What will the end of noncompete agreements mean for advisors?

The days of noncompete agreements might be numbered, and that bodes well for advisors seeking to jump from broker-dealers to RIAs.

Not only will a rule passed in April by the Federal Trade Commission do away with noncompetes broadly when it takes effect in September, but New York City is considering a bill that would go even further. The regulatory has since been sued over its new rule.

“Any time there’s a loosening of that type of rule, it’s really good for the independent firms,” said Jodie Papike, partner at advisor placement firm Cross-Search. Restrictive employment agreements often keep advisors from leaving broker-dealers, regional firms, or even bigger RIAs that use noncompetes, Papike said.

“There are so many advisors who would like to break away from a wirehouse or a restrictive-type firm, but they’re scared,” she said. “There’ve been a lot of firms going after advisors that leave… Whenever that happens, advisors, rightfully so, get a little nervous.”

Often, advisors are uncertain about if and how they can bring clients with them, she noted. Even as non-solicitation agreements are becoming more difficult to enforce, advisors can’t be sure how their firms will act if they leave and end up with some of the clients, she said.

The FTC’s rule, which was finalized in April, will nullify nearly all noncompete agreements. About one in five people are affected by those, according to the regulator. An exception to the new rule is for senior executives who earn more than about $150,000 and have policy-making status at companies – those agreements will remain effective, but companies will not be able to include those in new contracts. Only about 0.75 percent of employees fall into that category, the FTC said.

A bill passed in New York State would not have had such an exception, though that legislation was vetoed last year by Democrat Gov. Kathy Hochul. Since then, Hochul has indicated support for a similar measure that would have a carve out for executives.

Even so, the New York City Council is considering a bill that would retroactively ban all non-compete agreements, though it would charge employers that violate it with only a $500 fine. But it would make such agreements unenforceable in the city.

That bill, which has been referred to committee, stands good odds of passage, in part given that New York City’s laws tend to be broader than the state’s, said Mark Saloman, partner at law firm Ford Harrison and co-chair of its noncompete, trade secrets and business litigation group.

“It wouldn’t shock me if this bill gets passed in something close to its current form,” Saloman said. “As the economic capital of the world, and of the financial services industry for sure, the New York City ban would have an effect on a lot of companies.”

And of course, the financial services sector is notorious for its use of noncompetes, he said.

“If you’re a financial advisor who’s interested in staying in the industry and switching jobs, it’s good news,” he said.

Wealth managers often use noncompetes and non-solicitation agreements, and some advisors who have left firms have pushed back on the enforcement of those. Hightower, for example, is facing two lawsuits from advisors, though it has filed a countersuit against at least one of them.

One case alleges the firm used overly restrictive noncompete clauses and attempted to poach clients from an advisor with 30 years in the industry, including through a “disinformation campaign,” according to the lawyer representing the advisor in the case. The agreement in question would keep the advisor from reestablishing his business until 2030, according to the lawsuit.

Not a new idea

Several states already have different levels of restrictions on noncompete agreements, including California, Washington and Massachusetts. The latter of which does not have an outright ban and instead focuses on garden leave – a temporary absence from the industry after job separation that has to be paid, Saloman noted.

There, “companies are putting their money where their mouth is,” and have to pay something, even if not a full salary for departing workers, he said. But in some cases, companies decide that the exiting worker may not be worth the payout and instead let them pursue industry jobs immediately, he said.

That type of garden-level provision “certainly enhances enforceability” in states that don’t require it,” he said. “You’re taking out the undue hardship arguments that can be made against enforcement, and that makes the application to enforce that much easier for a reviewing court to agree with you.”

Chuck Failla, the founder and CEO of Sovereign Financial Group, is on a self-reported crusade for the move from broker-dealers to independent RIAs. The demise of noncompetes will be a positive for the industry, he said.

“It’s generally a good idea to have more competition,” he said. “Whenever you restrict competition, it’s bad. I don’t think it’s going to be like flipping a light switch. [The change] is going to be incredibly disruptive.”

Even if “most people are dying to leave the broker-dealer space to go RIA… I don’t know if it’s going to be that dramatic” at first, he said. Partially that’s because of the signing bonuses people can get wirehouses, which place time limits on when those may have to be returned depending on when an advisor exits.

But he said he’s also not sure how enforceable noncompetes truly are. While nonsolicitation agreements can also prevent people from leaving firms for fear of not taking any clients with them, there is a better potential system, he said. His firm, however, has no noncompete agreements.

He cites a proposal made by Micheal Kitces last year that could make splits more equitable for advisors and their firms, which he compares to a marital prenup. That idea, called Advisor/Client Relationship Equitable Split, or ACRES, outlines what happens at separation. For example, if an advisor joins a firm and has clients they’re bringing along, they might be able to retain those clients afterword, without question. But for clients that they get through the firm, the departing advisor might have to pay to keep them, based in part of the revenue the firm was getting from those clients.

“If the firm is doing a lot of work to help that advisor get a client, the firms has a lot right to the revenue from that client,” Failla said. “It turns it into an agreement rather than a binding noncompete… I thought that was the most elegant, cleanest, fairest way to handle this. And I think you’re going to see more of it.”

That is necessary as some of the larger RIAs are beginning to function more like broker-dealers, with the lines between them getting blurry, he said.

But even nonsolicitation agreements have “always been very gray, and I would say that people should have a good securities attroenty look at their agreements,” Papike said.

Some restrictive noncompetes have meant that people can’t work within the securities industry for a period of time or even have interactions with former clients.

“Those have been more difficult to enforce, but it causes advisors to pause, if they want to make a move.”

In states like California, those are much more difficult to enforce, she said. Regardless, departing advisors should talk to a lawyer about what they need to document to protect themselvess from potential litigation, such as evidence that clients reached to them independently, she said.

“Ultimately, I can say that if an advisor wants to move firms, they’re going to,” Failla said. “And if they have a good relationship with their clients, the clients will come.”