New U.K. Non-Compete Law Means Hedge Funds Need To Find New Ways To Protect Their IP

Hedge funds love themselves a non-compete clause. For more senior executives, it’s not unheard of for these restrictions (often buried in one of the myriad of documents which executives are expected to sign) to last up to two years after they depart – whether that be voluntarily so, or not.

It’s not surprising. There’s a significant amount of intellectual property (IP) and other confidential information in the industry, whether that be sophisticated computer models developed by quant firms, or the ability of discretionary managers to analyse data and find opportunities where others can’t; not to mention the all-important ‘little black book’ of allocator contacts that competitors would love to make inroads into.

Hedge fund management companies - along with all other businesses -  in the United Kingdom are soon going to need to figure out alternative options when it comes to protecting their IP. The U.K. government recently published its response to its own consultation on measures to reform post-termination non-compete clauses in contracts of employment, which outlines measures to limit non-competes to just three months post-termination.

The hedge fund industry in the country is less than delighted with the British government’s plans, saying that these new restrictions could hurt both innovation and the broader economy.

“We are not supportive of the introduction of a statutory limit on the length of non-compete clauses,” said Aniqah Rao, Markets Regulation Associate at industry body the Alternative Investment Management Association (AIMA). “Non-compete agreements are an important part of the investment management industry. They play a critical part in protecting a firm’s confidential intellectual property and information that carries high commercial sensitivity, whether it be investment strategies, methodologies or algorithms, clientele, legal and tax strategies, and/or marketing activity. Limits on their use could disincentivise the development of active investing and trading strategies to the detriment of the firm, its personnel and its investors, with follow-on effects of impairing liquidity, price discovery and competition sensitivity in the UK’s financial markets.”

The planned changes limiting the length of the non-compete clause are certainly a benefit to the employee. Non-competes have always been an inexact science, with competition concerns not always being obvious. Whilst an equity hedge fund might not want an employee to leave for another equity hedge fund, should they kick up a fuss if the employee leaves for a credit hedge fund? Are the two really in competition with each other? Should the former really sue the ex-employee for joining the latter? That’s one issue that will now go away, according to James Hockin, an employment lawyer at law firm Withers LLP in London.

“At the moment there is a difference between the legal position and what’s happening in the market. The legal position is that the employer shouldn’t go further than what’s necessary, but we do see a lot of broad non-competes, some of which would not be likely to be enforceable if it went to court. But with the new rule, the three-month maximum means that any potential litigation around this issue ceases. The hiring hedge fund will just wait three months and then the employee will be available to start working for them.”

This means that hedge funds will need to figure out other ways to protect themselves. For more senior staffers, one option is already being used, albeit for different reasons, and it’s one that is likely to see additional focus from an employment perspective going forward.

“The main loophole here is that the new law applies to employees but not to an LLP member, and this is something that’s specifically carved out in the response. A number of people in the hedge fund industry are already members of an LLP for tax reasons, and an employer could simply introduce lengthy non-compete terms into those LLP arrangements,” said Hockin.

For more junior staffers that won’t be made part of an LLP, employers can adapt other terms. Notice periods with garden leave provisions is one example – these may be lengthened and are not considered in the U.K. government’s plans. Although the employer would effectively be paying for a non-compete clause by placing an employee on gardening leave during their notice period, this would significantly reduce the hedge fund’s exposure to confidential information leakage. Non-disclosure agreements are another, but they are difficult to police.  And Hockin expects there to be renewed focus on deferred compensation schemes and other equity and carry arrangements, which aren’t covered by the proposed new law, to disincentivise staffers from departing.

Regardless of seniority, technology firms could be licking their lips here as well. Surveillance technology, whether that be cameras in the office, or software installed on corporate networks and computers, already exists to help employers identify theft, whether that be something as obvious as walking out of the office with a large ring binder of documents, or printing or emailing to oneself a spreadsheet of contacts.

Hockin says that many hedge funds already have their own protections when it comes to hiring new employees – many have clauses in their employment contracts that provide grounds for dismissal should a new hire place their new employer at risk by bringing confidential information with them from their old employer – but for the industry, this, and the other avenues available to hedge funds to maintain their intellectual moat might not be enough.

“The legislative change could impact competition, at a time when investment capital flows to the UK are important. As mentioned, non-disclosure agreements and other clauses do not provide the same level of intellectual property and trade secrets protection as properly tailored non-compete agreements. Limiting the maximum length of non-compete clauses impacts an employer’s investment in its employees, whether through the employee’s training or disclosure of sensitive business information or intellectual property to the employee,” said Rao.