Federal proposal to ban noncompete clauses could affect RIA M&A

A federal ban on contract clauses that bind workers to employers could affect how acquisitions of investment advisory firms are structured and influence financial advisor moves between firms.

Last Thursday, the Federal Trade Commission released a rule proposal that would prohibit employers from using noncompete agreements that prohibit employees from joining rival companies. The agency said noncompetes are an “often exploitative practice” that suppresses wages and hinders innovation.

The proposal follows a Biden administration executive order in July 2021 that outlined 72 initiatives across dozens of federal agencies designed to promote economic competition.

An overview of the proposal says that one in five U.S. workers — or about 30 million people — are bound by noncompetes. The administration asserts that prevents them from seeking better job opportunities.

The proposal could affect mergers and acquisitions involving registered investment advisory firms, experts said. Under the rule, a person who owns 25% or more of an acquired firm could be subject to a noncompete, but those who own less or none could be free to leave.

This could give pause to private equity firms and other entities that buy RIAs, which often seek to keep the firms’ advisors onboard. If advisors leave, part of what acquirers were purchasing walks out the door.

“It does reduce the attractiveness of an acquisition because the buyer sees some risk in advisors leaving,” said Louis Diamond, president of Diamond Consultants, an advisor recruiting firm. “There could be some adjustment in the ways an acquiring firm might structure a deal or write their employment contracts.”

If minority owners and other advisors leave, they take some value of the deal with them.

“It would certainly cause a significant repricing of deals that have a lot of owners under that 25% threshold,” said Brian Hamburger, chief counsel at Hamburger Law Firm. “That’s not a very reliable revenue stream for the acquirer to purchase.”

In the strict employment context, the proposal might not have a big impact on the advisory sector, Hamburger said. The bigger hang-up for advisor moves is non-solicitation agreements that prevent advisors from bringing their clients with them to new firms.

“Very few wealth management firms are using noncompete provisions as it stands,” he said.

The broker protocol, a pact among several financial firms that makes it easier for brokers and advisors to switch firms, has helped facilitate job-hopping while limiting lawsuits, even though Morgan Stanley and UBS have withdrawn from it.

But Jon Henschen, founder of the advisor recruiting firm Henschen & Associates, said the FTC proposal could catalyze more advisor transitions to new firms, especially if non-solicitation bans are lifted as well.

“I look at it as a positive,” said Henschen. “It’ll increase the traffic of advisors moving where they want to. Getting rid of noncompetes would be a great benefit for competition, advisors and their clients.”

The proposed noncompete ban could have a particularly strong impact on the financial sector, said Daren Domina, a partner at Haynes Boone.

“The securities industry will likely be among the most affected areas given how prevalent non-compete restrictions are, including among higher earning investment management and brokerage professionals and executive officers,” Domina wrote in an email. “In many instances, securities employers would have to drastically reevaluate their employment considerations and treatment.”

The proposal will be open for a 60-day public comment period after it's published in the Federal Register.

One area where the FTC may be asked for clarification is how expansive the proposal potentially could be. The agency’s view of what constitutes a noncompete is vague, said Michael Jones, a partner at Morgan Lewis.

For instance, in the advisory sector, would the clawing back of a promissory note when an advisor departs a firm be considered a form of restricting movement?

“It’s unclear whether agreements like that trigger what the FTC considers to be a noncompete,” Jones said. “We just don’t know what it’s going to consider a noncompete.”

Although the Biden administration views noncompetes as an impediment to workers’ ability to increase their pay and enhance their careers, employers rely on noncompetes to protect trade secrets and other proprietary information.

The pushback from industry could be significant, leading to a controversial rulemaking process.

“[The proposal] seems overly broad and may be beyond the FTC’s scope of authority,” Hamburger said.