Did someone try to steal Goldman Sachs’ secret sauce?

While most in the US were celebrating the 4th of July, a Russian immigrant living in New Jersey was being held on federal charges of stealing top-secret computer trading codes from a major New York-based financial institution—that sources say is none other than Goldman Sachs.

The allegations, if true, are big news because the codes the accused man, Sergey Aleynikov, tried to steal is the secret code to unlocking Goldman’s automated stocks and commodities trading businesses. Federal authorities allege the computer codes and related-trading files that Aleynikov uploaded to a German-based website help this major “financial institution” generate millions of dollars in profits each year.

The platform is one of the things that apparently gives Goldman a leg-up over the competition when it comes to rapid-fire trading of stocks and commodities. Federal authorities say the platform quickly processes rapid developments in the markets and uses top secret mathematical formulas to allow the firm to make highly-profitable automated trades.

The criminal case has the potential to shed a light on the inner workings of an important profit center for Goldman and other Wall Street firms. The federal charges also raise serious questions about the safeguards Wall Street firms deploy to protect their proprietary trading systems.

The criminal case began to unfold on the evening of July 3 when Aleynikov was arrested by FBI agents at Newark Liberty Airport, after returning from Chicago. Aleynikov had just started a job with another firm in Chicago, after leaving the big firm in NY in early June. It appears the financial institution allegedly victimized by Aleynikov had alerted federal authorities that its former employee might be up to no good.

On July 4, Aleynikov was processed on a “theft of trade secrets” charge in a criminal complaint that was filed in federal court in Manhattan. As of this afternoon, he was still being held in federal custody pending posting of bail.

A Goldman spokesman declined to comment on the incident.  A spokeswoman for the US Attorney in the Southern District of New York didn’t comment. Authorities reportedly took all the computers from Aleynikov’s home in New Jersey.

Sabrina Shroff, Aleynikov’s lawyer, says the facts will bear out that her client is innocent. She’s hoping he will be released from custody soon.

His wife, Elina, says her husband is innocent. Speaking in a phone interview from the couple’s New Jersey home, she says her husband worked hard for Goldman Sachs and has been a good citizen–noting he’s lived in the US for 19 years. She seems mystified that federal authorities would arrest him on the eve of a holiday.

The Federal Bureau of Investigations, in charging Aleynikov, says he began working for the major financial institution in May 2007 as a computer programmer and left in early June. That would appear to match the description of a man  named Serge Aleynikov, as it is listed on the social networking website LinkedIn.

The bio information for Aleynikov on LinkedIn says he joined Goldman in May 2007 and was vice president for equity strategy. The bio says he was responsible for “development of a distributed real-time co-located high-frequency trading platform.” In his own words, he goes on to describe the platform as “a very low latency (microseconds) event-driven market data processing, strategy and order submission engine.”

The case against Aleynikov may explain why the New York Stock Exchange moved quickly in the past week to alter its methodology for reporting program stock trading. Goldman often was at the top of the chart–far ahead of its competitors.

On the week ending June 19, Goldman, for instance, was ranked first on the NYSE program trading list. But on the week of June 22, Goldman mysteriously didn’t appear on the list of the top 15 firms at all. It simply vanished without any explanation. Then the NYSE announced it would change some of the data for calculating the trading report. The Zerohedge blog was all over this controversy a week ago.

And now Tyler Durden of ZeroHedge has come in with his own excellent analysis of this strange, strange criminal case. I highly recommend reading it.

It’s possible Goldman asked the NYSE to alter some of its reporting methodology after the firm discovered that someone may have infiltrated the proprietary computer codes it uses.

Here’s the way the criminal complaint describes the Goldman trading platform:

The Financial Institution has devoted substantial resources to developing and maintaining a computer platform that allows the Financial Institution to engage in sophisticated high-speed, and high-volume trades on various stock and commodities markets. Among other things, the platform is capable of quickly obtaining and processing information regarding rapid developments in these markets.

Meanwhile, federal authorities appear to believe Aleynikov, who has lived in the US for more than a dozen years but frequently travels back-and-forth to his native Russia, may have had help. The German website that Aleynikov allegedly uploaded the stolen information to is registered to a person in London. That, of course, gives rise to speculation about this all being a case of international espionage.

This case is quickly unfolding and there’s plenty more information to unearth about Aleynikov. For instance, it appears that he and his wife are competitive ballroom dancers–there are some videos of them on youtube.com. The job he took in Chicago, according to the criminal complaint, paid nearly three times more than his $400,000 salary at Goldman.

Which Chicago firm hired Aleynikov? Inquiring minds want to know. But you can rule out the giant hedge fund conglomerate Citadel. It’s not them.

Also there’s more to learn about anyone who might have been helping him and the fallout this may have for Goldman.  When he was arrested, Aleynikov told the FBI he “only intended to collect ‘open source’ files on which he had worked, but later realized that he had obtained more files than he intended.” But authorities say after he uploaded the files he encrypted them and “erased” the program he used to encrypt them.

It’s not clear why the authorities and apparently Goldman waited so long to move on Aleynikov, even though they knew he had uploaded the information weeks ago.

One question investors need to ask is whether this incident will have any impact on Goldman’s second-quarter earnings. The alleged wrongoing by Aleynikov took place at the beginning of the month–although it’s not clear if it had any material impact on automated trading.

Update: The NYSE has not stopped reported program trading results. Instead, it’s altered the method it uses for putting together that report.