What you need to know about the FTC Workshop on Noncompetes

The FTC conducted its first workshop on noncompetes on January 9, 2020. An opportunity for the public to submit comments remains open until March 11, which is only two weeks away.

I attended the workshop and plan to submit written comments. If you’re thinking about making your own submission or just want to know what happened, see below. (Note that I’ve included some cites to the preliminary transcript (written as Tr. p. __) where I thought they might be helpful.)

Summary

I am pleased to report that it was an outstanding program, with multiple speakers and panels of experts providing a broad spectrum of information, viewpoints, and thoughtful discussion. There was discussion about the history of noncompetes, the purposes they serve, the approach companies, courts, and legislatures have taken to using and enforcing them, issues of federalism, and possible approaches to regulating them.

As might be expected with any emotionally charged issue, there were definitely some strongly held opinions and advocacy, misinformation, and confusion of the legal theory and practical realities of noncompetes. But the firebrands were few and, by the end of the program, the sense of the room (in my opinion) was that the available research is nascent, inconclusive, and at times conflicting, and more research is needed before any significant controversial measures should be undertaken.

In addition, most everyone in the room also seemed to agree that a moderate approach, targeting abuses and fairness issues, would make sense – assuming, of course, that the FTC has the power to regulate noncompetes, which is far from a foregone conclusion.

As will probably come as no surprise, these discussions (in my opinion) properly belong at the state level, where they have been for 200 years and where recent reevaluation has been underway in no fewer than 29 states.

Speakers and Panelists

The speakers and panelists at the workshop were (in order of their substantive participation):

Research and Background

Most of the background research and related information discussed during the workshop has been circulating in the literature for quite some time, but was well summarized, put in context nicely, and supplemented by some more recent research in the works.

Instructively, most people at the hearing who were involved in the research were the first to point out the difficulties with the research (including that it can be hard to isolate direct causal connections to noncompetes), that there are areas of (seeming) inconsistencies, and that there are many areas in need of additional study. Although he was not at the workshop, Professor Matt Marx of Boston University’s Questrom School of Business wrote an outstanding paper summarizing the scope of available economic research on noncompetes as of 2017, and the limitations of that research. It’s definitely worth a read, if you want a quick primer. 

On the low-wage worker front (which has been the focus of much of the research), there was significant discussion overall about the fact that the studies show that noncompetes (appear to) adversely affect low-wage workers’ wages. One of the broad themes on this issue discussed (and frequently in the news) is, as Ryan Nunn put it, the “wages for the median worker have grown extremely slowly over the last 40 or 50 years . . . .” Tr. p. 119. It is unclear, however, how noncompetes relate to this, given the questions about the impact of noncompetes on wages and that the wage problem preceded the (alleged) surge in the use of noncompetes. Relatedly, though not discussed at the workshop, the latest economic reports show that low-wage workers’ compensation has actually increased by almost 3% in the past year, and, the fastest wage growth in the last 17 months has been at the lower wage levels. “FTC may crack down on non-compete agreements, saying they are bad for workers” (video at 4:05-4:17).

Professor Kurt Lavetti summed up his view on the issue as follows: “There is a lot of discussion about attributing general wage stagnation in the labor market to non-compete agreements. I just want to comment that I think, to some extent, that’s an oversimplification. There’s a lot of factors that have contributed to this, and I don’t think we really have come close to being able to conduct a thorough decomposition of all these factors, including changes in skill bias, technological change, and how those types of other exogenous things that have been happening in the labor market interact with the use and enforceability of non-compete agreements over time. So I just want to sort of caution against thinking that policy changes are really going to have a first order effect on wage stagnation given how much is unknown elsewhere about the broader labor market trends.” Tr. p. 152.

And of course, no discussion of noncompetes (particularly with regard to low-wage workers) could be complete without at least one reference to the Jimmy John’s debacle. (I did not keep count, but suffice it to say, Jimmy John’s came up more than once – as it should; that was a prime example of the type of misuse of noncompetes that puts the proper use in the crosshairs.)

