Misha Malyshev to focus on quantitative hedge fund

Top high-frequency trader Teza to quit proprietary trading

• source: FT 10-Nov-16

One of the biggest and fastest traders in financial markets is abandoning its core business after its revenue engine stalled, a sign of the challenge of adapting in markets that unfurl in nanoseconds.

Teza Technologies of Chicago plans to exit its proprietary trading business in the next six months to focus on building up a quantitative hedge fund that manages more than $1bn, company executives said.

The new tack comes after net revenues at the proprietary business, which bets Teza’s own money in markets from futures to bonds, steadily declined from about $250m four years ago to $80m in 2015, according to three people familiar with the figures. In 2016, the business has struggled to make a profit, the people added.

“Generally, it is harder to make money,” Misha Malyshev, Teza chief executive, said in a rare interview.

Mr Malyshev founded Teza in 2009, naming it for a river in his native Russia. The high-frequency trading group used automated programs to vault to the top ranks of participants on venues such as the Chicago Mercantile Exchange and BrokerTec, a marketplace for US Treasury bonds once dominated by banks.

Mr Malyshev has a doctorate in astrophysics from Princeton. In 2008, he made more than $1bn for the hedge fund Citadel while serving as its head of high-frequency trading. Teza’s profile rose after it hired Sergey Aleynikov, a programmer who was convicted, and later exonerated, for stealing trading software codes from his former employer, Goldman Sachs. 

Teza’s situation reflects broader pressures within the industry, where increasing sums are spent on telecoms infrastructure, computer algorithms and exchange fees in order to be an instant faster than others. Chopper Trading, another HFT group, quit the arms race last year when it sold out to competitor DRW. 

The Teza payroll expanded from about 45 employees in 2013 to peak at 117 about a year ago. It has dropped to 93, Mr Malyshev said.

Teza in July began approaching investors with potential deals including purchasing equity in the core proprietary business, licensing its technology and becoming a partner in the fund business, three people familiar with the matter said.

Virtu Financial, a trading group based in New York, acquired wireless capacity and hardware from Teza in Europe and the US, including microwave towers that beam market information, people familiar with the matter said. Virtu declined to comment. 

Asked if Teza was trying to raise cash, Mr Malyshev said: “Capital is never bad.”

The hedge fund, Teza Capital Management, started managing outside money in October 2014 and contained $1.1bn as of February, according to a regulatory filing. “The future of Teza is the asset management business,” Mr Malyshev said.

The filing warned Teza Capital’s computer models could fall short, including by making “assumptions regarding the existence of relationships that appear to hold true or in fact held true in the past but that may not exist or hold true in the future”. 

Speaking a day after Donald Trump won his long-shot bid for the US presidency, Mr Malyshev added: “One thing we know is that in financial markets, six-sigma events are happening with the frequency of two-sigma or even one-sigma,” the lower numbers being statistically more likely.

Mikhail 'Misha' Malyshev ordered to pay $1.1 million fine for erasing computer files

Mikhail 'Misha' Malyshev ordered to pay fine to 2 charities after violating judge's order to preserve potential evidence in lawsuit

A former executive of hedge fund manager Citadel Investment Group LLC recently gave about $1.1 million to two Chicago charities, but the payments were not an act of good will.
The money was actually a fine that a Cook County judge ordered Mikhail "Misha" Malyshev to pay for violating a previous court ruling to preserve documents in a lawsuit. In July 2009, Citadel had sued him for breaking a contractual promise not to compete with the hedge fund.

Citadel had asked Judge Mary Rochford to sanction Malyshev when it discovered that he had used scrubbing software to erase files on his home computers. In an usual move, the company requested that any penalty be donated to charity. It selected the Greater Chicago Food Depository and the Coordinated Advice and Referral Program for Legal Services (CARPLS), according to court papers.
Malyshev sent $553,049.24 to each organization about a week ago, according to his lawyer, Chris Gair of Jenner & Block, after withdrawing his appeal of the judge's sanction.

Gair said he had never heard of such a large sanction in Illinois courts. His assertion was hard to verify but other judges in the Daley Center were surprised when told of the amount.
Even Rochford, in her July order, recognized that the penalty was significant. But it was less than Citadel had requested. Much less.

