Firms step up non-compete use to protect tech, data IP

Financial firms’ proprietary technologies play an increasingly important role in their ability to generate alpha and trade faster and better than their rivals. So it’s not surprising to see the headlines and courts full of examples of firms alleging that others have lured away their talent or accusing individuals of recreating one firm’s game-changing applications at their new employer.

In the past, intellectual property (IP) generally referred to physical assets, such as client lists, or perhaps the code base for a top-secret piece of technology or trading algorithm. But now IP is being defined—and defended via strict non-compete contracts—as something more nebulous and harder to quantify: knowledge of processes and workflows.

Millennium Advisors, a Charlotte, North Carolina-based broker-dealer specializing in fixed income markets, is one firm tackling the challenge of protecting knowledge of processes that it believes provide a competitive advantage.

“Algo trading has become more widely used in semi-liquid over-the-counter (OTC) asset classes like corporate bonds. So, technology and intellectual property in general have become very valuable—things we are very protective about because they give us a competitive edge,” says Millennium CEO Laurent Paulhac. 

“IP is all about methods, techniques, models, and specific algorithms that we use to make decisions,” Paulhac says. “It could be very high-level, such as how to deploy capital, or about how to price a security more accurately than the rest of the market, which can be extremely complex and relies on a series of models and algorithms. Because we’re a leader in this space, people know that our IP and techniques are strong … and that makes our competitors envious.”

The firm employs about 35 traders—about 80% of whom have quantitative backgrounds, Paulhac says—and trades using a combination of traders and algorithms. This background gives employees “the know-how, the tools, and the fundamental understanding to be able to dive deep into our models … and gain a full appreciation of our IP,” Paulhac adds. “The vast majority of our staff are technologists and quants. We view the collaboration between these areas as what makes our company so efficient and competitive.”

If there’s a chance that an employee will go somewhere else and make that new firm better, their employer doesn’t want that

Bernardo Santiago, S4 Market Data

Firms are becoming increasingly litigious in their attempts to prevent former employees taking their knowledge to competitors. For example, market-maker Virtu Financial recently sued to stop its former head of client technology Nathan Clark from joining prime broker Clear Street as CTO. Clark counter-sued, but according to Clear Street’s website, co-founder Sachin Kumar still holds the role of CTO.

Clark’s contract with Virtu reportedly contained an 18-month non-compete clause, which Virtu is attempting to enforce. Non-competes and “gardening leave” clauses are a common practice by which firms prevent employees from taking intimate knowledge of their internal workings into similar roles at rival firms. And this is no longer limited to C-level execs or star traders; rank and file data and technology employees are increasingly finding themselves subject to non-competes and being forced to sit out substantial periods when switching jobs.

“I’ve seen heads of data strategy bound by the same kinds of non-competes, because they are strategic resources. And even market data managers to some degree, though not as much,” says Bernardo Santiago, CEO of data consultancy S4 Market Data. One of S4’s offerings is managing firms’ data groups on a contract basis and helping firms with staffing and resourcing issues.

“These roles are viewed as a strategic resource by firms that have an appreciation for good data management and people with expertise in that space. So, if there’s a chance that an employee will go somewhere else and make that new firm better, their employer doesn’t want that,” Santiago says.

Cover your assets

A non-compete may protect specific IP or may be used to simply lock up an individual’s expertise from benefitting rival firms; it doesn’t have to involve any malicious activities. Any nefarious circumstances, such as stealing a firm’s proprietary technology and taking it to a rival, would also be covered by patent and copyright law, says one lawyer who has served in senior roles and as general counsel at capital markets firms.

IP that would fall under “residual knowledge” of processes and procedures may be considered trade secrets—the third arm of legal defense beyond patents and copyrights, the lawyer says, adding that there’s an element of responsibility in any employment agreement.

This is the first time since the company was established in 2009 that we’ve needed to litigate. We don’t think it’s the ideal use of time or resources, but ... the cost of IP leakage is greater than the cost of litigation.

Laurent Paulhac, Millennium Advisors

“Even if there is no written non-compete agreement, you have a legal obligation to maintain and protect the proprietary nature of your employer’s assets,” the lawyer says, adding that employees subject to non-competes are typically compensated generously to make up for this. “Usually, there’s a bargaining process where the employer says ‘We’ll pay you a lot of money to work here, but if you leave, we want you to not do what you did here for a period of time.’”

Most firms walk a fine line between “not wanting to make a stink,” but wanting competitors to know that they do check and enforce non-competes, the lawyer adds. How aggressively they choose to enforce agreements depends largely on the firm involved, and how severe the infringement.

“If it’s really bad, some firms won’t just take you to court; they’ll go to the Feds and accuse you of stealing trade secrets—and that’s a criminal offense,” the lawyer says, adding that the legal discovery process would allow a plaintiff to compare code bases and compare a firm’s performance before and after hiring an individual.

