April 15, 2024

DealBook: Prosecutors Hope for Deterrent Effect

Preet S. Bharara, the United States attorney in Manhattan.Ozier Muhammad/The New York TimesPreet S. Bharara, the United States attorney in Manhattan.

Will the conviction of Raj Rajaratnam, the founder of the hedge fund firm Galleon Group, change anything on Wall Street?

Federal prosecutors hailed Wednesday’s verdict as a powerful deterrent to investors trying to gain an unlawful advantage in the stock market.

“We will continue to pursue and prosecute those who believe they are both above the law and too smart to get caught,” Preet S. Bharara, the United States attorney in Manhattan, said in a statement after the verdict in the Rajaratnam case.

Mr. Bharara’s office, which has led the Justice Department’s pursuit of insider trading, has charged 47 individuals with insider trading crimes over the last 18 months — and secured 35 convictions.

While some question whether the rabid pursuit of insider trading has distracted the government from investigating senior executives at the center of the financial crisis, the success in the Galleon case vindicates the aggressive prosecutorial tactics and vast resources deployed in this area. For the first time in a securities case, the government used wiretaps to record traders’ telephone conversations — a tool traditionally used with drug traffickers and organized crime figures.

Prosecutors have readily employed hardball investigatory methods. Late last year, agents at the Federal Bureau of Investigation conducted simultaneous raids of three large hedge funds, sending shock waves across Wall Street. Two of those funds have since closed.

Federal authorities have pressured traders and analysts to record their calls in order to build their cases. Last October, F.B.I. agents appeared unannounced at the Portland, Ore., home of an analyst and asked him to tape his calls with a hedge fund client.

The analyst, John Kinnucan, refused to work with the government and e-mailed his trading clients that he had “declined the young gentleman’s gracious offer to wear a wire and thus ensnare you in their devious web.”

As recently as January, the F.B.I. instructed a cooperating witness in the Galleon case to record a call with a former colleague to elicit incriminating evidence.

Government crackdowns on insider trading tend to run in cycles. The last one that received as much attention was the Wall Street sweep in the 1980s that resulted in the convictions of Ivan Boesky and Michael Milken. Those prosecutions came during that era’s mergers-and-acquisitions boom, which was largely financed with the junk bonds popularized by Mr. Milken.

This time around, the insider trading scandals were borne out of the latest deal-making boom that occurred during the middle of last decade — a frenzied period in which some of America’s largest companies fall into private hands.

It coincided with the explosive growth of hedge funds, once-secretive investment partnerships that have emerged as a powerful force in the global economy — and minted more than two dozen billionaires, according to Forbes magazine. Among them: Mr. Rajaratnam, who at the peak managed $7 billion of investors’ money.

The insider trading investigation has spawned several arms of inquiry and has led to subpoenas of the world’s largest financial institutions and arrests in a number of states. Mr. Rajaratnam’s illegal stock tips came from all points of the globe. One witness testified that his chief source of confidential data about publicly traded technology companies came from a tipster in Taiwan. Another delivered secret information from Dublin about the investment activities of a Middle East sovereign wealth fund.

But some academics and Wall Street critics argue that prosecutors instead should have focused their efforts — and their resources — on ferreting out wrongdoing stemming from the crisis. The Justice Department has yet to bring criminal charges against any executive who ran a major financial-services firm leading up to the disaster, which was caused by aggressive risk taking and shoddy lending practices.

“The total amounts of money and the consequences in insider trading are trivial compared to the damage caused by the behavior that caused the financial crisis,” said Charles Ferguson, an academic and filmmaker whose movie about the financial crisis, “Inside Job,” won the 2011 Academy Award for best documentary.

“I’m not saying that insider trading isn’t a serious crime, but the government should be deploying more resources to investigate those cases,” Mr. Ferguson said.

Last week, Mr. Bharara filed a civil lawsuit against Deutsche Bank, accusing the firm of lying about the quality of mortgages it handled under a government program. At a news conference, he said there was not sufficient evidence to justify a criminal complaint.

Federal authorities have cited the loss of confidence in the stock market as a reason to pursue insider trading. In his closing argument in the Mr. Rajaratnam trial, Reed Brodsky, a prosecutor, belabored the point that such activities provided Wall Street professionals with an unfair advantage over the “average, ordinary investor.”

“The stock market is designed to make sure the investing public isn’t cheated,” Mr. Brodsky said. “Wall Street is supposed to be an even playing field.”

Whether the dozens of arrests and convictions will produce any meaningful change in the way professional investors trade stocks is unclear. Still, there has been a reaction as prosecutors’ tough talk and use of wiretaps spawn a culture of fear on Wall Street.

Security firms report an increase in hedge funds hiring them to conduct electronic sweeps of their offices to check for listening devices. Once lightly regulated, hedge funds have also stepped up their compliance procedures and increased their budget for legal services to ferret out illicit trading. Investors are also demanding a higher level of oversight at the funds and stepping up background checks on their managers.

“I probably get five or six requests every month seeking verification that we’re the auditor for a given fund,” said Alan Alzfan, a partner at accounting firm McGladrey and Pullen. “I used to get five or six a year.”

But for all the added scrutiny and negative publicity surrounding insider trading at hedge funds, investors — lured by the promise of outsize returns — continue to pour billions of dollars into them. Last month, the industry celebrated another milestone: the money under hedge fund control surpassed $2 trillion, an all-time high.

Article source: http://dealbook.nytimes.com/2011/05/11/prosecutors-hardball-tactics-produce-big-results-in-galleon-case/?partner=rss&emc=rss

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