July 9 (Bloomberg) -- Citadel Investment Group LLC, the $12 billion hedge fund firm founded by Ken Griffin, sued three former executives and the firm they started, Teza Technologies LLC, over claims they violated non-competition agreements.

“This is a case of industrial espionage,” Citadel said in a complaint filed today in Illinois state court in Chicago. The firm seeks a court order barring the individual defendants from conducting any business through Teza or related entities that compete with Citadel, for the duration of the agreements.

Teza described itself in a July 6 e-mail as a “formative” firm that is neither trading nor investing. Named after a river in western Russia, the Chicago-based firm was co-founded by Misha Malyshev, Jace Kohlmeier and Matt Hinerfeld. All were named as defendants in the complaint.

“We didn’t violate any non-competes,” Chris Gair, their attorney, said today in a phone interview. He said his clients took no trade secrets from Citadel.

U.S. agents arrested former Goldman Sachs Group Inc. computer programmer Sergey Aleynikov on July 3, one day after he started working for Teza, on charges he stole trading software from Goldman.

Aleynikov was arrested after he arrived at Liberty International Airport in Newark, New Jersey, prosecutors said. He told federal agents he intended to collect only “open source,” or non-secret, files on which he worked, prosecutors said. He admitted copying and encrypting the data, according to the government.

Allegations ‘Preposterous’

Sabrina Shroff, a lawyer for Aleynikov, said at a July 4 court appearance that the government’s allegations are “preposterous.” She said her client was downloading programs to his personal computer to work at home and hasn’t disseminated the code.

Teza said in the statement that Aleynikov passed background checks before he was hired. The firm said he also indicated he wasn’t violating anyone’s intellectual property rights.

Teza said in the July 6 statement that it suspended Aleynikov without pay after his arrest. The firm said it learned of the allegations on July 5.

Citadel alleged that Aleynikov was slated to receive a salary of $1.2 million a year from Teza, three times what he earned at Goldman.

‘Software Thief’

“Defendants’ activities, particularly Teza’s decision to hire Aleynikov, an accused software thief, create a substantial risk that they have stolen, or may be planning to steal, Citadel’s proprietary code,” the fund manager said in its complaint.

“It had nothing to do with us,” Gair said of the Aleynikov case. He also said he had “no idea” whether the salary figure cited by Citadel was accurate.

Gair denied news reports that Aleynikov had put Goldman software on Teza’s computers.

“There is no reason to believe Aleynikov uploaded Goldman code to any Teza server or computer,” said Gair, a partner at the Chicago law firm Jenner & Block LLP. When Teza’s executives learned Aleynikov had been arrested, they contacted the FBI, he said.

Aleynikov has told the FBI he placed non-proprietary, “open source” programming to Teza’s computer, said Gair.

Citadel lawyer Brian Sieve, of Chicago-based Kirkland & Ellis LLP, said Gair told Cook County Circuit Court Judge Mary Rochford the same thing during a court appearance today.

“They claimed not to know what it was,” Sieve said.

Injunction Hearing

Rochford set a Sept. 29 date for an injunction hearing and directed the parties to expedite their preparation and production of evidence.

Malyshev worked at Citadel for almost six years and, until February, was its head of high-frequency trading.

He was on the team that ran a $1.8 billion tactical trading fund that uses computer models to make trades every few seconds. That fund climbed 40 percent last year, while Citadel’s main funds tumbled 55 percent.

Kohlmeier worked under Malyshev at Citadel, while Hinerfeld was an in-house attorney who helped the firm draft employment agreements “similar to those signed by Malyshev and Kohlmeier,” according to the complaint.

Deferred Compensation

Citadel paid Kohlmeier and Malyshev tens of millions of dollars during their tenure at the firm, some of which was deferred compensation, the fund manager said in its complaint. If the court finds that Kohlmeier and Malyshev violated their agreement, Citadel won’t have to pay them that money, according to court documents.

In Malyshev’s case, the deferred compensation may total about $100 million, said two people with knowledge of the matter, who declined to be identified because the amount hasn’t been publicly disclosed. Gair declined to comment on the issue.

The noncompete agreements signed by Malyshev and Kohlmeier while at Citadel barred them from competing with that firm until November 2009, according to the complaint. In exchange, Citadel agreed to pay Malyshev $30,000 a month during that period, and Kohlmeier $21,000 a month.

Teza, in a statement issued in response to the complaint, called it “frivolous.”

“The suit appears to be timed to harass Teza executives,” the firm said in the statement. “Teza executives Misha Malyshev, Jace Kohlmeier and Matthew Hinerfeld have abided at all times by their agreements and acted in conformity with the law.”

The case is Citadel Investment Group LLC v. Teza Technologies LLC., 09CH22478, Chancery Division, Cook County, Illinois, Circuit Court, (Chicago).

To contact the reporters on this story: Andrew M. Harris in federal court in Chicago at aharris16@bloomberg.net; Katherine Burton in New York at kburton@bloomberg.net; Saijel Kishan in New York at skishan@bloomberg.net.

Last Updated: July 9, 2009 20:36 EDT