Hedge Fund Industry on Notice as Law Enforcement Tapes Phone Calls

Wednesday, December 15, 2010

For well over a year, prosecutors have been investigating insider trading in the hedge fund industry. Last month, the FBI searched the offices of several funds in the New York area and arrested and charged a New Jersey man. The FBI said there are large networks of information-peddling yet to be uncovered. The investigation has made use of a tool that makes many people on Wall Street uncomfortable: wiretaps.

Since last year, wiretaps have helped the U.S. Attorney for the Southern District of New York obtain 24 arrests and 14 guilty pleas in insider trading cases. Last month, a judge ruled recorded phone calls may be admitted as evidence in one of the planned trials, a decision that is sure to be challenged by defense lawyers. They say that with emails, trading records and other documents available as evidence, the Feds have no reason to listen in on people’s phone calls.

When the FBI tapped Don Chu’s line on July 14 last year, they heard him discussing earnings figures for a technology firm in Silicon Valley. They said they heard Chu, a research consultant for hedge funds, give the earnings information about the tech company to a hedge fund client, seven days before the tech company publicly released the information, giving the hedge fund a week to trade the stock based on information others didn’t yet have.

It’s the textbook definition of insider trading. It’s on tape. And it makes white-collar defense Attorney Andrew Frisch very uncomfortable.

“It’s America 101. You only use as intrusive an investigative technique as wiretaps when you need to,” Frisch said.

Frisch said wiretaps were intended to track businesses that don’t keep detailed financial records or pay taxes.

“Like drug trafficking or espionage or racketeering,” Frisch said. “You can think of the conversations that John Gotti and Sammy ‘the Bull’ Gravano had at the Ravenite Social Club.”

But U.S. Attorney Preet Bharara says it’s time to junk the unwritten rule that says crime on Wall Street gets treated differently from other crimes.

“When sophisticated businesspeople begin to adopt the methods of common criminals, we have no choice but to treat them as such,” Bharara said at a press conference last year, announcing the arrests of 14 people on charges stemming -- in part -- from secretly recorded conversations on prepaid cell phones.

The previous month, his office charged one of America’s wealthiest men and the founder of the Galleon hedge fund, Raj Rajaratnam, with insider trading, based on evidence from wiretaps.

“What happened here, I think, was that white-collar prosecutors, who tend not to come across ongoing crimes came across ongoing, serious crimes,” said Anthony Barkow, a former federal prosecutor who now directs New York University’s Center on the Administration of Criminal Law.

An anonymous tip or irregular trading activity was the likely red flag. Prosecutors then reached for wiretaps, a tool they’ve seldom, if ever, used in an insider trading case. All wiretaps require a judge’s consent, based on evidence.

“When you record people for a long time who are engaged in misconduct, you tend to get some pretty powerful evidence," Barkow said. “And it’s largely irrefutable, it’s their own voice, and they can’t say they didn’t say it.”

Using wiretaps also sends a message to the industry as a whole. “The community in general is all in favor of weeding out bad apples,” said Tim Selby, President of the New York Hedge Fund Roundtable.

But the investigations could also undercut a central selling point of hedge funds, their edge in trading. Hedge fund investor Neal Berger said hedge funds want you to think of them as smarter and faster than the other guys.

“A lot of managers have claimed that that’s their edge. That they just have better connections. They have better relationships with management. They have better relationships with the supply chain,” said Berger.


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Comments [2]

MasterG from Harlem

@BrettG You're d*** right is corruption. Have you seen the article in the WSJ by Paul B. Farrell about 10 reasons to shun the stock market? Nobody makes any money except insiders.

Dec. 15 2010 08:10 PM

Are we to believe that the SDNY & other FBI/DOJ offices did not seek out all forms of evidence simply because of the availability of email, trading records & other records because of the work the people are involved in?

Wiretaps and other criminal investigative techniques, with appropriate judicial oversight, are appropriate in all investigations.

How can these prosecutors establish evidence for possible civil/criminal RICO indictments. All personal contact information, phone, person to person must be available for proper use.

If these investigators to unilaterally decide not to use all forms of legal investigative methods, where is the investigation to find out how many cases have been lost due to lack of information confirming contact between indictees by any method?

Is this another indication of the corruption of GOP crony-capitalism instead of regulated truly competitive markets?

Another suggestion for the FBI & DOJ is that they should investigate a newer version of insider trading - namely hi-frequency trading which allows 300 large companies to effectively monopolize trading in all forms of markets, NYSE, NASDAQ, NYCBOT, CBOT, etc. as well as in all forms of securities, commodities, derivatives.

Dec. 15 2010 10:50 AM

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