Protect Your Retail Investments

Credit unions must arm themselves ahead of time in order to protect their book of business.

There are three primary structures for credit union retail investment services programs: broker dealer, dual employee, and managed programs. The roles, responsibilities, regulatory liability, and functions the credit union assumes differentiate the structures from one another. Regardless of the structure, when an investment representative leaves, it is natural to worry about lost business. The concern is particularly problematic for credit unions. Members’ usage of other services might change with the new rep. Also, the investment customer is harder to replace because of the credit union membership requirement.

Some representatives can’t resist the temptation of cutting out the credit union to earn a higher commission. New broker/dealers often provide incentives, such as an> interest-free loan that is forgiven over time, to entice a representative to move business with them. The raiding of representatives is a business model for some broker/dealers.

The relationship between credit unions and their investment services representative is further complicated by several factors. First, credit unions do not have the legal ability to own investment accounts. The accounts are owned by the broker/dealer. Typically, the representative acknowledges the broker/dealer owns the relationship and agrees to not solicit the accounts.

In the real world, it’s the customer that controls where the account goes. If a representative and broker/dealer part ways and a customer wants to follow the representative, then the broker/dealer must oblige. Likewise, the credit union cannot stop a member from exercising free will. The issue, then, is not whether the credit union can stop a member from leaving but if the representative can solicit the member’s business.

To protect against raids, contractual restrictions are necessary. The networking agreement between the credit union and the broker/dealer should have several provisions. First, the broker/dealer should renounce a proprietary interest in the accounts, and upon termination of the agreement, the broker/dealer should agree to cooperate with the credit union and its newly affiliated broker/dealer to transfer the accounts through bulk transfer where possible and ACAT transfer where necessary.

Second, the credit union is handing over member information and referrals, so the networking agreement should acknowledge the information is a protected trade secret.

Finally, the agreement should include a post-termination non-solicitation term during which the broker/dealer agrees to not solicit members. The agreement should provide easily exercisable injunctive powers, but be aware of your state’s position on non-solicitation clauses, as state law might not enforce the terms you’d like. Generally, courts do not favor terms that are too restrictive, and it is the credit union that must make the case that the restrictions are reasonable and necessary to protect its legally protected interests. The networking agreement should also require the broker/dealer have similar restrictions in its agreements with representatives.

If the representative is an employee of the credit union, the credit union should have an employment agreement with corresponding protections. A rogue representative is more likely to be a bad actor, so the contractual arrangement between the representative and the credit union is critical. In order to protect the member relationship, the credit union has to have the authority to enforce the protective provisions independent of the broker/dealer.

If the representative is not an employee of the credit union, the credit union should have an independent agreement in which it makes available the member information in exchange for the representative’s promise of non-solicitation. Alternatively, the broker/dealer’s agreement with the representative should give the credit union third-party beneficiary status to enforce the provisions that prevent solicitation.

But there’s a fly in the ointment. More than 300 broker/dealers have signed an agreement, called The Protocol that allows a representative to solicit their book of business if the representative and the new broker/dealer follow certain rules. Note: The Protocol only applies if both the old broker/dealer and new broker/dealer are signatories. The SEC modified its privacy rules to accommodate this contractual arrangement.

Just because your affiliated broker/dealer is a signatory does not necessarily mean the credit union must permit the solicitation, especially if the credit union has a strong non-solicitation and/or trade secret provisions it can assert independently. But to enforce the agreement protections, you need a solid contract with the representative and supportive state law. The credit union must arm itself ahead of time. Research available remedies and establish a strong agreement at the beginning of the relationship. Once the relationship winds down, it is too late.

The Protocol

When representatives move, they take the majority of their book of business. Brokerage houses recognize it is fruitless to spend time and money to stop the inevitable, so several years ago they created an agreement called The Protocol. According to The Protocol, a representative can solicit their book of business if both the old broker/dealer and new broker/dealer are Protocol signatories and if the rep and the new broker/dealer follow certain rules, including:

  • Representative cannot solicit before they leave the old broker/dealer.
  • Representatives cannot take customer information from the old broker/dealer.
  • Representatives can request customer information from the old broker/dealer if they and the new broker/dealer comply with The Protocol.
  • If they complied with The Protocol, the old broker/dealer is required to give the representative contact and account information for the customers they served.
  • After the old broker/dealer provides the customer information, the representative is then permitted to solicit the accounts.
May 27, 2014

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