California courts routinely refuse to enforce employment agreements that have non-compete provisions, and more frequently are rejecting certain non-solicitation provisions, based on California’s strong public policy favoring an employee’s right to work that is enumerated in California Business and Professions Code § 16600. However, courts have been cautious about expanding this right-to-work policy beyond explicit agreements that restrict an employee’s right to work after leaving the company.
In response, employers have expanded their use of broad “confidentiality agreements” to restrict their employees’ future employment opportunities without explicitly including a non-compete provision. These agreements implicitly function as noncompete agreements and prevent employees from seeking employment in their chosen field without fear of litigation. These broad confidentially agreements generally say an employee cannot use any of the company’s “confidential material” after they leave. The definition of “confidential” usually covers, in effect, anything the employee receives or learns during their employment. Many times, employers selectively enforce these provisions and only pursue enforcement after high-valued employees leave to work for a competitor.
Although a 2009 California Court of Appeal case recognized employers can only restrain an employee’s right to compete with them to the extent the former employee is infringing on the employer’s trade secrets, courts have shied away from broadly apply this rationale to other portions of employment agreements outside of explicit non-competes or non-solicitation provisions. The Retirement Group v. Galante, 176 Cal. App. 4th 1226, 1241 (2009).
A recent California Court of Appeal decision took up the issue of an overbroad confidentiality agreement in Brown v. TGS Management Company, LLC, 57 Cal. App. 5th 303 (Oct. 13, 2020). In this case, Richard Brown worked for TGS Management Company, LLC, for 10 years. TGS specialized in statistical arbitrage, which is a highly computerized form of equities trading. During his employment, Brown signed a confidentiality agreement that, in part, prohibited him from disclosing or using any of TGS’s “confidential information” for his own benefit or for the benefit of any party other than TGS, both during his employment with TGS and after he left the company. Brown also signed similar agreements tied to his annual TGS bonus compensation, which required him to repay or forfeit the bonus if he was found in the future to be in breach of any portion of the agreement, including the confidentiality provision.
TGS ultimately terminated Brown and the parties ended up in arbitration regarding whether the bonus agreement forfeiture provisions were enforceable. The arbitrator upheld the agreement and ordered Brown to repay over $650,000 in bonus money that he previously received and held Brown had forfeited his right to an additional $300,000 in deferred bonus compensation. The arbitrator also awarded TGS approximately $2.5 million in attorneys’ fees. Brown sought to have the arbitration award vacated, and he appealed after the award was confirmed by the trial court.
Brown sought to vacate the award on multiple grounds, including that the arbitrator exceeded his powers by enforcing an agreement that violated Brown’s right to be free from anticompetitive contracts. The Court of Appeal ultimately agreed with Brown, finding the arbitrator exceeded his powers by issuing an award that violated Brown’s unwaivable statutory rights granted to him by Business and Professions Code § 16600. The court held that the broad confidentiality provisions covered essentially all information that is used in, or relates to, the security industry, and the only exceptions were publicly known information or information known to Brown before he started working at TGS. Basically, Brown would be prohibited from using any information he learned while working at TGS in the future, unless that information had become public knowledge.
The court held this broad confidentiality provision acted as a de facto noncompete agreement, because it essentially barred Brown in perpetuity from working in the securities industry, much less from working in his chosen field of statistical arbitrage. The court overturned the order confirming the arbitration award and sent the case back to the trial court for review. In response to arguments by TGS that the court’s ruling would strip companies of their ability to protect confidential information and trade secrets, the court said “properly drawn” confidentiality agreements that preserve an employee’s right to compete with their former employer could be enforced, and that the ruling did not prevent companies from pursuing trade secret claims.
The Brown decision underscores the importance of a properly drafted and narrowly tailored agreement that preserves an employee’s right to compete within the protections of California law. It is yet to be seen how this opinion will be applied to other similar confidentiality provisions, that although may not be as egregious as the TGS agreement, also have the effect of stifling an employee’s right to compete without fear of litigation. It is unlikely, however, that companies will affirmatively remove or modify these provisions until there is more case law striking down overbroad confidentiality agreements.
