• Paul Peter Nicolai

Confidentiality Obligations Wiped Out by Non-Compete Restrictions

Most of those aware of California employment law know that non-compete clauses prohibiting employees from working for competitors after employment are unenforceable. Less understood is that the definition of “Confidential Information” or “Proprietary Information” in employment agreements can mean a complete loss of confidentiality and trade secret protection. In a recent case, the employee signed a confidentiality agreement that said confidential information was “information in whatever form used or usable in or originated, developed, or acquired for use in, or about or relating to the Business”. “Business” meant “analyzing, executing, trading and/or hedging in securities and financial instruments and derivatives thereon, securities-related research, and trade processing and related administration.” The court said this definition was strikingly broad and would, if enforced, effectively prevent the employee from trading in securities at all, even for himself, for the remainder of his life. The agreement contained two of the usual standard confidentiality exceptions. They made matters worse for the employer.

The first exception was for information which is or becomes generally known in the securities industry through legal means without fault by the employee. This exception is worthless to one desiring to work in statistical arbitrage because statistical arbitrage is profitable only if the variables and methods behind it are not generally known. In other words, the employee would be unable to work profitably in statistical arbitrage if restricted to using only securities-related information that is generally known. The second exception was information which was known by the employee on a non-confidential before his initial engagement or employment by the employer, as evidenced by the employee’s written records. In other words, securities-related information that was not confidential before his employment becomes the employer’s confidential information unless the employee has written records proving his prior knowledge of the information. The court said these confidentiality provisions patently violated the law and were void. They operated as a de facto noncompete provision. They plainly barred the employee in perpetuity from doing any work in the securities field, much less in his chosen profession of statistical arbitrage. The fact the employee had actually misappropriated confidential information and lied about it was of no relevance. The confidentiality obligation the employee had breached was void and unenforceable.

The lessons of this case become more important outside of California with the imposition of new restrictions on noncompete agreements in places like Massachusetts. It now requires that any post-employment non-competition requirement be compensated by payment of post-employment salary and be limited in term.

If a court were to decide that a confidentiality provision was, in fact, a substitute for a non-competition requirement because its terms were such that the employee could not compete, an employer could find itself in the same situation as this California employer.

You have to be careful to draft confidentiality agreements that preserve an employee’s right to complete post-termination.

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