Firms recruiting breakaway brokers need to be wary in the wake of a very stern administrative law judge's decision sanctioning NEXT Financial Group, Inc. for violating the SEC's customer privacy provisions even while the industry awaits expanded provisions that may allow more liberal customer information sharing.
Lawyers contacted on the case advise caution and say a literal reading of the NEXT case would actually prohibit the taking of basic contact information from clients, but also say that they don't expect the SEC to start cracking the whip right now.
In a June 18 decision, an administrative law judge verbally upbraided and financially sanctioned NEXT's behavior to the tune of $125,000 in supporting the transfer of customer information during the account transition process from previous firms to NEXT for several years leading up to February 2006. The ALJ, James Kelly, also found the firm acted negligently on the other side–allowing departing NEXT reps to take client information with them to a new firm. The decision cuts to the very heart of the independent broker/dealer community, which has consistently held that the client of a rep is "owned" by the rep, not the firm, and thus has the right to ask that client to follow him or her when the rep leaves a firm.
Brian Rubin, of the Sutherland law firm in Washington, who represented NEXT in the case, said the broker/dealer is "obviously disappointed with the decision," and that NEXT, "along with countless other firms, believed it was complying with Regulation S-P. The judge unfortunately disagreed. Going forward, the firm will, of course, comply with this decision." NEXT is not appealing the decision, so it will stand as precedent until the SEC issues its finalized rule on the new Reg S-P. In the meantime, compliance officers and lawyers are treading through a minefield of legal issues.
Yes, the SEC can conceivably whip up an enforcement action against firms' common practices now, but "practically speaking, I doubt there would be an enforcement case based on taking basic client info. The Reg S-P proposal is moving to allow such data to be taken with reps and it would seriously impede all reps from moving to any firm," said Patrick Burns, a lawyer in Beverly Hills where he represents financial advisors looking to go independent.
Burns concedes that what constitutes standard practice now is unclear. But the ALJ claimed that NEXT went too far, saying NEXT sat side-by-side with recruits to access computer systems of the recruits' brokerage firms and download customers' personal information, and in some cases even used the competing brokerage's password to access the system of its customer information there so NEXT could "pre-populate" customer account and transfer forms (www.sec.gov/litigation/aljdec/2008/id349jtk.pdf).
The ALJ agreed with the SEC that all categories of information that migrated from the previous firm into a NEXT customer account spreadsheet constituted "personally identifiable financial information." The ALJ stated that NEXT did not determine whether the customers had even consented to the transfer of information before the recruits joined NEXT. Customers were also not given a reasonable opportunity to opt out of this information sharing, among other cited failures.
Even agreement between firms cannot prevent enforcement action: the ALJ found that "protocol signatories cannot place themselves beyond the reach of Regulation S-P by signing a contract" to immunize themselves from possible enforcement action under Regulation S-P. "In these circumstances, the permissive sharing of information between contracting brokerage firms does not supersede the GLB [Gramm Leach Bliley] Act right of customers to opt out from the sharing of their nonpublic personal information," ruled ALJ Kelly.
So what should brokers be doing?