As to the seeming inconsistencies in the research discussed at the workshop, Professor Ryan Williams talked about his study on the use and impact of noncompetes on CEOs – as opposed to low-wage workers (which have been the focus of most of the other studies). The results? Those CEOs who signed noncompetes tended to receive greater compensation and were more accountable for their performance. Tr. pp. 179.

Taking a somewhat different angle, Professor Lavetti focused on “what’s missing from the empirical literature and what we know and what we don’t know yet about this discussion.” Tr. p. 137. For example, he noted that “relaxing the enforceability of non-competes [meaning making noncompetes less enforceable] actually makes firms less willing to fire their workers and leads to higher rates of misconduct among financial advisors. So this could actually be potentially harmful for consumers. Consumers are also charged higher fees.” Tr. p. 148. He also noted that “although non-compete agreements can reduce earnings on average, in some contexts, there’s evidence that they might systematically increase earnings.” Tr. p. 144.

Professor Lavetti commented about his testimony as follows: “My summary opinion overall, just to wrap up, is that my own opinion is that the scientific standard for a complete ban on non-compete agreements should be quite high. Non-competes have been used for a long time, and the literature is, in a relative sense, nascent compared to the history of the use of non-compete agreements. I think there are policies that can be used to protect vulnerable workers while still permitting non-competes in other contexts, that a lot of other people today have discussed examples of such policies, like setting minimum earnings and wage floors for workers who are bound by non-compete agreements.” Tr. p. 153.

Put another way, the bottom-line takeaway from Professor Lavitti’s testimony is that “context matters,” Tr. p. 144, and a lot more needs to be done before broad policy decisions can properly be made. There is enormous potential for unintended consequences of any legislative or regulatory policy based on the existing research – even if one were to accept that the effects on wages and worker mobility are known by the research.

Professor Evan Starr, who is one of the leading researchers in this area, provided (among other things) some very interesting context for understanding the impacts of any policy decisions. First, in discussing the research to be drawn from the research, he “highlight[ed] that it’s much harder to estimate the causal effect of using non-compete agreements.” Tr. p. 158. He also pointed out that, in drawing conclusions from research based on employees bound by noncompetes, “you have to worry that there are other differences between those workers, not just whether they have signed the non-compete, which could be driving any outcomes you observe, okay? And it makes it really tricky . . . .” Tr. p. 159.

Professor Starr also discussed the big picture, noting that recent studies of his and others estimate, between 18 and 28 percent of the current US labor force has a noncompete and that of that percentage, the breakdown is informative:  They are more frequently found in high-paying, technical jobs (35 to 45 percent according to a 2019 study by Professor Starr and others and a 2011 study by Professor Matt Marx); executives (at a rate of 70 to 80 percent according to a 2015 study by Professor Norm Bishara and others, and a 2009 study by Mark Garmaise); and physicians (at a rate of approximately 45 percent according to a 2014 study by Professor Lavetti). Tr. pp. 159. While so much of the research has been focused on low-wage workers, Professor Starr noted that only approximately 14 percent of those earning less than $40,000 are subject to noncompetes according to his 2019 study. Tr. p. 159. But, because low-wage workers make up such a large percent of the work pool, workers paid by the hour (at a median rate of $14/hour) account for approximately 53 percent of all people bound by noncompetes. Tr. p. 159-160. (That is based on a 2019 study by Professor Starr and others.)

In short, the takeaways from the developing body of research as it currently exists (and my reactions in the parentheticals) are as follows:

  • noncompetes are widely used (though the percentages are still in need of refinement);
  • they (as well as no-poach agreements) are (allegedly) being used with more frequency (though there is no actual proof of these claims, as there are no longitudinal studies looking for changes over time, and the opposite is possibly true for noncompetes, assuming one can draw such an inference from the apparent leveling off of noncompete decisions in the past decade (see here));
  • they appear to reduce wages for low-wage workers (but, as Professor Lavitti observed, this may be an over simplification, which, from my standpoint, includes unanswered causality questions among others);
  • they appear to systematically increase earnings for CEOs and physicians (same unanswered questions);
  • there appear to be positive wage effects when noncompetes are provided with job offer (same unanswered questions);
  • there are roughly as many noncompetes used (by percentages) in states that don’t enforce them (really, California) as in states that do;
  • firm-sponsored training is more common in states with more-stringent noncompete enforcement;
  • noncompetes are often presented to workers after the job offer was accepted or even on/after the first day of work; and
  • there are fewer but stronger startups in states that enforce more stringently.