If you have questions about confidentiality agreements, transitioning jobs, or your right to work, contact Shustak Reynolds today for a confidential and complimentary consultation.
Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes. We represent many broker-dealers, registered representatives, investment advisors, investors and businesses. Attorney Katherine Bowles can be reached in the firm’s San Diego office at (619) 696-9500.
Since Morgan Stanley and others started withdrawing from the Protocol for Broker Recruiting in the fall of 2017, there has been a significant uptick in firms bringing legal action against departing advisors to prevent them from soliciting clients after they leave. Although these actions have had mixed results, California federal courts recently have been highly skeptical of this approach and reluctant to grant the “drastic remedy” of a temporary restraining order or preliminary injunction.
Firms like Morgan Stanley generally follow a “sue and ask questions later” strategy to minimize the damage caused by departing advisors. Shortly after the advisor resigns and joins a new firm, the prior firm will file a FINRA arbitration against them and simultaneously file an action in state or federal court seeking a temporary restraining order and/or preliminary injunction to stop the advisor from soliciting clients away from the prior firm. In the 21 months since Morgan Stanley withdrew from the Protocol, it has brought 13 of these cases in federal court seeking temporary restraining orders barring departing advisors from soliciting Morgan Stanley clients and using proprietary material. Out of these 13 cases, 7 courts granted the TRO request, 2 denied the request, and 4 cases settled prior to the ruling.
Recently, however, California courts have become more skeptical of this tactic and are requiring firms to put forth credible evidence that the departing advisor has actually misappropriated a trade secret or otherwise violated the law. In June 2019, Morgan Stanley lost their bid for a TRO against a California advisor who left to join Wells Fargo. The court held that Morgan Stanley failed to put forth any persuasive evidence to justify such a drastic remedy. The court generally held that in order to seek such a drastic remedy the conduct must be severe and supported by a digital trail or eyewitness account.
Similarly, in May, a Northern District of California federal judge denied E*Trade’s attempt to get a preliminary injunction against an advisor who left for Morgan Stanley. The court looked at the advisor’s agreements with E*Trade and his conduct in light of California’s Business and Professions Code section 16600, which says that “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.”
The court found that portions of E*Trade’s employment agreement regarding solicitation of clients violated this statute, and held that E*Trade had not put forth credible evidence that the departing adviser had misappropriated E*Trade’s trade secrets. Edward Jones suffered a similar fate in October 2018 when a federal judge in California summarily denied its request for a temporary restraining order against a departing adviser.
Firms filing these types of actions have to be cognizant of the recent shift in how courts are interpreting non-solicitation law in California, and as one judge put it, “to the extent the law regarding Section 16600 is ‘evolving,’ it is developing in a direction unfavorable to [firms’] arguments.”
While advisors always face a threat of litigation when they switch firms outside the Broker Protocol, California federal courts are signaling they are skeptical of these types of bullying tactics and will require credible evidence of actual wrongdoing before they will take the drastic step of issuing a temporary restraining order or preliminary injunction.
Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes. We routinely represent broker-dealers and financial advisors in arbitrations, financial advisor transitions, broker protocol disputes and related matters. Please contact us today for a confidential, complimentary consultation.
Both Protocol and Non-Protocol firms have continued their sue-first-ask-questions-later litigation strategy against departing advisors, and advisors should be on high alert even when they are making a Protocol transition. Firms have increasingly been taking a highly critical look at what advisors do prior to and during their transitions and many are aggressively going after advisors that make any misstep.
In September, a Federal District Court in Illinois denied Morgan Stanley’s request for a temporary restraining order, which would have barred a team of six departing advisors from soliciting former clients following their jump to Stifel Nicolaus. The denial does not grant the team carte blanche to actively solicit their clients, but rather, it did find Morgan Stanley failed to convince the court such a severe order was necessary to prevent alleged further harm to Morgan Stanley. Nonetheless, Morgan Stanley has continued to pursue a permanent injunction against the advisors that would severely restrict their ability to contact their clients while the companion FINRA action continues.
