The FTC’s Noncompete Ban Was Long Overdue

The Federal Trade Commission (FTC) made history last week when it passed a new rule that fundamentally alters the landscape of employment agreements across the U.S. The agency’s noncompete rule adopts a comprehensive prohibition on the use of noncompete clauses in any industry with any worker, including those at senior executive levels. The rule is promulgated using the FTC’s authority to determine practices that are unfair methods of competition. For those like me who have long argued against the use of noncompetes, this moment has been a long time coming.

In 2016, I was part of President Obama’s team when his administration issued a call to action urging states to curtail the expansion of noncompete clauses, recognizing growing empirical evidence that noncompetes — terms or conditions of employment that prohibit a worker from seeking or accepting work for a certain period of time with a competitor or starting their own business after leaving their employer — are harmful not only to employees but to the economy at large.

Since then, I have been among the voices calling on the FTC to act on noncompetes and advising the Biden administration to give the FTC the authority to promulgate a national ban. This has been driven by my work as a law professor and labor policy expert, and my research-backed belief that noncompetes harm both workers and businesses.

Now that we’re here, questions still loom, as there are already challenges in court to block the FTC’s action. But company leaders would be well advised to understand what’s in the rule, its potential impact, and what it could mean for employees. Far from being an anti-business rule, the new FTC ban on noncompetes stands to actually spur innovation and grow markets. Employers should plan for a new landscape in which only true trade secrets are protected, while talent and creativity remain freely mobile.

What’s in the FTC’s Action

The FTC’s rule is broad in several ways. “Worker” is defined not just as an employee but also includes independent contractors, externs, interns, volunteers, apprentices, or a sole proprietor who provides a service. The rule also broadly defines noncompete clauses not only as terms or conditions of employment that explicitly prohibit a worker from competing with a former employer, but also to mean any other clauses that “penalize a worker for” or “function to prevent a worker from” competing. With this definition, the FTC also prohibits clauses that operate as de facto noncompetes, including overly broad NDAs, nonsolicitation clauses, and TRAPs — training repayment agreement provisions.

For example, if an NDA includes any information that “relates to” the industry, or bars the use of any information the worker obtained during their employment, including publicly available information, such agreements are so broad and beyond the definition of a trade secret that they are the functional equivalents of noncompetes.

The final rule does create a carveout for existing noncompete agreements with senior executives — those earning over $151,164 who occupy policy-making positions, a demographic constituting less than 1% of the workforce — that are permitted to remain effective. All other noncompetes with workers will become unenforceable when and if the rule takes effect. The rule should go into effect 120 days following its publication in the Federal Register.

Examining the Case Against Noncompetes

Banning noncompetes not just good for workers, it is good for business. As I argued in Talent Wants to be Free: Why We Should Learn to Love Leaks, Raids, and Free-Riding, a competitive labor market, just like a competitive product market, is an engine for innovation, investment, and economic growth. By curbing the enforceability of noncompetes, the FTC anticipates — based on research — several significant benefits. For wages, the removal of noncompete constraints is projected to boost worker earnings, with estimates suggesting an increase ranging from $400 billion to $488 billion over the next decade. The FTC has state-by-state modeling that projects that the average worker could see an annual wage increase of approximately $524.

This wage effect happens because when workers are free to move among competitors, and new employers are free to recruit and offer positions to their competitor’s employees, talent receives its market value. Employers dynamically recruit and retain by competing over the best workers through better terms and conditions of employment. Competition over employees raises salaries just as competition over consumers lower prices.

For market innovation, the new rule is projected to spur an increase in patent filings, as well as patent value, estimated at between 17,000 to 29,000 additional patents annually, reflecting an 11-19% yearly growth over a 10-year period. For a vibrant entrepreneurial economy, the rule is expected to encourage startup activity, potentially leading to a 2.7% rise in new business formation, equating to around 8,500 new enterprises each year.

The health care industry is projected to see a reduction in costs by an estimated $74 billion to $194 billion. According to the American Medical Association, between 37% and 45% of physicians have signed noncompetes. Noncompetes concentrate markets and have contributed to health care market consolidation and the rise of health care prices. A national ban on noncompetes is poised to improve patient access, continuity of care, and allow physicians to work for multiple hospitals.

