Alternative Investment Management Association Representing the global hedge fund industry
In this article, for convenience we refer to “employees”. The same issues apply to members of an LLP and consultants/contractors.
A big trend within the hedge fund industry in recent years has been the increased emphasis on intellectual property (IP), particularly for the systematic trading community. In particular, the protection of program-based models is becoming an increasingly contentious issue. Indeed, almost every aspect of an investment manager’s business involves confidential information, including formally protected IP rights. Success and failure can hinge on a firm’s (confidential) trading strategies, (confidential) investor relationships and (confidential) business planning information.
While the firm may take the view that this information is proprietary, the reality is that all information is in the hands of individuals, who may at some stage leave the organisation. What then can firms do to reduce the risk of an individual taking its proprietary information to competitors? This note focuses on prevention rather than cure. However, we include a brief section on the steps which can be taken through the courts to prevent abuse of confidential information by former employees and competitors.
What is proprietary information?
Some proprietary information will take the form of formally protectable IP rights but a large proportion falls within the wider category of confidential information.
Copyright: The source and object code of any computer program developed by an employee will almost certainly be protected by copyright which should in most cases be owned by the employer. In principle, the overall structure, architecture and design features on which a program is based can qualify for copyright protection. In practice, there has only been one successful reported case in the UK protecting copyright in these wider features which did also involve copying of the underlying code.
Confidential information: Track record and trading methodologies, models and algorithms are all theoretically protectable as confidential information. When determining whether information is truly "confidential" (and therefore capable of protection after the employment relationship has ended) the English courts look at up to seven factors: the nature of the employment; the nature of information itself; the attitude of the employer at the time; the steps taken to protect the information (see below); separability of the information - i.e. – can it be separated from the employee’s general skill, knowledge and experience (which he cannot be prevented from taking with him); the commercial value of the information; and the usage and practices of the trade.
Contractual definition: Firms can create a contractual definition of what information is confidential and an obligation not to disclose it to any person. Such a list does not enable a firm to protect information which is clearly not confidential in practice. However, an express contractual obligation provides a far stronger starting point in discussions with employees (and former employees) and in taking action in the courts.
Culture and attitude
In assessing whether information can be protected by the courts as confidential information, it is necessary to consider the attitude of the employer and practices of the trade. In the asset management universe, market practice is evolving. Historically, many in the industry held the view that trading strategies developed by an individual while working for Manager A were his to take with him to employ on behalf of Manager B. Whilst it was clear that individuals should not take and copy underlying code, there was some acceptance that the departure of an employee would inevitably result in losing that strategy.
Our observation is that this is changing, driven partly by trends from the US and partly by an increased recognition of the importance of certain types of information to the business, the cost of developing it and the cost of replacing it. For that reason, if a firm wants to protect this investment, it needs to make that attitude and culture clear upfront.
What steps can investment managers take to protect their proprietary information from misuse by employees?
Some examples of actions which may help minimise the risk:
If a firm believes that an employee has taken proprietary information and is planning to misuse it, it should take action immediately. With appropriate evidence, it is possible to obtain an injunction against the former employee and their new employer to prevent this misuse and require the return of proprietary material. More commonly, negotiations lead to an agreed settlement, with appropriate undertakings.
Is there anything else to consider?
This issue cuts both ways! Firms also need to take more care that they do not find themselves on the wrong end of actual or threatened litigation from their new employee’s previous employer. The steps listed above in relation to the firm’s own information apply in reverse to new joiners: make expectations and culture clear, confirm these expectations in the contract of employment and take practical steps to prevent improper use of a third party’s proprietary information.