The hedge fund asked for a staggering $15 million penalty. But the amount does not seem so large in context, Citadel said. Malyshev earned $150 million in 2008, the company said in court papers, so the penalty would have amounted to just 10 percent of his income.
Malyshev led Citadel's high-frequency trading group, with co-defendant Jace Kohlmeier as his top deputy. Together the men ran a department that made more than $1 billion in 2008, using computer programs to make rapid-fire trades across multiple trading venues. They left in February 2009 to form their own securities trading firm.
Citadel scored a partial victory in October 2009 when Rochford granted its request to temporarily block the pair from working at their own firm. Her ruling also granted sanctions against Malyshev, ordering him to pay Citadel's legal fees and costs associated with a forensic review of his home computers. The judge reserved the right to fine him for disobeying her order to preserve potential evidence.

Malyshev denied intentionally erasing Citadel files on his computers and testified that the only active files deleted were pornography.

Rochford, however, found Malyshev's conduct and testimony "more egregious than anything encountered before" in her experience.

"Malyshev has acted in disregard of the orderly administration of justice," the judge wrote in her July 13 ruling. "He improperly and significantly disrupted the discovery process and impaired the truth-seeking process for all parties."

She said the $1.1 million penalty was appropriate to deter future misconduct and to protect the integrity of the discovery rules. The penalty, the judge said, was equal to the legal fees and costs.
But she said Citadel's $15 million request was inappropriate because it was aimed at punishing Malyshev. Citadel declined to comment on the judge's order. One of Citadel's attorneys, Shawn Fagan, sits on the board of CARPLS.

Allen Schwartz, executive director of CARPLS, said the money would create some fiscal stability after the organization lost one-fourth of its funding in 2008. But the funds likely would be used to replenish the organization's reserves and not hire new staff, he said.

Ex-Goldman Programmer Aleynikov Pleads Not Guilty

(Bloomberg) -- Former Goldman Sachs Group Inc. computer programmer Sergey Aleynikov pleaded not guilty to federal charges that he stole trading software from the bank.
Aleynikov, 40, entered his plea today before U.S. District Judge Denise L. Cote in New York. The judge set a trial date of Nov. 29.

Aleynikov was arrested in July and indicted Feb. 11. A prosecutor said during a July court appearance that the alleged theft is the “most substantial” New York-based Goldman can recall. The programmer stole code on his last day at the bank in June, according to the indictment.

“The defendant has taken source code at various other times during the course of his employment,” Assistant U.S. Attorney Joseph P. Facciponti told Cote today.
Aleynikov’s lawyer, Sabrina P. Shroff, declined to comment after the hearing.

According to the indictment, Aleynikov’s last day at Goldman was June 5, before he left to join Teza Technologies LLC, a Chicago-based firm co-founded by Misha Malyshev, a former Citadel Investment Group LLC trader.

Beginning at 5:20 p.m., he transferred Goldman code for its trading platform to an outside server in Germany, according to the indictment.

Deleting History

“After transferring the files, Aleynikov deleted the program he used to encrypt the files and deleted the computer’s ‘bash history,’ which records the most recent commands executed on his computer,” U.S. Attorney Preet Bharara said in a statement.

Teza suspended Aleynikov after his arrest and has since fired him. On July 2, he attended meetings at Teza’s office and brought his laptop computer and another storage device, each of which held Goldman’s source code, the government said.

Facciponti told Cote today that a preliminary search of Teza’s computers didn’t turn up any Goldman source code.

“There’s a good reason why the U.S. attorney found no Goldman code on the Teza computers, and that’s because Teza got no Goldman code from Aleynikov or anyone else,” Chris C. Gair, a lawyer for Teza at Jenner & Block LLP in Chicago, said in a phone interview.

The software code at issue in the case, worth millions of dollars, lets Goldman do “sophisticated, high-speed and high- volume trades on various stock and commodities markets,” prosecutors said in court papers. Aleynikov planned to earn three times his salary by joining the new company and engaging in high-volume automated trading, prosecutors said at the time of his arrest.

$750,000 Bail

Aleynikov, who is free on $750,000 bail, lives in New Jersey and holds dual U.S. and Russian citizenship. He and Shroff, his lawyer, previously said the files prosecutors claim he stole weren’t shared with anyone and he took them so he could work from home.

The indictment followed Shroff’s appeals to prosecutors to drop the case.

Aleynikov starting working at Goldman in 2007, the government said. He was part of a team of workers responsible for improving the computer platform.

Before joining Goldman, Aleynikov worked for about eight years at IDT Corp., the U.S. vendor of prepaid calling cards, where he led the team responsible for developing routing systems, according to the profile on the social-networking site LinkedIn.

