Since 2000 the number of Investment Advisor Representatives (“IAR) associated with Registered Investment Advisors (“RIA”) has increased from 6,949 to 15,870. Along with this increase there has been an increase in the departure of IARs, who have employment agreements containing restrictive covenants, to a new RIA. This has likewise led to an increase in the number of court claims against departing IARs by their former RIA seeking injunctive relief to enforce the restrictive covenants contained within their employment agreement. Oftentimes these restrictive covenants include a provision that the IAR and his/her new RIA may not accept business from customers who the IAR serviced at his/her prior RIA, as well as non-solicitation and confidentiality clauses. If the court were to enforce the non-acceptance of business restrictive covenant the customer would be precluded from following the IAR to his/her new RIA and would lose the ability to decide who would service their account.
FINRA addressed this issue when FINRA Rule 2140 was approved in 2010. Rule 2140 provides:
No member or person associated with a member shall interfere with a customer’s request to transfer his or her account in connection with the change in employment of the customer’s registered representative where the account is not subject to any lien for monies owed by the customer or other bona fide claim. Prohibited interference includes, but is not limited to, seeking a judicial order or decree that would bar or restrict the submission, delivery or acceptance of a written request from a customer to transfer his or her account. Nothing in this Rule shall affect the operation of Rule 11870.
By enacting this rule FINRA recognized that the customer should be free to choose who should service his/her securities assets.
However, IARs and RIAs are not regulated by FINRA and are not bound by the FINRA rules. IARs and RIAs are either regulated by the SEC or the state depending on the amount of assets they manage. Neither the SEC nor the states have a rule similar to FINRA Rule 2140. Therefore, when an IAR departs to a new RIA, the RIA from which he/she departed may seek a court order to enforce the non-acceptance provision in an employment agreement. This lack of regulatory prohibition from enforcing a non-acceptance provision creates the distinct possibility that a court may enforce the provision and artificially separate the customer from their financial advisor of choice.
In Edelman Financial Engines v. Prime Capital Investment, U.S.D.C. Delaware C.A. No. 25-1412, Edelman, an RIA, sought to enforce a non-acceptance provision in its employment agreement with IARs who departed to Prime Capital, another RIA. However, the Court held that the non-acceptance provisions in IAR’s contracts go beyond what is necessary to protect Edelman’s interests and would not survive a balance of the equities because these provisions prohibit consumers from accessing and working with a financial planner of their choice.
This Opinion is significant when departing IARs are confronted with the possibility of the enforcement of a non-acceptance restrictive covenant and the disfunction it creates in the client advisor relationship.
