The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

Articles By Topic

By Topic: Intellectual Property

  • From Vol. 11 No.35 (Sep. 6, 2018)

    An Introduction to Quantitative Investing: Special Risks and Considerations (Part Three of Three)

    Although both quantitative and fundamental strategies expose fund managers to similar risks, a quantitative manager’s heavy dependence on technology and mathematical models means that it must consider and address those risks differently. It must, for example, place greater emphasis on cybersecurity and intellectual property, given that a cyber attack or reproduction of the underlying model are more likely to cripple its trading. In addition, quantitative managers must contend with unique capacity constraints – which inform investor negotiations – and compete with the technology sector for talent. This article, the third in a three-part series, explores the heightened importance of cybersecurity and IP protection for quantitative managers; negotiations with investors over capacity constraints; and methods for quantitative managers to attract and retain talent in the face of stiff competition. The first article provided an overview of quantitative investing and the ways it differs from fundamental investing; discussed the growth of quantitative investing; and evaluated the practical risks and misconceptions of quantitative investing. The second article analyzed regulatory actions and guidance applicable to quantitative managers, as well as the special regulatory risks those managers may face. See our three-part series on how fund managers should structure their cybersecurity programs: “Background and Best Practices” (Mar. 22, 2018); “CISO Hiring, Governance Structures and the Role of the CCO” (Apr. 5, 2018); and “Stakeholder Communication, Outsourcing, Co-Sourcing and Managing Third Parties” (Apr. 12, 2018).

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  • From Vol. 11 No.27 (Jul. 5, 2018)

    How Can Hedge Fund Managers Prevent Theft of Proprietary Trading Technology and Other Intellectual Property?

    Hedge fund managers who have made or are contemplating significant investments in proprietary technology face at least three major issues: (1) whether to develop that technology internally or buy or lease it from a third party; (2) whether to seek to patent it; and (3) how to prevent theft. More often than not, a hedge fund manager is better served by developing its own technology in cases where that technology is central to its trading strategy or operational infrastructures. Internal development confers greater control over the technology, increases the value of the advisory entity and strengthens the case for investors to invest with the manager as opposed to any other licensee of a third-party technology. In general, however, it is ill-advised to seek patent protection for these technologies, given that the process is long and may require disclosure of information that can undermine the proprietary value of the technology, and the protection itself is uncertain. To prevent theft, managers can utilize confidentiality agreements, robust pre-employment (or pre-independent contracting) screening and security measures embedded in the technology itself. Even with carefully thought-out protections, however, intellectual property (IP) remains uniquely susceptible to theft. This article explores the three issues identified above – whether to build or buy, whether to seek to patent and how to prevent theft – and discusses “soft” IP (copyright and trademark) in the hedge fund context. See our two-part series on how hedge funds can protect their brands and IP: “Trademarks and Copyrights” (Feb. 23, 2017); and “Trade Secrets and Patents” (Mar. 9, 2017).

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  • From Vol. 11 No.15 (Apr. 12, 2018)

    How Fund Managers Should Structure Their Cybersecurity Programs: Stakeholder Communication, Outsourcing, Co-Sourcing and Managing Third Parties (Part Three of Three)

    Cybersecurity stakeholders, particularly those in information security and legal/compliance, must communicate effectively to ensure that a fund manager’s cybersecurity program is fully implemented and able to respond to cyber attacks. Although managers of all sizes should aim to build in-house cybersecurity expertise to increase responsiveness, some may benefit from outsourcing or co-sourcing certain cybersecurity functions given the involved costs and shortage of qualified workers. Managers must, however, ensure that they properly vet and oversee third-party cybersecurity vendors, and this requires coordination between the chief compliance officer (CCO) and on-site technology leaders. This article, the third in our three-part series, evaluates methods for facilitating communication between cybersecurity stakeholders; outsourcing and co-sourcing of cybersecurity functions; and best practices for employing and overseeing third-party cybersecurity vendors. The first article discussed the risks and costs associated with cyber attacks; the global focus on cybersecurity; relevant findings observed by the Office of Compliance Inspections and Examinations during the examination of SEC registrants; and cybersecurity best practices. The second article analyzed the reasons why fund managers should hire a dedicated chief information security officer, reviewed information security governance structures and explored the role of the CCO as a strategic partner. See “Fund Managers Must Supervise Third-Party Service Providers or Risk Regulatory Action” (Nov. 16, 2017); and “How Managers Can Identify and Manage Cybersecurity Risks Posed by Third-Party Service Providers” (Jul. 27, 2017).

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  • From Vol. 11 No.12 (Mar. 22, 2018)

    How Fund Managers Should Structure Their Cybersecurity Programs: Background and Best Practices (Part One of Three)

    Nation-states, organizations, groups and individuals continue to employ increasingly sophisticated methods to target information systems and computer networks. Governments and regulators – including the SEC and the U.K. Financial Conduct Authority – are also intensifying their scrutiny of organizations’ cybersecurity programs. See our two-part series “Navigating FCA and SEC Cybersecurity Expectations”: Part One (Jan. 7, 2016); and Part Two (Jan. 14, 2016). As a result, it is becoming more expensive to combat and contain cyber-related attacks. Given that cybersecurity is an enterprise-wide risk, fund managers must, at a minimum, ensure that they comply with industry best practices, including adopting one or more cybersecurity frameworks and creating a culture of cybersecurity compliance. This article, the first in a three-part series, discusses the risks and costs associated with cybersecurity attacks; the global focus on cybersecurity; relevant findings observed by the Office of Compliance Inspections and Examinations during the examination of SEC registrants; and cybersecurity best practices. The second article will analyze the need for fund managers to hire a dedicated chief information security officer, review information security governance structures and explore the role of the chief compliance officer as a strategic partner. The third article will evaluate methods for facilitating communication between cybersecurity stakeholders; outsourcing and co-sourcing of cybersecurity functions; and best practices for employing and overseeing third-party cybersecurity vendors. See our two-part series on how fund managers can meet the cybersecurity challenge: “A Snapshot of the Regulatory Landscape” (Dec. 3, 2015); and “A Plan for Building a Cyber-Compliance Program” (Dec. 10, 2015).

