Non-Compete Agreements: Do They Overreach?

A company hires a software engineer, or a stock broker, or perhaps a bio-chemist.  This company, knowing the newly hired employee could in the future use his or her knowledge against them, requires the employee to sign a contract agreeing not to look for a job at a rival company for a set period of time.  This type of agreement is known as a non-compete clause.  These are clauses in contracts which prevent a company’s rival from “poaching” their employees.  Employers argue that these agreements are necessary in the world of high-tech and highly skilled jobs, where intellectual property and know-how means everything.  Interestingly, there has been an increasing trend of inserting these agreements into the contracts of jobs that have traditionally not included them, many times unbeknownst to the future employee.

Take Colette Buser of Boston, Massachusetts, a 19-year-old college student searching for a summer job.  As reported by the New York Times, Colette had worked the previous three summers as a camp counselor in the nearby town of Wellesley.  The camp where she worked for all three summers is owned and operated by the Linx Company.  According to Linx’s website, they have “over 30 premier camps” in the Wellesley area; one could say they have captured the summer camp market in Wellesley.  When Colette applied to work at a different camp this summer, she was surprised when the camp turned her down.  Not known to Ms. Buser, her previous contract with Linx included a non-compete clause forbidding her from seeking employment from a non Linx owned camp within a 10 mile radius, for an entire year.  The year-long ban may seem somewhat harsh, but the 10 mile radius stipulation is rather draconian for a young college student with limited means.  As it was with Colette and her family, this probably seems rather bizarre to most people.  How could a rival summer camp threaten Linx by hiring one of their former employees?  Colette’s story is not unique, non-compete clauses are now increasingly being used in all manners of jobs that have traditionally not included any, and like camp counselors, many of these jobs do not require much technical skill (if any).   This begs the question: do companies own the products of their employee’s labors, or do they in fact own the actual talent of their employees?

The owner of Linx, John Kahn, defends the non-compete clauses in his company’s contracts, “Our intellectual property is the training and fostering of our counselors, which makes for our unique environment,” he said. “It’s much like a tech firm with designers who developed chips.”  Mr. Kahn’s statements are not only a bit far-fetched, but many believe the reasoning behind supporting non-compete clauses for all manners of jobs may be flawed, as well.  According to Massachusetts State Representative Lori Ehrlich, these clauses possibly contribute to a moribund economy and halt innovation.  Both Massachusetts and California have a large tech industry sector of their economies.  For many years now, the tech industry in Silicon Valley, California has continued to grow at an astronomical rate, while in Massachusetts it has grown at a much slower pace and has stagnated at times.  Certainly there are many factors contributing to this discrepancy, but it is impossible to ignore that California bans non-compete clauses (except in very special situations), while Massachusetts does not.  California does however have a much higher unemployment rate than Massachusetts, so this may be an aberration.

Virginia courts strongly disfavor restraints on trade.  Virginia Law further require that “non-competition clauses be strictly construed against the employer” (Roto Die Co. v. Lesser, 899 F. Supp. 1515, 1519 (W.D. Va. 1995) (citing Grant v. Carotek, Inc., 737 F. 2d 410,411 (4th Cir. 1984)(emphasis added)) and that ambiguities in the contract [be] construed in favor of the employee” (Omniplex World Servs. V. U.S. Investigations Servs., 270 Va. 246,249 (Va. 2005) (citing Simmons v. Miller, 261 Va. 561, 580-81 (Va. 2001)).  The Supreme Court of Virginia holds restrictive covenants unenforceable when the prohibited competition is “too indirect and tenuous” (Preferred Systems Solutions, Inc. v. GP Consulting, LLC, 284 Va. 382, 393 (Va. 2012).

When determining whether a restrictive covenant is valid, the Virginia Supreme Court considers the function, geographic scope, and duration of the restriction as a whole (Home Paramount Pest Control Companies, Inc. v. Justin Shaffer, et al., 282 Va. 412, 415 (Va. 2011) (citing Simmons v. Miller, 261 Va. 561, 581, (Va. 2001)).  Thus, a non-compete provision is not enforceable unless it is “narrowly drawn to protect the employer’s legitimate business interest, is not unduly burdensome on the employee’s ability to earn a living, and is not against public policy (Omniplex, 270 Va. at 249).  Conversely, the Supreme Court of Virginia has upheld contracts not to compete only if they are sufficiently “narrowly drawn” to prevent only direct competition with the employer by the former employee.  For example, in Preferred Systems Solutions, Inc. v. GP Consulting, LLC, the court enforced a non-compete clause that proscribed work on one specific project, for only two specific companies, and was limited to only 12 months (284 Va. 382,393 (Va. 2012)).

Bank Fined for Supervisory Failures Related to Facebook and Yelp IPOs

In May 2014, the Financial Industry Regulatory Authority (FINRA) fined the bank Morgan Stanley Smith Barney LLC $ 5 million for supervisory failures related to the way its brokers solicited investments in certain initial public offerings (IPOs).  Between February 2012 and May 2013, Morgan Stanley Smith Barney LLC sold shares of 83 IPOs to retail customers without adequate procedures and training to make sure that its sales staff properly distinguished between “indications of interest” and “conditional offers” when they solicited investors.  The affected IPOs include Facebook and Yelp.  When Morgan Stanley Smith Barney LLC settled the matter with FINRA and agreed to the $5 million fine, it did not admit or deny the charges, but it consented to the entry of FINRA’s findings.

As the Wall Street Journal’s Market Watch reports, before the effective date of an IPO registration statement, a brokerage firm may solicit non-binding indications of customer interest.  But that “indication of interest” may only result in an actual purchase of shares if the investor reconfirms it after the registration statement becomes effective.  Alternatively, a brokerage firm may solicit a “conditional offer to buy,” which may become binding after the registration statement becomes effective if the investor does not revoke it.

Morgan Stanley Smith Barney LLC ran into trouble when it adopted a policy on February 16, 2012 that used the terms “indications of interest” and “conditional offers” interchangeably.  The policy did not require the broker to acknowledge whether the investor was required to reconfirm his interest before the purchase was executed.  Further, the firm did not provide its financial advisors with any training or materials on the policy.  Consequently, the sales staff and consumers may not have understood what type of commitment was solicited for the IPOs.

FINRA also found that Morgan Stanley Smith Barney LLC did not adequately monitor its financial advisors’ compliance with the policy.  Additionally, FINRA found that the firm did not have adequate procedures to ensure that its brokers solicited “indications of interest” and “conditional offers” in line with the federal securities laws and FINRA rules.

It is vital that an investor understand exactly when they enter a contract to buy shares in an IPO.  Investors should be able to have open discussions with their brokers about possible IPO investments without later finding out that their broker purchased shares in that IPO without their knowledge or consent.  As Brad Bennett, FINRA Executive Vice President and Chief of Enforcement, stated in the FINRA News Release, it is “the firm’s duty to establish clear procedural guidelines for soliciting conditional offers to buy and to educate its sales force regarding this type of solicitation. There must not be ambiguity regarding the customer’s obligations given the significant legal differences between an indication of interest and a conditional offer to buy.”

If your investment broker purchased shares of the Facebook IPO, Yelp IPO, or any other IPOs without your authorization, you should contact an attorney to discuss your options.