not use. The most important point was that they could not come out and ask their clients to follow them to their new digs, but had to treat the conversations as informational sessions. “We explained we had left and what we were going to do, and that's all,” says Itzoe. Both kept about 10 percent of their clients. Today, Greenspring has about $40 million in assets under management.

Beyond The TRO

Today, beyond TROs, some wirehouses are trying a new tactic. They're claiming that departing reps who take client information (even names, addresses and telephone numbers), are violating privacy rules. Specifically, they're pointing to the SEC's regulation S-P, which was adopted in 2000, to enforce the Gramm-Leach-Bliley Act, a law which regulates financial institutions' ability to disclose nonpublic information about consumers. “Privacy is a hot button, and they're using it to their advantage,” says Hamburger. Every week, he sees at least “one rep or more” who has been sued by a former employer on these grounds. The SEC is getting involved: In March it indicated it was investigating NEXT Financial Group, a Houston-based independent broker/dealer, to see whether reps joining and leaving the b/d improperly disclosed customer information. Shane Hansen, a partner with Warner Norcross & Judd, a Grand Rapids, Mich., law firm that is representing NEXT says, “It's clearly potentially a big stumbling block for brokers going out on their own.” The SEC declined to comment on the investigation.

Ultimately, no matter what the circumstances, it's best to wait until after you've left your employer to contact clients. That's true whether you've signed a non-solicitation agreement or not. The reason: In many states, there's a legal concept called duty of loyalty. This means that even if you don't have a written agreement on the matter, you can't take business for yourself from an employer during regular work hours, or from the employer's place of business. Just to be safe, watch what you say even to non-clients. Hamburger recalls one rep who shared his plans to start his own practice with his Friday night poker buddies. The next day, several of them emailed him at work to offer their congratulations. Naturally, the firm picked up on it and his manager called a meeting to discuss the issue. The rep managed to delay the meeting, and resigned before it was held.

Beyond the non-solicitation agreement, you can also face a problem if you were given a promissory note when you started with the wirehouse firm. The contractual terms may include a stipulation that if you haven't paid that note back, you're forbidden from contacting clients when you leave. Or, the wirehouse could freeze your personal account with the firm. To avoid arbitration, you'll most likely have to work out a deal to pay some, or all, of the money back, over a period of up to two years, according to William Jacobsen, an attorney and mediator in Barrington, R.I.

One way to protect yourself is through stealth. “A lot of brokers will slowly, over several months, withdraw money from accounts they have at the firm,” says Jacobsen. “By the time they leave there's not much left in there.” Or, you can wait to resign until you've paid off the loan. When Michael Garrison joined UBS in 2000 he received “a check” from his employer, to be paid out over a specified period of time. (He doesn't want to say how long.) But before he'd paid it off, he started thinking about leaving to become an independent. The independent life itself wasn't terribly daunting: Before joining UBS, Garrison had already spent more than 10 years as an independent affiliated with Raymond James Financial Services. Still, he decided to wait until 2006 to launch his new West Chatham, Mass.-firm Garrison Financial, in part because his loan had been forgiven by then.

You may also find that clients who call your ex-employer looking for you get quite an earful from your replacement. At best, they may be told that the firm has no idea where you are. In Hunter's case, she learned that within 12 hours of her departure, her old firm had flown someone in from central headquarters to handle her old accounts. “Clients who contacted me said the replacement badmouthed me, telling them I was never that good,” she says. Such actions can have ugly results. David Levine, director of sales for GunnAllen Financial, a Tampa, Fla.-b/d, recalls a rep who left after 15 years with a firm. When he left, his record was spotless, without a single customer complaint. “After he left, he suddenly got five complaints,” says Levine. “It was a message to the guys who hadn't left. This is what will happen to you.” Now, a recent ruling by the New York Court of Appeals could potentially give wirehouses permission to ding your U5 Form with impunity. That's because the court gave b/ds “absolute privilege” over statements reported on your U5. (See Registered Rep. May 2007.)

Your best defense is to take preventive steps when you contact clients. “Let the client know they may hear bad things about you from former colleagues for the sole purpose of winning over your business,” says Hamburger. Otherwise, you'll probably have to just let this kind of retaliation go.

Getting Started

Of course, there's one more set of challenges to consider: Going independent means you will be running your own business. That means taking on payroll, hiring and all the other headaches of being a small business owner. But there are also such tasks as handling compliance and completing administrative paperwork. Also, you are responsible for choosing the right software systems for CRM, portfolio management and financial planning. “We always find there's a big learning curve for wirehouse reps,” says Levine. It also involves a lot of money. Joe Taylor, who left Morgan Stanley in 2005 to start Oak Street Advisors in Myrtle Beach, S.C., is typical. He says that startup expenses were about 25 percent higher than he expected.

The good news is you can get some help from your new b/d, especially if the firm has a transition team to help advisors set up a practice. Another possibility is to join an existing operation, so you don't have to start from scratch. In 2004, G.B. Bose, for example, left the wirehouse he'd been at for five years to go independent, taking just a handful of clients with him. But he joined a Scottsdale, Ariz.-based practice called the Householder Group, launching an office in Bethesda, Md., for them. The firm helped him with everything from choosing a computer to finding an office. He now manages around $50 million in assets and expects that number to grow to $100 million by the end of next year. The lesson: Going independent can be a great experience. Just make sure you know what you're getting into.

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