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  • From Vol. 11 No.10 (Mar. 8, 2018)

    Beware of False Friends: A Hedge Fund Manager’s Guide to Social Engineering Fraud

    Cybercriminals are increasingly relying on social engineering to attack corporate systems. Hedge funds are particularly vulnerable, given that they typically lack extensive in-house cybersecurity expertise; deal with large sums of capital; and have relationships with powerful clients and individuals. Social engineering fraud poses a number of risks to fund managers, including money transfer fraud; theft of passwords or trade secrets; customer-data compromise; revelation of trading positions and plans; and attacks on principals. Fortunately, managers can mitigate these risks by educating and training employees; instituting multi-factor authentication; adopting verification procedures; limiting user access; and monitoring cybersecurity regulations. In addition, managers are increasingly able to rely on insurance to cover social engineering fraud losses. In a guest article, Ron Borys, senior managing director in Crystal & Company’s financial institutions group, and Jordan Arnold, executive managing director in K2 Intelligence’s New York and Los Angeles offices and head of the firm’s private client services and strategic risk and security practices, examine the risks of social engineering fraud, how fund managers can prevent it and how insurance policies can be used to protect against related losses. See “New CFTC Chair Outlines Enforcement Priorities and Approaches to FinTech, Cybersecurity and Swaps Reform” (Nov. 9, 2017); and “SEC Tackles Internal Cybersecurity Issues While Sharpening Cybersecurity Enforcement Focus” (Oct. 5, 2017). For additional commentary from Borys, see “How E&O and D&O Liability Insurance Can Help Hedge Fund Managers Mitigate the Consequences of Regulatory Enforcement Actions” (Jun. 2, 2016).

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  • From Vol. 11 No.3 (Jan. 18, 2018)

    A Fund Manager’s Roadmap to Big Data: MNPI, Web Scraping and Data Quality (Part Two of Three)

    As fund managers increasingly turn to sophisticated data streams to boost investment returns and produce greater operational efficiencies, it is critical that they understand the legal and practical risks posed by the use of big data. Issues surrounding material nonpublic information (MNPI) pose the greatest threat to firms. Managers must understand not only the misappropriation framework under the Securities Exchange Act of 1934, but also how the New York State Attorney General and regulators in the E.U. pursue insider trading claims. Additionally, whether engaging internally in web scraping or purchasing scraped data from third parties, managers must be conscious of contractual, intellectual property and tort claims that a site owner may allege against a fund manager. Finally, many of the largest challenges posed by the use of big data are practical or ethical in nature. This second article in our three-part series on big data analyzes issues and best practices surrounding the acquisition of MNPI; web scraping; and the quality and testability of data. The first article explored the big-data landscape and how fund managers can acquire and use big data in their businesses. The third article will discuss risks associated with data privacy, the acquisition of data from third parties and the use of drones, as well as recommended methods for mitigating those risks. For more on big data, see “Best Practices for Private Fund Advisers to Manage the Risks of Big Data and Web Scraping” (Jun. 15, 2017).

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  • From Vol. 10 No.24 (Jun. 15, 2017)

    Best Practices for Private Fund Advisers to Manage the Risks of Big Data and Web Scraping

    On April 13, 2017, craigslist obtained a judgment against RadPad, a third party that collected data through automated means from its site. The $60.5 million judgment was based on various claims relating to RadPad’s use of sophisticated techniques to evade detection and harvest content from craigslist’s site, as well as distribution of unsolicited commercial emails to craigslist users to market RadPad’s own apartment rental listing service. While it is doubtful that craigslist will ever collect this sizeable judgment, the case highlights some of the issues faced by persons, such as hedge fund managers, who collect – or engage others to collect – data through automated means for commercial purposes. In a guest article, Proskauer partners Robert G. Leonard, Jeffrey D. Neuburger and Joshua M. Newville provide an overview of big data and web scraping, outline potential sources of liability to hedge fund managers that collect big data and describe best practices for navigating several areas of potential liability. For additional insight from Newville and other Proskauer partners, see “Ten Key Risks Facing Private Fund Managers in 2017” (Apr. 6, 2017). For further commentary from Leonard, see our two-part series on The SEC’s Recent Revisions to Form ADV and the Recordkeeping Rule: “Managed Account Disclosure, Umbrella Registration and Outsourced CCOs” (Nov. 3, 2016); and “Retaining Performance Records and Disclosing Social Media Use, Office Locations and Assets Under Management” (Nov. 17, 2016).

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  • From Vol. 10 No.10 (Mar. 9, 2017)

    How Hedge Fund Managers Can Protect Their Trade Secrets in Light of Recent NY Appellate Ruling

    A New York state appellate court recently issued a significant ruling in People v. Aleynikov that clarifies and settles the state’s ability to pursue criminal charges for theft of trade secrets in cases involving computer code. The ruling provides hedge fund managers an additional weapon in their arsenal to protect their valuable technology and trade secrets. In a guest article, Sean O’Brien, managing partner of O’Brien LLP, along with counsel Sara A. Welch and associate James Ng, discuss the theory of criminal liability used by the state of New York to convict Sergey Aleynikov for stealing trade secrets from his former employer, Goldman, Sachs & Co. For additional insights from O’Brien, see “Recent NY Appeals Court Rulings Clarify How Fund Managers May Pursue Former Employees for Breach of Fiduciary Duty and Improper Use of Performance Record” (Dec. 15, 2016); “DTSA Provides Hedge Fund Managers With Protection for Proprietary Trading Technology and Other Trade Secrets” (Jun. 23, 2016); and “How Can Hedge Fund Managers Protect Themselves Against Trade Secrets Claims?” (May 16, 2014). For coverage of other employment disputes involving alleged theft of trade secrets by employees of hedge fund managers, see “Quant Fund Manager Moves Aggressively Against Former Employee Who Allegedly Stole Trade Secrets and Other Proprietary Information” (Mar. 21, 2014); and “Opus Trading Fund Accuses Former Trader That Joined Competitor of Breach of Contract and Misappropriation of Proprietary Information” (Apr. 21, 2011).

