Inside hedge fund DE Shaw's compensation structure and employment contracts

DE Shaw is one of the world's oldest, biggest and most successful hedge funds. Famously founded in a New York bookstore in 1988, it has 2,500 employees and $65bn in assets under management. Last year, it was the world's most profitable hedge fund. This year, DE Shaw generated returns of over 9% in the year to August, compared to 4% and 3% at Citadel and Millennium respectively. It has a reputation for employing laid back quantitative types as portfolio managers, and poets and artists as operations professionals.

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All this might explain why people who've worked for DE Shaw rarely leave and why - if they do - they don't seem to have a bad word to say about their time there.

However, things may not be so simple. Dan Michalow, a 42-year-old former DE Shaw managing director who ran the macro trading group who and left the firm in 2018, says DE Shaw's lack of detractors isn't because of its great culture. Instead, Michalow claims that DE Shaw has some unusually pernicious employment contracts. 

Michalow has reason to feel aggrieved. In 2022, DE Shaw was ordered to pay him $52m in compensation after a FINRA panel determined that the fund had defamed him when claimed he'd been fired for sexual harassment and had committed “gross violations" of the fund's "standards and values" during his time there. 

$52m is a lot of money, but Michalow says he's owed even more. A prodigy who joined DE Shaw out of Harvard aged 21, Michalow founded DE Shaw's structured credit group aged 25 and made partner aged 29. When he left DE Shaw, Michalow was earning up to $40m a year. DE Shaw confiscated $14.4m of his deferred compensation. He still hasn't received that to this day.

Michalow is trying to recover the remaining money. He's doing so by contesting the technique which he says enabled DE Shaw to withhold his pay. Michalow claims that DE Shaw obliges its employees to sign two key contracts. When they arrive, they sign something agreeing to allow the firm to withhold a portion of pay on the understanding that they sign another contract at a later date. This later contract absolves the fund of any legal liability for events that occurred both while the employee worked there and for a three-year period after they've left. If they don't sign, Michalow's complaint says DE Shaw won't pay the money it's withheld. He didn't sign; he didn't get the money.

In a filing at the State of New York Court of Appeals, Michalow says DE Shaw applies this "release for pay" requirement even to situations in which employees are sexually harassed, racially victimised, or where the fund commits an "intentional tort" against an employee. Employees are therefore allegedly forced to choose between receiving their deferred compensation and submitting complaints against DE Shaw, even in the event of sexual harassment. 

DE Shaw didn't respond to multiple requests to comment on this article. In 2022, DE Shaw stated that it was "disappointed" by the outcome of Michalow's initial hearing and said it supported its decision to terminate him in 2018.  The Wall Street Journal reported in 2023 that DE Shaw had amended its contracts after the SEC investigated whistleblower impedance clauses. However, Michalow's own site on the issue claims the fund still uses these contracts to this day. Rivals, like Citadel and Jane Street, allegedly don't have anything similar.

If Michalow is able to successfully contest the existence of DE Shaw's "release for pay scheme", he will be able to excuse his refusal to sign the contract, and will regain his $14.4m. Other DE Shaw employees will also be able to avoid signing the punitive contracts. 

DE Shaw's pay structure 

In the meantime, Michalow's new complaint helpfully details the structure of his pay. As a managing director and partner at DE Shaw, the complaints says Michalow didn't receive a salary but a "guaranteed, formulaic amount."  

This included:

• A fixed percentage of the yearly profits and losses on his trading strategies each year. 
• Some money based on "MD points" based on Michalow's share of the management and performance fees (net of expenses) that investors paid the firm.
• A guaranteed amount of "aggregate minimum annual total compensation" based on the elements above.
•  A small "base draw," paid every two months, deducted from his annual pay. 

It's thought that DE Shaw applies this pay formula to all its MDs. Michalow claims that no element of his pay as detailed above was discretionary. Everything was governed by these formulae. - Which helps to explain why people prefer the certainty of bonuses and pay in hedge funds to the discretionary nature of bonuses in banks. 

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