Citadel Investment Group v. Teza Technologies

Citation: Not availableDocket: 1-09-2828 Rel

Court: Appellate Court of Illinois; February 23, 2010; Illinois; State Appellate Court

Original Court Document: View Document

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Citadel Investment Group, LLC, has filed an interlocutory appeal against the circuit court's order that granted preliminary injunctive relief against defendants Mikhail Malyshev, Jace Kohlmeier, and Teza Technologies, LLC, with the injunction set to expire on specific dates in November 2009. Citadel seeks a longer injunction, while the defendants cross-appeal, arguing that the court should have dismissed the case and that the interpretation of noncompetition agreements violates public policy by hindering their ability to compete. The court affirmed the lower court's decision.

Citadel, established in 1990 and headquartered in Chicago, manages approximately $14 billion in capital and employs around 1,300 staff globally, with 1,000 based in Chicago. The firm specializes in alternative investment management and is notable for its pioneering role in high frequency trading, which evolved from its extensive experience in statistical arbitrage. Establishing a high frequency trading operation involves several critical components, including recruiting talent, developing market data systems, creating trading signals, and executing trades through sophisticated technology and historical data analysis. Citadel has amassed a significant amount of historical market data, essential for its trading strategies, and has developed tools to manipulate and analyze this data effectively.

Citadel's high frequency trading infrastructure is characterized by significant collaboration between quantitative research and IT teams, developing the business from 2004 to 2009. Malyshev, who joined in 2003 without prior trading experience but with a quantitative background, oversaw the entire high frequency business, including IT infrastructure and talent recruitment. Kohlmeier, hired in 2002 and joining the high frequency group in 2004, reported to Malyshev and was responsible for ensuring the effective trading of alphas and writing code for the Phase Zero HFE System, the first trading engine for the group. This system, adapted from an existing IT platform, allowed trading on NASDAQ but ultimately incurred losses and was discontinued. Malyshev was instrumental in defining the infrastructure requirements and implementing security measures to protect confidential high frequency work, including restricted access, security cameras, encryption, and employment agreements. All high frequency employees signed noncompetition, nonsolicitation, and nondisclosure agreements to safeguard Citadel’s proprietary information.

Malyshev and Kohlmeier, due to their significant positions at Citadel and access to confidential information, were mandated to sign noncompetition, nonsolicitation, and nondisclosure agreements, as well as a partnership agreement. Malyshev executed 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 entered into the 'Citadel Partners Equity Participants, LP Limited Partnership Agreement' on July 21 and July 23, 2008, respectively.

The noncompetition agreements stipulate that during employment and a specified 'Restricted Period' thereafter, which Citadel can designate as 0, 3, 6, or 9 months, they are prohibited from engaging in 'Competitive Activity.' 'Competitive Activity' includes becoming an employee or partner at a competing enterprise or acquiring significant equity in such an enterprise. A 'Competitive Enterprise' is defined as any business involved in investment or trading activities similar to those of Citadel.

The agreements assert the reasonableness of these restrictions, acknowledging Citadel’s global business scope and the necessity of these limitations to protect its legitimate interests, despite potential impacts on Malyshev's and Kohlmeier's future employment opportunities.

Additionally, the nonsolicitation agreements bar them from soliciting Citadel employees during their employment and for 12 months after, defining 'Citadel Employee' to include those employed at the time of contact or within the preceding 30 days. The nonsolicitation agreements also prevent them from making disparaging remarks about Citadel or its personnel. The nondisclosure agreements emphasize Citadel's investment in developing proprietary trade secrets and know-how, which are critical to its competitive edge.

Malyshev and Kohlmeier recognized that any loss of Citadel’s competitive advantage due to the misuse of its trade secrets could severely impact the company. They agreed to use confidential information solely for their work-related duties, not for personal gain. Under their partnership agreement, they were obligated to inform the General Partner of all business activities for eighteen months after termination. Citadel’s employee handbook discourages the use of personal email accounts for official business and mandates that former employees protect the company’s confidential information.

Malyshev had considered starting his own high-frequency trading firm since at least 2007, consulting with attorneys about his employment agreements and discussing his ambitions with Kohlmeier. Throughout 2008, he continued to express his intent to leave Citadel and discussed plans for his company with various colleagues, envisioning a structure similar to competitor Jump’s "bucket shop" model. By December 2008, Malyshev was increasingly certain about leaving Citadel and began formal discussions with former in-house counsel Matthew Hinerfeld regarding his departure and the establishment of his own firm. Malyshev resigned on February 16, 2009, followed by Kohlmeier the next day, marking the inception of their new venture, Teza.