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  • From Vol. 10 No.10 (Mar. 9, 2017)

    How Hedge Funds Can Protect Their IP: Pepper Hamilton Attorneys Discuss Trade Secrets and Patents (Part Two of Two)

    Hedge fund managers are often portrayed by the media as a secretive group. In recent years, this stereotype has been reinforced when managers have pursued civil litigation against – or assisted the DOJ in the criminal prosecution of – former employees that have allegedly stolen the managers’ “secret sauce.” See “Citadel Commences Action Against a Former Employee for Misappropriation of Confidential Information With the Intent to Aid a Competitor” (Sep. 8, 2011); and “Protecting Hedge Funds’ Trade Secrets: The Federal Government’s Enforcement of Criminal Laws Protecting Proprietary Trading Strategies” (Dec. 10, 2010). A panel of intellectual property (IP) attorneys at Pepper Hamilton’s recent symposium reviewed the protections available to investment managers to protect their IP. Moderated by Pepper Hamilton partner Gregory J. Nowak, the panel featured Evan H. Katz, a managing director of alternative asset investment firm Crawford Ventures, Inc.; Pepper Hamilton partners Michael K. Jones and Peter T. Wakiyama; and their associates Lori E. Harrison and Joseph J. Holovachuk. This article, the second in a two-part series, explores the panelists’ insights with respect to trade secrets and patents in the investment management context. The first article discussed how investment managers can safeguard their brands through trademarks and protect their copyrightable materials. For more on trade secrets, see “Procedures for Hedge Fund Managers to Safeguard Trade Secrets From Rogue Employees” (Jul. 21, 2016); and “Eight Measures That Hedge Fund Managers Can Take to Mitigate the Risk of Theft of Their Trade Secrets” (May 24, 2012). 

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  • From Vol. 10 No.8 (Feb. 23, 2017)

    How Hedge Funds Can Protect Their Brands and IP: Pepper Hamilton Attorneys Discuss Trademarks and Copyrights (Part One of Two)

    An adviser’s name and proprietary trading methods can be among its most valuable assets. A panel of intellectual property (IP) attorneys at Pepper Hamilton’s recent symposium offered a thorough overview of the fundamental elements of trademark, copyright, trade secret and patent law, as well as practical examples of how IP law intersects with fund management. The panel was moderated by Pepper Hamilton partner Gregory J. Nowak and featured Evan H. Katz, a managing director of alternative asset investment firm Crawford Ventures, Inc.; Pepper Hamilton partners Michael K. Jones and Peter T. Wakiyama; and associates Lori E. Harrison and Joseph J. Holovachuk. This article, the first in a two-part series, discusses how investment managers can safeguard their brands through trademarks and protect their copyrightable materials. The second article will explore the panelists’ insights with respect to trade secrets and patents in the investment management context. For more on IP protection, see “Trending Issues in Employment Law for Private Fund Managers: Non-Compete Agreements, Intellectual Property, Whistleblowers and Cybersecurity” (Nov. 17, 2016). For additional insight from Pepper Hamilton, see “Marketing and Reporting Considerations for Emerging Hedge Fund Managers” (Jun. 16, 2016). For more from Nowak, see “Tax Proposals and Tax Reforms May Affect Rates and Impose Liabilities on Hedge Fund Managers” (Apr. 16, 2015).

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  • From Vol. 9 No.45 (Nov. 17, 2016)

    Trending Issues in Employment Law for Private Fund Managers: Non-Compete Agreements, Intellectual Property, Whistleblowers and Cybersecurity

    Attracting, compensating and retaining talented employees is a critical part of a fund manager’s business. Managers routinely use non-compete agreements and other measures to ensure that employees do not harm the manager’s business when they depart. A recent program presented by EisnerAmper offered an overview of the law of non-compete agreements and insight into other common employment issues that private fund managers face, including portability of track records, status of employees, protection of intellectual property and cybersecurity. Moderated by EisnerAmper director Frank L. Napolitani, the program featured Cole-Frieman & Mallon partner John Araneo. This article highlights the key takeaways from the presentation. For additional insight from EisnerAmper, see our three-part series on how hedge funds can mitigate FIN 48 exposure in certain jurisdictions: Europe (Mar. 17, 2016); China (Mar. 24, 2016); and Australia and Mexico (Mar. 31, 2016); as well as our two-part series on hedge fund audit holdbacks: “Operational Considerations” (Sep. 10, 2015); and “Implementation” (Sep. 17, 2015).

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  • From Vol. 9 No.25 (Jun. 23, 2016)

    DTSA Provides Hedge Fund Managers With Protection for Proprietary Trading Technology and Other Trade Secrets

    On May 11, 2016, the Defend Trade Secrets Act (DTSA) became law. The DTSA provides a new and powerful – but complex – federal statute that hedge fund managers can rely upon to protect their trade secrets, including computer models underlying high-frequency and algorithmic trading. The statute also requires hedge fund managers to take affirmative steps in order to protect those trade secrets and obtain the full benefit of the new law. As discussed in prior articles, laws governing the protection of trade secrets and computer crimes are fueling significant interpretative debates. See “How Can Hedge Fund Managers Protect Themselves Against Trade Secret Claims?” (May 16, 2014); “Recent Developments Affecting the Protection of Trade Secrets by Hedge Fund Managers” (Oct. 25, 2013); “Protecting Hedge Funds’ Trade Secrets: What A Difference A Year Makes” (Apr. 19, 2012); and “Protecting Hedge Funds’ Trade Secrets: The Federal Government’s Enforcement of Criminal Laws Protecting Proprietary Trading Strategies” (Dec. 10, 2010). In a guest article, Sean R. O’Brien and A.J. Monaco, managing partner and associate, respectively, at O’Brien LLP, discuss how the DTSA is an extremely important step toward rectifying and clarifying some of those issues and explore questions raised by the new statute.

