Blog > What the FTC’s Non-compete Ban Means for the Investment Management Industry

What the FTC’s Non-compete Ban Means for the Investment Management Industry

New rule spurs competition, innovation, and worker mobility nationwide

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The Federal Trade Commission (FTC) issued a final rule on April 23, 2024, banning non-compete agreements for most workers nationwide. This rule is designed to promote competition, bolster worker freedom, and stimulate innovation and the creation of new businesses. The decision to ban non-competes is grounded in extensive research and robust public feedback. The FTC determined that they generally suppress wages by limiting worker mobility, hinder innovation by obstructing the free flow of talent and trade ideas, inhibit the formation of new businesses, increase market concentration, and ultimately lead to higher consumer prices due to reduced competition.

Hedge funds have historically relied on non-compete agreements to safeguard proprietary information and maintain competitive advantages, necessitating a reevaluation of how firms will protect their interests and retain talent in light of this regulatory change. Arootah Advisor Michelle McGurk covers how the new rule marks a significant shift in employment law and competitive practices across industries, with particularly profound implications for the investment management industry.

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Key Provisions of the Rule

The new rule renders existing non-compete agreements unenforceable, although exceptions are made for senior executives who exceed an income threshold of $151,164 and hold policy-making authority. However, no new non-compete agreements can be established with senior executives after the rule’s effective date.

Given the broad scope of the FTC’s new rule, it may impact various compensation arrangements, including garden leave, non-solicitation, and non-disclosure agreements. The FTC has noted whether these structures fall under the non-compete clause will depend on various facts and circumstances. Garden leave refers to the practice where an employee, upon resignation or termination, is required to stay away from work during their notice period while still receiving regular pay and benefits. The FTC has noted that a simple garden leave arrangement wouldn’t be viewed as a post-employment restriction, subject to the non-compete clause, if the employee remained employed and was receiving the same total annual compensation and benefits on a pro- rata basis.

The FTC expects this will positively impact new business formation and estimates it’ll result in over 8,500 new businesses being created each year. It’s also estimated to raise average worker earnings by $524/year and lower healthcare costs by up to $194 billion over the next decade. The rule is expected to drive innovation further, resulting in an average increase of 17,000 to 29,000 more patents each year for the next ten years.

The FTC encourages employers to use trade secret laws and nondisclosure agreements (NDAs) as an alternative way to protect proprietary and sensitive information. Firms can retain employees by increasing wages and improving working conditions rather than relying on non-compete agreements.

Employer Compliance with the New Rule

Employers must notify employees bound by existing non-compete agreements that these agreements will not be enforced. The FTC has also provided model language for this communication to help aid in compliance. The rule will become effective 120 days after its publication in the Federal Register, giving employers a grace period to comply with the new requirements. The FTC will oversee enforcement of the new rule, and market participants can report suspected violations to the Bureau of Competition via email.

Non-compete Agreements in the Investment Funds Industry

Non-compete agreements have been a staple in employment contracts across the investment management industry, serving several essential functions. First, they protect proprietary strategies by ensuring that firms’ unique trading strategies, financial models, and client relationships are not taken to competitors or used to start rival firms by former employees. Second, they help with employee retention by discouraging staff from leaving for potentially higher-paying jobs with rivals. Finally, by reducing turnover, non-compete helps a firm maintain a stable workforce, which is essential for consistent performance and building client trust.

Here are some transformative changes the FTC’s rule banning non-competes will bring to the asset management industry.

Increased Employee Mobility

The ban will significantly boost talent mobility within the industry. Analysts, portfolio managers, and other key employees can now move more easily between firms. This increased fluidity can lead to a more dynamic and innovative industry. However, firms can’t establish new non-compete agreements with senior executives after the rule’s effective date.

Heightened Competition for Talent

Firms must compete more intensely to attract and retain top talent. As firms strive to become more attractive employers, this could result in higher salaries and better working conditions, ultimately benefiting employees and fostering a more competitive labor market.

Innovation and New Ventures

The ban is likely to spur the formation of new hedge funds and investment firms by former employees who now have the freedom to start their ventures. This could lead to a more vibrant and diverse market, driving further innovation and growth.

Rethinking Proprietary Protection

Firms must explore alternative methods to protect their proprietary information. The FTC suggests that trade secret laws and nondisclosure agreements (NDAs) can serve this purpose. Firms may need to enhance their NDAs and bolster other internal security measures to safeguard sensitive information effectively.

Legal and Compliance Costs

Implementing the new requirements and ensuring compliance will incur additional costs. Firms are advised to review and revise their employment agreements and provide the necessary notifications to current and former employees. However, these costs invest in a more open and competitive industry environment.

6 Takeaways for Investment Managers

Given these significant changes, investment managers must proactively adapt to the new regulatory landscape. Here are six practical takeaways for investment managers to consider:

1. Review and Revise Employment Agreements

All employment agreements must be immediately reviewed and revised. Non-compete clauses must be removed, and NDAs and other protective measures must be strengthened to ensure proprietary information remains secure.

2. Enhance Talent Retention Strategies

Focus on creating a more attractive workplace by improving compensation packages, offering career development opportunities, and fostering a positive work culture. These measures will be crucial in retaining top talent without non-competes.

3. Strengthen Internal Security

Invest in robust internal security measures to protect proprietary information. This includes advanced cybersecurity protocols, rigorous employee training on data protection, and stricter access controls to sensitive information.

4. Leverage Legal Counsel

Engage legal counsel to navigate the complexities of the new rule. Legal experts can share guidance on compliance, help draft enforceable NDAs, and develop strategies to protect intellectual property without relying on non-competes.

5. Monitor Industry Practices

Stay informed about how competitors adapt to the new rule. Monitoring industry trends and practices can nurture valuable insights and help firms remain competitive.

6. Evaluate Business Opportunities

Consider the potential for new business ventures or partnerships. The increased mobility and potential for innovation within the industry may present opportunities for growth and diversification.

The Bottom Line

The FTC anticipates the ban on non-compete agreements will lead to a stronger and more inventive economy. By removing barriers to job mobility, workers can pursue new opportunities, and businesses can benefit from a more competitive labor market. This shift will propel economic growth, reduce healthcare costs, and spur technological advancements.

While the ban poses challenges to investment managers, it also allows the industry to evolve into an even more dynamic, innovative, and employee-friendly environment. Investment managers must proactively adapt to these changes by revising employment agreements, enhancing talent retention strategies, and strengthening internal security measures. By doing so, firms can effectively navigate the new regulatory landscape and capitalize on its opportunities.

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Disclaimer: This article is for general informational purposes only and does not constitute legal, investment, financial, accounting, or tax advice, or establish an attorney-client relationship. Arootah does not warrant or guarantee the accuracy, reliability, completeness, or suitability of its content for a particular purpose. Please do not act or refrain from acting based on anything you read in our newsletter, blog, or anywhere else on our website.

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