of Federal Trade Commission recently announced a monumental decision: outlawing non-compete clauses in employment contracts. The move is sending shockwaves throughout the business world – particularly in the wealth management industry, which has historically relied on these clauses to lock out advisers under threat of legal action. As the future of the rule hangs in the balance due to potential legal challenges, it is time for firms to ditch these outdated contracts and let advisers freely choose what is best for them and their clients.
The wealth management industry includes over 400,000 professionals who manage trillions of dollars of the nation's wealth. Large banks, national brokerage houses or conglomerates of registered investment advisers impose non-compete, non-solicitation and non-solicitation clauses on many advisers. Typically, these agreements attempt to limit an advisor's ability to leave the firm, barring them from working as an advisor for years or restricting them from assisting their clients at another employer.
One last one CNBC article outlining the federal regulators' proposed rules featured the story of Ted Jenkin, a financial advisor who sold his practice in 2019. Ted found himself trapped in his RIA's non-solicitation and non-compete agreement, which which effectively banned him from working with any of his former clients or pursuing any other work in the industry, anywhere in the country, for five years.
“When you sell a business, you're essentially selling clients or ideas, but not being able to work in the business makes no practical sense,” he lamented. What Ted initially saw as a golden opportunity in a booming industry turned into a situation in which he could not even practice his chosen profession.
Ted is not alone. Mergers and acquisitions within the RIA sector are on the rise 20% compared to the same time last year. This increase in activity can be exciting for the buying firms, but for the advisors who make up the companies being sold – often bystanders to these decisions – they can end up losing control over their businesses and their livelihoods.
A typical scenario goes like this. First, the decision makers at the top of the two firms agree on a sale and purchase. Firms will keep adviser employees and clients in the dark until they agree on terms. Once the terms are announced, lengthy non-compete and non-solicitation agreements are handed out—sending many advisors out the door and onto safer pastures, with the mindset that it's better to take your chances on the move (despite potential legal threats) than lose your ability to carry on your trade with another employer.
Thesis firms that impose these agreements argue that they deserve to keep clients (and more importantly, the client's revenue) because the firm has worked to develop those client relationships. However, this is rare. Advisors themselves—not their firms—carefully build and maintain personal relationships with clients.
Financial professionals are often left to market themselves and cultivate their client base independently, apart from their primary responsibility of managing client assets and providing personalized advice. We can see that the collective impact of marketing and branding at the firm level even in the best capitalized organizations does not significantly influence most advisors. If it happened, 80% of the advisors in Merrill's old training program would not fail after five years.
Even more damning, despite all the restrictions in place, when the counselors move, 80% of their customers move with them. It is clear that the present thesis and assumptions fail to hold water.
Non-compete agreements not only impair an advisor's freedom to associate, they can also deter clients from trusting that their advisor will act in their best interests. For example, a financial advisor with the opportunity to transfer his clients' assets to another firm that offers superior technology, investment solutions and support is likely to be constrained from making this move and achieving potentially better results for himself and their customers. In this case, it is not only the advisor who suffers, but also the clients who trust their advisor to preserve and grow their wealth.
Advisors want to perform their jobs as effectively as possible for their clients. They are limited in their ability to do this when firms compete on constraints rather than delivering great experiences and financial returns for their talent and clients. Our industry can do better and both advisers and clients should expect more. Thankfully, federal regulators seem on board with the need for a much-welcomed change — not a moment too soon.
Taylor Matthews is the CEO and co-founder of Farther