Michael Wexler
Bio: Partner at Seyfarth Shaw LLP, specializing in trade secrets, corporate espionage, and employment restrictive covenants
Josh Soven
Bio: Partner at Paul, Weiss
If you’d like to share your thoughts on this episode, consider sending a message to @larrybernstein on Substack.
Transcript:
Larry Bernstein:
Welcome to What Happens Next. My name is Larry Bernstein. What Happens Next is a podcast which covers economics, politics, and law.
Today’s topic is Enforcing Non-Competes.
We have two speakers to discuss the FTC’s recent rule curbing the use of non-competition agreements in employment contracts.
Our first speaker is Michael Wexler who is a partner with the law firm Seyfarth where he specializes in trade secrets, corporate espionage, and employment restrictive covenants. I met Michael 12 years ago at the Father-Son event at Camp Horseshoe in Rhinelander Wisconsin and became friends.
Our second guest is Josh Soven who is a partner at Paul Weiss. Josh learned his trade working for the US Department of Justice’s Anti-Trust Division and at the Federal Trade Commission. I met Josh in our first class in college an English Seminar called the Malcontent in the Novel. We became college roommates and have been close friends for nearly 40 years.
Let me give you some background as to why I chose this topic for today’s podcast.
A couple of weeks ago, the Federal Trade Commission led by its Chair Lina Khan announced a major rule change banning the use of employee non-competition agreements. Many firms rely on non-competes to safe keep their intellectual property and trade secrets from their competitors. Standard confidentiality agreements are generally insufficient because invariably know-how is leaked when employees go to work with other firms in the same industry.
Non-competition agreements allow firms to disclose confidential information to make employees more productive and learn more on the job. Firms that want to protect their IP pay their employees who leave the company their salary for a year to prevent them from taking a job with a direct competitor.
The FTC’s ban on non-competes undermines thousands of employment relationships that are meant to safeguard trade secrets.
I want to learn from Michael and Josh whether the Federal courts will strike down this new rule because the FTC lacks the authority to regulate employment contracts, which have been a matter of state law.
24 states have already prohibited non-competition agreements for low-skill and low-compensation employees. I want to find out why a more nuanced state law solution isn’t the better answer here.
Buckle up.
Let’s open with a question for Michael Wexler.
Michael, tell us about the FTCs decision to ban non-competes.
Mike Wexler:
A little over a year ago, the FTC proposed a rule in which non-competes would be banned except in very limited situations throughout the United States for all employees. The FTC received 26,000 comments for and against the ban. They then came out with what their actual rule would be and held a vote of the FTC, which is five people: three Democrats, two Republicans. And pursuant to that vote, they adopted the ban throughout the United States.
A 570-page rule is supposed to go into effect in September 2024. However, there have been several lawsuits filed.
Larry Bernstein:
Let's get into the litigation. The top issue is whether the FTC has the authority to make this rule.
Mike Wexler:
So that's one of the major issues, Larry. The FTC is an appointed body. It's not elected. And because of that, what comes into play is the Major Questions doctrine, a Supreme Court precedent that says an agency cannot propose a rule that has major consequences with economics and politics. And there was a case 2022 West Virginia versus EPA.
Larry Bernstein:
As I recall that case, the EPA decided to regulate coal plants in West Virginia. And West Virginia said, you don't have that authority EPA. And Chief Justice Roberts said that agencies could micromanage regulations, but they can't make law particularly if it's going to have a major impact on the economy or on an industry. And this regulation that the EPA passed was written so broadly and had such ramifications that it was beyond their authority as described by Congress. Tell me about the EPA decision and its application to this FTC issue with non-competes.
Mike Wexler:
It's up to Congress to pass laws that have far sweeping economic, political, and industry impact. And in the West Virginia v. EPA case, the Supreme Court said, you EPA that's not elected, you can't do this. That's the identical situation that has been raised in the cases that have been filed against the FTC for this rule. That exact same issue saying that your mandate FTC doesn't permit you to pass such a far sweeping rule that has major impact on both economics, politics, how states regulate themselves. There's also a side issue federalism, right? Can the federal government pass a rule that dives into the states and tells the states how to handle their rules with non-competes?
