Welcome back to another episode of the Independence Playbook. In today’s episode, John is joined by Jon Morris, Chief Legal and Governance Officer at Dynasty Financial Partners. Jon shares some of the essential items advisors need to know from a legal perspective before breaking away.
JOHN: [00:18:00] Welcome back, everyone, to another episode of The Independence Playbook podcast. I’m John Sullivan and I head up Business Development for Dynasty Financial Partners. In this episode, I’m going to be interviewing Jon Morris who’s the Chief Legal and Governance Officer for Dynasty.
Jon’s been here for the last 10 years. Prior to Dynasty, he worked in private practice where he was the chair of a large law firm covering the independent advisor practice group. Prior to that, he was also managing director and general counsel of Barclays Wealth as well as general counsel for Lehman Brothers Investment Management.
So Jon, thanks for joining us today. Obviously, you’re well-credentialed and I think we can kind of jump right in.
JON MORRIS: Thanks, John. Good morning. I appreciate your hosting this podcast and inviting me to participate. I look forward to speaking about the independent movement and breakaways as they intersect with the legal and compliance issues.
JOHN: That’s great, Jon. So let’s get started. You know, a lot of advisors are thinking about this movement that’s happening around them. What are some of the most important things that a breakaway advisor needs to know about legal issues as it relates to launching their own independent firm?
JON: Sure. breakaways need to understand what contractual restrictions they have with their existing firms whether it’s a non-solicit of clients or employees as well as what confidentiality obligations they have. Oftentimes, advisors don’t recall what they have signed in the first instance.
Once they have those agreements, they need to, with the assistance of a knowledgeable counsel, construct a strategy or an approach to departing that minimizes their litigation risk.
As I noted, oftentimes, advisors will not recall what they signed. And we generally know what firms require of their advisors and so we can construct from just past practice what restrictions they may have. But it is important, if they can, to obtain the actual documents so we can review them in advance.
JOHN: Thanks, Jon. You’re obviously the first call when I’m in discussions with advisors and we get to that point around the legal documents. What are some of the best practices as advisors start to embark on this process just as it relates to some legal guidelines and advice?
JON: [00:04:00] Sure, John. I mean as I noted earlier, you know, the first thing is to obtain copies of agreements that they have signed with their employer and review them with counsel.
Second, you know, and equally as important, avoid taking any files from your employer. That means hard copies or electronic copies. Recognize that your employer has the ability and will review any email traffic going back six months or longer and they’ll be looking for any materials that you sent, you know, to your personal email account. So just be aware of that. So avoid any of that.
Avoid pre-soliciting clients. I.e., that means speaking to clients, telling them what you’re going to do in advance of your resignation. You work for your employer and have a duty of loyalty up until the time you resign. You need to be aware of that.
It often will come out in post-departure litigation that an advisor was soliciting clients in advance. That’s a violation of any solicitation restriction and a violation of the duty of loyalty.
Don’t take any client information or any information from your employer unless it’s a protocol departure, which we’ll get into in a moment. Client list should be recreated, post your departure, from publicly available information.
Another good practice is to — and this is in the context of a protocol departure — leave your protocol list on your credenza or at your desk. Leave everything there at your desk so that your manager has that… your manager from your departing firm has that in front of them.
[00:06:00] We can’t emphasize enough the importance of not taking any information. You have, not only a non-solicitation restriction but you have confidentiality obligations to your employer that you need to abide by.
JOHN: Yeah. Great. And obviously, there’s a lot of work that gets done up to that time of the actual resignation day. So let’s go back a little bit and just kind of define it with a little more clarity, the differences between a “Protocol” and a “Non-protocol” departure.
JON: Sure, John. I describe protocol… It’s essentially a safe harbor that allows a person leaving a protocol firm to join a protocol firm and to solicit the clients that they handled at that prior firm and not be subject to a non-solicitation restriction. It also allows the advisor to take certain information regarding their clients. That is the name, the address, the telephone number, the email and the title of their account.
I caveat that by noting that if you take anything more than that, you’re going to fall outside of the protocol and you won’t be able to avail yourself of its protections.
It’s also worth noting that certain firms, recently in recent years… UBS and Morgan Stanley, for example, have left the protocol.
So in such cases, where it’s a non-protocol departure, your approach is simply going to be different. You’re not going to be able to solicit clients. You will not have the protections of the protocol and you’ll have to come up with a different approach. And oftentimes, the approach that people use is just simply announcing their departure but avoiding any kind of solicitation of clients.
JOHN: Sure. Thanks, Jon. We’ve seen a lot of advisors transition over the last number of years — obviously, both protocol and non-protocol. And the reality is the clients do come. We’re seeing up to 90 percent of assets in eight to 10 weeks in most cases. But let’s talk about some of the mistakes that advisors do make leading up to the transition
JON: Sure. I think that the biggest mistakes is not planning the departure and being strategic around the approach to the departure.
the mistakes I do see in the industry are things such as pre-soliciting clients while still employed with their current firms. As stated earlier, that’s a violation of their duty of loyalty and their non-solicitation restriction.