Other potential issues, not discussed are that the studies that ask employees whether they are bound by a noncompete have no real way to know whether the employee actually understands the difference between a noncompete, nonsolicitation agreement, or even a nondisclosure agreement. (I have seen many employees who don’t know the difference. This became particularly clear to me during the lengthy legislative process in Massachusetts, where employers would talk about their use of noncompetes, only to learn that they were talking about nonsolicitation agreements.) That said, in speaking with Professor Starr, he has recently focused on that very issue and has been making an effort to ensure that his research hits the right questions to ensure that the people surveyed understand the difference.

Justifications for Noncompetes

Putting aside whether noncompetes hinder or help wage growth for certain groups of employees and the myriad other issues discussed above, there are separate reasons for their enforcement. Broadly they come down to the protection of trade secrets (and other confidential information), the protection of customer relationships, and ensuring that investments in training, sharing of information, and innovation are protectable. Quite simply (as will be discussed in a forthcoming blog post), these agreements are rarely sufficient. Indeed, this is why the new Massachusetts noncompete law expressly authorizes courts to impose a “springing noncompete” (or “time out noncompete,” as John Marsh has called them) when an employee violates these other contractual obligations (as well as certain other obligations).

The Right Forum and Procedure

Noncompetes have been around since at least the early 1400’s and have been enforced in the United states since the early 1800’s. See Hess v. Gebhard & Co., 808 A.2d 912, 918 n.2 (Pa. 2002) (“The earliest known American case involving a restrictive covenant is Pierce v. Fuller, 8 Mass. 223 (1811).”). Instructively, they were initially illegal. That was because the Plague ravaged the workforce, causing Europe to need every worker it could get. Accordingly, England made it illegal to not work (if you were able to work and under the age of 60). Noncompetes hampered that requirement and were therefore illegal. However, by 1621, a restriction limited to a specific geographic location was found to be an enforceable exception to the ban. See Alger v. Thacher, 36 Mass. 51, 53 (1837).

Almost 100 years later, the exception became the rule with the 1711 watershed case of Mitchel v. Reynolds, 24 Eng. Rep. 347 (Q.B. 1711), which established the modern reasonableness framework for the analysis of the enforceability of noncompetition agreements. See Catherine L. Fisk, “Working Knowledge: Trade Secrets, Restrictive Covenants in Employment, and the Rise of Corporate Intellectual Property, 1800–1920,” 52 Hastings L.J. 441, 453–54 (2001); Alger v. Thacher, 36 Mass. at 53.

The United States followed suit and for the past 200 years, states have refined the framework based on the particular needs of their citizens and economy. And they continue to do so.

Only recently has there been consideration of federal legislation or regulation. (For background, see here.) Instructively, presumably recognizing issues of both federalism (specifically raised by Senator Romney during the Senate Committee on Small Business and Entrepreneurship’s hearing on “Noncompete Agreements and American Workers”) and the broad disagreement among the states about the proper scope of legislation, members of Congress from both the Senate and House are pushing the FTC to circumvent the legislative process and move straight to rulemaking.

The issue of the FTC’s authority to engage in rulemaking on this subject was discussed at length, with serious questions raised by several panelists at the workshop, and FTC Commissioner Phillips. To overcome those concerns, suggestions ranged from the extreme (of just ignoring the possible lack of power and moving forward to make a point), to limited rulemaking that would up the odds of surviving a challenge, to something short of rulemaking (such as issuing guidance or a statement of policy), to pushing the issue back to Congress. However, as Bill Kovacic noted, “[T]he bolder the measure, the stronger the evidentiary armor is going to have to be and the more thoughtful the analyses.” Tr. p. 37.

The panels also discussed the fact that there is a patchwork of state laws, and acknowledged that the diversity of state economies might militate against a federal one-size-fits-all approach.

Next steps at the FTC

The FTC has kept open the public comment period, extending it from February 10, 2020 to March 11, 2020. As indicated on the FTC’s website, “Interested parties are invited to submit written comments on the topics described [below] to the FTC electronically or in paper form.”

