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Raiding and Pirating:
A Primer for Brokers and Managers Considering Switching Firms
rokers and managers considering a group departure from their firms need to understand the possible consequences of doing so. These types of departures may be called "raiding" or "pirating" and perhaps are the most contentious of all industry disputes.
In the typical scenario, the departing group has busy plans for Friday evening and the weekend. Upon giving resignation notice (almost always late Friday afternoon, when the market is closed), the process of attempting to transfer customer accounts begins in earnest. On the other hand, once notified of the group's resignations, the firm is busy too. The counterattack includes dispatching a firm representative to the branch and placing inside and outside legal counsel on alert. Documents, such as employment agreements, commission runs and branch office profit and loss reports, are studied. Mailings are prepared to inform the customers of their "new" account executive.
Unless the matter can be settled amicably, it is likely that the courts (and/or NASD or NYSE arbitration panels) will be called upon to decide the issue of whether the firm has been wrongfully raided. In a typical raiding suit, the firm seeks a TRO (temporary restraining order) in court to stop the group (and their new firm) from soliciting or further soliciting customers. The raided firm asserts several causes of action against the broker(s) and the manager. Principally, the raided firm argues breach of the restrictions on competition and disclosure of trade secrets contained in any employment agreements. Additionally, the raided firm argues tortious interference, unfair competition, conversion and, especially against the manager, breach of fiduciary duty. Although all employees have a fiduciary duty to act honestly and with loyalty to their employers, the branch office manager has a heightened fiduciary duty. For example, the manager is charged with protecting the firm's assets and supervising the employees at the branch.
In their defense, brokers and managers often argue essentially that they were constructively discharged. That is, they contend that the raided firm mismanaged its operations to the point where, effectively, the group was discharged. This is known as the "sinking ship" defense. Common bases for asserting constructive discharge are: (1) loss of substantial income due to new compensation formulas; (2) loss of substantial income due to the firm's discontinuing profitable investment products for new, in-house products that are not as attractive to customers; (3) considerable back-office failings in processing or executing trades; or (4) material cutbacks in research and trading capabilities. Note, however, that a critical element in establishing this defense is that these adverse changes were within management's discretion and control.
Another defense, at least as against the raided firm's seeking a TRO in court, is that of "unclean hands". A court of equity will not grant a TRO unless the party requesting that equitable relief has "clean hands". That defense was employed successfully in Salomon Smith Barney v. Vockel, a Pennsylvania court opinion. The court denied Salomon Smith Barney's request for a TRO because, six years before, it had engaged in nearly the same kind of conduct in raiding Vockel from his former firm, Merrill Lynch!
Whether or not a court grants TRO relief to the raided firm, monetary damages (and injunctive relief) are available in NASD and NYSE arbitration. We surveyed arbitration awards to find several million-plus dollar awards, based upon profits that the raided firm had lost. In addition, damages may include attorneys' fees, as well as costs for replacement recruiting, overtime help and account transfer fees.
Illustrating these points are the following arbitration awards. In a 1999 NASD arbitration between John G. Kinnard and Company and Dain Rauscher, Dain Rauscher hired ten brokers and several licensed sales personnel from three branch offices in or around Minneapolis - St.Paul. Dain Rauscher denied that it had raided Kinnard & Company and asserted several defenses, including unclean hands and compensation complaints. Nonetheless, the NASD arbitration panel awarded over $9 million in compensatory damages and over $7 million in punitive damages against Dain Rauscher.
Dain Rauscher fared much better in a NASD arbitration involving U.S. Bancorp Piper Jaffray. There Dain Rauscher hired a manager, an assistant manager (with large production), two brokers and two licensed sales assistants from one branch office. The raided firm requested $2.4 million in compensatory damages. However, Dain Rauscher asserted several defenses. One defense was that the announcement of the U.S. Bancorp acquisition of Piper Jaffray, and related changes in operations, had caused double the normal broker attrition rate. A second defense, roughly akin to the unclean hands defense in a court of equity, was to expose the raided firm's own recruitment practices. Indeed, Piper Jaffray admitted that every instance of complained conduct was conduct that it itself had practiced, such as hiring away 40% of the production in an office and being provided with confidential client documents from the raided firm. The panel concluded that Piper Jaffray "cannot credibly claim any impropriety …" The panel awarded a scant $360,000 in compensatory damages.
Finally, Raymond James successfully defended a raiding claim brought by Wachovia Securities (formerly Interstate/Johnson Lane Corporation). That action involved a fixed income institutional sales group, including the branch manager, which generated $10,000,000 in annual gross commissions. Against the raiding charges Raymond James defended chiefly by claiming that the planned bank merger would impair the sales group's careers and impair their dealings with clients. As a matter of fact, the arbitration panel found that Wachovia Securities "knew that its bank merger would prompt material employee and client attrition. Thus [Wachovia Securities'] alleged losses arise solely from the predictable business consequences of its merger decision". Consequently, the arbitrators dismissed Wachovia Securities' claim.
These arbitration awards and court decisions signal caution to brokers and managers considering switching firms. Brokers and managers should examine a number of issues. First and foremost, what are the restrictions contained in any employment agreement(s) and are they legally enforceable (see OWS, January, 2000, "The Ties That Bind - Restrictive covenants may not be as restrictive as your firm leads you to believe"). Beyond that, and always subject to the advice of counsel, brokers should note the following general advice before switching firms:
Copy only records that are personal to you and not confidential to the firm, and do not even consider destroying or altering your firm's records;
Continue normal production until you terminate your employment;
Leave promptly once you decide to terminate;
In your very short resignation letter, thank the firm for giving you the opportunity to work there;
Until then, do not attempt to convince your co-workers to join you in switching firms; and
Until then, do not alert your clients to the fact that you plan to switch firms.
Brokers and managers are well advised to consult competent legal counsel (not just the prospective firm's branch office manager or inside legal counsel) to formulate and implement the most prudent strategy to effectuate their move and to provide litigation defenses. Nothing less than one's career and reputation are at stake.
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Sponsored by James J. Eccleston, an attorney representing stockbrokers, financial planners and
investors nationwide in arbitration, litigation and regulatory matters, and a shareholder with the law firm
Shaheen, Novoselsky, Staat, Filipowski & Eccleston
P.C.(www.snsfe-law.com). This Web site contains material
of general interest. It is neither intended to, nor constitutes, either legal advice or investment advice.
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