Citadel Investment Group, LLC v. Teza Technologies LLC

Citations: 924 N.E.2d 95; 398 Ill. App. 3d 724Docket: 1-09-2828

Court: Appellate Court of Illinois; February 24, 2010; Illinois; State Appellate Court

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Citadel Investment Group, LLC appealed an interlocutory order from the circuit court, which granted preliminary injunctive relief with limited duration against defendants Mikhail Malyshev, Jace Kohlmeier, and Teza Technologies, LLC. Citadel sought a longer injunction. The defendants cross-appealed, arguing that the circuit court erred in not dismissing the case and in issuing the injunction, claiming it restricted their ability to compete and misinterpreted noncompetition agreements in a way that contravenes public policy. The Appellate Court affirmed the circuit court's decision.

Citadel, founded in 1990 by Ken Griffin and based in Chicago, is a financial services firm with about 1,300 employees, 1,000 of whom are in Chicago. It specializes in alternative investment management, managing approximately $14 billion in capital. Citadel's activities include traditional investments and quantitative strategies such as options market making, volatility arbitrage, statistical arbitrage, and high-frequency trading (HFT). The firm was a pioneer in HFT, developing its capabilities over seven years of prior statistical arbitrage work. Establishing a successful HFT business necessitates recruiting talent, building market data systems, developing trading signals, and creating robust trading engines, all of which are critical to maintaining a competitive edge. Citadel has amassed extensive historical market data, equivalent to around 100 times the Library of Congress, which requires sophisticated coding and organization to utilize effectively.

Market data replayers enable the testing of trading signals, or 'alphas,' against historical market data, a tool developed by Citadel for its high-frequency trading operations. Citadel employs a mix of signals in its trading strategies and has created trading engines to analyze real-time market data for executing buy and sell orders. The development of Citadel's high-frequency business involved close collaboration between teams focusing on signal development and those handling information technology and trading infrastructure from 2004 to 2009.

Malyshev, who joined Citadel's high-frequency group in 2003 without prior trading experience but with a Ph.D. in plasma physics, managed all facets of the high-frequency operations, including IT infrastructure. Kohlmeier, who began in the finance technology associates program in 2002 and joined the high-frequency group in 2004, reported to Malyshev until his resignation in 2009. Kohlmeier was responsible for ensuring effective trading of the alphas and contributed to the development of the Phase Zero HFE System, Citadel's first order entry system for high-frequency trading, which was adapted from existing systems used for trading Korean options.

Despite its initial implementation, the Phase Zero system incurred losses and was subsequently deactivated. Malyshev also played a vital role in establishing the necessary infrastructure for Citadel's high-frequency trading platform, actively participating in meetings to guide its development. To safeguard its high-frequency trading operations, Citadel implemented stringent physical and electronic security measures, including restricted access, surveillance, and robust encryption protocols for sensitive systems and data.

Access to high-frequency source code at Citadel was restricted and granted only on a need-to-know basis. Citadel implemented various employment agreements to safeguard its confidential information, requiring all employees in the high-frequency trading group to sign noncompetition agreements during their tenure. They also had to sign nonsolicitation and nondisclosure agreements to protect the company's business interests. Employees Malyshev and Kohlmeier were specifically mandated to sign these agreements, along with a partnership agreement. Malyshev signed his noncompetition agreement on August 3, 2004, and his nondisclosure agreement on January 21, 2004; Kohlmeier signed his noncompetition and nondisclosure agreements on April 13, 2005. Both executed the 'Citadel Partners Equity Participants, LP Limited Partnership Agreement' in July 2008.

The noncompetition agreements included provisions that prohibited Malyshev and Kohlmeier from engaging in any Competitive Activity during their employment and for a designated Restricted Period following their departure, which Citadel could select as 0, 3, 6, or 9 months post-employment. "Competitive Activity" encompassed joining or providing similar services to a Competitive Enterprise, defined as any business with similar investment or trading strategies to Citadel's. The agreements emphasized the reasonableness of these restrictions to protect Citadel’s business interests, notwithstanding potential limitations on the individuals’ future employment prospects.

Additionally, both signed nonsolicitation agreements prohibiting them from soliciting Citadel employees to leave the company during their employment and for 12 months after termination. A "Citadel Employee" is defined as anyone employed at Citadel during the contact period or within 30 days prior to such contact.

Nonsolicitation agreements executed by Malyshev and Kohlmeier prohibited any disparaging statements about Citadel or its personnel. They also signed nondisclosure agreements acknowledging Citadel's significant investment in proprietary trade secrets, which are crucial for its competitive advantage. Both agreed to use confidential information solely for their duties and not for personal benefit. The partnership agreement required partners to inform the General Partner of any business activities for 18 months post-termination. Citadel's employee handbook discouraged the use of personal email accounts for work-related communications and mandated that former employees safeguard confidential information, prohibiting the use of proprietary information after leaving.

Malyshev had long contemplated establishing his own high-frequency trading company, starting discussions about his ambitions as early as 2007. He consulted attorneys regarding his employment agreements and discussed his plans with Kohlmeier. By late 2007, he was already consulting with a lawyer about launching his trading firm. Throughout 2008, he reiterated his intentions to leave Citadel, shared his vision with colleagues, and even expressed interest in a business model similar to that of competitor Jump. By December 2008, Malyshev felt 80% certain about resigning from Citadel in February 2009.