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  • From Vol. 9 No.22 (Jun. 2, 2016)

    Independent Contractors vs. Employees: What Hedge Fund Managers Must Know About Classifying Staff and Protecting Proprietary Secrets

    As high-profile corporations such as FedEx and Uber find themselves embroiled in, or in the aftermath of, costly lawsuits over the misclassification of people they have hired, it is critically important for hedge fund managers to understand how classification issues may affect their businesses. Under federal and state law, the status of independent contractors is fundamentally different from that of employees, affecting everything from compensation and taxes to the safety procedures and protocols needed to protect employers’ sensitive information from theft. Even without the crackdown at the regulatory level and the massive liability facing employers who misclassify workers, the risk of data theft requires asset managers to be specially knowledgeable and vigilant about the issue’s implications. These topics were the focus of a recent panel discussion held at the New York offices of law firm Pepper Hamilton. Moderated by Pepper Hamilton partner Gregory Nowak, the panel featured Richard Reibstein, a partner at Pepper Hamilton, and Laura Kibbe, managing director of professional services at RVM Enterprises. For more on hedge fund manager employment issues, see “District Court Decision Suggests That Overly Broad Restrictive Covenants Will Not Be Enforced in Employment Agreements in the Wealth Management Industry” (Apr. 26, 2012); and our two-part series on “How Can/Do Hedge Fund Managers Legally Penalize Employee Wrongdoing?”: Part One (Apr. 7, 2016); and Part Two (Apr. 14, 2016). For coverage of other Pepper Hamilton seminars, see our two-part series on “How Hedge Fund Managers Can Establish/Operate an AML Program Under FinCEN’s Proposed Rules”: Part One (Nov. 5, 2015); and Part Two (Nov. 12, 2015); as well as “Tax Proposals and Tax Reforms May Affect Rates and Impose Liabilities on Hedge Fund Managers” (Apr. 16, 2015). 

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  • From Vol. 7 No.11 (Mar. 21, 2014)

    Quant Fund Manager Moves Aggressively Against Former Employee Who Allegedly Stole Trade Secrets and Other Proprietary Information

    Private fund managers have become highly attuned to the risks posed by theft of proprietary information and have been aggressive in seeking recourse against former employees who have attempted to misappropriate such information.  See “Proprietary Trading Firm Sues Former Chief Operating Officer for Allegedly Misappropriating Confidential Information to Benefit His New Hedge Fund Manager Employer,” The Hedge Fund Law Report, Vol. 6, No. 42 (Nov. 1, 2013).  Federal and state authorities have, in many cases, added criminal charges to the civil efforts of managers.  See “Recent Developments Affecting the Protection of Trade Secrets by Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 6, No. 41 (Oct. 25, 2013).  A recently-filed action by a quantitative hedge fund manager against a former employee illustrates the difficulty of preventing theft of trade secrets – despite sophisticated legal and technological efforts – as well as the claims and remedies available to private fund managers and prosecutors in such circumstances.

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  • From Vol. 6 No.22 (May 30, 2013)

    U.K. High Court of Justice Rules on Whether Software Written by Co-Founder of a Hedge Fund Manager Belongs to the Co-Founder or the Firm

    A decision recently handed down by the U.K. High Court of Justice involving a dispute over software created by a co-founder of a hedge fund manager highlights the risk of failing to clearly document intellectual property rights at the inception of a manager’s business.  The decision also emphasizes the importance of clearly delineating, in hedge fund manager partnership and employment agreements, ownership of software and other intellectual property developed or modified by principals, employees or contractors of the manager.  This article summarizes the facts and legal analysis underpinning the court’s decision.  See also “Protecting Hedge Fund Trade Secrets: What a Difference a Year Makes,” The Hedge Fund Law Report, Vol. 5, No. 16 (Apr. 19, 2012).

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  • From Vol. 5 No.44 (Nov. 21, 2012)

    U.K. High Court of Justice Rules on Request by Hedge Fund Manager Affiliates to Search Computers of Two Former Employees

    Most hedge fund management companies are built on a foundation of confidential and proprietary information – strategies, technologies, positions, plans, investor and prospect lists, etc.  To add value, employees must be given access to some or all of that confidential information, which of course invites the prospect that employees will walk away with it.  Managers take various steps to prevent theft of confidential information, including legal and technology precautions.  See “Protecting Hedge Fund Trade Secrets: What a Difference a Year Makes,” The Hedge Fund Law Report, Vol. 5, No. 16 (Apr. 19, 2012).  However, confidential information can be hard to secure absolutely and difficult to monitor.  Thus, with some frequency, litigation over ownership of and access to confidential information follows the voluntary or involuntary departure of employees from hedge fund managers.  See “Eight Measures That Hedge Fund Managers Can Take to Mitigate the Risk of Theft of Their Trade Secrets,” The Hedge Fund Law Report, Vol. 5, No. 21 (May 24, 2012).  This article discusses a recent example of such litigation.

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  • From Vol. 5 No.21 (May 24, 2012)

    Eight Measures That Hedge Fund Managers Can Take to Mitigate the Risk of Theft of Their Trade Secrets

    Technology has made it increasingly easy for firm personnel and unauthorized third parties to steal proprietary information from hedge fund managers.  Managers that fail to adopt effective safeguards may face theft of their “secret sauce,” which could jeopardize their businesses.  A spate of high-profile alleged trade secret thefts emphasizes the need for managers to take such protective steps.  See “Protecting Hedge Fund Trade Secrets: What a Difference a Year Makes,” The Hedge Fund Law Report, Vol. 5, No. 16 (Apr. 19, 2012).  On May 11, 2012, Yihao (Ben) Pu, a computer programmer, was indicted in the United States District Court for the Northern District of Illinois on 13 counts of theft of trade secrets and computer fraud in connection with the alleged misappropriation of proprietary software from two financial services firms, including hedge fund manager, Citadel LLC (Citadel).  The indictment (Indictment) comes on the heels of a civil lawsuit filed by Citadel against Pu, alleging that Pu misappropriated Citadel trade secrets in breach of a non-disclosure agreement executed by Pu and in violation of the Illinois Trade Secrets Act.  For a discussion of the civil action, see “Citadel Commences Action Against a Former Employee for Misappropriation of Confidential Information with the Intent to Aid a Competitor,” The Hedge Fund Law Report, Vol. 4, No. 31 (Sep. 8, 2011).  The Indictment is instructive in that it offers a glimpse into some of the measures that Citadel instituted to prevent theft of its trade secrets.  This article summarizes the factual allegations and causes of action in the Indictment and recommends eight specific steps that hedge fund managers can take to mitigate the risk of trade secret theft.

