Keeping Them On Your Side

Generally, there are two types of agreements that an investment advisory firm can require its employees to execute:

Non-competition. In this type of agreement, a firm generally seeks to prohibit the employee from accepting employment in the investment advisory/financial services industry for a certain period of time. A non-competition covenant can be modified to limit the restriction by geography, such as a ban on accepting employment for a period of two years in particular states or within a 100-mile radius of the firm's offices.

Non-solicitation. In this agreement, a firm does not seek to prohibit the employee from accepting employment in the same or similar industry. Rather, it generally seeks to prohibit the employee for a certain period of time either from soliciting or providing services to firm clients, no matter where they may be. The non-solicitation covenant can be modified to limit or expand the client prohibition to past and current clients as well as prospective clients reasonably identified by the firm prior to the employee's departure.

Both types of restrictive covenants are intended to protect a company's legitimate business interests and, most important, its client relationships. The primary difference is whether the employee will be prohibited from seeking or accepting employment in the same industry, or will be permitted to become employed in the same industry, but not with the benefit of the firm's clients or employees.

I favor the latter type of agreement: the non-solicitation covenant. Certain states generally look unfavorably upon or prohibit non-competition covenants based upon the principle that it is contrary to public policy to bar an individual from making a living in his or her chosen profession. Thus, if the enforceability or reasonableness of the non-competition covenant could potentially be challenged, the firm is better off seeking a reasonable non-solicitation covenant that is generally more enforceable.

In addition to the type of restrictive covenant, a properly drafted agreement should also include a confidentiality provision in which the employee is bound to keep confidential all firm information, such as client data or proprietary investment processes or technology, and not to use any of this for any purpose other than for the benefit of the firm. In addition, the confidentiality covenant should also require any employee who maintains or has access to any of the firm's confidential information outside of the firm's offices to return all such information to the firm upon departure.

Finally, the agreement should provide the firm with adequate legal recourse against the employee if he or she violates the non-solicitation covenant or confidentiality provisions. This includes the ability to immediately request that a court issue a restraining order to enjoin the former employee from violating the agreement or to recover monetary damages.

The best time to have an employee execute the agreement is immediately prior to beginning employment or, at least, when the employee starts on the job. If a prospective employee declines to execute the agreement, don't hire him.

A properly prepared agreement with reasonably drafted non-solicitation and confidentiality covenants only asks the new employee, at the inception of the employment relationship, to agree not to steal from the firm by recognizing its legitimate proprietary interest in protecting client relationships and business operations. But what about a new employee who brings clients along with him to the new job? It is not unusual to exclude those pre-existing client accounts, in a schedule to the agreement, from the non-solicitation covenant. However, unless there are unusual circumstances, the agreement should also make clear that any new clients that the new employee subsequently brings into the firm are the firm's clients and are subject to the non-solicitation covenant.

Is it too late if you did not have the employee execute the agreement upon joining the firm? No–but you should not present the agreement to an existing employee without first ascertaining whether the state in which the employee is located is a "consideration" state. If this is the case, you may have an agreement that is unenforceable.

In these states, the employer must provide adequate consideration to the existing employee for the employee's non-solicitation covenant to be enforceable. The employee's continued employment is not considered adequate consideration in these states. Depending upon the state, adequate consideration could be a raise, bonus, or promotion. I generally prefer a one-time execution bonus so that the employee cannot later attempt to use an "insufficient consideration" defense to enforcement of the agreement, claiming that she was due a raise and promotion in the ordinary course of her employment. Even in "continued employment" states, I recommend that the firm consider providing the existing employee with some type of consideration.

Many principals of investment advisory firms think about the day that they may sell their largest asset–their firm. But as Jack discovered, the firm's most important asset–its client relationships–must be protected. You don't have to suffer the same fate as Jack. If you do not have an agreement in place for your employees, get one. If you do, but are concerned about its enforceability, have it reviewed. If you accomplish this relatively simple task, you will be in a much better position to ensure that your Mark, Donna, or Bill will not leave the firm with your most important asset and place in jeopardy the value of your firm.

Thomas Giachetti is the chairman of the Securities Practice Group of Stark & Stark (www.stark-stark.com), a law firm in Princeton, New Jersey, New York, and Philadelphia, representing investment advisory firms in the U.S. and Canada. He is reachable at [email protected].