Matthew Hinerfeld, a former in-house counsel at Citadel, entered into an attorney-client relationship with Malyshev on December 6, 2008, to discuss Malyshev’s potential departure from Citadel to start his own trading firm, with Hinerfeld serving as general counsel. Malyshev communicated his intentions to leave with Citadel employees Kelley, May, and Stube. Malyshev resigned on February 16, 2009, followed by Kohlmeier the next day. On February 19, 2009, Citadel employees approached Yeh regarding resignations, and by February 22, Yeh warned Malyshev that soliciting employees could lead to legal action. Malyshev later received a letter from Citadel's general counsel regarding returning Citadel documents, which he failed to do, retaining a confidential profit and loss statement that could jeopardize Citadel's competitive edge.

Citadel enforced a nine-month restricted period per the noncompetition agreements, with Malyshev receiving $30,000 monthly and Kohlmeier $21,000. Despite this, they met at Malyshev's home during their 30-day nonsolicitation period, where they did not discuss future business. However, on March 23, 2009, they agreed to start a new high-frequency trading business, leading to the incorporation of Pelagicus Group LLC in Delaware three days later, which later became Teza. Citadel discovered Teza’s formation on July 6, 2009, prompting an emergency motion for a preliminary injunction on July 9, alongside sanctions against Malyshev for destroying evidence related to the lawsuit.

An evidentiary hearing began on September 28, 2009, resulting in the trial court finding that while Malyshev acted independently in scrubbing his computers, sanctions could not be imposed on Teza for his actions. However, sanctions against Malyshev were deemed appropriate. Citadel sought injunctive relief on specific counts of their amended complaint without prejudice.

Count I alleges violations of noncompetition agreements by Malyshev and Kohlmeier, while Count II alleges violations of nonsolicitation agreements. Count V claims breach of fiduciary duty against both individuals. Citadel seeks several forms of relief: 

1. An injunction preventing Malyshev and Kohlmeier from working with Teza for nine months post-injunction, and potentially longer if further violations are found.
2. An injunction against Teza from any work for nine months, with all current work to be destroyed.
3. An injunction preventing all defendants from soliciting Citadel employees for twelve months.

The trial court determined that Malyshev and Kohlmeier engaged in competitive activities by forming and working for Teza, thus breaching the noncompetition and nonsolicitation agreements. However, the court did not rule on the breach of fiduciary duty claims. The preliminary injunction granted prohibits the defendants from competitive activities and soliciting Citadel employees for defined periods. The court noted that the agreements did not allow for extension based on violations.

In the subsequent appeals, Citadel argues the injunction should ensure compliance for the full nine-month noncompetition period, citing consistency with Illinois law and public policy. Conversely, the defendants contend that the trial court's injunction improperly restricts their postemployment activities, misinterprets the agreements, and wrongly categorizes Teza as a competitive enterprise. They also challenge the injunction based on the nonsolicitation agreements. The document explains that a preliminary injunction is a temporary measure to maintain the status quo before a full hearing, reserved for extreme circumstances to prevent serious harm.

A party seeking a preliminary injunction must show (1) a clear right needing protection, (2) irreparable harm without the injunction, (3) no adequate legal remedy, and (4) a likelihood of success on the merits. The decision to grant or deny such an injunction is reviewed for abuse of discretion, but the validity of a restrictive covenant is a legal question. An injunction cannot be overturned unless the trial court abuses its discretion or the decision contradicts the weight of the evidence. Courts interpret non-compete clauses strictly, resolving ambiguities against the restrictions. 

In the case of Citadel, the trial court declined to extend a noncompetition agreement's restriction period to the full nine months, which Citadel argued was inconsistent with precedent and public policy. The reference case, Electronic Support Systems, involved an employer seeking to enforce an 18-month non-compete clause after the employee's termination. The court found that despite the employee's breach within the restriction period, extending the injunction after the contract's expiration would impose an unreasonable trade restriction. Thus, the refusal to extend the noncompetition period was upheld.

The trial court's ruling was upheld, finding no contradiction with the precedent set in Electronic Systems and affirming its similarity to the Stenstrom case. The trial court determined that the defendants breached their noncompetition agreements but noted that these agreements did not allow for any extension beyond the originally agreed-upon period. The Stenstrom case, where a six-month injunction was imposed after employment ended, was referenced, highlighting that the defendant argued for the injunction period to start later, which was rejected. 

In contrast, the Prairie Eye Center case involved a covenant with explicit language allowing for an extension upon breach, which was not present in Stenstrom. Citadel's agreements, which allowed for various restrictive periods, were explicitly set for nine months post-termination without any provision for extension. The trial court's decision to adhere to the terms of the agreements was supported by the principle that restrictive covenants must be strictly interpreted. The court concluded that the trial court's ruling was consistent with the evidence and did not warrant an extension of the injunction period. The defendants' cross-appeal was rendered moot due to the expiration of the preliminary injunction. The judgment from the circuit court of Cook County was affirmed.