Legally speaking: When changing dealers

Last week we reported on a recent British Columbia Court of Appeal decision that awarded punitive damages in a case where RBC Dominion Securities sued several defecting advisors and Merrill Lynch Canada for “dangling various inducements” and encouraging them to bring client records before leaving DS. Click here to read more.

Punitive damages aside, the court explicitly ruled that clients did not “belong” to RBC-DS. Furthermore, the court ruled that advisors should be allowed to contact their clients after a move, essentially affirming that it is the advisor who maintains the client relationship, and not the firm. It also ruled that departing advisors did not have a legal obligation to give RBC a reasonable opportunity to persuade any affected clients to remain with the firm.

To put the ruling into perspective, legal expert Harold Geller discusses the case and how it will affect business for advisors changing firms in the future.

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How should an agent or an advisor act when changing dealers? This question is frequently posed by financial advisors who are negotiating a change of dealer or agency and by those who run dealers and agencies.

Unfortunately, as a legal advisor to advisors and advisory companies, the answer is complex. There are some clear dos and don’ts but there are also many grey areas. Fortunately though, an unusually clear and insightful British Columbia Court of Appeal decision will help guide financial intermediaries during future transitions.

In my opinion, the analysis in RBC Dominion Securities Inc. v. Merrill Lynch Canada Inc. et al (“RBC v. ML”) will be accepted as the leading case on this issue. This case is unique in the way it recognizes the client’s interests in continued service — both the dealer’s and the advisor’s business interests must give way to the interests of the client.

Although this case involves IDA dealers and representatives, most of the rulings are relevant to all financial advisors, branch managers and compliance officers working in MGAs, and MFDA or IDA dealer firms.

In RBC v. ML, Merrill Lynch and its local branch manager enticed almost all of the representatives at two small RBC offices, including RBC’s local branch manager, to leave in a coordinated exodus. Aside from the extent of departures and some obvious errors in judgment on the part of departing advisors, the exodus was a fairly standard matter.

Clarification of duties

The Court recognized that in addition to the jousting between the dealer and representatives, there was an important question about client interests. Although to those of us who regularly work with the OSC, the IDA, MFDA and FSCO, the paramount interest of the client is obvious, but the courts have only recently caught on to this truism.

Clearly, for those of us who routinely work with transferring representatives and advisors, clients’ interests include consistent and ongoing advice from their chosen advisor. This interest cannot be properly served without the client’s historical files. Delayed file transfers can result in significant losses or lost opportunities.

Imagine if you chose to transfer your book of business and the transfer was coincidental with the 10% market correction some experts are calling for? If you were permitted to take your clients’ contact information, but not their files, and you could not obtain their files post-transfer quickly enough, then your clients would likely be adversely affected.

In my view, the true interest to be weighed is a client’s right to continuous advice from their chosen and fully informed advisor. Inherently, this includes the clients’ right to order the immediate transfer of all records or to refuse such a transfer.

At the moment it is the lack of a mechanism for transferring files, not assets under administration, and the lack of clear industry protocols, that places the client at significant risk.

Lessons from RBC v. ML

1. Take care!

Although the RBC defections in question occurred in 2000, the first lesson to be learned is that “litigation chill” (the threat of expensive litigation) against departing advisors is alive and prospering. Seek legal advice prior to transferring your business. Carefully review the new dealer or MGA contract terms, give sufficient notice and take care to adhere to the terms of any existing contracts.

2. Non-competition

Arguably, IDA dealers, MFDA dealers and MGAs are sophisticated employers and contractors. Failure to require a non-solicitation or non-competition clause in the advisor contract is significant. “If there is no such contractual obligation,” the Court ruling says “it would follow that there can be no inducing a breach of it.”

3. Client information

Although advisors are entitled to approach former clients, they are not permitted to remove confidential information when they leave their dealer or MGA. What is confidential information then, and what damages, if any, flow from a breach of this duty?

The Court says a client is entitled to be informed immediately when their advisor transfers firms and where the advisor has gone to. The client is entitled to choose who will advise them after the transfer.

As a result, an advisor may prepare a client contact list from their own book of business using records from the dealer or MGA he or she is leaving. This may include full names, addresses, telephone numbers and email addresses. The advisor cannot take any other client information or any information about dealer or MGA business processes unless the information is disseminated and available outside the firm.

Post transfer, the client can instruct the former dealer or MGA to hand over copies of all relevant documents. Removing or copying the client’s documents without the explicit instructions, obtained following the transfer, is wrong.

4. Can an advisor be successfully sued for leaving abruptly or without notice?

Yes. The advisor is obligated to give reasonable notice before switching firms. If no notice is given, the advisor risks paying damages to their dealer or MGA for the firm’s share of commissions lost during the notice period.

No meaningful direction was given by the Court on how to determine a reasonable notice period but original contracts usually contain notice periods. Contractual notice periods cannot be manifestly unfair or “in restraint of trade.” In my experience, dealers and MGAs, when asked, will often waive the notice period in order to avoid disruption in their workplace.

5. Do managers or senior employees have a higher degree of duty to the firm?

Yes. In this case the branch manager should have notified the dealer as soon as he learned that a group of advisors was planning to depart. It remains unclear when notice must be given, but by the time discussions crystallized into a planned course of action, the duty was clear. On the other hand, aside from minor punitive damages that appear related to his decision to be a leader in the mass exodus, the branch manager faced no further damages in RBC v. ML for his error in not warning the dealer.

It is interesting to note that Merrill Lynch was also sanctioned for its role and for some of the errors made by the transferees. While it is not clear what specifically gave rise to this sanction, it would appear that the lack of reasonable notice by the transferring advisors and their decision to take confidential information called for some punishment and since Merrill Lynch enticed the advisors, the firm shared some responsibility.

Conclusions

Advisors must be careful when preparing to leave their dealer or MGA. Overall, good contracts make for better dealings when joining or leaving a firm.

Give sufficient notice and don’t simply walk out unless you are prepared to risk litigation and damages.

The clients’ interests are paramount and should remain in the forefront throughout this process. Don’t take your clients’ records with you — only contact information. As soon as you have moved, contact your clients and have them instruct your former dealer or MGA to provide copies of their records.

When in doubt, seek legal advice before it is too late. It is much less expensive to get advice in advance than to get advice after the problems have occurred.

Harold Geller is an expert on legal issues affecting financial intermediaries. Harold assists and represents dealers, MGAs, branch managers, compliance officers and advisors dealing with their compliance, regulatory and negligence issues. Harold also helps financial intermediaries with internal business and their clients’ legal issues. Harold is a well-known industry commentator, a CE provider and administrator with foradvisorsonly.com. Harold can be reached at hgeller@miltongeller.com.