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  • From Vol. 5 No.16 (Apr. 19, 2012)

    Protecting Hedge Funds' Trade Secrets: What a Difference a Year Makes

    Hedge fund managers zealously guard their trade secrets from unauthorized access and use and seek to prosecute misappropriation or misuse of such trade secrets because they represent a significant asset of the firm.  In December 2010, Sean R. O’Brien and Sara A. Welch, Managing Partner and Counsel, respectively, at O’Brien LLP, published in The Hedge Fund Law Report an article analyzing the government’s efforts to regulate and protect, through the aggressive enforcement of criminal laws, the trade secrets underlying proprietary hedge fund trading strategies.  See “Protecting Hedge Funds’ Trade Secrets: The Federal Government’s Enforcement of Criminal Laws Protecting Proprietary Trading Strategies,” The Hedge Fund Law Report, Vol. 3, No. 48 (Dec. 10, 2010).  At that time, the government had recently obtained the criminal convictions of two former employees of high-frequency trading firms who were alleged to have misappropriated computer code relating to high frequency trading systems.  Two recent rulings by federal appellate courts have significantly reined in the government’s efforts in this area.  The appellate courts have significantly narrowed the scope of criminal liability that may be imposed upon an employee who is alleged to have misappropriated elements of proprietary trading strategies, especially if the challenged conduct involves only the taking of “intangible” aspects of those strategies.  The rulings are therefore of great interest to both hedge fund managers and their employees.  This follow-up article by O’Brien and Welch discusses the rulings and the reasoning in the two federal appellate court decisions.

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  • From Vol. 5 No.11 (Mar. 16, 2012)

    Hedge Fund Names: What a Hedge Fund Manager Should Do Before It Starts Using a Name

    Although the pace of new hedge fund formation these days is nowhere near that of several years ago, new funds are still being formed at a fairly healthy clip.  Whether as a result of investment banks spinning off their proprietary trading operations due to the Dodd-Frank regime or as a result of successful traders leaving funds that are stuck below their high-water marks, new funds are being formed and new managers will need to come up with names for their management companies and funds.  In the wake of last decade’s exponential growth in the industry, they will find that most of the obvious sources of names (e.g., trees, birds, constellations and mythological entities) are already being used.  Other names, although no longer in use, have been so tarnished by their past use in the investment management field (whether due to scandal or simply poor performance) that they are no longer viable candidates for a new manager.  This makes selecting a name for a new management company or fund increasingly difficult and presents a greater risk now than ever before.  It also makes obtaining trademark protection for a name increasingly important.  Complicating the name selection issue is the fact that trademark rights exist on a country-by-country basis, which means that a given name might be available for use and registration in one country but not in another.  With the globalization of financial markets and the rise of multi-jurisdictional hedge fund managers, new managers must consider name rights outside the United States and may have to devise intricate use and registration strategies internationally to ensure their ability to use their name and prevent others from adopting similar names across many countries.  In a guest article, David Nissenbaum and Scott Kareff, Partner and Special Counsel, respectively, at Schulte Roth & Zabel LLP, discuss various topics related to hedge fund name selection, including: the importance of trademark registration for hedge funds; specific disputes that can arise as a result of name selection; ten lessons that can be learned from prior name disputes; and the value of name searches, including a discussion of the name search process and its inherent limitations.

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  • From Vol. 4 No.31 (Sep. 8, 2011)

    Citadel Commences Action Against a Former Employee for Misappropriation of Confidential Information with the Intent to Aid a Competitor

    Useful proprietary trading technologies are expensive to develop, easy to copy and significantly undermined if obtained by a competitor.  Not surprisingly, therefore, a significant body of civil and criminal case law, as well as commercial best practices, have developed around the protection of proprietary trading technology.  On the civil side, for example, the allegations in a complaint filed on August 29, 2011, by Citadel LLC (Citadel) against former employee Yihao Ben Pu (Pu), echo legal allegations brought by Citadel in July 2009 against the founders of Teza Technologies (Teza), and allegations in unrelated complaints.  See “Citadel Investment Group Sues Former Employees Alleging Violations of Non-Disclosure, Non-Solicitation and Non-Compete Agreements,” The Hedge Fund Law Report, Vol. 2, No. 28 (Jul. 16, 2009); “Opus Trading Fund Accuses Former Trader That Joined Competitor of Breach of Contract and Misappropriation of Proprietary Information,” The Hedge Fund Law Report, Vol. 4, No. 13 (April 21, 2011); “New York Trial Court Permits Action for Misappropriation of Hedge Fund Proprietary Software and Breach of Partnership Agreement To Proceed,” The Hedge Fund Law Report, Vol. 2, No. 6 (Feb. 12, 2009).  On the criminal side, the most notable recent case was the DOJ’s action against Sergey Aleynikov, who joined Teza from Goldman Sachs.  See “Protecting Hedge Funds’ Trade Secrets: The Federal Government’s Enforcement of Criminal Laws Protecting Proprietary Trading Strategies,” The Hedge Fund Law Report, Vol. 3, No. 48 (Dec. 10, 2010).  Regarding commercial best practices for protection of trading technology in the hedge fund context, see “How Can Hedge Fund Managers Prevent Theft of Proprietary Trading Technology and Other Intellectual Property?,” The Hedge Fund Law Report, Vol. 2, No. 33 (Aug. 19, 2009).  This article details the allegations in Citadel’s complaint against Pu, and concludes with a note on the procedural posture of the matter.