Millennium, for example, recently had to tackle an issue where an employee left to join another firm in violation of a non-compete. Millennium won a Finra arbitration process, but there’s still an active lawsuit in the courts. Paulhac says that Millennium has very low turnover in general, but when employees have left the company in the past—after all, Millennium is based in Charlotte, NC, and sometimes people want to move to bigger financial centers—the firm has liaised with the individual’s new employer to ensure that they’re working in a non-competing position.

“Most cases of this nature in the industry get resolved without going to court or arbitration. But in this particular case, we could not resolve it despite our efforts,” Paulhac says. “It’s very comforting to know that IP is treated as valuable and protectable and that the terms of our non-compete were preserved” by Finra.

“This is the first time since the company was established in 2009 that we’ve needed to litigate. We don’t think it’s the ideal use of time or resources, but ... the cost of IP leakage is greater than the cost of litigation,” he says. “Arbitration proved there was a violation of the agreements, but it’s very hard to stop someone working.”

Check the fine print

Ed Guy, managing partner at recruitment firm Nationstaff, which specializes in hiring for financial firms and financial technology providers, says it’s common for firms who view IP as a competitive factor to impose standard non-competes—say, one year—across all employees, but notes that how enforceable they are may depend on where an individual’s employment agreement is based, which may not be the same as where they or their employer’s office is based. 

In addition, Guy notes, employment law differs from state to state. For example, non-compete contracts are already banned in several US states, and New York looked set to follow that lead when legislators passed a bill banning non-competes, but governor Kathy Hochul this week refused to sign a complete ban.

I would advise people to use their non-compete period as an opportunity. If your skills fade, that’s on you. I built my skillset during that year instead of letting it rust

Chris Petrescu, CP Capital

Yet among financial firms, the practice is becoming more and more widespread. Lawyers and recruiters say there’s nothing unfair or sinister about this: It’s an added layer of protection for firms that employees should be cognizant about when they sign a contract or employment agreement.

“At Millennium, we segregate and separate access to IP. So, a non-compete can vary from six months to 24 months, depending on roles. Over time, we have evolved from a standard non-compete to a gardening leave structure ... and all active prop firms in our space protect their IP in the same way,” Paulhac says. 

“Whatever someone learns while working here at Millennium, they cannot unlearn when they leave,” he adds. “But we’re comfortable that after two years, the knowledge someone acquired at our firm has decayed enough that their recollection of details has become harder.”

Not only that, but in a fast-paced and highly competitive trading environment, after those kinds of time periods, the tools and inputs used may have already seen significant alpha decay, and firms would move on to new ones. An example of Millennium’s IP, for example, is the combination of about a dozen factors that need to be considered “at all times” to ensure optimal performance when the firm allows a computer to execute a trade rather than a human trader.

Learning and implementing that combination of factors—and other, undisclosed examples of what the firm deems its IP—can take several years of training. 

“We have a rigorous training program, and we rotate staff so that people can look at our business from different perspectives. We’re big believers that the more we invest in people, the better returns we get, and the more people will enjoy working here,” Paulhac says. “After three to five years, they have a deep understanding of our methods and how to extract better returns.”

Essentially, the more experience and training someone gains, the more valuable they become, but also the more risky: There’s the issue of key-man risk if they leave, but also the risk that they’ll take that knowledge elsewhere—not necessarily maliciously, but just because, as Paulhac says, they can’t un-learn what they’ve learned at a firm. They can only wait until they’ve forgotten it or that knowledge is no longer as valuable as it was.

And therein lies a challenge for staff subject to non-competes: how to remain relevant and sharpen one’s skillset while unable to work directly on what their skills are best suited to.

Chris Petrescu, a former data strategy executive at WorldQuant and ExodusPoint Capital Management and now founder and CEO of CP Capital, which provides data strategy advisory services, has been subject to non-competes in the past, and while not a fan of them in general, he understands why firms use them, but warns against allowing skills to decay.

“When I left one of my previous employers, I had a one-year non-compete, and I abided by it. But that doesn’t mean I wasn’t actively talking to people and keeping up with the industry. I used it as an opportunity to continue to build my personal brand. I attended and spoke at conferences, I took an online Python course—I was almost as busy during my non-compete as I ever was when employed,” Petrescu says. “I would advise people to use their non-compete period as an opportunity. If your skills fade, that’s on you. I built my skillset during that year instead of letting it rust.”

And while Millennium won’t be ditching its non-competes, Paulhac says the company’s preference is that the situation never arises because in an ideal world, if you run your business well, offer career development and encourage initiatives that result in more satisfied employees, they won’t want to leave. In short, fostering a culture of collaboration and innovation creates a competitive advantage in itself.

“When you engage 100% of the brains employed at the firm, you improve your ability to be nimble and to evolve faster,” Paulhac says. “When the whole employee base is focusing on things that improve the bottom line, you get good outcomes, such as improved algorithms, better deployment of capital, and partnerships with other institutions to expand our business.”