Wall Street Tightens Up On Non-Compete Contracts

When the partner of a large trading house decided to leave for a competing firm, he took a handful of his best friends on the trading desk with him. He said it's not enough to bolster your new firm with your old client list. You want to knock your old firm out of the box in the process.

With that attitude, it's no surprise Wall Street firms are increasingly demanding their employees sign longer non-compete and non-solicit contracts before starting a new job.

New employees are now being asked to sign non-compete clauses for anywhere from three months to a year, prohibiting them from working for rival firms for that period. They are also being asked to sign non-solicit clauses for six months to a year, which bans them from soliciting fellow employees to defect with them for that time period. It also prohibits them from asking clients to join them at their new firm. The non-compete clauses are often shorter than the non-solicit clauses.

The concept isn't new. But it was under-utilized. New employees were asked to sign non-compete clauses. They just weren't very long. In fact the time frames stipulated were usually a lot shorter than in other industries, sources say.

"Wall Street was never big on this," said Michael Segal, a partner with Paul, Weiss, Rifkind, Wharton & Garrison. "There was just a feeling on Wall Street that people should be able to move from firm to firm. That's pretty much gone."

And it's not just new employees. Senior people who have been working at a firm for some time are also being asked to sign. They're not forced to. But they know if they don't, they won't get the restricted stock shares they expect to get at bonus time.

"You can't make them too broad. The courts don't like enforcing that," Segal said.

Putting a lid on poaching

Prompting the trend, in part, is the fact that it's becoming more popular for firms to poach an entire team from a rival if they're trying to break into a particular business or expand an existing one. In the hot fixed-income investment management arena, for instance, Nuveen Investments recently hired a dozen taxable fixed income employees this year from Banc of America Capital Management. And HSBC Asset Management hired seven high-yield fixed income professionals from Credit Suisse Asset Management. If nonsolicit agreements had been signed, those teamwide moves might not have been possible.

Segal says even if a manager has not signed a nonsolicit agreement, he would still have a common law duty of loyalty to his current employer that would make it a bit "dicey" for him to solicit fellow employees while he is still working at a firm. But there's nothing to stop him from soliciting employees at his old firm once he's left. It comes down to the timing of the solicitation.

"As a legal matter, it's usually fine to leave and then recruit your former co-workers, which is why they're being asked to sign these agreements," Segal said. "It's interesting, from a lawyer's perspective, when a large group of people leave at the same time, because it isn't so clear that co-workers can discuss leaving together while they are still employed. So when you see these groups leave en masse, there are always difficult legal issues involved."

Kenneth Taber, an employment law attorney with Pillsbury Winthrop Shaw Pittman LLP, says at the firms with which he deals, human resources departments are becoming fairly rigid about demanding non-compete clauses, typically for a year's duration.

"They're no longer willing to be flexible on that," he said. "Non-compete clauses have been around for a long time, but they're reaching deeper and deeper into the organization."

And the way in which some firms are enforcing them is through what some call claw-back provisions. That is, part of an employee's compensation is given in options or restricted stock that is not yet vested. If the employee leaves to go to a competing firm, the options or stock not yet vested are taken back, Taber said.

Interestingly, firms don't just sue these days when poaching occurs. Morgan Stanley reportedly told some of its traders recently to reduce their business with Merrill Lynch because the firm was soliciting too many of Morgan's employees.