The Federal Trade Commission under Chair Lina M. Khan has set its sights on banning non-compete agreements, potentially affecting over 30 million American workers. This move is particularly relevant in financial services and could have significant implications for mergers and acquisitions in the industry.
FTC's Ban on Non-Competes
In April 2024, the FTC announced a final rule banning most non-competes nationwide, expected to take effect on Sept. 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.
Key provisions of the ban include:
- Employers must provide written notice to relevant workers 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 exemption for non-competes related to the "bona fide sale" of a business or an individual's ownership stake in a company.
However, as reported by Bloomberg, a recent Supreme Court decision overturning the Chevron doctrine has cast doubt on the FTC's authority to implement such sweeping regulations. This ruling significantly impacts the FTC's power and creates uncertainty for existing and future regulations.
Non-Solicit and Non-Disclosure Agreements Still Allowed
While the FTC's rule bans most non-competes, it does not prohibit non-solicit and non-disclosure agreements. This allowance is particularly relevant for financial advisory firms, which have historically relied more on non-solicits to retain control over client relationships when an advisor leaves.
However, enforcing non-solicit agreements can be challenging, as it's often difficult to determine whether an advisor actively solicited former clients or if clients followed the advisor of their own volition. This ambiguity may lead to increased legal disputes between firms and departing advisors.
California's Approach and the Sale-of-Business Exception
California has long been at the forefront of restricting non-compete agreements. As outlined by Hanson Bridgett LLP, California Business and Professions Code §16600 generally prohibits non-compete agreements, with some exceptions. One key exception is the "sale-of-business" clause, which allows non-compete agreements when a business owner sells their company or its assets.
This exception in California law allows any business owner who sells the goodwill of a business, all their ownership in a business entity, or all or substantially all of the assets of a business together with the goodwill, to agree with the buyer to refrain from carrying on a competing business within a specified geographic area.
Implications for Equity Ownership and M&A
The exemption for sales transactions in the FTC's rule could have significant implications for financial advisors with equity stakes in their firms. Unlike the initial proposal, which only applied to those with at least a 25% ownership stake, the final rule allows non-competes for any level of ownership in the case of a business sale or an individual selling their stake.
This change could make small equity stakes less attractive for some advisors, as they might find themselves subject to non-compete agreements if their firm is sold or if they want to leave and sell their equity stake back. On the other hand, it might make offering equity stakes more appealing for firms looking to retain advisors and make themselves more attractive to potential buyers.
For M&A activity, this exemption could impact how deals are structured and valued, particularly in the RIA channel where shared ownership of the business 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 employment agreements: Advisors should review their current agreements to understand their obligations, including any non-solicit or non-disclosure provisions that will remain in effect.
- Build stronger team cultures: With non-competes 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.
- Craft more equitable non-solicits: Firms might consider developing non-solicit agreements that recognize the "yours, mine and ours" split of client relationships. The Advisor/Client Relationship Equitable Split Agreement is one potential template for this approach, as detailed by Kitces.com.
- Reconsider equity offerings: Both firms and advisors may need to reassess the value and implications of equity ownership considering the non-compete exemption for business sales.
A Significant Shift
The FTC's ban on non-competes, whether it sees the light of day, could represent the harbinger of a significant shift in the financial services industry, particularly for M&A activity and advisor retention strategies. While it provides advisors with 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. At this year's Gladstone Group Annual M&A Conference, Sharron Ash, chief litigation counsel at Hamburger Law Firm LLC, said firms need to be aware of state-specific laws regarding non-competes, which may apply regardless of the FTC's ruling. She added that the development of more equitable non-solicit agreements and a focus on building strong company cultures, could help firms navigate the new legal framework of talent retention and client protection in the financial services industry.
Ultimately, this new era may lead to a more competitive marketplace 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 Clark, president of DAK Associates and senior advisor of Gladstone Group
