Thursday, October 22, 2009

Defection At Citadel's High-Frequency Trading Unit Warrants Injunction - To A Degree (Citadel Investment Group v. Teza Tech.)

One of the most high-profile non-compete disputes in the Chicago area has resulted in a victory for Citadel Investment Group and a set-back for two executives who defected to start their own high-frequency trading firm.

In a 36-page memorandum opinion and order Judge Mary K. Rochford enjoined Mikhail Malyshev and Jace Kohlmeier from violating non-compete restrictions contained in their Citadel employment agreements for the balance of the nine-month term. Effectively, this means that both Malyshev and Kohlmeier may be free to compete as soon as February of 2010, since the court refused to extend the non-compete term on an equitable basis for the period in which the defendants were in breach.

The case involves a shadowy, but highly profitable business known as high-frequency trading (HFT). In essence, HFT relies on powerful computers to enter trade orders (often without human intervention), with algorithms deciding on specific aspects of the trade such as how much to buy, when, and at what price. HFT is a relatively new phenomenon, but it yields enormous profits. A disproportionate amount of equity trading volume is conducted by HFT firms.

Citadel itself invested heavily in HFT. It paid off - Citadel's HFT unit reaped earnings of $1.15 billion in 2008. Malyshev and Kohlmeier were instrumental, key employees for Citadel's HFT group. Neither had HFT experience prior to joining Citadel. For quite some time, each considered leaving to start his own proprietary trading firm. And each had a non-compete agreement, barring employment with a "Competitive Enterprise" for a period to be selected by Citadel upon departure, ranging from 0 to 9 months.

Upon their departure, Citadel elected the maximum 9-month period and paid Malyshev and Kohlmeier to sit on the sidelines. No surprise, there, given their access to proprietary information and involvement in recruiting R&D talent to Citadel. However, both ex-employees formed Teza Technologies and hired 15 employees, essentially daring Citadel to file suit.

It did.

Citadel pursued each aggressively and sought preliminary injunctive relief. The court dispatched with a number of the arguments raised by the defense. Given that one of the defendants deleted a fair amount of Citadel information (despite a court order not to do so), the court really did not have to address whether a legitimate business interest supported the non-compete. The adverse inference it could draw about the document deletion was more than enough to demonstrate the defendants had access to and attempted to use Citadel's confidential information.

The defendants also seemed to challenge the non-compete due to the fact that they really weren't actively trading, but merely preparing the firm's trading infrastructure to compete eventually. However, nothing in the non-compete allowed the defendants to wash their hands of liability based on this "preparing to compete" theory, and the theory itself ignored the fact that HFT firms depend heavily on building infrastructure. By getting a headstart in developing a trading platform, the defendants were essentially entering the market much faster than they agreed to under their employment contracts.

The most important feature of the decision, though, concerned the length of the injunction. And it is here where the defendants probably were able to take some solace in defeat. The court refused to extend, or equitably toll, the non-compete period for the time in which the defendants were in breach. The court looked at the Second District Appellate Court's decision from two years ago to hold that, under Illinois law, a contract must specifically provide for an equitable tolling, or extension, remedy. Otherwise, the court will not imply the term under the contract.

This, of course, does nothing to mitigate the defendants' damages during the non-compete period. But it does serve as a cautionary tale for counsel in drafting non-compete clauses. Unless an equitable tolling remedy is clearly contained in the contract, the court will not agree to extend it even if the defendants were in breach leading up to the injunction order.

UPDATE X1: Both parties have filed a notice of appeal with the Circuit Court.


Court: Circuit Court of Cook County, Chancery Division
Opinion Date: 10/16/09
Cite: Citadel Investment Group, LLC v. Teza Technologies, LLC, 09 CH 22478 (Cook Cty. 2009)
Favors: Employer
Law: Illinois


  1. "The adverse inference it could draw ..." The request for an adverse inference was denied, wasn't it?

  2. No. It wasn't specifically addressed in the memorandum order.

  3. Do you have a copy of the Judge's order that you can post? I believe Citadel has appealed the Order, I suspect to obtain a tolling of the non-compete period in the absence of tolling language in the agreement.