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Due Diligence Matters – May 2024

perfORM is an award-winning, international (UK, Switzerland, USA) and standalone Operational Due Diligence solutions provider with 100+ years of collective ODD experience.

Please contact us for more information or to receive sample ODD Reports. Over 150 operational due diligence reviews were completed in 2023.

We have now launched our Due Diligence Clinic and encourage Allocators, Investment Managers and Services providers to book in a virtual (and confidential) appointment (no fees applied) with one of our experienced practitioners, to discuss due diligence related challenges or questions.

Missed the last e-bulletin? Click here for the April 2024 edition.

Non-compete ban: Good or bad?

On 23 April the US Federal Trade Commission (“FTC”) voted to ban non-compete agreements (“NCAs”) in a bid to unshackle approximately 30m US workers currently contractually prevented from working for a competitor or setting up on their own for a period of time after leaving their job. The FTC believes this will improve competition and fire up start-ups.

The response from industry groups has been broadly unsupportive, resulting in legal challenges. Indeed, the alternative investment industry’s representative bodies, AIMA and MFA oppose the ban. In the UK (which is not subject to the FTC’s ruling), government research puts the number of workers subject to NCAs at a third. The UK government announced in May 2023 that it would limit the duration of NCAs to three months post-employment; however, there is no sign of any change to current legislation at present.

In terms of other stakeholders, it is likely that the larger, more well-resourced investment managers will also oppose the ban, for fear of expediting the loss of key staff with valuable proprietary information/system knowledge to competitors or to their own competitive start-ups. Smaller managers may benefit from no longer having to buy out a prospective employee’s previous contract and may be able to offer other lifestyle benefits that are more flexible. In any event, firms will need to turn to confidentiality agreements and/or non-solicitation agreements limited to ‘post’ event protections rather than an NCA’s ability to stop breaches in the first place. Interestingly, traditional banks are not subject to the FTC’s ruling, which could hinder their ability to attract senior hires, if they continue to impose NCAs on new staff.

The other major group of stakeholders is investors – pension funds, endowments, fund of funds, etc. Are the changes positive or negative for them?

Discussions with some of our key clients revealed the following: 

  • There is concern that what an institutional investor is “buying” – the people, the skill, the  proprietary information – is key, and they need to be convinced that key people are not going to be moving on and thus changing the whole investment proposition. However, as one investor put it, “[NCAs are] legally very difficult to enforce so they become a bit of a nonsense” and “should only be used for personnel who can seriously impact the business”.
  • The ban on NCAs could have the unintended consequence of firms withholding proprietary information from key staff, and potentially a negative knock-on effect on fund performance, staff morale and loyalty – all to the detriment of investors.
  • The banning of NCAs is likely to increase staff turnover without alternative ways to retain staff.
  • NCAs are a kind of handcuff but investors acknowledge that there are other ways to protect their interests, such as key staff co-investing in funds, policies to avoid over-reliance on one portfolio manager and succession planning.
  • It is hard to predict the impact of an NCA ban on fund launches. There are a number of factors that influence launches, including regulatory burden, availability of capital, investor risk appetite, market cycles, etc. According to research by the MFA, often it is the employee’s former employer that seeds the new fund launch and so without this capital/support launches may be adversely impacted.

Assuming the rule comes into effect in September, as currently scheduled, we anticipate that law firms will find inventive ways to re-write contracts to allow for some kind of protection. Training could be introduced, as part of compliance and conduct, to reinforce employees’ awareness of what can and cannot be used and taken when leaving a firm. Alternatively, or additionally, firms may limit the dissemination of proprietary information to very few staff.

One risk is an increase in staff turnover and the kind of revolving door that used to be common at investment banks. Key person risk is a significant consideration in any investment or operational due diligence review, and managers will need to come up with solutions to protect themselves from an increase in staff turnover.

ODD Report Solution

Our ODD Report Solution is not just another tick in a box, it is an innovative approach to operational due diligence. A pragmatic solution for Investment Managers and Service Providers which engage us to complete an ODD review.

  • Investment Manager: Hyperion Decimus, LLC – please contact here to request access to our March 2024 dated ODD Report
  • Investment Manager: Coral Cove Capital Ltd – please contact here to request access to our January 2024 dated ODD Report
  • Investment Manager: MARK Capital Management LP – please contact here to request access to our November 2023 dated ODD Report
  • Investment Manager: Wincent Capital Management Limited – please contact here to request access to our September 2023 dated ODD Report
  • Investment Manager: Hivemind Capital Partners UK LLP – please contact here to request access to our September 2023 dated ODD Report
  • Investment Manager: Old Street Digital Limited – please contact here to request access to our April 2023 dated ODD Report
  • Digital Asset Service Provider: Copper Technologies (Switzerland) AG – please contact here to request access to our March 2023 dated ODD Report [undergoing annual renewal review process]