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  • From Vol. 4 No.26 (Aug. 4, 2011)

    Hedge Fund-Specific Issues in Portfolio Management Software Agreements and Other Vendor Agreements

    Hedge fund managers require various third party vendor-provided products and services to manage their daily operations.  Typical agreements entered into by hedge fund managers for such products and services include trading system agreements, license agreements for investment analysis tools, risk management and portfolio valuation software, market data license agreements, software development agreements, hardware purchase agreements, website design agreements, consulting agreements and administration agreements.  All vendor agreements cover a common set of issues, including vendor performance obligations, indemnification and limitations on liability.  In addition to these common issues, vendor agreements entered into by hedge fund managers contain a few distinctive issues arising from the unique structure and the private nature of hedge fund groups.  In a guest article, Robert R. Kiesel, a Partner at Schulte Roth & Zabel LLP and chair of the firm’s Intellectual Property, Sourcing & Technology Group, and David L. Cummings, an Associate in Schulte’s Intellectual Property, Sourcing & Technology Group, discuss: selection of vendors and vendor breach; hedge fund structuring as it relates to vendor agreements; party selection; IT agreement standard scope restrictions; liability for trades; use of output and results; issues related to hedge fund secrecy; confidentiality; in-house systems versus third-party systems; privacy; arbitration; and publicity.

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  • From Vol. 4 No.22 (Jul. 1, 2011)

    What Hedge Fund Managers Need to Know About Information and Data Security

    While hedge fund executives are experts at identifying and managing the risks relating to their financial assets and portfolios, they generally do not have the time or expertise to focus on the security of their people and intellectual property assets.  However, all organizations – especially financial institutions – must be prepared for the inherent risks and responsibilities associated with doing business in an online world through a sound digital risk management strategy.  The appropriate approach to digital risk management varies from firm to firm based on unique business models and requirements.  However, all hedge fund managers should take a risk-based approach to security and ensure that the approach is aligned with the way executives manage other business issues.  While physical security and information security present different challenges, they are strongly related, are part of internal controls and should be managed using an integrated strategy.  In a guest article, Edward Stroz, Co-President of Stroz Friedberg, a digital risk management and investigations firm, and Steven Garfinkel, Vice President of Stroz Friedberg’s Business Intelligence & Investigations Division – and both former FBI Special Agents – outline the most critical aspects involved in implementing a digital risk management program for hedge fund managers.

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  • From Vol. 4 No.4 (Feb. 3, 2011)

    Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Hedge Fund Manager Perspective (Part Three of Three)

    This is the third installment in our three-part series on the movement of talent from bank proprietary (prop) trading desks to hedge fund managers.  The series focuses on the legal and business considerations raised by such moves, and highlights the different considerations faced by the different constituencies.  The first article in the series focused on the talent perspective, that is, the considerations that investment and non-investment personnel should address when moving from a bank to a hedge fund manager.  See “Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Talent Perspective (Part One of Three),” The Hedge Fund Law Report, Vol. 3, No. 49 (Dec. 17, 2010).  The second article in the series focused on the bank perspective, and demonstrated that while banks face many of the same issues as talent in this context, banks often face those issues from a different perspective, and weight those issues differently.  See “Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Bank Perspective (Part Two of Three),” The Hedge Fund Law Report, Vol. 4, No. 2 (Jan. 14, 2011).  This article focuses on the perspective of the hedge fund manager to which talent moves.  While the legal and business issues faced by such recipient managers are complex, at a broad level, they can be broken down into a simple binary question: Are your hiring decisions motivated by the goal of buying talent or access?  Generally, if you are looking to buy talent, you are okay, but if you are looking to buy access, you are in trouble.  Put slightly differently, while a variety of legal disciplines govern the relationships between hedge fund managers and their employees, the unifying theme among those disciplines is ensuring that business success or failure is based on merit commercialized on a level playing field.  If this sounds too pious to be plausible, read on – and also read some of our cautionary tales of recent access-buying in the hedge fund arena.  To illustrate this general idea, this article discusses the following categories of considerations for hedge fund managers receiving talent: avoiding insider trading violations based on material, non-public information possessed by incoming talent; the three-step process for avoiding liability for aiding and abetting a breach by a new employee of that employee’s employment or post-employment covenants with his or her former bank employer, including non-competition agreements (non-competes), non-solicitation agreements (non-solicits), termination, severance and option agreements; special considerations in connection with the movement of teams (as opposed to individuals); avoiding liability for unauthorized use by an incoming employee of trade secrets or other intellectual property owned by a former bank employer; use of data regarding employee performance at a prior bank employer; avoiding pay-to-play violations; and what to look for when performing background checks.

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  • From Vol. 4 No.2 (Jan. 14, 2011)

    Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Bank Perspective (Part Two of Three)

    Hedge fund industry talent is increasingly mobile, but the consequences of that mobility impact different institutions differently.  In an article in our issue of December 17, 2010, we discussed the implications of that increasing mobility from the talent perspective.  Specifically, that article, among other things: identified seven discrete reasons for the increasing pace of mobility; defined "talent" (including investment and noninvestment talent); defined "proprietary trading" (to the extent it can be defined); identified the various types of institutions from and to which talent is moving; predicted which entities stand to gain the most from the movement of talent; and offered recent examples of talent moves.  See "Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Talent Perspective (Part One of Three)," The Hedge Fund Law Report, Vol. 3, No. 49 (Dec. 17, 2010).  Working from the foundation of that article, this article discusses the implications of increasing talent mobility from the bank perspective.  (The third and final article in this series will discuss the relevant issues from the perspective of the hedge fund management company to which the talent migrates.)  In particular, this article discusses the key legal, business and cultural issues to be considered by investment or commercial banks in connection with departing hedge fund talent (ideally well before that talent departs), including: eight distinct methods that banks use to protect trade secrets, confidential information and other intellectual property; business considerations that may impact decisions regarding enforcement of intellectual property rights; and the strategic interaction among non-competition provisions (non-competes), non-solicitation provisions (non-solicits), accrued but unpaid compensation and ownership of performance data.  Before continuing, three points should be noted.  First, many of the issues identified in this article are, in certain ways, the mirror images of issues identified in the first article in this series.  That is, when discussing the movement of talent from bank proprietary (prop) trading desks to hedge fund managers, if an issue is relevant to the talent, it is, almost by definition, relevant to the bank; and vice versa.  However, the weighting, implications and consequences of issues are different for the different parties, thus justifying separate discussions.  By analogy, both hedge fund managers and investors are concerned with the general issue of hedge fund money raising, but their specific areas of concern differ markedly.  Second, while the discussion in this article focuses on the relevant issues from the bank perspective, the intended audience for this article is not just banks.  Rather, the article is written in the conviction that the other constituencies − including talent and the hedge fund management companies to which talent moves − can benefit from a deeper understanding of the bank perspective.  Third, as indicated in the outline of the article above, the legal rights of the parties when talent leaves a bank for a hedge fund manager are powerfully determined by the business facts and circumstances.  In other words, the relevant analysis is often a hybrid legal-business analysis, rather than a pure legal analysis.  For example, assume that the head of commodities prop desk is leaving to start a commodities hedge fund manager, and his employment agreement contains a narrowly drawn, well-crafted non-compete.  Will the bank be able to enforce the non-compete?  A pure legal analysis may say yes, but if the bank is exiting the commodities trading business altogether, the legal analysis may be moot.  Of course, the facts always determine legal outcomes; the point here is to suggest that the universe of relevant facts may be broad, and actions outside of the talent's control may bear directly on the parties' legal rights.