On February 19, 2009, James Thomas, Kelley, May, and Stube discussed resigning with Yeh. Three days later, Yeh warned Malyshev that Citadel would take legal action if he solicited their resignation. Yeh urged Malyshev to persuade them to remain, which resulted in May, Kelley, and Stube returning to Citadel. Following his resignation, Malyshev received a reminder from Citadel's general counsel about his obligation to return all company documents, but he did not comply and retained a confidential profit and loss statement that could potentially harm Citadel's competitive position. Citadel implemented a nine-month restricted period for both Malyshev and Kohlmeier, during which Malyshev was entitled to $30,000 monthly and Kohlmeier $21,000. After their resignations, Malyshev and Kohlmeier met twice, ultimately agreeing to establish a new high-frequency trading business. They incorporated Pelagicus Group LLC in Delaware, which would later become Teza, and formed additional entities by April 28, 2009. Citadel became aware of Teza's formation on July 6, 2009, and filed for a preliminary injunction on July 9, 2009, also seeking sanctions against Malyshev for destroying evidence related to the lawsuit. An evidentiary hearing began on September 28, 2009, where the trial court found Malyshev acted independently in scrubbing his computers and thus could not impose sanctions on Teza but did find sanctions appropriate against Malyshev. Citadel sought injunctive relief for breaches of noncompetition and nonsolicitation agreements, as well as for breach of fiduciary duty.

Citadel requested several forms of relief against Malyshev, Kohlmeier, and Teza, including: 1) a nine-month injunction against Malyshev and Kohlmeier from working with Teza, with possible extensions for competition or fiduciary breaches; 2) a nine-month injunction against Teza from any work, requiring destruction of prior work; and 3) a twelve-month injunction against all defendants from soliciting Citadel employees. The trial court found that Malyshev and Kohlmeier’s formation and work with Teza constituted competitive activity in violation of noncompetition agreements, and that Malyshev induced Kohlmeier to leave Citadel, breaching nonsolicitation agreements. However, the court did not rule on Citadel’s breach of fiduciary duties claims. Consequently, the court granted a preliminary injunction restricting competitive activities for Malyshev and Kohlmeier until the end of their noncompetition periods, with Teza's period lasting longer, and preventing them from soliciting Citadel employees for twelve months. The court noted that the agreements lacked provisions for extending restrictions due to violations. Citadel subsequently appealed, arguing the injunction duration should extend for the full nine months as per the agreements and is aligned with Illinois law and public policy. In response, the defendants cross-appealed, claiming the injunction improperly restricts their post-employment activities, misinterprets the agreements, violates public policy, and erroneously categorizes Teza as a competitive enterprise. They also disputed the injunction based on the nonsolicitation agreements. A preliminary injunction serves to maintain the status quo until a case is fully heard.

A preliminary injunction is an extraordinary remedy applicable only in extreme emergencies to prevent serious harm. The requesting party must prove four elements: (1) a clearly defined right needing protection; (2) irreparable injury without the injunction; (3) absence of an adequate legal remedy; and (4) likelihood of success on the merits. The decision to grant or deny such an injunction is typically reviewed for abuse of discretion. However, the validity of a restrictive covenant in an employment contract is a legal question that influences whether injunctive relief is appropriate. Courts strictly interpret non-compete covenants, resolving any ambiguities against enforcement.

In a case involving Citadel, the trial court declined to extend the restriction period of a noncompetition agreement to the full nine months as requested, arguing it was inconsistent with prior case law and public policy. The referenced case, Electronic Support Systems, involved a similar scenario where an injunction was sought after the contractual period had expired. The court in that case determined that granting an injunction after the restriction period was unreasonable, despite a breach occurring within that timeframe. The trial court found no basis to extend the restriction in Citadel’s case, noting that the agreements did not allow for such an extension. The decision was consistent with prior rulings and upheld the principle that restrictions must adhere to negotiated terms.

The trial court relied on the Second District’s decision in Stenstrom to support its ruling regarding a six-month injunction following the defendant's departure from employment under a restrictive covenant. Stenstrom argued that the six-month period should start from the date of the preliminary injunction to avoid applying the injunction retroactively. This position was supported by the Fourth District's opinion in Prairie Eye Center, where a two-year noncompete was validated and extended due to breaches. However, the Stenstrom court distinguished its case from Prairie Eye Center because the latter's covenant allowed for extensions based on breach, while Stenstrom's agreement was strictly limited to six months post-termination without any extension provisions.

In the current case involving Citadel, the noncompetition agreements permitted a restrictive period of zero to nine months. Citadel selected a nine-month restriction for two employees, which would end nine months after their termination dates. The court determined that, based on the explicit terms of the agreements, no extensions or modifications were applicable. Thus, the trial court’s decision to honor the terms of the restrictive covenant was affirmed, as it aligned with the principle that such covenants are to be strictly interpreted. The court concluded that the injunction period had appropriately expired, rendering the defendants' cross-appeal moot. The judgment from the circuit court of Cook County was affirmed, with Justices Quinn and Coleman concurring.