Navigating RIA Non-Compete And Non-Solicit Employment Agreements As A Financial Advisor

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#OfficeHours with @MichaelKitces Video Transcript

Welcome, everyone! Welcome to Office Hours with Michael Kitces.

In some of our recent Office Hours segments, we've been talking about what it takes to find a good financial advisory firm to work with and how to interview for the right fit. But today I actually want to talk about what happens at the other side. What happens if you decide to leave your advisory firm?

Because the unfortunate reality is that our industry actually makes it really hard to switch firms. And most new financial advisers don't realize this, especially when they get started. They're just so happy to get a job that they don't think about what they're agreeing to in that employment contract if it doesn't work out. Or at worst, they're thinking, "Well, if it doesn't work out because I don't get any clients, then I'll just be finding another job in another industry, so it doesn't matter."

Except the caveat is that sometimes it does work out, just not with your current firm. And when you want to stay in the industry as a financial adviser but not stay at your current firm, you have to figure out what happens to the clients that you have a relationship with when you leave the firm and are you allowed to take your clients with you?

This theme is the inspiration for today's Office Hours. I was reminded of the issue with a recent question that was submitted through the blog that I find, unfortunately, to be a pretty common situation. This comes from someone we'll call Alan, who said:

I recently decided to leave the RIA I was working at after it became clear that the succession plan that was being promised was never going to happen which I realized after listening to your Financial Advisers Success podcast with David Grau from a few months ago. I've always had a very clear book of clients that I service within the firm, but the firm did make me sign a non-compete in an employment agreement when I joined where I agreed not to provide financial advisory services to the clients of the firm for one year if I left, although I did have a specific list of clients that I was allowed to contact a week after my departure. But once I left the firm, within two days, they were contacting all of my clients with a letter alerting them that they were being reassigned to another adviser of the firm, being assured that the firm would still be able to serve them. At that point, one of my former clients alerted me of the letter so I contacted a few of them to explain the situation and what was actually happening. I wasn't leaving the industry, I was just leaving the firm. And then, in turn, the firm hit me with a cease and desist letter and five days later I was served a lawsuit for violating the non-compete. What was I supposed to do?

Ouch. My sympathies to you, Alan, on the difficult situation, and one that I find is increasingly common in the RIA community. And unfortunately, I'm sorry to say the short answer is that it sounds like you really were in violation of your employment agreement with the firm.

There was a one week blackout period and you contacted the clients during the blackout period. Now, I understand your frustration that the firm is soliciting your clients to stay once you're gone and you can't even respond to it because of the non-compete, but the truth is that's why the firm likely put a one week wait for you to contact the clients. Because they know that gives them a one-week head start to contact all of your clients and convince them to stay before you have a chance to contact them and convince them to go.

And so, as unfortunate as that is from your end, if your employment contract said that you weren't supposed to contact them for a week, then you really needed to wait that week. The time to have negotiated this was before you left or when you originally joined. But as I said earlier, these kinds of situations are increasingly common because more and more RIAs are using employment agreements with these kinds of restrictions to protect themselves if an adviser leaves the firm at some point.

Advisory Employment Agreements: Non-Compete, Non-Solicit, and Non-Accept [3:49]

It is important to recognize that there are actually some differences in the types of RIA employment agreement restrictions. They're not all the same. There are basically three core types that get used in most RIA employment agreements.

Non-Compete Agreements – Not Always Enforceable [4:04]

The first type of restrictive covenant in an employment agreement is called a non-compete. A non-compete provision in the full variety states that if you leave the advisory firm, you cannot continue to be a financial adviser for another firm or your own firm if it competes with your prior firm. As in, you literally can't compete and be a financial adviser anymore with a comprehensive non-compete.

In practice, those kinds of comprehensive non-competes are typically very difficult to enforce and, in many states, they're outright unenforceable, because no judge is going to tell a trained, experienced professional, "You're not allowed to have any job for which you were trained and educated." Judges don't want to take away someone's entire livelihood. Now, that being said, some states will allow narrower non-competes.

It might simply state that you can still be a financial adviser, but not for a competing firm within 20 miles of your current firm. Or you can still be a financial adviser but not compete with them head to head in the local market. Or the non-compete might say you can still be a financial adviser but not in that firm's particular niche. Or it might say you can be a financial adviser but you can't compete with the firm for any existing clients that are already with the firm. You just have to go out there and do something completely new and different.

In general, the narrower the non-compete, the more likely it is to be enforceable. And the broader and more generalized it is, the harder it is for the firm to actually enforce. But that hasn't stopped a lot of firms from putting broad non-competes into their employment agreements because they recognize, unfortunately, that not everyone realizes the non-compete might not be enforceable in their state and a lot of advisers don't have the financial wherewithal to fight the non-compete and prove their case, so the firm kind of gets away with it.