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  • From Vol. 3 No.49 (Dec. 17, 2010)

    Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Talent Perspective (Part One of Three)

    Talent has always been mobile in the hedge fund industry.  But at least seven factors are increasing the pace with which hedge fund talent − investment talent (portfolio managers, analysts, traders) as well as non-investment talent (professionals focusing on marketing, operations, law, accounting, compliance and technology) − is moving from proprietary trading desks at investment or commercial banks (prop desks) to a range of other entities, most notably, start-up and existing hedge fund managers.  First, the Volcker Rule generally prohibits U.S. banking institutions and non-U.S. banking institutions with U.S. banking operations from: (1) proprietary trading unrelated to customer-driven business; and (2) sponsoring or investing in hedge funds or private equity funds, or engaging in certain covered transactions with advised or managed hedge funds or private equity funds.  See "Implications of the Volcker Rule – Managing Hedge Fund Affiliations with Banks," The Hedge Fund Law Report, Vol. 3, No. 10 (Mar. 11, 2010).  Second, many of the investment and commercial banks that house proprietary trading desks have been subject to explicit or implicit restrictions on or reviews of compensation of key personnel.  Third, the availability of hedge fund seed funding has increased.  For example, a December 2010 survey conducted by private fund data provider Preqin found that the number of hedge fund investors expressing an interest in seed investments has almost doubled, from 11 percent in 2009 to 21 percent in 2010.  See also "How to Structure Exit Provisions in Hedge Fund Seeding Arrangements," The Hedge Fund Law Report, Vol. 3, No. 40 (Oct. 15, 2010).  Fourth, many existing hedge fund managers have renegotiated, reset or regained their high water marks.  See "How Are Hedge Fund Managers with Funds Under their High Water Marks Renegotiating Performance Fees or Allocations?," The Hedge Fund Law Report, Vol. 2, No. 33 (Aug. 19, 2009).  Fifth, many hedge fund industry professionals have no choice: they have been fired from prop desks, and plying their trade at a new institution is their highest value opportunity.  Sixth, according to a Fall 2010 Institutional Investor Survey conducted by Bank of America Merrill Lynch Capital Introductions, institutional investors are considerably more “bullish” on alternative investments than they are about traditional equities and fixed income investments.  Seventh, and finally, there is a considerable volume of dormant savings, particularly in the developing world (especially the so-called BRIC countries) and parts of developed Asia; many of the new funds being launched (by new or existing managers) are intended to tap this well of savings.  See "Local Currency Hedge Funds Expand Marketing and Investment Opportunities, but Involve Currency Hedging and Other Challenges," The Hedge Fund Law Report, Vol. 3, No. 1 (Jan. 6, 2010).  Despite these seven factors (and there are likely others) motivating and hastening the movement of talent into and within the hedge fund industry, talent does not move in an entirely free market.  Rather, the mobility of talent is bound up in a web of legal and practical restrictions.  The basic purpose of this article − the first in a three-part series − is to identify relevant legal issues and offer practical suggestions to help talent negotiate the transition from a prop desk to the next hedge fund opportunity.  (The second article in this series will look at talent moves from the bank perspective, and a third article will look at talent moves from the perspective of the hedge fund management company to which the talent moves.)  To serve its purpose, this article discusses the following: the definition of "talent" (we are using the word as shorthand for a variety of typical job descriptions); the working definition of proprietary trading; the various types of entities from which and to which talent may move; which types of entities are likely to be the biggest winners in the movement of talent away from prop desks, and why; examples of recent talent moves from prop desks to other institutions; key legal considerations applicable to all moving hedge fund talent, whether such talent is moving to an existing hedge fund manager or starting its own shop (this discussion includes subtopics such as non-competition agreements, non-solicitation agreements, ownership of performance data and intellectual property, etc.); the key legal considerations specific to talent leaving a prop desk to start a new hedge fund management company; and the chief practical and cultural issues faced by talent that departs a prop desk to start or participate in running a hedge fund management company.

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  • From Vol. 3 No.48 (Dec. 10, 2010)

    Protecting Hedge Funds’ Trade Secrets: The Federal Government’s Enforcement of Criminal Laws Protecting Proprietary Trading Strategies

    On December 10, 2010, the trial of Sergey Aleynikov, a former Goldman, Sachs & Co. employee accused of stealing the computer code underlying Goldman’s high-frequency trading system, ended in a guilty verdict.  The Aleynikov trial follows close on the heels of the trial of Samarth Agrawal, a former employee of Société Générale who was convicted last month of theft of trade secrets, also in connection with misappropriation of high frequency trading code.  These cases reflect a new emphasis by the federal government on high-technology and intellectual property-related crimes, and should be of great interest to hedge funds, many of which rely upon trade secrets or proprietary trading strategies to some degree.  In a guest article, Sean O’Brien and Sara Welch, Partner and Associate, respectively, at Arkin Kaplan Rice LLP, focus upon the key legal issues presented and resolved in the Aleynikov prosecution, and the implications of those issues for hedge fund managers.

