Court voids non-compete contracts

Lawyers say that an August decision by the California Supreme Court that voids narrow-restraint exceptions for non-competition agreements could be a big boon for brokers.

Many brokerage firms, including most of the wirehouses, require brokers to sign employment agreements that restrict them from soliciting clients or taking customer information once they depart the firm.

The contracts are sometimes the basis for nasty legal disputes that erupt when brokers leave. They have long been a sore spot among financial advisers who are employees of a brokerage firm.

But non-compete provisions, and possibly non-solicitation and other restrictions, no longer have a sound legal standing in California, attorneys say.

Brokers in other states could be helped by the California case as well, according to industry observers.

The decision is a legal precedent that non-California “litigants can now point to,” said Richard Roth, president of The Roth Law Firm PLLC in New York.

“It’s an inroad into the whole anticompetitive situation that broker-dealers have utilized for years,” said Michael Blumenfeld, a partner at Freeman Freeman & Smiley LLP in Los Angeles.

Federal courts in California had previously held that non-compete agreements were legal if narrowly tailored, he said.

But the state Supreme Court said “no way,” Mr. Blumenfeld said. “It rejected that narrow restraint idea and said these agreements are illegal.”

“It’s a very difficult case for employers,” said David Barth-ol-omew, of counsel at Palmer Lombardi & Donohue LLP in Los Angeles, which does defense work for firms and brokers.

“It will make it easier for people to move,” he added.

The case “should be good for recruiting,” said Elayne Horton, co-founder of The Horton Group Inc. of Los Angeles, a recruitment firm.

A broker at Merrill Lynch & Co. Inc. of New York welcomed the decision. Employment disputes are “like an ugly divorce,” said the broker, who asked not to be identified. “No one wins except the attorneys.”

NO MORE HARDBALL?

The plaintiff in the California case, Raymond Edwards, was a tax and estate-planning lawyer who worked for Arthur Andersen LLP of Chicago until the company ceased operations in June 2002 after being indicted for its role in the scandal involving Enron Corp. of Houston.

In 2003, after a new job offer fell through, Mr. Edwards challenged Andersen’s non-compete agreement, which prohibited him from soliciting Andersen clients for a year or more after leaving the firm.

The kind of restriction in the Andersen contract is similar to ones used by the securities industry.

For example, Merrill Lynch forbids former employees from soliciting anyone whose name became known to them while they were employed at Merrill for one year following separation.

That’s a broad restriction that can cause trouble for reps.

Firms typically cite these restrictions in seeking restraining orders against defecting brokers. Most disputes are settled, lawyers say, but if not, they end up in arbitration.

“Some firms really play hardball,” Mr. Blumenfeld said.

“I just lost a case where the arbitrators [upheld a contract like Merrill’s] and prohibited my [broker] client” from contacting social ac-quaintances who were not customers of the firm, said an industry attorney who asked not to be identified.

RESTRICTIONS APPLY

California law still allows non-compete agreements that prohibit the taking of trade secrets and confidential information, said Patrick Burns of the Law Offices of Patrick J. Burns Jr. PC in Beverly Hills, Calif.

“The focus [by the securities industry] will now be on [how to] call things like client information trade secrets,” Mr. Burns said.

Indeed, shortly after the California decision was published, several law firms issued bulletins suggesting that employers scrutinize their employment agreements to make sure that restrictions on solicitations were limited to the use of trade secrets and confidential information.

Firms may argue that a former broker is using trade secrets, Mr. Burns said, “but I think courts will … ask if a relationship with clients is really a trade secret.”

The California Supreme Court did not specifically address the trade secrets issue, Mr. Burns said, but the decision “seemed to give endorsement” to the argument that employees have the right to use some client information.

The decision “opens the door” to challenges against restrictions on solicitation and use of customer information, Mr. Blumenfeld said.

Separately, in February the Ohio Supreme Court ruled that a customer list — even if memorized — qualifies as a trade secret under the Uniform Trade Secrets Act, a model law adopted by most states.

The Ohio ruling could hurt brokers in that state who change firms, even when they take no customer records.

At the same time, proposed revisions to the Securities and Ex-change Commission’s privacy rules would allow brokers and advisers to take basic customer contact information, but only with the permission of their former employer.

Similarly, a voluntary recruitment protocol agreed to by many brokerage firms allows departing brokers to take limited customer contact information.

E-mail Dan Jamieson at [email protected].