The team of advisors has not remained passive in response to Morgan Stanley’s efforts. The team filed two motions to dismiss Morgan Stanley’s complaint against them, setting forth several reasons why they believe Morgan Stanley’s claims fail. The latest motion to dismiss not only attacks the factual basis for the allegations, but also it cuts to the enforceability of Morgan Stanley’s policies and employment agreements–which serve as the basis for Morgan Stanley’s claims. Put simply, the advisors allege Morgan Stanley’s complaint is supported by nothing but “speculation, suspicion, conjecture, guesses, and hunches.”
While a ruling on whether Morgan Stanley’s amended complaint can proceed is not expected until mid-December at the earliest, this delay in entering a temporary restraining order or injunction is considered a crucial win for the advisors who are going through the process of transitioning their clients to Stifel. Additionally, the denial is a setback to Morgan Stanley’s aggressive sue-first-ask-questions-later litigation strategy it has taken since exiting the Broker Protocol.
In mid-October, Wells Fargo filed a complaint for a temporary or preliminary injunction against a group of five advisors alleging the team took more client information than the Protocol allows. The complaint, filed in conjunction with a FINRA arbitration, was filed shortly after the advisors left, and showed that Wells Fargo did an extensive investigation into the advisors’ actions in the months leading up to their departure.
While Wells Fargo continues to stay in the Broker Protocol, this suit signals that they will be keeping a close eye on advisors that try to leave and will aggressively pursue any perceived violations of the Protocol. It is more important now than ever for advisors to ensure they have a solid exit strategy in place before they take the plunge to join a new firm.
Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes. We routinely represent broker-dealers and financial advisors in arbitrations, financial advisor transitions, broker protocol disputes and related matters. Please contact us today for a confidential, complimentary consultation.
It has been almost a year since Morgan Stanley abruptly exited the Protocol for Broker Recruiting (“Protocol”), and in that time it has implemented an aggressive legal strategy against departing advisors. On Wednesday, Morgan Stanley filed a federal complaint against a team of six departing advisors less than a week after they resigned from Morgan Stanley to join Stifel Nicolaus & Co., and was then able to drag them into court just two days later for a hearing on Morgan Stanley’s Emergency Motion for a Temporary Restraining Order and Preliminary Injunction. Morgan Stanley concurrently filed a companion arbitration against the team in FINRA.
Morgan Stanley requested extremely broad relief by asking the court to block the $660-million team from soliciting any Morgan Stanley client (excluding family members) and from using any records, documents or information relating in any way to any Morgan Stanley clients, business and marketing strategies, or business operations. Morgan Stanley alleges in their complaint the team has been calling clients and asking them to transfer their accounts to Stifel, as well as reaching out to clients on social media. Morgan Stanley, however, has not produced any direct evidence of these alleged violations.
The team is comprised of Ronald Ouwenga, Brian Thomas, Myron Hendrix, Michael Bruner, Jeff Schimmelpfennig, and Zachary Birkey, who worked out of Morgan Stanley’s Bourbonnais, Illinois office, a relatively small financial services market about an hour outside Chicago. In their opposition papers, the team adamantly denies they did anything wrong, and calls out Morgan Stanley for unilaterally changing the terms of the team’s employment agreements by exiting the Protocol without giving the team anything in exchange for stripping them of Protocol protections or giving them the option to voluntarily leave Morgan Stanley before the Protocol exit was finalized.
Morgan Stanley claims the team’s alleged client solicitations violate a joint production agreement that was entered into during the short period of time between Morgan Stanley announcing their intention to exit the Protocol and the date the exit was finalized. The court has not yet entered an order on Morgan Stanley’s emergency motion.
This is just the newest in a long line of cases Morgan Stanley has initiated in the last year against ex-Morgan Stanley advisors who moved to rival firms. Morgan Stanley, however, is not alone in implementing this sue-first-ask-questions-later strategy. JPMorgan Chase has filed similar lawsuits this year, and many more are expected to follow as more firms make their exit from the Protocol.
Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes. We routinely represent broker-dealers and financial advisors in arbitrations, financial advisor transitions, broker protocol disputes and related matters. Please contact us today for a confidential, complimentary consultation.
