Investor’s column: Here’s why big firms are dumping the broker protocol

The 2004 agreement called the broker protocol (founded by three of the largest retail firms on Wall Street) is starting to experience an exodus of its founding members.

So, why have a few large firms exited in the past few months?

Generally, it is based on legal loopholes that have rendered the broker protocol less effective, according to one of the firms.

Also, the exit allows firms additional litigation to protect their trade secrets from exiting employees and those secrets being used if they are hired by a new firm.

There are many firms that have not participated in the broker protocol; those firms have relied only on their employment agreements as their primary protection.

The broker protocol has served multiple purposes. It greatly reduced litigation that was boiling over at the time due to firms’ recruiting practices.

And, based on a November 2017 research paper titled “Investment in Human Capital and Labor Mobility: Evidence from a Shock to Property Rights” by Christopher Clifford and William Gerken, the broker protocol also has positive influence on an adviser’s relationship with clients.

According to their research, the broker protocol “effectively” transfers the ownership of the client relationship from the firm to the adviser.

That doesn’t mean that someone is not a client of their firm. When a financial adviser transitions from a member firm of the broker protocol to another firm that is a member of the broker protocol (transitions occur for many reasons), the data from behavioral studies suggests that the financial advice given comes with additional human capital.

When the adviser, protected under the broker protocol, has the confidence to see the long-term picture of the opportunity to serve you, they have less client complaints and have added incentive to work more effectively for the client. Clearly, the goal of firms and advisers is to protect the client while protecting their relationship with the client.

General growth patterns have been identified by Cerulli Associates, and that research shows that growth is occurring in independent investment firms and regional investment firms. So, if more financial advisers are moving toward these business models, I believe that the variables driving those changes are going to continue.

One thing is for sure: The age of financial advisers is increasing (the average is 51, according to Cerulli Associates), meaning that younger advisers beginning their careers are not replacing their older counterparts fast enough.

There is a myriad of state and federal regulators who oversee the protections of investors. The broker protocol has been a successful covenant for member firms to participate in orderly transitions of financial advisers.

Rest assured, investment firms are still bound by the same governing rules to protect their clients.

This story was originally published January 22, 2018 at 1:09 PM with the headline "Investor’s column: Here’s why big firms are dumping the broker protocol."