Wealth firms must prepare for demise of non-competes, despite legal challenges to FTC rule

Jim Witz, of Littler Mendelson, and Matt Prewitt, of ArentFox Schiff.

A growing sentiment against restricting employee moves could affect non-solicitation, too.

It didn’t take long for the U.S. Chamber of Commerce to try to block a sweeping regulation that prohibits the use of employment clauses that prevent workers from leaving and taking jobs with competing firms.

The large business trade association filed a lawsuit on Wednesday – the day after the Federal Trade Commission approved a final rule that would eliminate the use of non-compete agreements for almost every U.S. employee.

But the financial industry should not be lulled to sleep by the Chamber’s and other legal challenges that are certain to emerge, said Matt Prewitt, a partner at ArentFox Schiff. They need to start preparing for the profound changes in business practices that the rule will usher in.

“They may take their eye off the ball and think ‘problem solved’” by the legal action to scuttle the regulation, Prewitt said. “That’s probably the worst thing they can do in this climate.”

Prewitt points to the split FTC vote, 3-2, on the 570-page final rule. The three Democratic commissioners were in favor, saying it’s needed to protect workers and promote competition. The Republican commissioners asserted the FTC exceeded its authority in issuing the rule.

But there was no praise for non-competes at the FTC open meeting on Tuesday.

“Nobody gave a full-throated, aggressive defense of non-compete agreements,” Prewitt said. “Employers need to recognize the FTC’s action, even though it may exceed constitutional authority, is part of a broader trend against the enforcement of non-compete agreements.”

FTC touts freedom to pursue a new job

The FTC said approximately 30 million U.S. workers are subject to non-compete agreements. The final rule would:

Make unenforceable existing non-competes for most employees.
Ban non-competes for senior executives, or those making more than about $151,000, after the effective date of the rule, which is 120 days from when it’s published in the Federal Register.
Allow existing non-competes for senior executives to remain in effect.

The FTC said non-compete reform would result in an annual $524 increase in earnings for the average worker and spur the creation of 8,500 new business each year.

“The FTC’s final rule to ban non-competes will ensure Americans have the freedom to pursue a new job, start a new business or bring a new idea to market,” FTC Chair Lina Khan said in a statement.

Businesses have turned to non-compete clauses in employment contracts as a way to protect trade secrets and other proprietary information. The FTC rule will close off that option.

“There’s more skepticism about non-compete agreements,” said Kevin Paule, an attorney with Hill Ward Henderson. “In the long-term, businesses should think about whether there are other ways they can protect their assets.”

A opportunity for advisors?

The FTC suggested that the goal of protecting proprietary business information can be met through trade-secret laws and non-disclosure agreements.

The FTC rule does not ban non-solicitation agreements, where employees are free to work at a competing firm but restricted in taking customers or clients with them.

Jodie Papike, CEO of Cross-Search, a third-party recruiter that specializes in advisor transitions to independent broker-dealers, RIA firms and hybrid models, believes the rule is potentially a “fantastic thing” for advisors.

“Many of the advisors that are on the captive side, whether they’re at a wirehouse or a bank, a lot of advisors are stuck in situations that they’re not necessarily happy with,” she says.

Papike believes if the non-compete threat is removed, this opens the door not only for those who want to break away and go independent, but also the independent firms who are circling top talent.

“For independent firms, whether that be independent broker dealers or RIAs, where you’re completely independent and own your book of business, it’s fantastic because there’s also a hesitancy in a lot of cases for those types of firms to bring advisors over if they have a really difficult non-compete, as they don’t know how that firm is going to respond once they leave.”

Even though the FTC rule doesn’t ban non-solicitation agreements, firms may still have to review the scope of their non-solicits. The FTC rule says that employment agreements that are so broad that they effectively become non-competes are prohibited.

Pros and cons

Whether a non-solicit is a de facto non-compete depends on its parameters, and the details of the rule will take some time to digest. Liz Miller, founder and president of Summit Place Financial, thinks this will spur advisors to look for legal clarification into what can or can’t be written into a non-solicit agreement.

