Trader fired over off-color joke challenges hedge fund secrecy

A former senior trader is now claiming in court that his employment contract violated New York labor laws, a case charged with the politics of the #MeToo movement on Wall Street that could also have repercussions for contracts throughout the industry.

In a brief filed in New York Supreme Court on Tuesday, Daniel Michalow and his lawyers are laying out their case that the policy of his previous employer, D.E. Shaw, of withholding back pay until soon-to-be-ex-employees sign separation agreements that essentially waive their rights to ever to sue the firm or report misconduct is illegal under New York State labor laws. They also allege that these types of contracts are widespread throughout the hedge fund industry.

Michalow was fired by D.E. Shaw in 2018 after telling a former assistant that he was looking for a new assistant whom he could call “sugar tits” — a quip he later said was intended as a Mel Gibson impression. The fund said that his behavior had violated the firm’s code of conduct. In 2022, he was awarded $52 million by a Financial Industry Regulatory Authority panel that found D.E. Shaw and four senior executives defamed Michalow when they suggested to a Bloomberg reporter and internally that he had been fired for sexual misconduct.

Since the Finra finding, Michalow has been appealing the size of his award, arguing that D.E. Shaw is still hiding millions of dollars of his deferred compensation behind a contract that isn’t strictly legal. In May, a New York judge ruled against his attempt to get $14 million of his deferred compensation from D.E. Shaw on the basis that he had refused to sign a compulsory release agreement.

D.E. Shaw did not immediately return a request for comment.

Michalow’s argument is that D.E. Shaw’s separation agreement is essentially a “release-for-pay” clause that requires employees to vouch on their way out the door that they will never report a firm’s misconduct to regulators or sacrifice vast amounts of earned compensation being held back by the firm. That would force, the brief states, Michalow to sign away his civil rights under New York State law for 35% of what he made in his last six years at the firm.

In the filing, Michalow and his lawyers also cite D.E. Shaw’s own argument that “release-for-pay” provisions are “pretty standard” in the finance industry. If true, that could intensify ongoing probes into the structure of hedge fund employment contracts where everything from binding arbitration agreements to onerous confidentiality and lockup agreements have come under scrutiny in recent years.

Just last September, D.E. Shaw paid a $10 million fine to the SEC for failing to have adequate whistleblower protections in its employment agreements.

Michalow, a multi-millionaire in his forties who left his hedge fund after making an off-color joke, and now asking for millions more, might not cut the most sympathetic figure. But his case also captures the way in which hedge funds’ secrecy can hamstring their employees’ attempts to preserve their own reputations.

Hedge funds are micro-cultures and many of those cultures are very protective of the secret sauce behind how they invest and trade. For quant funds like D.E. Shaw, which rely on proprietary algorithms to make money, that secretiveness can verge into a cultish level of clandestine.

In their eagerness to keep their talent and ideas to themselves, quant funds have ramped up the language in their employment contracts, attempting to make it nearly impossible for traders who know the math behind trades to take it with them to a competitor. But that insularity has metastasized with funds now writing all kinds of protections into their agreements, and using things like deferred compensation as a cudgel to get talent to sign on.

What has helped fuel the phenomenon is that quant funds often recruit straight out of undergraduate and graduate programs, offering huge sums of money to people that are relatively new to the workforce and unfamiliar with employment contracts. Once they sign and the money pours in, it becomes less and less likely that anybody feels the urge to sue and courts remain largely blind to what’s actually in these very private contracts.

Michalow, who lays out in his brief that he signed on with D.E Shaw as an undergraduate, clearly has an axe to grind with his former employer even after his pretty hefty defamation reward, but it’s also clear that the “release-for-pay” issue is not just a D.E. Shaw problem.

Hedge fund traders are paid a lot to pay attention to details, so the argument could be made that they should take more care when looking over the fine print of a contract that could help them to create generational wealth during the course of their employment. In effect, the firm might argue, the withheld back pay is the fee for signing away some rights meaning that the money that becomes a cudgel does turn back into money if the agreement is honored. Whether the courts agree with that is another matter.

• Bloomberg was the first to report on Michalow’s firing (minus the actual “sugar tits” comment) while the FT reported on how the fallout led to a skirmish at an exclusive Westchester golf club, and the WSJ had details of his defamation case.