Another mistake is sending information — and particularly, client information — to their personal emails in advance of their departure. They have a duty of loyalty to their firm. They cannot do that. And recognizing that the firms will be looking for, you know, post to departure, any evidence that they send… confidential information to their personal emails.
[00:10:00] Another mistake, soliciting other employees working on setting up their new code, their new registered investment advisor, while in the office. Any activities related to the new business of planning to compete should be done outside of the office.
Another mistake would be soliciting — you know, in the case of a protocol departure — soliciting relationships, clients that are not on your protocol list.
Again, you have to identify, for a protocol departure, those clients that you served while at your former firm. You can’t go beyond the list of the clients that you served and you can’t poach other people’s clients. So going beyond your protocol list would be another mistake.
Another mistake, in the context of a protocol, would be taking information beyond what is permitted on the protocol. As I noted, there’s five pieces of information that you can take under a protocol departure. Going beyond that can result in a… Basically, you’ve lost the protection of the protocol.
And I sit as a FINRA arbitrator from time to time and, you know, I’ve sat on cases where that’s exactly the point, that an advisor took more than what was allowed under the protocol and lost its protections.
JOHN: Excellent, Jon. So advisors are thinking about this. They’re engaged with council. They’re kind of moving through the process. And obviously, a fair amount of almost fear has been instilled in them by the current firm as it relates to legal issues if they are to depart.
What are some of the misperceptions that advisors have about the legal landscape in terms of issues that may come up or not come up for that matter?
JON: [00:12:00] Well, I’d have to say, you know, there’s a misperception that the firm won’t become aware of activity that might be violative of a restrictive covenant.
So I think, you know, a big misperception is that the company won’t pursue litigation. They often will pursue litigation not just from a perspective of the individual advisor but to send a message more broadly through the organization that they’re not going to stand by and let advisors leave without enforcing what they believe to be their rights.
The other misperception, and I stated this earlier, is that advisors will frequently say they never signed anything. I mean there’s many, many occasions where I hear that from advisors. And I often tell them that they just forgot that they signed something that restricts them. Oftentimes, restrictions are embedded in larger documents. Any kind of loan that is taken, there’s going to be, presumably, a restrictive covenant in there.
So don’t think that you are not subject to a restrictive covenant. I would have to tell you that, you know, 95 percent of the time, the advisors have signed something that they’re… And even though they think they didn’t, it comes up post their departure.
JOHN: Right. And now, let’s kind of segue, Jon. [00:14:00] I know that we’ve covered a lot of the legal issues and concerns. Another big concern advisors have when they’re contemplating a move like this is compliance.
And again, I think it’s almost a four-letter word at many of the firms where they are currently sitting and there’s a lot of angst and concern about what compliance is really like in the independent RIA space. Can you just give us a high level overview of how compliance works when you have an RIA?
JON: Sure. Sure. In the independent space, you’ll register your firm as a registered investment advisor with the SEC — Securities and Exchange Commission. And as part of that, you’ll be required to designate a person on your team who will serve as the chief compliance officer.
In the case of Dynasty, we’ll provide support and assistance to that individual to get them up to speed on what he or she needs to know in that role.
Typically, the larger firms or about dual registrants registered with the SEC also registered with FINRA. Unlike FINRA, there’s no specific licensing requirements for such individuals other than they should have their Series 65. But it’s much more of a prudential body of regulation than a rules-based body of regulation which is more where FINRA is.
JOHN: And as far as setting up the compliance program as it relates to the SEC, what are some of the concerns that advisors should be thinking about or some of the support that they know they will need as they move into the fully independent model?
JON: [00:16:00] Well, first off, I’ll just say that, you know, compliance is less prescriptive in the independent space than what an advisor will typically be used to leaving a large firm. Keep in mind, large firms’ compliance programs are designed to address many competing interests within a large organization. Some say that the programs have built to the lowest common denominator.
In the independent space, you’re responsible for the activities of your firm and you can decide how conservative or aggressive you want to be on certain matters. Recognize that you need to take compliance seriously.
But there is some discretion on what that means. We’ve seen some firms, for example, set up separate businesses. Examples might be concierge services, tax or financial planning, sports services, corresponding divorce practice.
These are the kind of things that you’re allowed to do in the independent space, having a registered investment advisor. It’s not, again, as prescriptive as in a larger firm. It’s unlikely you could do any of these kind of businesses in a large firm. So that is, basically, the difference. The compliance program will be tailored to your business.
JOHN: Thanks, Jon. I think that’s all the time we have for today. But it’s really about freedom, flexibility and control when you launch and own your own independent RIA. So thank you for the time. — Please join us on the next podcast series.