Empirical studies provide compelling evidence that talent mobility, especially at the higher echelons of management, plays a critical role in fostering an innovative environment. This relationship can be understood through several key dynamics. Fostering talent mobility is not just about filling leadership roles but is also a strategic innovation lever. The unimpeded ability to bring in new talent brings fresh perspectives, less constrained by the status quo or groupthink that hinder creative breakthroughs. Talent mobility means richer experiences from different corporate cultures and industries, giving employees insights and an edge that can inspire new ideas and drive change more effectively than long-tenured workers.

Moreover, when employees have the freedom to move within an industry, they have more of an incentive to build their human capital and develop their skills. Noncompetes reduce employee motivation, entrepreneurship and sharing of knowledge, fundamental elements of innovation.

In turn, mobility strengthens professional networks across organizations and sectors. These networks bring in new ideas, accessing cutting-edge research, and implementing best practices from the industry at large. And when employers cannot confine workers by threat of noncompetes, new carrots rise as an alternative to the sticks of restrictive covenants: Employers use more performance-based incentives, active retention efforts, and stock options to encourage the best employees to stay. All of these effects together operate to create a more productive, competitive, and innovative ecosystem.

Until now, the enforceability of noncompetes has been determined by the states, and there is a natural experiment that has brought a wealth of research insights, documenting the effects of noncompetes on market dynamism. California and Massachusetts are often cited as the paradigmatic natural experiment, as California has always banned noncompetes, while Massachusetts has long enforced them, though since 2018 are limiting their reach with a new law. California’s Silicon Valley benefited from the nonenforcement of noncompetes in fueling its startup culture, drawing more talent from out-of-state,

The empirical evidence, gathered from diverse methodologies including longitudinal and comparative regional studies, has helped bring a consensus among scholars and policymakers on the significance of ensuring that the labor market remains competitive. To that end, the FTC received more than 26,000 comments on the proposed rule (I submitted two), with over 25,000 of the comments supporting the rule. In terms of wider U.S. public opinion, an Ipsos survey in 2023 found that most Americans supported banning noncompetes.

What Happens Next

The FTC final rule was approved in a 3-2 vote and is already facing legal challenges in federal court. As of April 29, at least three lawsuits have been filed, from the U.S. Chamber of Commerce, and other business groups. The challenges include, in part, that the FTC lacks authority to promulgate such a rule, or any rulemaking authority altogether, that the rule is arbitrary and capricious, and that it fails the favorite new doctrine of the current Supreme Court, the major questions doctrine. Many predict that under the current court climate, the challenges have a good chance to lead to the striking down of the rule. Ever the optimist, I remain hopeful that the robust record of empirical evidence about the benefits of the rule will be heard. But if facts don’t sway the court, then the action to protect talent mobility will continue to be the purview of the states, and congress could pass a law that statutorily bans noncompetes. Last year, I drafted a bill to strengthen California’s longstanding public policy that voids all noncompetes, signed into law by Governor Gavin Newsom. Other states have recently moved closer to California’s policy, providing further support to the natural experiment that a ban on noncompetes boosts market dynamism.

During this period of uncertainty, businesses should take a page out of the California playbook: Be the best employer possible, use affirmative steps to attract and retain the best talent, and take a hard look at what it is that is truly secret in your innovation landscape. Trade secrets still need to be protected, and taking the right steps to identify and secure this information, training one’s employees on how to protect proprietary information, and conducting exit interviews to remind departing employees of their continued duty to not disclose secrets, are fundamental practices that companies should adopt. Still, keep in mind that NDAs and other restrictive covenants cannot be so broad as to prevent competition by former employees.

The FTC’s new rule also emphasizes that — like all restrictive covenants — non-solicitation agreements, no-hire, and no-business agreements are subject to the general prohibition of unfair methods of competition under Section 5 of the Federal Trade Commission Act, which prohibits “unfair or deceptive acts of practices in or affecting commerce,” regardless of whether the final rule becomes the law of the land. Companies should therefore continue to protect their intellectual property through exercising reasonable measures to protect their secrets and informing their employees about the need to keep certain sensitive information confidential. Companies can continue to use the patent system to protect innovation. They may also continue to use non-disclosure agreements as long as those do not attempt to overclaim what is confidential.

Intellectual property laws — patents, copyright, trademarks, and trade secrecy — balance the protection of inventions and creativity with the free flow of ideas. The best businesses are already realizing that rather than deny the mounting evidence about the harms of noncompetes, they can lead the way in embracing a competitive talent market. With the new rule, companies must move forward by attracting talent and fueling innovation rather than preventing mobility. Entire industries will benefit.

Copyright 2024 Harvard Business School Publishing Corporation. Distributed by The New York Times Syndicate.

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