The topics for which the FTC is seeking input are listed as follows:

  • What impact do non-compete clauses have on labor market participants?
  • What are the business justifications for non-compete clauses?
  • Is state law insufficient to address harms associated with non-compete clauses?
  • Do employers enforce non-compete agreements contained in standard employment contracts? How routine is such enforcement?
  • Are there situations in which non-compete clauses constitute an unfair method of competition (UMC) or an unfair or deceptive act or practice (UDAP)? How prevalent are these situations?
  • Should the FTC consider using its rulemaking authority to address the potential harms of non-compete clauses, applying either UMC or UDAP principles? What “gap” in existing state or federal law or regulation might such a rule fill? What should be the scope and terms of such a rule? What is the statutory authority for the Commission to promulgate a rule?
  • Should the FTC consider using other tools besides rulemaking to address the potential harms of non-compete clauses, such as law enforcement, advocacy, or consumer/industry guidance?
  • What additional economic research should be undertaken to evaluate the net effect of non-compete agreements? Should additional economic research on the empirical effects of non-compete agreements focus on a subset of the employee population? If so, which subset?

Where do we go from here?

First, as Evan Starr, among others, urged at the workshop, the professors should continue their research.

Separately, I encourage people who are versed in this area to submit comments — whatever your viewpoint is. Through a diverse, balanced submission of ideas, the FTC will be in the best position to evaluate the right course of action.

As I mentioned above, I plan to submit testimony, and I welcome anyone interested in joining me, to let me know. (A draft is in process.)

In that vein, assuming the FTC has the authority to issue regulations (or guidance or a policy statement) concerning noncompetes, my recommendation for an approach is to do something similar to what we did in Massachusetts, what many other states have done, and what the Obama Administration suggested in its Call to Action: focus on the abuses, rather than giving into the easy, knee-jerk reaction of a wholesale ban.

Specially, a few very top-line suggestions in that regard are:

  • Require noncompetes to be disclosed with an offer.
  • Prohibit noncompetes for certain groups of workers, presumably low-wage (however defined) and physicians, among certain others. I would focus on where the right dividing line is (assuming there is one) to balancing the harms (such as the apparent different impacts on wages for certain groups) against the benefits of noncompetes.
  • Use the “purple pencil” approach to modifying overly broad noncompetes. To explain, states take one of three general approaches to overly broad noncompetes: reformation (sometimes called “judicial modification,” in which the court essentially rewrites the language to conform the agreement to a permissible scope); blue pencil (in which the court simply crosses out the offending language, leaving the remaining language enforceable or not); and red pencil (also referred to as the “all or nothing” approach, as its name implies, requires a court to void any restriction that is overly broad, leaving nothing to enforce). Although in its new law, Massachusetts retained the reformation approach (which it the majority of states have historically used), an equitable, middle-ground approach (which one senator coined as the “purple pencil”) is a hybrid of the reformation and red pencil approach, requiring courts to strike the noncompete in its entirety unless the language reflects a clear intent to draft a narrow restriction, in which case the court may reform it.
  • Provide for “springing” (or “time-out”) noncompetes. To encourage employers to limit their use of noncompetes, they must have a clear and viable remedy when employees violate other, less-restrictive obligations such as nondisclosure agreements and nonsolicitation agreements, misappropriate trade secrets, or breach their fiduciary duties to the company. In Massachusetts, the new noncompete law expressly allows a court to, in effect, create a noncompete for someone engaged in this unlawful conduct. As noted above, we colloquially refer to these as “springing noncompetes” (or sometimes “time out” noncompetes) because they are not required of the employee in the first instance, but are only activated if the employee engages in otherwise unlawful behavior.

If you just can’t get enough and the summary merely wetted your appetite, watch the recording of the entire day (the video is in two parts: Part 1 and Part 2) or read the transcript (first version). Enjoy!

Once again, I owe another thank you to Erika Hahn for all of her work pulling tons of information together for me both before and after the workshop, and for her help in editing this post, and a thank you to Callie MacDonald (who recently joined our firm) for her continued efforts working with Erika and me to pull all of the comments submitted to the FTC to date, as I work on my own submission to the FTC.