Shock on Wall Street: Non-compete agreements banned

The United States Federal Trade Commission’s (FTC) action to ban noncompete agreements has left Wall Street businesses rushing to restructure contracts and find new ways to tie down the high-priced personnel that their business models rely on.

The contracts, which constrain a worker’s ability to work for a competitor for a certain period of time after leaving their current employer, have long been a hallmark at big banks, brokers, asset managers and hedge funds.

But led by chair Lina Khan, FTC commissioners voted by three to two to invalidate existing contracts for most employees and for all new contracts starting in August.

The move undermines some of the fixtures of Wall Street life, including the ability to impose paid “gardening leave” and to withhold deferred bonuses when an employee leaves for a competitor. Headhunters predict it will free talented traders, investors and bankers to leave jobs where they are unhappy and give a boost to well-run groups that can offer more money and a more congenial environment.

“Businesses are going to get built and destroyed because of this rule,” predicted Laura Pollock, founder of Third Street Partners, a boutique executive talent firm. “This is the beginning of real change.”

Industry groups counter that it will make US financial companies less competitive, drive up compliance costs and lead to a flood of lawsuits between employers and departing workers. They contend that highly paid professionals are well-positioned to negotiate fair remuneration for giving up some of their freedom.

“This will harm investors, including pensions, foundations, and endowments. It is disappointing that the FTC took an indiscriminate approach to rule-making that jeopardises the success of America’s capital markets,” Jennifer Han, chief counsel of the Managed Funds Association, said.

The US Chamber of Commerce has already filed a lawsuit alleging that the FTC overstepped its authority.

Further legal challenges are expected. “The firms and their lobbyists will fight this,” said one corporate lawyer.

But lawyers and financial businesses say they cannot afford to wait for the outcome of that lawsuit. They are combing through the rule’s more than 500 pages and seeking workarounds that will allow Wall Street to continue to protect its intellectual property and trade secrets.

One of the biggest problems for Wall Street would be if companies are unable to use gardening leave to protect proprietary information. The FTC rule against non-compete clauses appears to outlaw the most common structure, although lawyers think it may be possible to rewrite contracts to allow for extended notice periods that could be used to sideline a departing employee.

Either way, lawyers and industry professionals predict that the changes could lead to more theft-of -trade-secret lawsuits such as the one that trading house Jane Street recently filed against two former employees who jumped to rival Millennium. They deny the allegations.

“The purpose of the non-compete is to allow the information to grow somewhat stale,” Peter Orszag, chief executive of investment bank Lazard, said. “If you have fresh information, even if your intent is not to reveal anything, sometimes by not answering a question, you’re revealing something, sometimes by body language. It is a really tough place to put people into without that kind of cooling-off period.”

While the FTC rule includes an exception for “senior executives”, that carve-out is only retroactive. The regulator defines this slice of the workforce as those making more than US$151,164 ($254,000) a year who are also in “policymaking positions”. New noncompete agreements, for any level of employee, are prohibited.

The ban may also have sweeping ramifications for employee bonuses. Industry groups believe the rule will stop businesses from cancelling deferred bonuses if an employee leaves while the money is being paid out.

As a result, new employers would face less pressure to buy old contracts, making it easier for smaller groups to compete for staff. Pollock predicted that the FTC ban will have an impact on work cultures even if it is held up or struck down by the courts.