The cases that were filed in Texas and Pennsylvania raised the identical issue. They also raised an issue under what's called the Chevron doctrine, agencies can't pass these far sweeping rules. It's up to Congress elected officials to make these decisions.
The Congress delegates authority to these agencies to do certain things, but not to make these broad sweeping pronouncements that have such an effect on everyday businesses, workers, everyone. It's a Pandora's box that the FTC has stepped into, I think quite deliberately.
Larry Bernstein:
Federalism allows for experimentation. It allows for different states to do different things. What do you think of federalism and the broadness of this FTC rule?
Mike Wexler:
This rule turns federalism upside down because it's a sweeping pronouncement across the entire United States. Right now, we have 24 states in the US that have passed what are called low wage worker statutes, where states have said, if you make under a certain amount of money or you're in certain professions, we're not going to allow employers in those states to sign people to non-competes. And the whole point of federalism is to say, you the states know what's best for your citizens, know what's best for your businesses. And at least half the United States has determined that we don't want someone like the guy cutting grass or the guy who's delivering fast food, we don't want non-competes in those situations because it's abusive. And the states, at least half of them so far, and there's a movement for more states to do this. Most states have seen that where non-competes are abusive, they've been overused or they're inappropriate for a level of employee, they've figured out what's best for their citizens. And when the FTC comes in and says, we're just going to make this broad sweeping generalization, non-competition agreements are inappropriate, they're telling the states what to do.
Larry Bernstein:
Alright, let's try to defend the FTC action. The other side is ridiculous that a hamburger flipper at Burger King can't quit and take employment at McDonald's. And it's absurd that a driver for Domino's Pizza can't become a driver for Little Red Hen, which is the local pizza shop where I grew up in Glencoe.
Mike Wexler:
They also have fried chicken and ribs.
Larry Bernstein:
It's very good. Now what's interesting is when some businesses overdo it and they incorporate a non-compete in their standard employment agreement that affects these drivers at the pizza place, it seems problematic. But on the other hand, they don't ever seem to be enforced.
Why do you think there is a problem?
Mike Wexler:
The FTC would take your example and would say the interim effect of a non-compete for that burger flipper or that driver prevents that person from potentially taking another job I'll say most people would agree that a non-compete for the burger flipper, a non-compete for the driver is probably overkill. And so that's why you have about 24 states right now that have these low wage worker statutes to address the exact situation you're talking about either A, it's just not necessary for people who work in a position at that level, or B, the interim effect of having it in an agreement is just something that is abusive to a worker.
Had the FTC gone the route of most of these low wage worker statutes that these states have passed, they probably have less objection to the rule because most people agree that the non-compete should not be used for someone at that level.
Larry Bernstein:
I went to the Wharton School and one of the required classes was labor management. In that class, which I referred to as a union busting class, we discussed principles of labor economics. The one thing that really stuck with me was how you should invest in your workers' skills and education. And what the textbook implied was if you invest in the workers where the education was idiosyncratic to the firm, and it couldn't be used by other firms in the industry then all the benefits would accrue to the firm and none of it would accrue to the employee. Industry-wide skills were helping the worker and competitors within the industry. And then broad skills, if you paid for an MBA for your worker and then he could go work anywhere and take those skills elsewhere, that was just a waste of money unless he stayed, and you could benefit from those additional skills.
Society has a different objective. We want to invest in skill building for employees. That's a social goal and limiting it to the idiosyncratic skills of the individual firm is too narrow. And as a result, we want the ability for the worker and the employer to contract in a way so that we can deal with either industry or life skills and pay back to the employer in case you wanted to leave. And this is what that non-compete agreement basically is. It's skill building and this FTC prohibition prevents those contracts. How do you think about answering a microeconomic labor management issue between employer and worker and how this FTC rule in its broadness prevents contractual relationships that would allow for investing in workers?
