As the independent registered investment advisor channel continues to grow, firms are getting larger; many RIAs now have national aspirations, acquiring firms and, increasingly, recruiting new advisors from established companies.
“With that comes some burdens that we can’t overlook,” said Brian Hamburger, president and CEO of MarketCounsel, speaking at the DeVoe & Company G2 Forum this week. “Not only does the potential for client-related issues and disputes increase, but employment-related challenges are to be expected.”
“As those challenges emerge, the founding advisors are likely to encounter human resource issues and conflicts as diverse as violations of the firm’s own policies and procedures, issues like sexual harassment or discrimination and similar claims, consistent supervision of staff and effective implementation of client related policies and procedures, and management risks surrounding staff termination and recruiting all are essential components as firms continue to grow.”
These emerging challenges have the potential to distract an advisor from productive growth of the firm. That’s why Hamburger and his colleague, Sharron Ash, chief litigation counsel at The Hamburger Law Firm, say it’s important to have plans in place for hiring and firing employees when necessary.
“We really want advisors to identify their needs, goals and objectives, and their risk tolerance. What is your appetite for risk? It’s the same exact question you ask your clients, because here, just like your clients, you’re making an investment. You’re making an investment in human capital,” Hamburger said. “Your recruiting plan really should be part of a purposeful effort—not just someone you know or the person who happens to land on your doorstep. And it should be constructed based on a predetermined, acceptable risk matrix.”
“In every one of the instances that we’re going to talk about today, the firm was taken by surprise by the conduct of their employee—either on their way in, on their way out, or by that employee violated firm policies and procedures in a pretty intentional way during the course of their employment,” Ash said.
Ash provided an example of one of her clients, who asked MarketCounsel to write a letter of resignation for an advisor coming out of a wirehouse. That advisor had assured MarketCounsel’s client that he didn’t have any non-solicitation agreements preventing him from freely moving his clients with him. Ash and her team talked to that advisor to gather more information.
“It turned out that not only did the advisor have non-solicitation restrictions, he was the most junior guy on his team, and he wasn’t even a producer,” Ash said. “He didn’t have any clients and had gathered all of his information about his transition strategy from just talking to a buddy who left the same firm earlier. This is not the time to be establishing a legal strategy based upon taking a survey on what others may or may not have done.”
Ash believes had they gone ahead and brought that person on, the firm would likely be facing litigation.
“That scenario where you’re not taking a practical look at the individual, where they fit into a larger group that’s not coming along, if you’re not anticipating what happens after that letter of resignation goes in, then boy you’re really just in reactive mode, and you’ll be relegated to a position of responding to what is thrown at you.”
Ash said her firms look for the typical agreements that will impact an employee after they leave, the most restrictive being non-competition clauses.
“Those types of clauses are litigated every day,” she said.
Often they are binding and enforceable, she said. Those clauses may say the employee can’t do business in a certain geographical area or with certain individuals, such as past clients or prospects.
“Even if not for the long term, they might be enforceable enough to get you a temporary restraining order for two weeks, to put you on the bench for two weeks,” she said.
She also looks for requirements that an employee planning to leave gives notice to their employer, whether it’s two weeks or 30 days. Sometimes those provisions are tied to benefits.
“There are some contracts out there that say, ‘Look if you give us two weeks' notice that you’re leaving, we’re going to let you engage in certain behaviors—like soliciting clients—that would otherwise be unavailable to the transitioning representative,” she said.
The most common agreement is a non-solicitation provision, which would prohibit an advisor from inviting, or encouraging or inducing a client to join them at the new firm. An advisor can have communications with clients that are not solicitation conversations, but there are limits. And advisors want to make sure those conversations don't trigger a legal breach.
“The most common one is certainly non-solicitation,” Hamburger said. “The trojan horse, however, is confidentiality, which leads to then trade secrets. That’s the one that judges have become far more sympathetic to because it’s about protecting clients, it’s not about restricting advisors. It just has the effect of restricting advisors.”
Confidentiality clauses are the No. 1 driver of disputes in this industry in the context of employment transition, Ash said. Even if someone does not have an employment contract requiring them to keep client identities confidential, there are regulatory obligations.
When terminating an employee, both Hamburger and Ash recommend advisors keep it short, high level and not specific. It’s best to lead the conversation with the termination.
“Despite all my legal training, I learned all my lessons on how to fire from these documentaries that show NFL general managers, and the way they fire is just short and sweet,” Hamburger said. “‘We don’t have a place for you on the team. Thanks so much for your efforts.’”
But the alignment of operations during a termination may be even more important than the conversation, Hamburger said. For most firms, a number of things must be coordinated at the time of the termination, such as human resources, technology and data protection, security measures, changing passwords, and locking up access to physical and technology facilities.
“There really needs to be strong alignment amongst the entire team as to what has to happen at the time of a termination,” he said.
