US Federal investigators are gearing up to file charges against a wider array of insider-trading networks, some linked to the criminal case against billionaire hedge-fund manager Raj Rajaratnam that shook Wall Street last week, people familiar with the matter said.
The pending crackdown, based on at least two years of investigation, targets securities professionals including hedge-fund managers, lawyers and other Wall Street players, the people said, declining to be identified because the cases aren’t public.
Some probes, like the one that focused on Rajaratnam, rely on wiretaps. Others stem from a secret Securities and Exchange Commission data-mining project set up to pinpoint clusters of people who make similar well-timed stock investments.
Investigators have struggled for years to build cases against large institutional investors such as hedge fund managers, who often deflect regulatory queries about suspiciously timed bets, arguing they’re statistical flukes amid their millions of trades. The case against Rajaratnam, built on recorded conversations within a web of alleged conspirators, offers a glimpse of how US investigators are using more aggressive tactics to cut through the blizzard of trading and trace the flow of information.
“If you’re going to shoot the king, you better shoot to kill,” said Bradley Bennett, a partner at Baker Botts in Washington who formerly focused on insider-trading cases as an SEC investigator. “If they’re going to take on a billionaire, they need to have the strongest possible cases. The defendant’s own words are the strongest possible evidence.”
Rajaratnam, who founded the Galleon Group hedge fund in 1997, was arrested with five alleged conspirators on Friday in what prosecutors called the biggest insider-trading ring targeting a hedge fund. Prosecutors said he and his firm reaped as much as US$18 million by investing on tips from a hedge fund, a credit-rating firm and employees within companies including Intel Capital, McKinsey & Co and IBM Corp.
He hasn’t yet entered a plea. Rajaratnam’s lawyer, Jim Walden, said last week that prosecutors are misconstruing the evidence against his client and that the case isn’t as strong as prosecutors allege.
US senators including Pennsylvania Democrat Arlen Specter have pressed regulators for years to more aggressively scrutinize hedge funds. Some of those concerns were spurred by the SEC’s decision in 2006 to close an insider-trading probe of Pequot Capital Management Inc, once the world’s biggest hedge- fund manager, after investigators said they lacked evidence to bring the case.
The SEC later reopened part of the inquiry focusing on whether Pequot abused information from a former Microsoft Corp employee. In August, Pequot and founder Arthur Samberg, 68, said they may be sued by the agency. Insider-trading claims would be “without merit,” they said.
Many cases begin when stock exchanges send the SEC reports on traders who place profitable bets shortly before corporate announcements. Someone who rarely trades may have difficulty explaining later what prompted an uncharacteristic investment. Hedge funds, on the other hand, can more plausibly attribute their windfalls to skill or chance.
To overcome that hurdle, the SEC began using computer software about two years ago to sift hundreds of millions of electronic trading records, known as blue sheets, attached to the stock exchange reports about suspicious incidents, according to people familiar with the project. By looking for patterns in the library of data, they identified groups of traders who repeatedly made similar well-timed bets.
Once investigators find a cluster of correlated trades, they tap other sources of information to unravel how its members obtain and share tips, the people said. For example, if a group profits on trades before a series of corporate takeovers, the SEC may check so-called league tables listing which investment banks or law firms advised the deals. If one firm was involved in all of them, an employee there may be the source of the leak.
The data-mining strategy yielded one of its first cases in February, when the SEC and US prosecutors charged takeover advisers at UBS AG and Blackstone Group LP with taking part in an US$8 million insider-trading case, people familiar with the inquiry said. Authorities used a “novel” technique to detect the scheme, the SEC’s lead investigator on the case, Daniel Hawke, said at the time, without elaborating.
While the investigation of Rajaratnam didn’t stem from the data-mining project, it did start with the SEC’s identification of suspicious trades, people with knowledge of the case said.
Investigators developed at least one informant in the ring, who began meeting in November 2007 with agents from the FBI, charging documents said. Prosecutors also obtained warrants for wiretaps, a level of surveillance typically reserved for organized crime, drug syndicates and terrorism prosecutions.
Surveillance during the probe of Rajaratnam, 52, led investigators to other suspects and more charges are likely, people familiar with the matter said. US Attorney Preet Bharara said on Friday that the US Justice Department would continue using wiretaps to root out insider-trading.
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