The U.S. Federal Trade Commission (FTC) has finalized rules prohibiting noncompete clauses, which restrict a worker’s ability to work at competing firms after leaving an employer, common in the financial services industry to guard trade secrets and retain talent.
The new rules will require firms to undergo an exhaustive review of employment contracts and practices regarding talent retention, as well as their human resources (HR) practices involving separation and severance agreements.
Led by FTC chair Lina Khan, commissioners voted 3-2 on April 23 to invalidate existing noncompete contracts for most employees and to ban all new contracts starting in August. In the announcement from the FTC, the agency said the new rule banning the “often exploitative practice” of noncompetes would protect the fundamental freedom of workers to change jobs, which in turn would increase innovation and foster new business formation.
“Noncompete clauses keep wages low, suppress new ideas, and rob the American economy of dynamism, including from the more than 8,500 new startups that would be created a year once noncompetes are banned,” said Khan. “The FTC’s final rule to ban noncompetes will ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.”
The final rule defines a “noncompete clause” as “a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from i) seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition; or ii) operating a business in the United States after the conclusion of the employment that includes the term or condition.”
Under the new rule, and according to the FTC’s Fact Sheet, existing noncompetes will no longer be enforceable. The rules primarily target lower-wage workers as they don’t cover senior executives who are employed in what the rule called “policy-making positions” and who earn more than $151,164 annually. Existing noncompetes for senior executives can remain in force, but employers are banned from entering into or attempting to enforce any new agreements, even if they involve senior executives.
The FTC acknowledged that “garden leave” provisions in which a worker is still technically employed and receiving the same total annual compensation and benefits or “severance” pay on a pro-rata basis are not considered noncompetes because they are not a post-employment restriction. Firms will be required to notify workers that they will not enforce noncompetes against them in the future, with the FTC including model language that employers can use to communicate this.
Although banks are arguably outside the FTC’s jurisdiction, employees at non-banks, such as asset managers, hedge funds, and private equity firms, would be covered. The final rule will become effective 120 days after publication in the Federal Register. After it becomes effective, the final rule would supersede any contrary state laws. The new rules were first proposed in January 2023 and were opened for public comment. The proposals received more than 26,000 comments.
One of the most notable letters opposing the rule change was a joint letter signed by the American Bankers Association, the Futures Industry Association, the Securities Industry & Financial Markets Association, and dozens of other industry trade associations and companies spanning far beyond financial services. The letter said noncompetes promote pro-competitive interests far more effectively than alternatives such as trade-secret laws or nondisclosure agreements (NDAs).
The group also argued the FTC lacks legal authority to issue the proposed rule. In fact, immediately following the FTC vote, the U.S. Chamber of Commerce announced its commitment to challenge the final rule, and the following day filed suit in federal court in Tyler, Texas, alleging that the FTC lacks the power to adopt the rules.
“Companies will face substantial legal costs as they are forced to resort to other tools to attempt to protect their investments,” the Chamber said. “And the economy as a whole will suffer as start-ups and small businesses are unable to prevent dominant firms from hiring their best employees and gaining access to their confidential information.”
Firms should not wait for the outcome of lawsuits challenging the new rules. The ban on noncompete clauses does not affect banks, savings and loan institutions, and credit unions, as they fall outside FTC jurisdiction, but federal banking agencies like the Federal Deposit Insurance Corporation (FDIC) are authorized by the Federal Deposit Insurance Act to enforce Section 5 of the FTC Act against banks.
The federal banking regulators have historically exercised this authority to apply the FTC Act’s prohibition of “unfair and deceptive acts or practices.” In the rulemaking, the FTC acknowledged that “whether [the federal banking regulators] apply the rule to entities under their own jurisdiction is a question for those agencies.”
The new rules will cause firms’ compliance, legal, and HR departments to review and rework employment and separation agreements with employees at virtually all levels across Wall Street. To protect trade secrets and intellectual property, firms must find workarounds that rely on customer non-solicitation agreements, employee non-solicitation agreements, trade secret laws, and NDAs to protect proprietary and other sensitive information.
Attorneys at the law firm Troutman Pepper wrote: “We believe it is unlikely that the federal banking regulators will attempt to apply the FTC’s noncompete ban on banks unless and until the lawsuits challenging the rule have been resolved in the FTC’s favor. Given the significant likelihood of a preliminary injunction while these challenges proceed, no quick action is likely required.
“On the other hand,” the Troutman attorneys continued, “the FTC expressly declined to exclude bank holding companies, subsidiaries, and other affiliates of excluded financial institutions from the rule if those entities otherwise fall within the FTC’s jurisdiction. Thus, while banks and credit unions are currently excluded, their parent companies and affiliates are subject to the noncompete ban and the FTC’s enforcement. This an important consideration for banking organizations with shared or dual-hatted employees.”