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  • From Vol. 3 No.45 (Nov. 19, 2010)

    U.K. Chancery Court Holds That, Under European Union Intellectual Property Law, Financial Services Company “OCH Capital” Infringed the Trademarks of European Hedge Fund Manager Och-Ziff Capital Management

    On October 20, 2010, a Judge of the United Kingdom High Court of Justice, Chancery Division, ruled that OCH Capital, LLP infringed two trademarks, “OCH-ZIFF” and “OCH” registered by hedge fund Och-Ziff Management Europe, Ltd. and its manager, OZ Management LP (collectively Och-Ziff or Claimants), and that OCH Capital committed “passing off,” the European equivalent of “unfair competition.”  Specifically, it found that, by using the sign “OCH Capital,” and derivations thereof, in the course of its trade in the financial services industry, OCH Capital created confusion in the marketplace with the Och-Ziff trademarks, and caused damage to, and took unfair advantage of, the Och-Ziff Group’s established reputation in the same industry.  The Court also held OCH Capital, its founder, Thomas Tadeus Antoni Ochocki, and its management firm, Union Investment Management Ltd. jointly liable.  We detail the background of the action and the Court’s legal analysis.

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  • From Vol. 3 No.27 (Jul. 8, 2010)

    Supreme Court Invalidates Patent on Hedging Risk But Leaves Door Open for Less “Abstract” Business Methods

    On June 28, 2010, the U.S. Supreme Court, in Bilski v. Kappos, held a patent directed to a series of steps for hedging risk in commodities trading invalid as not being drawn to statutory subject matter.  While the Supreme Court affirmed the Federal Circuit Court of Appeals’ decision that the patent was invalid, the Supreme Court did instruct the Federal Circuit to fashion additional tests for patentable subject matter based on the Supreme Court’s broad and somewhat antiquated principles.  In a guest article, Mark Scarsi and Blake Reese, Partner and Associate, respectively, in the Intellectual Property Litigation & Technology Department of Milbank, Tweed, Hadley & McCloy LLP, explain the facts, holding and legal analysis in Bilski.  The Bilski opinion is complex, but Scarsi and Reese convey the key legal and business points in a manner that is comprehensible to hedge fund industry participants who may not be intellectual property experts.  The case is particularly relevant to hedge fund managers that develop and use proprietary technology, such as managers with high-frequency or algorithm-driven strategies.

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  • From Vol. 2 No.33 (Aug. 19, 2009)

    How Can Hedge Fund Managers Prevent Theft of Proprietary Trading Technology and Other Intellectual Property?

    Hedge fund managers who have made or are contemplating significant investments in proprietary technology, such as trading technology, face at least three major issues: (1) whether to develop such technology internally or buy or lease it from a third party; (2) whether to seek to patent it; and (3) how to prevent theft.  The relevance of these issues has been highlighted recently by at least two developments: the debate surrounding flash trading, and the implicit recognition in that debate that sophisticated trading technology has become central to the investment strategies of many hedge funds; and Citadel Investment Group’s recent lawsuit against three former employees and their new firm for alleged theft of Citadel’s trading technology.  On flash orders, see “What Are Flash Orders, and How Might Regulation Curtail the Ability of Hedge Funds Employing High-Frequency Trading Strategies to Profit from Such Orders?,” The Hedge Fund Law Report, Vol. 2, No. 32 (Aug. 12, 2009); and on the Citadel suit, see “Citadel Investment Group Sues Former Employees Alleging Violations of Non-Disclosure, Non-Solicitation and Non-Compete Agreements,” The Hedge Fund Law Report, Vol. 2, No. 28 (Jul. 16, 2009).  Based on interviews with specialists working at the intersection of technology and hedge fund investments and operations, the consensus answers to these questions appears to be: while every situation is unique and it is difficult to generalize with any reliability, more often than not, hedge funds would be better served by building their own technology than by licensing it, in cases where that technology is central to their trading strategy or operational infrastructure.  Among other things, building versus buying vests more control in the manager over its technology and changes and revisions thereto, and it increases the value of the advisory entity and the case for investors to invest with the manager as opposed to any other licensee of a third-party technology.  As for whether to seek patent protection, the answer, with exceptions, is often no because the process is long, the protection is uncertain, seeking patent protection may require disclosure of information that can undermine the proprietary value of the technology and most hedge fund technology is intended for use only by the manager; it is not intended to generate revenue via licensing.  And as for how to prevent theft, techniques involve confidentiality agreements and similar contractual protections, robust pre-employment (or pre-independent contracting) screening and security measures embedded in the technology itself.  Though as the Citadel case demonstrates, even with carefully thought-out protections, intellectual property (IP) remains uniquely susceptible to theft.  This article explores the three issues identified above – build versus buy; whether to seek to patent; and how to protect; includes an update on and analysis of the Citadel case; and discusses “soft” IP (copyright and trademark) in the hedge fund context.

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  • From Vol. 2 No.6 (Feb. 12, 2009)

    New York Trial Court Permits Action for Misappropriation of Hedge Fund Proprietary Software and Breach of Partnership Agreement To Proceed

    On January 6, 2009, a New York County trial court denied a motion to dismiss a lawsuit brought by Kenneth L. Telljohann and his company, CoVision Capital Group, LLC, against defendants Lawrence Doyle, a hedge fund manager, and his business entity, Tower Capital, Inc. The plaintiffs alleged that Doyle breached their partnership agreement and his fiduciary duty to his partners, and misappropriated the plaintiffs’ hedge fund asset allocation and risk analysis software. Alternatively, the plaintiffs sought to recover the value of the work they had performed on behalf of defendants through claims of unjust enrichment and quantum meruit and to prevent the further misuse of their software through a claim of unfair competition.  We describe the factual background and the court’s legal analysis, and in the process provide insight into how hedge fund managers and their service providers can structure arrangements to avoid disputes over ownership of intellectual property, and the revenue streams from such ownership.

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  • From Vol. 1 No.2 (Mar. 11, 2008)

    One hedge fund manager sues another for alleged theft of intellectual property

    • Elliott Management Corporation, a major structured credit manager, developed proprietary software and alleges that Cedar Hill Capital Partners hired an employee and contractor of Elliott to steal the underlying source code and executable code.
    • TRO issued in state action based on same allegations.
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