Knut Rostad is the compliance officer for Rembert Pendleton Jackson, an independent advisory firm in Falls Church, Virginia, with $700 million in AUM. Over the past three years, his firm twice has been involved in the issues surrounding departing advisors. I referenced one of these instances in my blog at www.investmentadvisor.com last June, and in subsequent entries and phone conversations with Rostad, explored the myriad ramifications of the issues involved in this sensitive and timely topic. Without delving into the details of the suit itself, he graciously agreed to share his thoughts with me for a fuller treatment of the subject in this column.
The lawsuit first came to my attention last spring, when Rostad called to talk about the broader industry issues involved with advisors leaving a firm and to get my opinion. It's possible that he was expecting a different reaction (I get that a lot). It struck me much the same as the record companies suing the now-defunct Napster for enabling free electronic downloads of music, and I told him why: In both cases, we're dealing with knee-jerk reactions to inevitable and unstoppable realities, making the plaintiffs look self-serving and possibly vindictive.
For RPJ, I suggested a suit over this all-too-common occurrence in the independent advisory industry is based on the illusion of a primary relationship between client and firm, and would neither bring back the clients, nor the renegade advisor, and makes the firm appear more interesting in its own economics than the well-being of its clients.
As you might expect, Rostad was not entirely swayed by my analysis and our ensuing discussions along with some responses to my blogs illuminate the issues that advisory firms must wrestle with when deciding how to handle defecting advisors who leave the firm, taking clients with them.
Clark: I'm still not sure what your firm wanted to accomplish. Seems the Chinese proverb that if you have to resort to violence you've already lost, applies here: filing suit is a no-win for anyone.
Rostad: We are a small business that's in many respects operated like a family. Naturally we aren't happy when anyone leaves us. It causes a break in the family. Our primary concern in any departure is that 1) the client's interests are protected, and 2) laws and regulations are upheld. Our firm is legally responsible for the confidentiality of client information. Federal law here is clear. The personal nonpublic information that clients entrust to a firm may not be transferred outside that firm without client permission.
Clark: Frankly, it sounds to me that the partners were mad, and found a legal excuse to file suit. I understand the files were the property of the old firm. But if her exclusive clients in all likelihood would continue working with her, then for the welfare of the clients, wouldn't it behoove the old firm to just give her the files to ensure a continuity of good advice?
Rostad: Legally, as you point out, the information is property of the firm. A departing advisor needed to have certain forms executed before lawfully removing client files. The business issue is quite simple. The marketplace is competitive and any client is essentially free to choose where to seek investment advice. Contrived barriers that seek only to negate this reality are plainly wrong. However, I don't believe that federal privacy law is a contrived barrier, aiming to distort the free market.
Clark: You're right, of course, in an ideal world. Yet, that solution strikes me as totally unrealistic. Think of the timing: The leaving advisor would approach the owners of the firm and announce her intention to leave at some future date, taking the clients with whom she works directly with her. Either she would already have their transfer authorization forms signed (which could raise questions about breaching her responsibility to the firm while on its payroll), or plan to get them signed in short order. Is it really unreasonable for her to expect that the firm owners might react in a hostile manner, either by physically throwing her out of the office, getting a legal injunction against her, dragging out the file transfer process, or some combination of these? Point is, because she can't trust the owners to act professionally, she has little choice but to act the way she did.
Rostad: I see your point about the reality of the situation, but I don't think that justifies what's tantamount to stealing the client files. What's more, while no one would argue that the clients themselves aren't free to choose any advisor they wish, don't you think the leaving advisor has a responsibility to their former firm and the clients to not break the law? If you think about it, this is not a very high standard.