Mike Wexler:
Great question because I was somewhat shocked when I participated in this Brookings Institution panel. The former interim labor secretary believed that the rule was a good thing because by not having non-competes, would give more power to the worker to quit, and the employer couldn't control the worker. He also noted in the same breath that giving employees the ability to quit would also increase union participation, which would give more power to the worker. And I said, that's a completely political agenda that doesn't do anything with protecting the workers or protecting employers.
There's a complete lack of recognition for the practical side of what goes on for someone that starts a business and invests in workers, invests in a product or a service, right? And if I don't have a non-compete and I can't protect myself that what I've created or what I've invested in the worker, then I have nothing.
If they can simply leave and go next door and open their own business that competes with me or turns around and goes to a competitor and can use the training that you gave them or use your confidential proprietary information.
You need non-competes to protect the small business owner or even large businesses who invest in creating something.
Larry Bernstein:
Tell us about narrowly tailoring non-competes to meet legitimate business interests.
Mike Wexler:
And that's the exact point. A narrowly tailored non-compete can be highly effective and be perfectly fair to the employer and to the employee. Go work at a competitor but just don't hold this role or don't go to these customers or don't work on this product. Those are neatly tailored. You look at case law throughout the United States, those are typically enforced.
Larry Bernstein:
How is this going to play out?
Michael Wexler:
My prediction is that the district court in Texas will most likely issue an injunction staying the FTC rule. That should come out around July 3rd based upon the briefing schedule that's currently in place. That injunction, I suspect, would be far reaching. I don't think it would be limited to strictly Texas citizens. The district court will have to rule on a motion for summary judgment whether the FTC has authority to do this. Is the rule, arbitrary and capricious. At that point, I think the case is generally over. This isn't a case where there's going to be depositions and evidence. The issue here is the rule. This is a matter of law.
Larry Bernstein:
You would place a very high probability that this rule will never be implemented, and the FTC must have known this. What's going on here?
Mike Wexler:
I think there's political motivations. This might be an issue that this administration may find attractive to its base.
I think as a sideshow, I think it's a bone to the far left. They got a bone, maybe they then come out and vote in the election.
Larry Bernstein:
Michael, I end each podcast with a note of optimism. What are you optimistic about as it relates to employment contracts, non-competition agreements and training and investing in employees?
Mike Wexler:
I'm optimistic that what's going to come out of this is the FTC will be told that they don't have authority to do this. I'm optimistic that you'll see more states have more limitations on non-competes so that the abuses that are being ascribed to the motivation for this rule are handled. That non-competes are tailored, that businesses can continue to invest in employees, invest in relationships with customers, invest in innovation, entrepreneurship, and that those business owners won't feel that their resources and time are being wasted because someone can just leave that investment and take it next door. And we continue to protect the backbone of America, which is innovation, training workers, investing in products, services, and customers. So hopefully that's what comes out of this.
—
Larry Bernstein:
Josh, Lina Khan is the Chair of the Federal Trade Commission. What is her philosophy? What is she trying to accomplish and how does the ban on non-competition agreements fit within that philosophy?
Josh Soven:
Larry, the Chair of the FTC has a lot of objectives. This one fits into her core view that antitrust has moved too far away from bright line rules towards a case-by-case analysis. For the past 40 years, there's been a fair amount of bipartisan consensus to move antitrust towards a more effects-based analysis. The chair strongly disagrees with that. The chair thinks that antitrust should be driven by bright line rules and the non-compete ban that the commission issued really is the ultimate bright line rule that three individuals who were appointed by elected officials but themselves were not elected overnight declared a practice in the US economy, which is ubiquitous as unlawful across the board.