Non-Solicit Agreements – Easier To Enforce [5:40]

Because of the challenges though in enforcing non-competes, many RIAs that want to actually protect their clients require advisers to sign a non-solicit instead. A non-solicit agreement says that you will not solicit any of the clients of the firm. In other words, you can't contact any of the clients of your now former firm to ask them to do business with you after you leave. Because, even if they were your clients, in truth they're not your clients. They're the firm's clients. They signed an advisory agreement with the RIA entity, not you personally. You are an investment adviser representative, an IAR of their RIA, which means you're the rep for the firm because the client is the client of the firm, even if you were assigned as the client's primary adviser and point of contact as the relationship manager.

From the employment agreement perspective though, the key difference between a non-solicit and a non-compete is that with the non-solicit, you can continue being an adviser. You can continue being in the same industry, in the same niche, in the same geographic region, and in the same market. The firm is not limiting your ability to be a financial adviser, they're simply limiting your ability to contact their clients when you're no longer an adviser at the firm. And because a non-solicit is narrower in scope and doesn't generally disrupt someone's ability to earn a livelihood as a financial adviser, they're much more likely to be enforced if challenged.

In other words, with a non-compete, you might fight it and get it struck down. But be much more careful about violating a non-solicit. Notably, a non-solicit doesn't actually mean you can't work with your former clients. It just means you can't solicit them. So you can't reach out to them after you leave and ask them to keep working with you. You can't contact them to tell them you're starting a new firm or suggest they might work with you. That's a solicitation because the whole point is you can't solicit them.

However, if you start a new firm and you make a website and they Google your name and they find you, it's generally still permissible for them to make a decision to switch and work with you under a non-solicit. But the key is they have to find you. You can't reach out and solicit them which means you have to wait and be passive, which will be frustrating, because, as in Alan's case earlier here, the firm you left will almost certainly be proactive in contacting all those clients to retain them.

And you can't intervene because intervening would breach your non-solicit agreement. You have to wait and hope that they find their way to you or as actually happened in one relatively infamous case, the advisor actually bought a billboard ad on a major highway in the city to announce his new firm after he left his old firm because he knew most of the clients would drive on that highway. So, technically, he didn't solicit those clients. He just did a broad-based billboard ad to announce his new business to the entire public in an open forum that happened to also notify his former clients along with tens of thousands of others, which means he a lot of the former clients he wanted to reach got the message.

Again though, the key to the non-solicit is that you can still be a financial adviser and you can go get new clients. You can start fresh and if your old clients find their way to you, you can work with them, but you cannot contact them and solicit them to come with you. You can't ask them before you leave, because that's actually an outright breach of your employment contract with your current firm that will almost certainly get you fired. And you can't solicit them after you leave, because that would breach the non-solicit.

Non-Accept Agreements – An Extended Non-Solicit? [8:47]

The third kind of agreement that exists in some RIA employment agreements is what's called a non-accept. A non-accept is basically an extended version of a non-solicit. The non-solicit says here's a list of clients you can't solicit, contact and reach out to. A non-accept says, "Here are a list of clients you're not allowed to accept even if they contact you unsolicited." In other words, even if you respect the non-solicit and don't reach out to them, if they find their way to you, you're still not allowed to work with them under a non-accept. Literally, you can't accept them as clients. In practice, I find non-accept agreements are less common in the RIA business, kind of similar to broad reaching

In practice, I find non-accept agreements are less common in the RIA business. Similar to broad reaching non-compete agreement, it's not clear how enforceable they really are in court if challenged. You know, it's one thing when an employment agreement says you won't compete with a firm and you won't solicit the firm's existing clients, but it's a whole other thing to tell clients, "Hey, even though you want to leave and work with this new firm and not the old firm, the new firm isn't allowed to work with you because they used to be part of the old firm." Judges don't necessarily like to tell consumers what businesses they are and aren't allowed to do business with.

So the non-accept portion of a non-solicitation agreement may not always be enforceable, but still – and I can't emphasize this enough – this varies state by state. And some RIAs include a non-accept provision in their non-solicitation agreements simply on the hopes that the advisor either won't realize it might not be valid or won't have the capacity to fight it. Though again, depending on the state, it might actually be enforceable in that state and you have to honor it. But at a minimum, if you have a non-solicit, you need to read very carefully to clarify whether it's just a non-solicit where you can't contact the clients but they can follow you, or if you have a non-solicit with a non-accept that says you can't even take the clients that follow and seek you out on their own after you leave.

Are Employment Agreements With Non-Compete And Non-Solicit Provisions Really Fair? [10:27]

Now, from the financial adviser's perspective, this rise of RIA employment agreements with non-competes and non-solicits provisions are a huge challenge, because it means that when you get started and build your career and a client base in a firm and you decide to leave, you're going to have to start over and leave your clients behind. Particularly if it's a non-solicit agreement because those most commonly are enforceable in most states and, almost by definition, it means if you leave you cannot solicit the clients to come with you. And while it is possible that some will follow you if you have a good relationship with them and it's only a non-solicit and not a non-accept as well, be prepared for the fact that the firm is going to put a hard-core press on those clients to stay with the firm when you leave.

