Almost six years ago, Federal Bureau of Investigation (FBI) agents David Chaves and Patrick Carroll surveyed the midtown New York skyline to the north, home to much of the world’s financial industry. They had received some disturbing intelligence: A surge in profits at hedge funds might be the result of an epidemic of insider trading.
The two men, head of securities and commodities fraud units at the New York office, faced a dilemma. Informants had told them the hedge fund industry was similar to organised crime: Insular and distrusting of outsiders. Without people on the inside, the government would have a tough time gathering enough evidence to prosecute. They needed more tools to gather more information on traders who moved faster, and more secretly, than your typical Mafia soldier.
“It was reminiscent of that scene in Jaws where they got their first look at the shark,” Chaves said. He told Carroll, “We’re going to need a bigger boat.”
That bigger boat came in the form of a landmark change in the way white-collar crime was investigated in the US, agents said. The only way to uncover insider trading was to apply the same techniques agents used to dismantle the Mafia: Court- authorised wiretaps of phones, informants and cooperating witnesses.
‘Perfect Hedge’
At that moment, “Perfect Hedge” was born.
Over the next five years, the operation by the New York offices of FBI and Manhattan US Attorney led to prosecutions that disrupted multiple rings of illegal trading by portfolio managers, bankers and consultants. It is the biggest insider trading investigation since the days of Ivan Boesky and Michael Milken, and the largest ever in the world of hedge funds.
Agents in New York spent years monitoring clandestine wiretaps as traders received and passed illicit tips. FBI learnt everything it could about fund managers suspected of being criminals, conducting surveillance as targets passed secrets on street corners, in gyms, or handed out bags of money for information.
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Illicit profit
And it all began with the realisation that hedge fund managers who illicitly profited on knowledge the public didn’t have access to could be pursued as vigorously as those who commited more traditional crimes.
“We coined this investigation ‘Perfect Hedge’ because if you’re armed with that insider’s information, you can initiate the perfect hedge,” Chaves said in an interview. “You’re always protected — the upside and the downside.”
The results can be seen in the scores of insider-trading prosecutions made in New York — from the conviction of Galleon Group LLC Co-founder Raj Rajaratnam to those involving expert- networking consultants and employees at technology and pharmaceutical companies.
Wiretaps played a role in many of these cases.
| THE BOARD MEMBER WITH THE TIPS |
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‘Identified the problem’
“We identified the problem, we created the solution to infiltrate the industry and we put people in well-placed hedge funds who reported to us on a daily basis,” said Chaves, 48, a lawyer as well as supervisory special agent. He worked on the prosecutions of WorldCom Chairman Bernard Ebbers, who was imprisoned for accounting fraud, and Martha Stewart, convicted of obstruction of justice in an insider trading case.
In some circumstances, Chaves said, agents would send in people wearing wires to record incriminating statements by targets. Such evidence, he said, “could then be used to provide us enough probable cause to obtain a wiretap”.
Ironically, the wiretaps that were so crucial to bringing down defendants in Perfect Hedge would be the basis of an appeal in its biggest case so far, that of Rajaratnam.
The hedge fund manager was found guilty on all 14 counts of securities fraud and conspiracy he faced. The trial showcased 45 recordings by agents working for Chaves and Carroll of the more than 2,400 taped conversations between Rajaratnam and friends, business associates and alleged accomplices.
Goldman Sachs
Prosecutors said he made more than $72 million by using illegal tips to trade in stocks of companies including Goldman Sachs Group, Intel, Google, ATI Technologies and Clearwire Corp. The investigation also led to charges against former Goldman Sachs board member Rajat Gupta.
Electronic surveillance
Under the leadership of now-retired FBI Special Agent In Charge Peter Grupe, who supervised Chaves and Carroll, FBI’s New York office began to use cooperating witnesses to build insider trading cases. In some instances, Chaves said, agents sent in cooperators wearing wires to record incriminating statements by targets.
Use of wiretaps allowed the targets of an investigation to unwittingly explain complex, multi-million-dollar transactions, making schemes easier for jurors to understand.
Soon after starting Perfect Hedge, FBI determined insider trading was a business model at some hedge funds, Chaves said. The industry manages $1.97 trillion in assets, according to Hedge Fund Research in Chicago.