BOSTON -- Money management executives wondering whether a partnership's noncompete agreement is enforceable received a resounding answer last week.
A Massachusetts Superior Court judge ruled the noncompete provisions in the partnership agreement of Wellington Capital Management LLP of Boston were reasonable and enforceable.
He also ruled former partner Arnold Schneider was obligated to abide by the agreement.
It was a relief and a victory for Wellington partners Duncan McFarland, Robert Doran and John Ryan. They filed the lawsuit against Mr. Schneider, their former partner, after he left the firm in late 1996 and took $1.4 billion in Wellington business with him to his new firm.
A spokesman said Mr. Schneider will seek an appeal and is working on a stay to keep the former Wellington clients at Schneider Capital Management Inc., his new firm in Wayne, Pa. Without the Wellington clients, Schneider Capital would manage $300 million.
The public bickering -- unusual for a publicity-averse firm like Wellington -- has been watched closely by investment management professionals nationwide as a test of the enforceability of non-competition agreements.
Firms that don't have noncompete clauses in their partnership agreements might be compelled now to consider them, said Michael Martinolich, president of Tennyson Advisors, a New York recruitment firm.
The situation at Wellington began in mid-1996 when the other partners rejected a bid by Mr. Schneider for more autonomy. Mr. Schneider, who worked in the Philadelphia office, was expelled as a partner in December of that year. Three of his eight Wellington clients quickly moved their accounts to Schneider Capital.
The Wellington partners filed an injunction to prevent Mr. Schneider from accepting any more Wellington accounts, and the case went to trial last spring.
At the heart of the controversy was the portion of the partnership agreement that forbids partners from soliciting Wellington clients for five years after leaving the firm.
Middlesex Superior Court Judge James McHugh ruled Mr. Schneider had disregarded this obligation and that he must now terminate his relationship with the former Wellington clients within 90 days. They are: Frank Russell Co., Tacoma, Wash.; Utah State Retirement Systems, Salt Lake City; and RJR Nabisco Inc., New York.
Judge vs. clients
The former Wellington clients had argued they were free to choose Schneider Capital as their manager. The judge's decision questions that argument.
"I am not persuaded that Russell, Utah Retirement and RJR would have left Wellington if Mr. Schneider had announced to them that he was unavailable to manage their money following his departure," the judge concluded in his Feb. 18 judgment.
The judge ruled that Mr. Schneider structured things in a way that encouraged clients and staff to follow him, yet still allowed him to say he had not solicited them.
"The fact that solicitations occurred in the form of responses to questions the clients raised does not make Mr. Schneider's ostensibly reactive overtures any less solicitous," the judge wrote.
The judgment states the clients Mr. Schneider took with him didn't check to see if he was bound by a Wellington agreement. And Wellington officials, while offering the client an alternative Wellington manager, neglected to tell the client Mr. Schneider would be prohibited from managing their money if he started a new firm, according to court records.
Mr. Schneider discussed the possibility with some potential clients, but said he didn't think the Wellington agreement would be enforced, according to court documents.
Small Schneider victories
There were, however, a couple of small victories for Schneider Capital.
First, the decision does not require Schneider Capital to close. One portion of the partnership's noncompete agreement restricts a departing partner from starting a competing firm or from taking Wellington staff, both of which Mr. Schneider did.
Freed from the threat of closure, Schneider Capital now can enter manager searches, improve contacts with consultants and build its assets under management, said Schneider Capital spokesman John Conlin.
The judge also addressed the three financial adjustments the Wellington partners had made to Mr. Schneider's compensation after his departure.
Mr. Schneider was paid $474,794 in incentive compensation for the first six months of 1996, but was not paid the estimated $481,449 he was supposed to get for the last six months of 1996, during which time he worked as a portfolio manager. The judge ordered Mr. Schneider be paid what he "would have received had he remained a partner" through Dec. 5, 1996, plus 12% interest per year from the date the payment would have been made until the date the payment is made.
The partners also had decided Mr. Schneider was not entitled to a 10-year series of payments as outlined in his partnership agreement. The judge ordered Wellington to make those payments when Mr. Schneider stops managing assets for former Wellington clients.
In addition, the managing partners had reduced his allocation for profit sharing, or merit pay, for 1996. It was $730,000 in 1995; they decided it would be zero in 1996. The judge ruled that was reasonable.
Mr. Schneider joined Wellington after he graduated college in 1983, working as an analyst. He was elected a partner in 1991.