There are a few exceptions. What she did is said, look, I think that the right way to do this is just to have a flat prohibition and to the extent that that impedes a few non-competes, which are pro-competitive, I'm willing to incur that risk. So, her approach, which is reflected in that rule is we want to clear no exceptions bright line rule, and this is the ultimate example of that so far.
Larry Bernstein:
Why does Lina Khan think that the labor markets are uncompetitive?
Josh Soven:
The chair certainly believes that many markets, including the labor markets, are far less competitive than people have thought.
Larry Bernstein:
When we studied in college the question of labor relative to management power, we looked at examples where employers did have power and it was usually like a one town mill. Each of us has been employed in large MSAs, I've been employed globally. The thought that an employer could somehow dictate terms seems ridiculous on its face.
Josh Soven:
You're exactly right that the one mill town is long gone from the American landscape. So that's not usually the analysis. Rather the analysis is whether the merging parties somehow have a specialized service for which a limited number of employees can provide those services and that the combination of the parties will therefore reduce competition for employees with those capabilities. So, it's very common, for example, in mergers in the healthcare markets to see if the combination will result in a reduction in competition for a certain type of physician or nurses or things like that.
Larry Bernstein:
The most important legal issue associated with this new non-competition rule is whether the FTC has the authority to make this rule. Josh, you worked for the Federal Trade Commission, you were an assistant to one of the commissioners as one of your first jobs. What do you think the perception was in the FTC when you were working there?
Josh Soven:
If you were to poll the large number of people who have worked at the commission over the years, the majority would say that the commission does not have this power to ban non-competes across the board. All of that is TBD that is being litigated in the courts in Texas. Presumably it will make it to the Fifth Circuit, and it may well make it to the Supreme Court. I don't know how that will turn out. We'll see.
Larry Bernstein:
And so how will the court evaluate that value judgment?
Josh Soven:
I think that's a great question. You've had speakers in your book groups before who've sort of opined on how judges think, right?
Larry Bernstein:
Judge Posner specifically.
Josh Soven:
Judges will do their best to follow the law. I think where there is ambiguity, these broader policy issues can sometimes affect how judges come out when things are a close call. And so, to the extent that a judge thinks, well look, this is not consistent with the overarching legal system that may affect how she or he resolves what is a close question of legal doctrine.
So that even if the rule is struck down, I do think it will cause employers to be more judicious in the use of non-competes to reevaluate their non-competes to decide whether on balance is worth it given litigation risks, even in a world without the rule. And the effects of that are to be determined. It may be pro-competitive; it may not be if you're chilling pro-competitive contracts because of worries about litigation.
Larry Bernstein:
Winning by losing. This seems to be in the Lina Khan playbook.
Josh Soven:
Definitely. I mean there's a lot of examples. Long before Lina Khan became the chair of the FTC of legal strategies attempting to win by losing that, by raising an issue to a certain level of prominence, that even if the proponents of that issue lost in round one, there are certainly historical examples of them winning in rounds two and three with significant changes on legal policy and broader political policy.
Larry Bernstein:
Imagine you're running a business and you've got trade secrets and confidential information and you've relied on non-competes to structure your business. It could have been structured in different ways. You could not have disclosed this very important information to the employee, and you relied on it. You could have used deferred compensation that would be lost if they joined a competitor in lieu of relying on the non-compete. There are a lot of ways to have structured your business to achieve the same objectives. But by doing something with immediate action, this really throws a wrench on the private markets. How should we think about how employers should react to something like this?
Josh Soven:
It won't surprise you that the phones of antitrust lawyers and employment lawyers have been bringing off the hook since the rule came out asking exactly that question about what to do. We think about it in steps. One, there's a pretty high probability that the implementation of the rule will be stayed pending litigation. Given the prominence of the issue that has been created by the rule and the Chair's prior comments about non-competes, it is worth assessing whether non-competes that are in contracts today are worth it.
I think there will be some modifications to non-competes because of this, but a large majority of them, particularly for businesses that are heavily IP dependent and trade secret dependent will stay in place.