And because most clients have inertia, once they're with the firm, it's a lot easier to stay there than to make changes and they don't have to re-paper and redo their accounts and all the rest, if the firm tries to retain them. So a lot of them are going to stay, especially if you are working with part of a team where you may have left but the rest of the team is still at the former firm and it's just easier for most clients to stick with the current firm, the current team, and maybe just get a new adviser at the firm on the team to replace your role.

Which means, for better or worse, be cognizant that if you start out at an RIA, get some clients and decide to change firms in the future, you may have to start over and leave your clients behind. In some cases at least, the reality is that the firm got the clients in the first place and gave the clients the adviser to work with, or at least the firm got the lead and handed it to the adviser to close and work with, which means it is arguably the firm should get to keep the client because they got the client. The adviser was servicing the clients which is a valuable role for which you were paid, but the fact that you serviced a client for the firm doesn't mean you should get to keep the client if you leave the firm.

Now, another situation I'll grant's a little murkier but maybe the adviser really did do the work to get the client, but the adviser didn't do it alone or the firm was your platform. You got it under the umbrella of the firm, so maybe it was 60% you and 40% firm or 40% you and 60% firm. There's really no way to tell and there's no way to allocate like 40% of a client human being to one person, 60% to the other. Someone gets the client as the human being and if the adviser agreement is with the firm and you're an adviser with the firm, then it's the firm's client and they have a right to keep the client and if you don't like that, go make your own firm. Start from scratch, take the risks that go with it because that's what the firm went through to build to the point that they could have a platform and employ you as an advisor.

That's part of the risk and trade-off which while it might feel frustrating to some advisor that you have an employment agreement with a non-compete or a non-solicit. But from the firm's perspective, they take a lot of risk and they're bearing the costs of taking that risk for you. So, even if you get the client, you did it with their brand, their resources, their support, and their operations. In some cases, it's even their leads in the first place.

But, at a minimum, it means as a financial adviser working with an advisory firm, you need to know what your employment agreement actually says. Is there a non-compete? Is there a non-solicit? Does the non-solicit have a non-accept requirement? If you care about trying to take clients with you, will it be legal to do so? If you have to, you should hire an employment lawyer to review the agreement. Pay an hour for an expert's time to be able to clarify what your agreement really says, whether it's actually binding, whether it's enforceable, and what your rights are as an adviser employee. Because employment law varies by state by state, and that means you really need an attorney in your state that knows employment law and non-competes and non-solicits in your state, because – and I can't emphasize enough – the rules vary from one state to the next.

Of course, not all RIAs have these types of restrictive employment agreements. Some don't use them at all. Others explicitly state you're allowed to keep your clients you develop. Just don't take the rest from your firm. Others say you can't take your clients, but you can buy them out for a reasonable price.

Now, if you're at a broker-dealer or an insurance company, you also need to contend with broker protocol about what information you're allowed to take with you or not in the first place. And you need to check whether leaving will require you to repay a salary draw or other compensation you received. That's pretty rare at RIAs, but very common at a lot of insurance companies and broker/dealers. We may do a whole separate hour at some point issues to be aware of when you're leaving a broker/dealer, as in many cases, it actually gets even messier than with RIAs.

But the bottom line, as long as there's money on the line – clients with assets, and revenue that's being paid to the firm – expect that leaving your firm is going to be a high-stakes issue. Even if you think you have a good relationship with the firm and its owners, when they see money leaving and revenue walking out the door, even a good relationship can quickly turn sour. It's a really sad thing but I've seen it happen over and over again where advisers say I've got a good relationship with the firm, I've been there for years. We've got a good dynamic. We'll all be respectful if I leave and then they leave and it turns ugly.

You can pray that it won't turn ugly, but if you're leaving your firm and you're planning on taking clients, read your employment agreement carefully. Get an attorney to understand what is really enforceable, how much in your state, and treat it like it will be a contentious issue. And then pray it doesn't turn out to be messy because as Alan's earlier story illustrates, it's better to be prepared in advance than to leave, figure it out as you go, find out it's not going well, try to intervene to save your clients, and then find out you're getting slapped with a cease and desist and a lawsuit for violating your non-solicit agreement.

I hope that's helpful food for thought and heads up about some of the issues you need to be aware of if you're thinking about leaving your current advisory firm while subject to some kind of employment agreement with a non-compete or a non-solicit. This is Office Hours with Michael Kitces. Normally, 1:00 p.m. on the East Coast. As you can see, I've been traveling for speaking engagements this week, so here we are at the airport, but thanks for joining us everyone, and have a great day!

So what do you think? Have you ever left a firm with a non-compete or non-solicit? Are these types of employment agreements becoming more popular in the advisory industry? Do you think these types of agreements are "fair" for new advisors? Please share your thoughts in the comments below!