Court of Appeal:
Provision in Contract Restraining Employee From Using Knowledge Beyond What He Gleaned From Access To Company’s Secrets Held to Breach Bar on Non-Competition Clauses That Preclude Making a Living
By a MetNews Staff Writer
Confidentiality provisions in an employment contract were so drastic in inhibiting a former employee’s use of his general knowledge in the securities field, after leaving the company that he worked for, as to constitute an impermissible bar to earning his livelihood in the securities industry in the future, Div. Three of the Fourth District Court of Appeal has held.
In reversing a judgment confirming an arbitration award in favor of the employer, the appeals court lifted an obligation imposed on the plaintiff, Richard Hale Brown, to pay his former employer, TGS Management Company, more than $2.6 million in attorney fees and costs under a fee-shifting agreement in the contract and to repay a 2014 bonus he received in the amount of $652,243.35. The matter of what, if anything, Brown owes TGS, Justice Richard M. Aronson said in his opinion—filed Oct. 13 and certified for publication on Thursday—can be addressed on remand.
For now, what is decided is that Orange Superior Court Judge John C. Gastelum erred in determining that that the arbitration award by a former judge of his court, James L. Smith, of the alternate dispute resolution firm JAMS, must be given effect. Confidentiality provisions barring the use by Brown of what he has learned in his field, independently from access to company secrets, “illegally restrict Brown’s right to work,” Aronson declared.
Smith, who was presiding judge of the court in 1994 and 1995, found nonjusticiable the contention by Brown that the noncompetition clause in an employment contract he signed in 2005 with TGS, after it flew him here from his home in the United Kingdom, was invalid under Business and Professions Code §16600 which provides:
“Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void.”
The non-competition clause in the 2005 contract (and in a subsequent agreement) provided for a two-year bar on employment with a competitor to TGS and, Smith observed, more than two years had passed since Smith left TGS’s employ, leaving no controversy to be decided.
Use of Knowledge
Viewing it differently, Aronson said that §16600 was violated because the contract prohibited Brown from using in the future knowledge within his possession about securities that was not derived from private company information which he gained in the course of his employment with TGS, an Irvine investment company.
The contract required that he “keep all Confidential Information in strictest confidence and trust” while employed by TGS and afterward, defining “Confidential Information” as information, in whatever form, used or usable in, or originated, developed or acquired for use in, or about or relating to, the Business.” It then defines “The Business” as including “without limitation analyzing, executing, trading and/or hedging in securities and financial instruments and derivatives thereon, securities-related research, and trade processing and related administration....”
That language, Aronson remarked, is “strikingly broad”—so broad, he said, as to render meritorious Brown’s contention that it would “prevent him from ever working again in securities trading, much less in his chosen specialty of statistical arbitrage,” a trading strategy relying on mathematical computations.
The jurist said that two exceptions to the confidentiality pledge demonstrate the “vast scope of the prohibition.” One permits use of “information which is or becomes generally known in the securities industry through legal means” which, he noted, Brown asserts is of no value to him “because statistical arbitrage is profitable only if the variables and methods behind it are not ‘generally known.’ ”
“The second exception even more sharply illustrates TGS’s overreach in identifying ‘Confidential Information’ Brown never may use or disclose in future employment. This exclusion comprises information which ‘was known by Employee on a non-confidential basis prior to his initial engagement or employment by Employer, as evidenced by Employee’s written records.’ Brown points out the absurdity of this exception: ‘In other words, securities-related information that was not confidential before Brown’s employment with TGS metamorphoses into TGS’s ‘Confidential Information’ unless Brown has written records proving his prior knowledge of the information.’ ”
“[W]e conclude the confidentiality provisions in the Employment Agreement on their face patently violate section 16600.6 Collectively, these overly restrictive provisions operate as a de facto noncompete provision; they plainly bar Brown in perpetuity from doing any work in the securities field, much less in his chosen profession of statistical arbitrage. Consequently, we conclude the confidentiality provisions are void ab initio and unenforceable.”
Smith also found that Brown was not entitled to relief based on the unclean hands doctrine, inasmuch as he pilfered electronically-stored confidential information about TGS’s “historical earnings” by copying it onto his cell phone and retaining it after he left the company.
“The arbitrator certainly had grounds for concluding Brown’s hands were unclean, given his theft of TGS’s confidential information before being terminated, and then lying about those circumstances in his testimony at the hearing,” Aronson said.
“On the other hand, the weighing of the equities is complicated here because of the importance of the public policies at stake in the declaratory relief claim. We are cognizant of the oppressive, potentially career-ending confidentiality provisions Brown agreed to as a condition of employment, and the fact his theft of the information apparently caused no harm to TGS.”
He reached the conclusion that “the unclean hands defense here was irrelevant to the question of whether the confidentiality provision was enforceable under section 16600,” and in light of that unenforceability, “the award exceeded the arbitrator’s powers” and judgment should not have been entered on that award.
Aronson noted that TGS “is a private limited liability company which engages in a highly computerized form of equities trading known as statistical arbitrage” but did not undertake to explain the nature of that specialty.
Brown’s complaint sets forth a definition, with one not apt to instill an understanding of the term by persons not versed on the field:
“Statistical arbitrage is an approach to make a profit from pricing inefficiencies between securities. Investors identify the arbitrage opportunities through mathematical modeling techniques. More specifically, the statistical arbitrage methodology generally consists of several steps: (a) develop an expectation model at the individual stock level and perform principal component analysis of the market; (b) develop minimum-variance portfolio with the highest expected return, taking into trading costs and various constraints; (c) test and validate the model; (d) improve the model from the test and validation.”
The case is Brown v. TGS Management, 2020 S.O.S. 5398.
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