The Federal Trade Commission under Chairman Lina M. Khan has set its sights on banning non-compete agreements, potentially affecting over 30 million American workers. This move is particularly important in financial services and could have significant implications for mergers and acquisitions in the industry.
FTC Injunction Not to Compete
In April 2024, the FTC announced a final rule banning most non-competes nationwideexpected to take effect on September 4, 2024. The ban applies to both existing and future non-compete agreements, covering not only employees but also independent contractors, interns, volunteers and other workers.
The main provisions of the ban include:
- Employers must notify applicable employees in writing that their non-compete agreements are unenforceable.
- An exemption for “senior executives” with existing non-competes, defined as individuals in a “policy-making position” earning at least $151,164 annually.
- An exception to non-competes relating to the “good faith sale” of a business or an individual's ownership interest in a company.
However, how reported by Bloomberg, a recent Supreme Court decision overturning the Chevron doctrine has cast doubt on the FTC's authority to enforce such sweeping regulations. This decision significantly affects the power of the FTC and creates uncertainty for existing and future regulations.
Non-solicitation and non-disclosure agreements still allowed
While the FTC rule prohibits most non-competes, it does not prohibit non-solicitation and non-disclosure agreements. This compensation is particularly important for financial advisory firms, which have historically relied more heavily on non-claims to maintain control over client relationships when an advisor leaves.
However, enforcing non-solicitation agreements can be challenging, as it is often difficult to determine whether an advisor actively solicited former clients or whether clients followed the advisor of their own volition. This ambiguity could lead to increased legal disputes between firms and departing advisors.
California Approach and Sale of Business Exemption
California has long been at the forefront of restricting non-compete agreements. As described by Hanson Bridgett LLP, California Business and Professions Code §16600 generally prohibits non-compete agreements, with some exceptions. One major exception is the “sale of business” clause, which allows for non-compete agreements when a business owner sells his company or its assets.
This exemption in California law allows any business owner who sells the goodwill of a business, all of his ownership in a business entity, or all or substantially all of the assets of a business along with the goodwill, to comply with the buyer refraining from holding on to a competing business within a particular geographic area.
Implications for Equity Ownership and M&A
The exception for sales transactions in the FTC's rule could have significant implications for financial advisors with equity stakes in their firms. Unlike the original proposal, which applied only to those with at least 25% of the ownership stake, the final rule allows for non-competes for any level of ownership in the case of a business sale or an individual selling their shares.
This change may make small equity stakes less attractive to some advisors, as they may find themselves subject to non-compete agreements if their firm is sold or if they want to exit and sell their equity stake again. In turn, it can make the offering of equity shares more attractive to firms looking to retain advisers and make themselves more attractive to potential buyers.
For M&A activity, this exception may affect how deals are structured and valued, particularly in the RIA channel where joint ownership of the entity is more common.
Next steps for firms and advisors
As the financial services industry adapts to this new environment, both firms and advisors should consider the following steps:
- Review of Employment Agreements: Advisors should review their current agreements to understand their obligations, including any non-solicitation or non-disclosure provisions that will remain in effect.
- Build stronger team cultures: Since non-competes are no longer an option for most employees, firms may need to focus more on creating a positive work environment and attractive compensation packages to retain talent.
- Create more non-solicitation rights: Firms may consider developing non-solicitation agreements that recognize the “yours, mine and ours” division of client relationships. The Equal Share Agreement for Advisor/Client Relationships is a possible template for this approach, as detailed by Kitces.com.
- Reconsider equity offerings: Both firms and advisors may need to reevaluate the value and implications of equity ownership, taking into account the non-compete exception for business sales.
An important change
The FTC's ban on non-competes, whether or not it sees the light of day, could represent a significant shift in the financial services industry, particularly for M&A activity and advisor retention strategies. While it offers advisors increased flexibility, it also presents challenges for firms seeking to protect their client relationships and intellectual property.
As the industry seeks to adapt, firms may need to explore alternative strategies to protect their interests. In this year Gladstone Group Annual M&A Conference, Sharron Ash, chief litigation counsel at Hamburger Law Firm LLC, said firms should be aware of specific state laws regarding non-competes, which may apply regardless of the FTC's ruling. She added that developing fairer non-solicitation agreements and focusing on building strong company cultures can help firms navigate the new talent retention and customer protection legal framework in the financial services industry.
Ultimately, this new era could lead to a more competitive market in financial services, potentially benefiting both advisors and the clients they serve. However, it will require careful navigation of this regulatory topic and a willingness for business leaders to adapt traditional practices.
Steven Clarkpresident of DAK collaborators and senior advisor to the Gladstone Group