What non-compete and non-solicit lawsuits mean for RIAs

As the war for talent and clients' wallet share gets more heated, it's hardly surprising to see messy breakups play out between advisors and their former firms – even in the pro-independent RIA space.

Just last week, an ex-Hightower advisor in Washington claimed a substantial victory as an arbitration panel refused to support his former firm's attempt to enforce a non-compete clause against him. Earlier in February, a California-based advisor scored his own win against the firm, as a Delaware court dismissed Hightower's claims that his move to launch a new firm in 2024 breached a non-compete agreement he signed.  

Last month, Illinois-headquartered Choreo Advisors sued four of its former employees in Iowa, claiming breach of contract by virtue of how they coordinated their resignations, took client information to their new firm, Compound Planning, and went on to solicit clients at Choreo after their departure. Choreo also named the rival RIA in the lawsuit, claiming it knowingly encouraged the advisors to break their contractual obligations and misappropriate trade secrets.

That case took an early turn on April 1, with Chief Judge Stephanie M. Rose issuing a preliminary injunction prohibiting the advisors from using Choreo's confidential information, servicing Choreo clients they worked with, and contacting those clients and other employees at the fim, among other things. It also enjoins Compound Planning from permitting its new employees in Iowa to violate prior contracts.

"We are pleased the court has granted a preliminary injunction in this case and grateful for its thoughtful analysis of the issues presented. Further, we regret that the defendants’ actions left Choreo with no choice but to seek court intervention and have sympathy for the hundreds of investors impacted by those same actions,” a spokesperson from Choreo said in an emailed statement to InvestmentNews.

Taylor Matthews, co-founder and CEO at Farther, sees non-competes and non-solicits as an attempt to address a fundamental misalignment between a firm's leadership and the interests of a departing advisor.

"If you put yourselves in the shoes of the management of those firms, they're up against their own revenue goals and their own asset goals," Matthews told InvestmentNews in a recent interview. "Anytime an advisor leaves, it's a challenge to those goals."

A bitter Catch-22

Firms who attempt to solve for misalignments with restrictive covenants, Matthews says, put advisors in a terrible position, leaving them potentially unable to ply a trade they've engaged in their entire lives. The upshot for advisors, he argues, is that they have to be more diligent about scrutinizing the contracts they're signing, and thinking hard about the values of the firms they're signing up with.

Proponents of non-competes and non-solicits argue those terms are necessary, as they help safeguard firms' intellectual property and trade secrets. They also help protect against disgruntled advisors who might seek to undermine their former employers' business and undermining client relationships built up over years or decades.

For the advisors who might want to leave their current firm, whether it's due to challenges in servicing clients or simply better technology and economics elsewhere, those contractual restrictions can create a bitter Catch-22: they want to move to a better place for their clients, their families, and their businesses, but switching means potentially leaving behind the very reason they're making the move.

"It's not surprising that we see more and more acrimony in these relationships, especially as private equity has really stepped into the arena and governs more and more of the decisions that these leadership teams face," Matthews says.

In some cases, advisors leave thinking that they've followed their contracts to the letter, only to later get sued by their former firm. The fallout from that type of litigation can be very harmful, Matthews argues, especially for elite advisors.

"One thing that elite advisors do better than others is build deep relationships with their clients," he says. "When you haven't been selling the brand name that happens to be plastered on the wall, and you've been selling yourself, and you choose to go somewhere else, clients are going to want to continue to get that experience."

A fragmented legal landscape

In April last year, the Federal Trade Commission under former President Joe Biden announced a rule against non-compete clauses, drawing swift backlash and opposition from across the country. But before the rule's ultimate effectivity date in September, a district court judge in Texas issued an injunction setting the rule aside nationwide, noting that the FTC "promulgated the non-compete rule in excess of its statutory authority."

While the fate of the federal rule is still uncertain as it stands, it's worth noting that the currently appointed chairman at the FTC, Andrew Ferguson, was one of two commissioners to vote against the non-compete rule when it was still up for consideration.

At the state level, Matthews says laws and regulations remain deeply fragmented, with some jurisdictions including California taking leading positions in favoring employees' freedom from restrictive non-competes.

"As members of RIA firms, we have a fiduciary duty to act in a way that's best for our clients," he says. "Firms that put these restrictions in place are violating that fiduciary imperative, and that, I think, is something that we as an entire industry need to think a little bit harder about."

As a matter of policy, Farther does not impose non-solicits, non-competes, or non-accepts on those joining its advisor community. That makes for a more advisor-centric structure, Matthews argues, as it incentivizes the firm to earn advisors' business year in and year out.

"The way we think about things is if we're building the right environment for financial advisors and their clients, we're investing in the types of services they want, the experiences they want to provide, then we're probably going to end up attracting quite a number of advisors to our team," Matthews says. "And I think other forward-thinking advisors are going to think about it the same way."