By Chris Dolmetsch and Tiffany Kary
July 17 (Bloomberg) -- The plan was for Kang Gao to do his exit interview with Two Sigma Investments LLC, a $21 billion quantitative hedge fund in New York, and jump to Citadel LLC, a rival firm in Chicago.
Gao never got that chance. Unbeknown to him, that final meeting had been recorded for investigators at the Manhattan District Attorney’s Office, and instead, the 29-year-old native of China found himself sitting in a New York City jail. He’s accused of stealing Two Sigma secrets and faces a potential four-year prison term.
Gao is the fourth Wall Street analyst or programmer to be ensnared in a crackdown by the D.A., Cyrus Vance Jr., on intellectual property theft from financial firms. His decision to charge Gao, former Goldman Sachs Group Inc. programmer Sergey Aleynikov and ex-employees of the Dutch firm Flow Traders BV, signals a willingness to criminalize financial industry disputes formerly relegated to contract litigation.
The prosecutions come as Wall Street is increasingly protective of intellectual property, including trading models and software code, which have become more valuable as firms seek a millisecond advantage over rivals through strategies including high-frequency trading.
Financial companies are looking to the government to protect their tech, said Joel Reidenberg, academic director of Fordham University’s Center on Law and Information Policy in New York. He said they have convinced prosecutors that the financial services sector may otherwise be brought to a “crushing halt.”
While Vance has moved assiduously to protect the technological achievements of Wall Street, other prosecutors are taking a more adversarial tack, looking into whether that intellectual property is being used to rig the market and fleece Main Street.
New York Attorney General Eric Schneiderman is probing whether high-speed electronic traders profit from non-public information, and the Justice Department is also investigating the industry, people familiar with the matters have said.
Reidenberg said trading firms, far from seeing high technology as an unfair advantage, view it as a means to survival.
“The concern about high-frequency trading is that these are highly proprietary programs, Wall Street depends on them,” he said. “If someone can jump ship and potentially corrupt the high-frequency program, it’s going to skew the market.”
Prosecutors are confronting the modern realities of the marketplace in which a company’s most valuable property may be software, said Anthony Sabino, a law professor at St. John’s University’s Peter J. Tobin College of Business.
“We used to live in a day where, on Wall Street, things such as client lists or Rolodexes or other antiques were the tools of doing business,” Sabino said. “In our hyper-electronic world, so many of our business methodologies have been reduced to source code.”
Dave Lauer, president of consulting firm Kor Group LLC, said prosecutions have become easier since strategies that were once in a trader’s head have taken physical form as stored code.
“I don’t see how it’s any different from what it used to be, where if you were a good trader you traveled with your trading strategy from firm to firm and nobody seemed to care about that,” Lauer, a former high-speed trader, said. “Or you had your contact list and you would bring your clients.”
Kevin McPartland, head of market structure for research firm Greenwich Associates in Stamford, Connecticut, said moving these cases into criminal court is “sending a message.”
“Even if it feels inconsequential, it’s still the property of the firm for which it was developed,” McPartland said. “And they’re taking that seriously.”
While charges against an employee who stole a company’s car, computer or cash wouldn’t raise eyebrows, software theft is newer ground in criminal law.
New York State Supreme Court Justice Jeffrey K. Oing in Manhattan, who oversees a lawsuit against Gao by Two Sigma, questioned the need for Vance’s prosecution during a hearing in March. He asked lawyers for the hedge fund whether it was going “over the top” by having Gao jailed.
“Something just doesn’t ring right in this case,” said Oing, who froze Gao’s bank accounts and put the lawsuit on hold until the criminal case is resolved. The judge said he’s handled lawsuits against former Wall Street employees accused of taking trade secrets or client lists.
“None, none of them have ever risen to a level of a criminal indictment,” he said.
It’s also a first for Two Sigma.
Under questioning from Oing, lawyers for the firm said that while Gao wasn’t the first worker it accused of breaching an employment agreement, he was the first to be jailed for it.
In November 2006, the firm sued a former software developer, Jianjun Qiu, accusing him of stealing its property and fleeing to his homeland of China. Both parties agreed to end that case less than three months later, according to court records. The terms weren’t made public.
In Gao’s case, he is charged with the same counts as Aleynikov, who also looked to move to a Chicago based firm, Teza Technologies LLC, and three men alleged to have taken software from Flow Traders, an Amsterdam-based company founded in 2004.
Aleynikov, 44, a Russian-born naturalized U.S. citizen, was convicted on federal charges of stealing code in 2010 and served about one year of his eight-year sentence before the verdict was overturned by the U.S. Court of Appeals in New York. Undeterred, Vance had him arrested six months later. Aleynikov pleaded not guilty to state charges and is awaiting trial.
In the Flow Traders case, former employees Jason Vuu, 27, of San Jose, California, and Glen Cressman, 27, of Fort Lauderdale, Florida, are accused by Vance of taking trading strategies and code for the firm’s proprietary trading platform.
Flow Traders describes itself as a “leading international proprietary trading house” that “distinguishes itself with state of the art technology and a focus on niche competencies.”
Vuu is charged with giving the information to Simon Lu, 26, of Pittsburgh, a former classmate at the Massachusetts Institute of Technology. All three have pleaded not guilty. Cressman is scheduled for trial Oct. 14.
The firm didn’t respond to an e-mail seeking comment on the case.
Vance’s office is also probing an alleged theft of code from KCG Holdings Inc., a firm that specializes in high-frequency trading, said a person familiar with the matter who asked not to be identified because the matter was private.