FINRA has issued new guidance on the use of social media and digital communications for member firms and persons associated with member firms. Regulatory Notice 17-18 provides guidance in the areas of recordkeeping, third-party posts and hyperlinks to third-party sites. This notice builds on prior Regulatory Notices 10-06 and 11-39 that concerned communications with the public to social media sites and the use of personal devices for business communications.
Text Messaging – More frequently, clients want to interact with registered representatives through text messaging and other chat services. Records of these communications related to its business that are made by these means must be retained, and any firm that intends to communicate using these means must first ensure that it can retain records of those communications as required by SEA Rules 17a-3 and 17a-4 and FINRA Rule 4511.
Sharing of Content – This new FINRA guidance makes clear that by sharing or linking to third-party content, the member firm has adopted the content and is responsible for the content to the same extent it is for firm-generated communications. As for personal communications, an associated person who shares or links to content that the member firm made available, which is not related to its products or services (such as the firm’s sponsorship of a charitable event), is not subject to Rule 2210.
The firm is not responsible for links to other content in the third-party content it shares, unless the facts and circumstances indicate the firm has adopted or became entangled with such content. Whether the firm has adopted this content depends on whether the firm has influence or control over it. This analysis changes when the firm shares or links to content that itself serves primarily as a vehicle for links, and in that situation the firm would have adopted the other content accessed through those links. This rule would apply if a firm linked to a webpage made up largely of links to other content.
Additionally, if a firm includes on its website a link to a section of an independent third-party website, whether it has adopted the content of that website depends on two factors: (1) whether the link is “ongoing” and (2) and whether the firm has influence or control over the content of the third party site. The firm has not adopted content if the link is “ongoing”. “Ongoing” means that: (i) the link is continuously available to investors who visit the firm’s site; (ii) investors have access to the linked site whether or not it contains favorable material about the firm; and (iii) the linked site could be updated or changed by the independent third party and investors would still be able to use the link. The language introducing the ongoing link must also conform to the content standards of the communication rules, including not being misleading or inaccurate.
Native Advertising – This is advertising content that matches the form and function of the platform on which it appears, such as content that is similar to a news feature article, product reviews, or other material that surrounds it online. This regulatory notice clarifies that native advertising is not inherently misleading and can be used as long as it complies with Rule 2210, meaning the firm must ensure the communication is fair, balanced and not misleading. Native advertising must prominently disclose the firm’s name, accurately reflect any relationship with the firm and any other entity or individual named in the advertisement, and state whether mentioned products or services are offered by the firm. Also, if a firm or representative has paid for the publication, production or distribution of any communication that appears to be a magazine, article or interview, then the communication must be clearly identified as an advertisement. Any communications that take the form of comments or posts by influencers should be clearly identified as advertisements and include the broker-dealer’s name as well as any other information required for compliance with Rule 2210.
Testimonials and Endorsements – Unsolicited third-party opinions or comments posted on a social network site such as LinkedIn are not communications of the firm or representative for purposes of Rule 2210. However, if the firm or representative likes or shares content, they have adopted the content and become subject to the communication rules, including prohibitions on misleading or incomplete statements or claims, the testimonial requirements, and the supervision and recordkeeping rules. Required testimonial disclosures may be provided in the interactive electronic communication itself in close proximity to the testimonial or the disclosures may be made through a clearly marked hyperlink accompanying the testimonial using language such as “important testimonial information”.
Third-Party Content – If an unaffiliated third-party publisher posts an online directory of business information, contacting the publisher to provide a correction is not considered a communication of the firm or the representative as long as the correction pertains to factual information. The firm or representative may also post a correction by posting a comment on the listing without it being deemed to have adopted the incorrect listing.
BrokerCheck Link – FINRA has clarified that apps created by firms do not need to have a reference and hyperlink to BrokerCheck because Rule 2210(d)(8) specifically references websites. However, if the app displays a webpage of the firm in the app, the firm must ensure that the link is readily apparent when the page is displayed through the app.
Shustak Reynolds & Partners, P.C.’s experienced San Diego FINRA and securities attorneys are well versed in guiding financial advisors through transitions from one firm to another. Our FINRA arbitration practice group routinely represents financial advisors and registered representatives in employment and promissory note disputes before FINRA’s arbitration division. Contact us today for a confidential, complimentary consultation.
