The Non-Competition Revolution Begins | Wealth Management

The Federal Trade Commission, under Chairwoman Lina M. Khan, has set its sights on banning noncompete agreements, potentially affecting more than 30 million American workers. The move is particularly significant in financial services and could have significant implications for mergers and acquisitions in the industry.

FTC Ban on Non-Competition Covenants

In April 2024, the FTC announced a final regulation banning most non-compete agreements nationwide, set to go into effect on September 4, 2024. The ban applies to both existing and future non-compete agreements and includes not only employees but also independent contractors, interns, volunteers, and other workers.

Key provisions of the ban include:

Employers must notify affected employees in writing that their non-compete agreements are unenforceable.

An exception for “senior executives” covered by non-compete agreements, defined as individuals in “decision-making positions” earning at least $151,164 annually.

Exception to non-compete clause for “fair sale” of a business or a person’s ownership interest in a company.

However, as Bloomberg reports, the Supreme Court’s recent decision overturning the Chevron Doctrine has undermined the FTC’s authority to implement such sweeping regulations. The ruling significantly impacts the FTC’s authority and creates uncertainty about current and future regulation.

Non-solicitation and confidentiality agreements still allowed

While the FTC rules prohibit most non-compete agreements, they do not prohibit non-solicitation and confidentiality agreements. This authority is particularly important for financial advisory firms, which have historically relied more on non-solicitation agreements to maintain control over client relationships when an advisor leaves.

However, enforcing non-solicitation agreements can be difficult because it is often difficult to determine whether an advisor was actively soliciting former clients or whether clients were following the advisor of their own accord. This ambiguity can lead to an increase in legal disputes between firms and departing advisors.

California’s Approach and the Business Sale Exception

California has long been at the forefront of restricting noncompete agreements. As Hanson Bridgett LLP points out, California Business and Professions Code §16600 generally prohibits noncompete agreements, with some exceptions. One key exception is the “sale of business” clause, which allows noncompete agreements when a business owner sells his or her business or its assets.

This exception in California law allows any business owner who sells goodwill, all of his or her interest in a business entity, or all or substantially all of the assets of a business together with goodwill, to enter into an agreement with the purchaser not to conduct competitive business in a specified geographic area.

Implications for Equity Ownership and M&A

The FTC’s sale exception could have significant implications for financial advisors with equity interests in their firms. Unlike the original proposal, which applied only to those with at least a 25% stake, the final rule allows noncompetes for any level of ownership when a firm sells or an individual sells their equity.

This change could make small equity stakes less attractive to some advisors, as they could find themselves subject to non-compete agreements if their firm is sold or if they want to walk away and sell their equity stake. On the other hand, it could make offering equity stakes more attractive to firms looking to retain advisors and become more attractive to potential buyers.

In the case of mergers and acquisitions, this exclusion may impact the structure and valuation of the transaction, particularly in the RIA channel where common ownership of a business entity is more common.

Next steps for companies and advisors

As the financial services industry adapts to this new environment, both firms and advisors should consider the following steps:

Review employment agreements: Advisors should review their current agreements to understand their obligations, including any non-solicitation or confidentiality provisions that will remain in effect.

Building a Stronger Team Culture: With most employees no longer able to benefit from non-compete clauses, companies need to focus more on creating a positive work environment and attractive compensation packages to retain talented employees.

Create more equitable non-solicitation agreements: Firms may want to consider developing non-solicitation agreements that recognize the division of client relationships into “yours, mine, and ours.” An equitable advisor/client relationship agreement is one potential template for this approach, as Kitces.com details.

Consider Reconsidering an Equity Offer: Both firms and advisors may need to reassess the value and implications of owning equity when considering non-compete exemptions for business sales.

A significant change

The FTC’s ban on noncompetes, whether or not it sees the light of day, could herald a significant shift in the financial services industry, particularly in M&A activity and advisor retention strategies. While it provides advisors with greater flexibility, it also poses challenges for firms seeking to protect their client relationships and intellectual property.

As the industry struggles to adapt, companies may need to explore alternative strategies to protect their interests. At this year’s Gladstone Group Annual M&A Conference, Sharron Ash, chief litigation counsel at Hamburger Law Firm LLC, said companies need to be aware of state laws on noncompetes that may apply regardless of the FTC ruling. She added that developing more equitable noncompete agreements and focusing on building a strong company culture can help companies navigate the new legal framework for retaining talent and protecting customers in the financial services industry.

Ultimately, this new era could lead to a more competitive financial services market, potentially benefiting both advisors and the clients they serve. But it will require careful navigation of this regulatory landscape and a willingness by business leaders to adapt traditional practices.

Steven Clark, President of DAK Associates and Senior Advisor to Gladstone Group