Vance, 60, has called for tougher laws penalizing the theft of trade secrets. The prosecutor said he wants to protect the ability of Wall Street firms to compete around the world.
As head of New York’s District Attorneys Association, he convened a task force to reform “antiquated” white-collar crime laws, including those that deal with cybercrime.
In September, the panel recommended changing the state’s definition of larceny to cover information theft, including computer data and programs, and extending New York’s jurisdiction to crimes that occur in other states if they affect New York residents.
Vance, who has jurisdiction over much of the financial industry by dint of geography, said when announcing Gao’s indictment in March that the group is pushing for legislative action to make those changes.
“Protection of intellectual property and trade secrets, such as computer source codes, is critical to building and maintaining economic growth and prosperity,” Vance said at a financial crime and cybersecurity conference in November. He cited statistics that intellectual property industries support at least 40 million jobs and contribute more than $5 trillion to the U.S. gross domestic product, or one-third of GDP.
Gao, who worked at Two Sigma for 3 ½ years, has pleaded not guilty to the charges. His attorney, Marc Agnifilo of Brafman and Associates PC, said companies like Two Sigma take cases against former employees to prosecutors because it’s less expensive and more effective, since the government can “bring a tremendous amount of pressure.”
“What you’re starting to see now is these companies, rather than paying money for a private law firm, go to the district attorney’s office and have the district attorney’s office do their bidding,” Agnifilo said. “The district attorney’s office is certainly better at it -- they hold people in jail.”
Kelly Howard, a spokesman for Two Sigma, said the decision to charge Gao was “not in our hands.”
“We brought the actions to Vance’s office and from there it’s really their decision,” Howard said in a phone interview.
Agnifilo has asked for Gao’s charges to be thrown out, saying that the information he’s accused of taking isn’t proprietary or is based on common concepts. Gao is set to return to court July 29 for a decision on that request.
Joan Vollero, a Vance spokeswoman, declined to comment on the Gao case or other prosecutions.
Gao attended Peking University before transferring to MIT, where he graduated in 2009 with degrees in physics and electrical science and engineering. He worked as a summer intern at Merrill Lynch & Co. in New York and, after graduation, at DRW Holdings LLC in Chicago before taking an analyst position in 2010 with Two Sigma.
The New York-based hedge fund, which uses complex mathematical models to decide when to buy and sell securities, was started in 2001 by David Siegel, a former chief technology officer at Tudor Investment Corp., and John Overdeck, a former managing director at D.E. Shaw & Co.
According to its lawsuit, Two Sigma confronted Gao more than a year ago after learning he had viewed code unrelated to trading models he had worked on. Gao said he looked at the code “out of curiosity,” according to the complaint.
He continued to view information he wasn’t allowed to see on his home computer, and repeatedly e-mailed confidential information to his personal Gmail account, including research on trading in China and a new method to improve models, the hedge fund claimed.
Competing Hedge Fund
In January, Two Sigma said, Gao flew to the U.K. for a job interview with GSA Capital Partners LLP, a competing hedge fund. Upon his return, he continued viewing models that he wasn’t authorized to access, wrote a letter to U.S. immigration officials indicating his intention to resign from his job and start a new company in China, and researched cases involving employee theft of trade secrets and other intellectual property, Two Sigma alleged.
On Feb. 5, after winning the Citadel job, Gao resigned from Two Sigma. Six days later, he was arrested during his exit interview and taken to jail, where he remains, unable to post bail. Citadel rescinded its job offer a week later.
Katie Spring, a spokeswoman for Chicago-based Citadel, declined to comment on the case.
To successfully prosecute departing employees who take intellectual property, Vance will have to show that more is at stake in such disputes than traditional sniping between rival firms, said Steve Kramarsky, a lawyer with Dewey Pegno Kramarsky LLP.
Lawsuits have been effective in dealing with alleged code thefts quickly through restraining orders and settlements, Kramarsky said, adding that Vance has to prove such thefts actually harm the public to require prosecution.
But even intellectual property theft like the production of knockoff designer handbags can lead to charges, Kramarsky said.
“You would think that the only person being harmed by a fake Louis Vuitton is Louis Vuitton, but that’s not what Congress has decided,” Kramarsky said.
Since Aleynikov’s appeals court victory, the U.S. Economic Espionage Act, which had previously applied mostly to manufactured goods, was updated to include products or services used or intended for use in interstate commerce, giving more federal coverage to theft of software code and trade secrets.
One case the U.S. Justice Department has pursued in this arena is against former Citadel employee Yihao “Ben” Pu, who was charged in 2011 by the Chicago U.S. attorney with trying to steal the firm’s high-speed trading software. He pleaded not guilty. His trial is set for September.
Citadel sued Pu two months before the charges were filed, accusing him of transferring confidential information about its trading business. According to Citadel’s lawsuit, Pu discussed leaving to join Teza, the firm founded by former Citadel high-frequency trading chief Mikhail ‘Misha’ Malyshev that hired Aleynikov.
Teza suspended Aleynikov after his arrest and later fired him.
Bob Iati, partner and head of consulting at New York-based research firm Tabb Group LLC, said the computerization of finance has made trading software, and its protection, critical to the industry.
Regulators and politicians have taken the position “that technology -- computer code -- as it relates to the markets, impacts everybody, including John Q. Public and grandma’s retirement money,” Iati said.
Oing, the judge overseeing Two Sigma’s lawsuit against Gao, said the prosecution of the ex-analyst may lead to others.
“That, perhaps, may now be opening the door for all employers to think ‘You know what, we are going to put these guys in jail now,’” the judge said. “That is going to be really something.”