He is charged in the indictment with one count of theft of trade secrets, one count of transportation of stolen property in foreign commerce, and one count of unauthorized computer access. He faces as long as 25 years in prison if convicted.

The case is U.S. v. Aleynikov, 1:10-cr-00096, U.S. District Court, Southern District of New York (Manhattan).

Misha Malyshev : From plasma physicist to Citadel's nemesis

Misha Malyshev, who grew up in central Russia in a home with a wood stove and no running water, has earned enough in his hedge-fund career to afford almost any luxury.

He may need that thick wallet to defend himself against recent charges that he stole former employer Citadel Investment Group's "secret sauce," the computer code that controls its trading decisions. The lawsuit stands in the way of Mr. Malyshev's plans to start his own trading firm, Teza Technologies LLC, after earning tens of millions of dollars at Chicago-based Citadel.

The case underscores how dependent big hedge fund managers are on individual minds like Mr. Malyshev, whose computer programs helped generate billions of dollars in profits for Citadel. Known as high-frequency trading, the programs find tiny price mismatches across different markets and send off rapid-fire buy and sell orders to snag profits.

Under Mr. Malyshev, who declines to be interviewed, Citadel's high-frequency trading fund gained 40% last year, even as Citadel's main funds dropped 55%.

Though the strategy relies heavily on computer technology, people are more important, says Robert Iati, a partner at Tabb Group, a financial industry consulting firm.

"The idea that somebody stole code so they are going to bring everyone to their knees, that's garbage," Mr. Iati says. Trading companies are profitable because "they have smarter people."

Smart is one way to describe Mr. Malyshev, 40, who has a doctorate in plasma physics. The son of a truck-driver father and an elementary-school-teacher mother, Mr. Malyshev took a correspondence course as a teenager and landed a coveted spot at the Moscow Institute of Physics and Technology, sometimes called Russia's MIT.

He arrived in the U.S. with his wife, a graduate of the same school, in 1993, getting his doctorate from Princeton University six years later. Vincent Donnelly, a professor at the University of Houston who oversaw Mr. Malyshev's dissertation research at Bell Labs in Murray Hill, N.J., recalls giving him an assignment to build a component for a machine used in the production of silicon chips. Mr. Donnelly expected the job would take several months. Mr. Malyshev got it done in a week.

After a short stint at Bell Labs and a few years at consulting firm McKinsey & Co. in New York, Mr. Malyshev took a job at Citadel in 2003.

He quit Citadel last February. His contract barred him from competing with his former employer for nine months, during which time the hedge fund company was to pay him $30,000 a month and as much as $100 million in deferred compensation.

His plans to launch his own firm hit a roadblock on July 3, when the FBI arrested a former Goldman Sachs Group Inc. programmer named Sergey Aleynikov, alleging that he stole the computer code for Goldman's high-speed trading strategy. Mr. Aleynikov had just started working for Teza, which promptly suspended him and said it would cooperate with authorities.

Mr. Aleynikov, who says he's not guilty, is due in court Monday.

High-frequency trading lately has come under scrutiny after Sen. Charles Schumer, D-N.Y., called on the Securities and Exchange Commission to ban a practice in which some stock exchanges allow high-speed traders a split-second look at investors' orders before they're made available to the broader market. Citadel uses so-called flash orders at the stock market it co-founded, Direct Edge; it's unclear whether Mr. Malyshev plans to.

Six days after the FBI arrest, Citadel filed its lawsuit, saying Mr. Malyshev and another programmer had violated their agreements not to compete and stole trade secrets. As developers, "they had the whole picture," says Michael Foradas, a Kirkland & Ellis lawyer representing Citadel. "The key part of the business is the development of the trading tools."

Mr. Malyshev has filed a motion to dismiss the complaint.

"This isn't a case about trade secrets at all," says Chris Gair, a Chicago-based lawyer at Jenner & Block LLP who is representing Mr. Malyshev. "It's a case about human talent."

Update April 2014 

Misha Malyshev resides in Wilmette, Illinois.

Teza is a science and technology driven global quantitative trading business headquartered in Chicago with offices in New York and London. Misha Malyshevhas led Teza as its CEO since he founded the company in 2009. Malyshev earned his Ph.D. in astrophysics from Princeton University, as well as an M.S. in theoretical physics and a B.S. in physics and mathematics from Moscow Institute of Physics and Technology. For more information, visit www.teza.com.