Larry Bernstein:
Why is this a partisan issue?
Josh Soven:
I'm not sure it is a partisan issue.
Larry Bernstein:
Why is it three, two all Democrats versus all Republicans?
Josh Soven:
If you look at the statements by the two Republican commissioners, they were not defending non-competes across the board and saying there can never be any anti-competitive effects from the use of non-competes. Rather, they were making two arguments, one that they were uncertain that the commission had this authority in the first place. And so given that doubt, they thought it was not worth doing something, which obviously the agency wasn't authorized to do, but to the broader economic and a policy point, they were asserting what we've been talking about that it probably makes sense to limit or ban non-competes for certain types of positions in the market, but that a total ban is not efficient because in many instances, particularly employment positions that do involve IP, lots of training, lots of investment, where there'd be lots of free rider problems that non-competes are an efficient mechanism that result in higher levels of compensation to workers. So it's partisan in the sense in a one dimensional framework in that Republicans voted against and across the board rule. But in no sense were they saying that non-competes should be viewed as fine without any scrutiny or review.
Larry Bernstein:
I end each podcast with a note of optimism. Josh, what are you optimistic about as it relates to competitiveness in the labor markets.
Josh Soven:
I'm optimistic. My real-world experiences show that competition for talent in the legal community is increasing and will continue to increase. And that prior limitations, restrictions, and inhibitions and conventions that were restricting mobility of talent are going by the waysides and that we're in a world of where law firms, governments, companies will need to compete intensely to get the best talent to come work for them. That will produce challenges for everybody. It will produce disruptions. It will produce uncertainty and it will drive technology to be adopted sooner rather than later. It will improve working experiences and it will improve compensation. All of that will benefit the economy.
Larry Bernstein:
Next September is our 40th anniversary of being friends. Tell us about having friendships that last 40 years.
Josh Soven:
They are essential. They're life fulfilling. They cannot be replicated by anything else. They're incredibly valuable to have. They underscore what we've been talking about for 40 years that associations community relationships are how people are designed to behave. That we are not hermits, we are not isolationists, we're not designed to live by ourselves and it's an incredibly valuable thing.
Larry Bernstein:
I agree. Thanks Josh.
—
Larry Bernstein:
Thanks to Josh and Michael for joining us today.
If you missed last week’s podcast, check it out. The topic was Running a Presidential Campaign from Prison. This episode was about Eugene Debs who ran his 1920 presidential campaign from a Federal penitentiary in Atlanta.
Our speaker was Ernie Freeberg who is a Professor of American History at the University of Tennessee. Ernie is the author of a book entitled Democracy’s Prisoner: Eugene Debs, the Great War, and the Right to Dissent.
Ernie described the political trial that sent Debs to prison and why the Supreme Court endorsed Debs’s verdict that limited free speech during wartime. Debs was the Socialist nominee for President in the 1920 election and Debs found it difficult to present his political ideas to the public because of his prison warden’s restrictions. That said, Debs energized a million people to vote for him because of their outrage caused by his imprisonment.
I would like to make a plug for next week’s podcast about President Lincoln and immigration.
Our speaker will be Harold Holzer who won the Lincoln Prize for his book Lincoln and the Power of the Press. Harold has a new book entitled Brought Forth on This Continent: Abraham Lincoln and American Immigration. I want to learn from Harold why Lincoln encouraged more Europeans to move to the US. Many were Catholics from Ireland and Germany who were generally viewed as potential Democratic urban voters, and I want to find out how Lincoln persuaded many of these new citizens to switch their allegiance to the Republicans during the civil war.
You can find our previous episodes and transcripts on our website whathappensnextin6minutes.com. Please subscribe to our weekly emails and follow us on Apple Podcasts or Spotify. Thank you for joining us today, good-bye.
Check out our previous episode, Running a Presidential Campaign from Prison, here.
Enforcing Non-Competes