The judge's ruling states Mr. Schneider understood the non-competition agreements, but at the time "was concerned with advancing his own career at Wellington, had no plans to leave and wasn't concerned about the restrictions."
Mr. Schneider received more than $1 million in total compensation in 1993. In 1995, he received total distributions from Wellington of nearly $1.5 million; $730,224 was his allocation of profit sharing, $100,000 was his draw and $633,775 was his incentive compensation.
But distance, apparently, was a factor.
Mr. Schneider always worked in Wellington's small Philadelphia office, never in the Boston headquarters, and therefore he "felt no real connection" to the Boston operation, according to the judge's decision.
"He was, by his own account, not very good at keeping those in Boston informed of what he was doing," the judge wrote, "or at helping his clients maintain a relationship to Wellington partners and employees other than himself."
Mr. Schneider's relations with Mr. Ryan, his contemporary and the only other partner who worked in the Philadelphia office, "were not warm and never had been . . . colored more by competition than by collegiality," the judge wrote. "As a consequence, Mr. Schneider and his team of analysts worked largely in isolation."
Mr. Schneider began to believe he could provide the same quality service to clients on his own, and that conviction began to dominate his outlook, according to the judge.
Wellington officials first had an inkling of trouble in June 1996, when Mr. Schneider proposed a new affiliation between himself and Wellington. The arrangement would have given Mr. Schneider access to Wellington's information and facilities, but he would not have to follow Wellington's trading policies. Mr. Schneider said the firm's policies were affecting his performance.
Wellington partners turned down the proposition in July, saying they were willing to explore other assignments for him. Two days after the meeting, Mr. Schneider resigned, effective at the end of 1996.
Mr. Schneider told one of the partners "that many of his clients were likely to leave Wellington after his departure, and that it therefore made business sense both for him and for Wellington to work out some kind of revenue-sharing plan so that, if clients joined him, Wellington would not be completely deprived of revenues," according to court documents.
Mr. Schneider told the partners then and for months following that he had no concrete plans or clear focus for his future plans, according to the documents. But even before his resignation, Mr. Schneider had begun preparations for a new venture, the judge wrote. Mr. Schneider had contacted a head hunter to find a marketing person, had interviewed potential marketing directors, had contacted a candidate for a back office position and had looked at office space.
In addition, Mr. Schneider visited the representatives of Russell and Utah Retirement, with whom he shared his specific plans of starting his own firm.
"Mr. Schneider had never been a team player and thus he had not acquainted his (clients) with others at Wellington with whom he worked and upon whose efforts he depended for at least some of his success," the judge wrote.
Mr. Schneider regarded the non-competition agreements "as potential obstacles to be overcome en route to his chosen objective, rather than as solemn undertakings surrounded by fiduciary obligations," the judge said.
Little by little, Wellington partners began to learn of Mr. Schneider's plans. According to court documents, Mr. Schneider told Mr. McFarland he thought the non-competition agreements were invalid and not enforceable. Mr. McFarland strongly disagreed.
"Mr. Schneider said that there was really no need to discuss the issue further because he believed it would be immoral to pick off clients and he had no intention of doing so," the judge stated.
"When he made that statement, however, he fully intended to take with him to his new firm at least Russell, Utah Retirement System and any others willing to come."
Court documents state that when Wellington management asked Mr. Schneider to recommend someone on his team to take his place at the end of the year, Mr. Schneider would not express an opinion nor would he recommend his team be retained. Consequently, Wellington notified all of Mr. Schneider's team they would be terminated when Mr. Schneider left at the end of the year. Mr. Schneider hired most of them for his new firm.
By October, Mr. Schneider had office space, analysts, a senior trader, a back-office manager and trading arrangements with other firms, while continuing to tell Wellington partners his plans for the future were uncertain.
By November, Mr. Schneider was called to Boston for a meeting with Mr. McFarland, Mr. Doran and Mr. Ryan. Mr. Schneider would not agree that he not accept business from Wellington clients for five years. He told the partners he didn't need a waiver to accept business from clients who were going to leave Wellington anyway.
On Dec. 3, there was a meeting of all Wellington partners to consider removing Mr. Schneider as a partner. The vote was 47-5 in favor of expelling him unless he signed a waiver agreeing, by 10 a.m. the next day, not to solicit clients. In return for his agreement, the partners would relieve him from other prohibitions in his contract and not challenge his right to start a competing business or hire the departing Wellington employees.
Mr. Schneider was present, spoke for about 15 minutes, and voted.
Mr. Schneider called Mr. McFarland that next morning saying he would not accept the terms of the letter.
He was expelled at 10 a.m. that day.