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7 Tips to Help Financial Advisor Firms Protect Their Customer Lists

May 23, 2022 Articles
Wealth Management

Customer relationships are a key asset for companies in the financial advising and wealth management industry. In California, however, the law is making it increasingly difficult to stop departing employees from soliciting customers after going to a competing firm. Courts are striking down non-solicitation and even confidentiality agreements that prohibit former employees from soliciting their old customers. Taking steps to establish that these customer relationships are a trade secret may be the best way to protect this valuable asset.

Background: Courts Begin Applying Non-Competition Law to Non-Solicitation and Confidentiality Agreements

It is widely understood that California law prohibits employers from imposing non-competition agreements on employees. Even if a California employee willingly agrees to a non-compete, courts won’t enforce it because these agreements violate a state-wide policy in favor of open competition, codified in Business & Professions Code section 16600. Even where employment agreements invoke another state’s more permissive laws, California courts routinely invalidate non-competition clauses if the employee is based in California.

Because non-competes are not viable, for many years, California companies protected customer contact lists through non-solicitation agreements. But California courts have increasingly extended the principles invalidating non-competition agreements to non-solicitation clauses, too. Following a 2008 California Supreme Court case, a number of California state and federal courts have invalidated customer non-solicitation provisions.

Next up were confidentiality agreements—if a confidentiality clause was worded broadly to include customer contact information, perhaps that could block employees from soliciting customers if they left for a competitor?

While the law isn’t settled, there is reason to doubt confidentiality clauses may be used this way. For example, in 2020, a California court refused to allow an equities trading company to wield a broad confidentiality clause to prevent a former employee from soliciting customers. The confidentiality clause acted “as a de facto non-compete provision” that would bar the former employee “in perpetuity from doing any work in the securities field.” Other cases suggest this decision is part of a trend. In two recent private arbitrations in the venture capital space, our firm relied on these and other cases to invalidate overbroad confidentiality clauses, winning our claim that our client’s previous employer couldn’t use confidentiality to block him from soliciting institutional investors he had previously worked with.

Note that confidentiality clauses still likely protect an actual customer contact list. In other words, we believe it’s likely that a properly tailored confidentiality clause could prevent an employee from taking a physical or digital copy of a customer contact list with them when they leave. But several recent cases cast doubt on whether confidentiality clauses can prevent a former employee from soliciting the customers on that list.

Using Trade Secrets to Protect Customer Information

Considering that, in California, it’s unlikely that non-competes, non-solicits, or perhaps even broad confidentiality clauses can stop former employees from soliciting customers, trade secrets may be the best way of protecting customer relationships.

A trade secret can be any information that “derives independent economic value” from not being generally known, and that is the subject of “reasonable” efforts to protect its secrecy. Customer lists, in some instances, can be trade secrets.

Not all customer lists are created equal, however. For firms that want to protect their customer relationships as trade secrets, here are some tips to maximize your chances:

Keep a Record of Effort and Cost in Developing the List: The effort required to identify the customers in the customer list matters a lot. Courts are “reluctant to protect customer lists” if they contain information that’s available “through public sources, such as business directories.” Conversely, a customer list that was “procured by substantial time, effort, and expense is a protectable trade secret.”

Distinguish Between Firm Clients and Individual Advisor Clients: In financial services, who devoted the energy to develop the customers also factors into whether a customer list is a trade secret. In one case, departing brokers defeated a trade secret claim by showing that they had developed their clients through their own efforts and without meaningful help from their brokerage firm. The court found that the client list, even if it was secret, did not belong to the brokerage firm.

Consider the Broker Protocol: A firm’s membership in the Broker Protocol may weigh against its ability to protect its customer list as a trade secret. Because the Protocol allows departing brokers to take certain customer information with them, at least that information cannot be considered a trade secret.

Mere Contact Information Is Probably Not Protectable: Customer databases that include information about the customers’ “particular needs or characteristics” are more likely to be protectable than lists of “mere identities and locations.” Information “linking” each customer to other confidential information, such as “the customer’s buying patterns, product needs, and preferences,” makes a customer list much more likely to be protectable. Similarly, a list reflecting research into many customers and their preferences is more easily protectable than one that contains market research into, for example, a “single prominent buyer that is presumably aware of its own needs.”

Don’t Use Boilerplate Confidentiality Clauses: As the cases discussed above and our firm’s two recent successful arbitrations show, overbroad and boilerplate confidentiality clauses can actually provide less protection than a clause that’s carefully tailored to your business. Whenever possible, be specific about the information that needs to be protected.

Make Efforts To Protect Secrecy of the List: Finally, keep in mind the requirement to take “reasonable” efforts to protect a customer list’s secrecy. If there’s a company-wide client database, protect it through passwords and restrict access to those with a need to know. Don’t allow employees to keep versions of the list on their personal devices. Require employees to sign non-disclosure agreements. And engage in good HR hygiene when employees leave: conduct exit interviews; require certifications that departing employees have returned all company information; and for manager-level employees, investigate whether their IT usage was unusual in the weeks before their departure.

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