White & Case LLP - News - As Banks Close Prop Desks and Traders Move to Hedge Funds, Hedge Fund Managers Focus on Permissible Scope of Use of Confidential Information

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As Banks Close Prop Desks and Traders Move to Hedge Funds, Hedge Fund Managers Focus on Permissible Scope of Use of Confidential Information
May 7, 2009, Hedge Fund Law Report

In the current economic downturn, numerous investment banks have closed their proprietary trading operations, leading to a surplus of highly skilled traders suddenly on the job market. Many have found new positions at hedge fund companies, who now must address a range of new legal and compliance questions about how such new employees' jobs should be structured.

"If you just have someone sitting on the sidelines for a period of time, the information they have is going to go stale. That's an effective way of keeping someone from trading against your positions," noted David Goldstein, Co-Head of White & Case LLP's Investment Funds practice.

Goldstein observed that software can be used to create virtual walls between new employees with confidential information and old employees, but the more important variable is a culture of compliance in which all employees are sensitive to confidentiality concerns. "The first thing a hedge fund should do is notify anyone else in the firm who is looking at those names that they cannot speak with the new trader or analyst about those names," Goldstein said. "There are also software barriers that can be put in place so traders cannot look at any file that person has viewed. But what you can't prevent is collusion. What becomes important then is a culture of compliance where everyone at the firm understands compliance is important and if anyone suspects wrongdoing they have a responsibility to report that."

Goldstein outlined this issue as follows: "It is the responsibility of the new firm to understand even before the person comes in the limitations on what this person can convey. You can't memorize the recipe to the secret sauce then move over to a new kitchen. The hiring firm has to really understand what that person did, how that person did his or her analysis, made his or her investment decisions and went about his or her business, and understand how that is going to translate in the new environment. Are they going to be able to do the same thing for the new firm and if not, what are the limitations? This all has to be sorted out before the person comes on so any conflicts can be dealt with."

According to Goldstein, "typically there is not a carve out that the agreements are no longer applicable if the bank goes out of business or the prop desk is shut down." Goldstein continued that in certain circumstances, the former employer bank can waive confidentiality obligations – "this," he said, "would seem a perfect scenario, but it all depends on the company and the employee involved."

For employees, violations – even negligent ones – can cut off the vesting of contingent compensation. For example, Goldstein noted that many bank employees receive stock options, warrants or similar claims on equity as part of their employment or severance compensation.

	In the Media
Expertise Funds	As Banks Close Prop Desks and Traders Move to Hedge Funds, Hedge Fund Managers Focus on Permissible Scope of Use of Confidential Information May 7, 2009, Hedge Fund Law Report In the current economic downturn, numerous investment banks have closed their proprietary trading operations, leading to a surplus of highly skilled traders suddenly on the job market. Many have found new positions at hedge fund companies, who now must address a range of new legal and compliance questions about how such new employees' jobs should be structured. "If you just have someone sitting on the sidelines for a period of time, the information they have is going to go stale. That's an effective way of keeping someone from trading against your positions," noted David Goldstein, Co-Head of White & Case LLP's Investment Funds practice. Goldstein observed that software can be used to create virtual walls between new employees with confidential information and old employees, but the more important variable is a culture of compliance in which all employees are sensitive to confidentiality concerns. "The first thing a hedge fund should do is notify anyone else in the firm who is looking at those names that they cannot speak with the new trader or analyst about those names," Goldstein said. "There are also software barriers that can be put in place so traders cannot look at any file that person has viewed. But what you can't prevent is collusion. What becomes important then is a culture of compliance where everyone at the firm understands compliance is important and if anyone suspects wrongdoing they have a responsibility to report that." Goldstein outlined this issue as follows: "It is the responsibility of the new firm to understand even before the person comes in the limitations on what this person can convey. You can't memorize the recipe to the secret sauce then move over to a new kitchen. The hiring firm has to really understand what that person did, how that person did his or her analysis, made his or her investment decisions and went about his or her business, and understand how that is going to translate in the new environment. Are they going to be able to do the same thing for the new firm and if not, what are the limitations? This all has to be sorted out before the person comes on so any conflicts can be dealt with." According to Goldstein, "typically there is not a carve out that the agreements are no longer applicable if the bank goes out of business or the prop desk is shut down." Goldstein continued that in certain circumstances, the former employer bank can waive confidentiality obligations – "this," he said, "would seem a perfect scenario, but it all depends on the company and the employee involved." For employees, violations – even negligent ones – can cut off the vesting of contingent compensation. For example, Goldstein noted that many bank employees receive stock options, warrants or similar claims on equity as part of their employment or severance compensation.