Broker Protocol signings regain momentum amid new signs that the wirehouses could shut the breakaway portal

The stock market’s recent rally isn’t the only one the industry should keep an eye on.

In January, 15 firms signed the Broker Protocol, agreeing to a set of industry rules under which advisors may leave one firm to join or start another. That was a reversal from late 2010, when signups steadily petered out—with just five firms putting pen to paper in December. RIABiz maintains a list of signatories at https://www.riabiz.com/protocol_members.

It turns out that January’s number was no fluke: 20 more firms signed on in February, and 11 more in March. The numbers for the first quarter – 46 — are equal to the same time period in 2010, when 46 firms signed the protocol, but significantly less than 2009, when 87 signed on in the first quarter after the financial crisis.

The Protocol numbers point to continuing demand among breakaway brokers to start their own firms and among independent firms to recruit them. At the end of last year, some experts had begun to predict that the Protocol list was reaching critical mass. But the fact that the number of signatories is on a pace equal to that of the previous year is a sign of a still-lively market for breakaways.

Second generation

“We’re still seeing a lot of breakaway brokers setting up their own shops or joining established independent firms,” says Patrick Burns Jr., a Beverly Hills, Calif.-based attorney and president of consultancy Advanced Regulatory Compliance, Inc.. “This is the second generation, the people who didn’t leave in 2008 or 2009.”

The Protocol was originated in 2004 by three big firms—Smith Barney, Merrill Lynch and UBS. But hundreds of independent firms have since crashed the party. By the end of February, there were 630 signatories. Last year, 189 firms signed the Protocol, way down from the 280 that signed in 2009. See: Fewer companies join Protocol as downsides emerge and Which firms are joining the Broker Protocol, and how your firm gets on the list.

The signatories to the Broker Protocol is only one indication of the strength of the breakaway stream – always a tough thing to predict. Burns says he believes that there will be a surge of breakaways and recently published a white paper to that effect

Many of the retention packages wirehouses handed top brokers are set to expire over the next few years, the paper notes. Meanwhile, there are new reasons for brokers to break away, he said in a phone interview.

Shotgun marriages

“There have been some major changes at the large Wall Street firms in the last year or two, including shotgun marriages and takeovers that resulted in changes in culture,” he says. “There are a number of people who may not necessarily like what’s transpired.”

Thomas B. Lewis, chair of the employment litigation group at Stark & Stark, in Princeton, N.J., says he’s not so sure there a flood of breakaways is in the cards. One reason is that clients in the post-Madoff era are concerned about the security of independent firms, he says.

“There seems to be a lot of pushback based on some of the scams and insider trading issues about whether a small platform would be a good fit for a broker as well as their client base,” says Lewis. “I don’t think it’s going to be that easy to be independent and bring a majority of your client base.”

Pat Burns: Do you take it
to the members for a vote?

About 85% of accounts traditionally transfer when brokers move from one wirehouse to another; Lewis speculates that percentage is lower for breakaways who join or start small firms.

It seems certain that Wall Street will continue to face at least a moderate stream of breakaways, facilitated by the rules of engagement that they themselves created. Wirehouses are concerned about the ease with which the Protocol has allowed brokers to leave not just individual firms, but the entire wirehouse club, says Burns.

Tilt the playing field

Big Wall Street firms have taken steps to “tilt the playing field back into their favor,” Burns’ white paper notes. A prominent example is the creation by Bank of America’s U.S. Trust unit of a “Garden Leave” policy. The policy requires departing advisors to provide 60 days’ notice before leaving—which would give clients plenty of time to get cold feet.

Although U.S. Trust is not a member of the Protocol, the white paper notes, many of its advisors maintain their securities license through Merrill Lynch, which is a member.

But Burns doubts that sweeping changes to the Protocol are possible, however much the once-exclusive club of wirehouses might yearn to amend it.

“Although the common perception is that the wirehouses run it,” he says, “for antitrust reasons they can’t change the rules.”

Independents have the vast majority

What’s more, the Protocol contains no provision specifying how it might be amended, Burns adds. “Do you take it to the members for a vote?” he asks. “If it’s one firm one vote, that means the independents have the vast majority of votes.”

Lewis agrees that amendments are not practicable. But he believes that eventually wirehouses will become frustrated enough to discuss creating a second protocol intended to supersede the original. See: Broker protocol may be endangered by complexities as membership starts to explode

The sheer number of signatories, along with the gradual proliferation of “side letters” such as B of A’s Garden Leave example, are making the Protocol extremely unwieldy, he says.

“I don’t think anybody back in 2004 thought the Protocol would turn into what it is today,” he says.

A new protocol might exclude non-wirehouses by, for instance, being open only to firms that meet a certain size threshold, he speculated. Wall Street firms are not talking about Broker Protocol II yet, Lewis admits.

“But I think it’s going to be a natural progression to have discussions about life after the current Protocol,” he says.