Goldman Arrest Highlights Problem with IP Law

Bloomberg reports a computer programmer, Sergey Aleynikov, was arrested July 3 on arriving at the Newark, New Jersey, airport and charged with theft of trade secrets. As someone involved in intellectual property litigation, it brings back nightmares, though I am happy to say I've never been arrested.

From Bloomberg, they note that:

the proprietary code lets the firm do “sophisticated, high-speed and high-volume trades on various stock and commodities markets,” prosecutors said. The trades generate “many millions of dollars” each year, they said.

This highlights the problem with IP law. These statements sound like sufficient probable cause to a judge, but they could be a program that buys stocks based on the simplest of pairs trading algorithms. The problem is that intellectual property law in most states allows an ex-employer a very broad scope to level charges, so if someone wants to accuse you of something very vague based on the flimsiest arguments (eg, 'he planned to do mean-variance optimization as he did at our firm') they have the right. As an instrument of harassment this is much scarier than any anti-terrorist legislation, because no one cares when it is abused.

The fact that while they engage in discovery (which can last years) and send and receive interogatories, searching your hard drives and emails, you cannot work for anyone because without a precise definition as to what information, code, algorithms, etc., are at issue, anyone doing business with you is taking on infinite liability. Plus, good IP lawyers cost a lot of money, and as litigation takes several years, a large firm can easily bankrupt a target. With such a prospect, a rich litigator can make the ex-employee an offer he can't refuse.

Firms who engage in such over broad litigation are invariably alpha-less because only those so insecure about how outsiders view their alpha, and how important non-principals are to their alpha, use this tactic gratuitiously. In the end, it does not work, mainly because 1) they demonstrate they believe they have little endogenous alpha, which is usually true and 2) no new alpha comes in, because those with a choice prefer to avoid such people.

In this case, I think Goldman is probably on the right side. This is because Goldman has a habit of letting ex-employees leave and prosper, as they have learned to use their ex-employee success to their advantage. They have no insecurity that people will think Goldman's alpha is from the current crop leaving to start new companies, as this has been going on for decades. Further, the person at issue is a computer programmer, not a trader or portfolio manager, and such code is often very specific (not broad concepts like 'variance' or 'cash flow'). Lastly, programmers are usually given algorithms to code; it is implausible that such workers already knew about parochial trading rules based on previous work automating account statements for Blue Cross.

Comments

[Kinabalu:]

"These statements sound like sufficient probable cause to a judge, but they could be a program that buys stocks based on the simplest of pairs trading algorithms"

Program trading often utilizes very simple trading strategies. The key is the speed of execution. GS can only win if they are faster than anyone else to react to market developments. This code is a legitimate trade secret and its blatant conversion should result in a prison term. The only issue is whether the thief has disseminated the code in a manner that will forestall GSs effective use of it in the future.

Jul 06 04:23 PM

[pimpjui:]

If the developer has coded the spec, he usually ends up knowing the concept better than the person who wrote the spec. He knows what works and what does not work, and why. The theoretical guy who wrote the spec can only hypothesize (until he gets some actual results). GS is going after this guy because it is about code, which can be disseminated immediately and at an exponential rate. In the next month, a sweatshop in India could be running the GS algo. The success of the GS "offspring" you mentioned may have prospered. But even rudimentary factor model analysis of returns would show strong evidence that they were just taking on credit risk and liquidity risk during an environment of easy credit. Throw on top of that that GS was probably their prime broker (and very likely seed investor), these success stories will disappear shortly. Really, offspring hedge funds were probably a lower risk source of revenue for GS that running a prop shop in house. Regarding GS itself , I am sorry, but that comany has lost all respect from an intellectual powerhouse standpoint. Bottom line: they could not take a drawdown, and had to go cap in hand to the government. GS is a now "confidence" play, not a value play.

Jul 06 04:33 PM

[MrMan:]

re:"Bottom line: they could not take a drawdown"

why weather such a drawdown unassisted if you don't have to? i do not like it, but I do not lose intellectual respect for those resourceful enough to do whatever it takes to survive.

Jul 06 06:24 PM

[TimTom:]

has 'oldman proved that the ex-programmer has actually used the code to give his new employer unfair advantage? or is the fact that he merely posesses the knowledge criminal now. or is it to protect against future crimes? In today's age of information overload and google, is any code really "original"? to be sarcastic one can implement "bubble-sort" only so many ways. And where do u think 'oldman got the algo from? From somebody's thesis at stanford, berkeley or MIT?

Jul 07 09:56 PM