She said there will be pros and cons if the final rule is approved. “There’s a lot of consolidation going on [in the industry] and it’s going to put more hoops and difficulties in that.”

For individuals looking to move, successful senior advisors may still find they are classified as an “executive” and, therefore, still tied to an existing non-compete. And for an RIA trying to build a succession plan with a young advisor, the rule may leave them vulnerable.

“What advisors are really trying to balance is the huge investment they make in developing a young advisor, or in providing even an experienced advisor with a lot of resources and support, and feeling that there is an awful lot invested in these professionals. How does the owner of an independent firm maintain some control or some value for how much they’ve been invested to develop these professionals?”

Prewitt urged firms to make sure when they’re drafting a non-solicit covenant that there’s a clear path for an employee to understand what is the right way to exit. The fact that the FTC rule doesn’t explicitly address non-solicits could have an effect on teams of advisors leaving one firm for another.

“An employer may continue to prevent a former employee from soliciting or ‘poaching’ former employees,” Paule said. “Employees and teams will be allowed to move, but there may be litigation regarding the basis for the movement and whether improper solicitation occurred.”

Allowing non-competes in business sales

In one of the biggest changes the FTC made to the final rule, it will allow non-competes to be used in the context of the sale of a business. The original proposal in January 2023 said that a seller had to own at least 25% of a business to be subject to a non-compete. The final rule removes that threshold.

“The fact that they took that out is certainly positive for sales transactions,” said Jim Witz, a shareholder at Littler Mendelson. “It would have made sales more difficult if companies were not able to protect their investment in the company they’re purchasing through a non-compete.”

That was a bright spot in the final rule for businesses. But Witz also cautions that they can’t count on the whole thing being eliminated even though legal challenges have created much uncertainty around the regulation.

“Employers have to prepare as if the rule is going to survive – at least pending a possible injunction staying enforcement,” Witz said.

Potential ‘game-changer’ requires new strategy

The FTC rule is “potentially game-changing” for businesses because they have relied on non-competes for decades to protect their propriety information, Prewitt said. Now they must think of ways to make employees want to stay, such as compensation incentives.

“They need a broader strategy beyond non-compete agreements,” Prewitt said. “That strategy needs to include trade secret protection policies, confidentiality agreements and employee-retention [practices] that are more carrot and less stick.”

Chuck Failla, president and CEO of Sovereign Financial, said his initial reaction was that the FTC wants to create an environment where clients have more freedom to choose who they can work with, which he agrees with in principle. In the financial advisory world, of course, this creates conflict. Who “owns” the relationship? The advisor or the firm? This is not clearly stated in most employment agreements and usually results in expensive, drawn out legal cases.

Renowned financial planner Michael Kitces told InvestmentNews he expects the FTC rule will result in a significant ramp up in non-solicit agreements but that it will be “messy” given they are a lot harder to enforce. Did the advisor solicit the client, or did the client pursue the advisor? And who can prove that?

“The irony is that non-competes made it ‘simpler’ by just knocking the advisor out altogether,” Kitces said. “I think [the FTC rule] is a positive for advisors and consumers. We’ve long advocated against non-competes and said that non-solicits are fairer. But they are tough to structure well.”

Last year, Kitces published a template non-solicit agreement for advisory firms to try to help advisors and their employers set fairer dividing lines, calling it the ACRES Agreement (short for “Advisor/Client Relationship Equitable Split Agreement”). “A lot of advisors can’t afford expensive lawyers to draft protective agreements for them, which otherwise makes non-solicits lopsided in favor of firms that have more money to spend on lawyers. I anticipate we’ll see a big uptick in use of ACRES Agreements now!”

As the dust settles on the FTC rule, Failla believes the smart move is to play the waiting game.

“I wouldn’t be rushing to do anything, especially if you’re looking to break a non-compete that you signed,” he said. “I would wait a little bit to see how this all settles. I suspect this is not going to be like flicking a light switch and now it’s an open game. I don’t think it’s going to be quite that simple, but it does seem like it’s moving toward more freedom, which I like.

“But we have to make sure things are fair. Where people accepted money for signing a non-compete, how are those people going to be treated? I’ll be curious on how that pans out.”