Pomerantz LLP

Government Goes After Insider Trading

Pomerantz Monitor, January/February 2013 

Whatever one thinks of the government’s record in punishing Wall Street for fomenting the financial crisis, the success rate against insider trading has been strong. Ever since Preet Bahara was appointed U.S. Attorney for the Southern District of New York in 2009, he has focused heavily on insider trading cases. In a 2010 speech to a room jam-packed with white collar criminal defense attorneys, he declared that “unfortunately from what I can see, from my vantage point as the United States Attorney here, illegal insider trading is rampant.” 

The law imposes liability for insider trading on anyone who improperly obtains material non-public information and trades based on such information, and also holds liable any “tippee,” the person with whom the “tipper” shares the information, as long as the tippee knows the information was obtained in breach of a duty to keep the information confidential or abstain from trading. Since the beginning of Bharara’s tenure in 2009, his office has secured 69 convictions or guilty pleas of insider trading without losing a single case. Many of those cases were developed jointly or in parallel with the SEC, which has commenced over 200 enforcement actions of its own since 2009. 

Critical to the prosecutors’ unblemished record of securing insider trading convictions has been the aggressive use of wiretaps and of informants. Private plaintiffs contemplating insider trading lawsuits can benefit from the treasure-trove of incriminating evidence collected by the government that private parties cannot get themselves through the normal “discovery” process. 

Of the 75 people recently charged by Bharara’s office, until now the biggest fish caught were Raj Rajaratnam, a billionaire investor who once ran Galleon Group, one of the world’s largest hedge funds, and Rajat Gupta, a former McKinsey chief and Goldman Sachs director who allegedly fed inside information to Rajaratnam. 

Wiretaps were key to the case against Mr. Rajaratnam. The case broke when prosecutors, while investigating a hedge fund owned by Rajaratnam’s brother Rengan, uncovered a slew of incriminating e-mails and instant messages between Raj and his brother, and wiretapped their conversations. In a call, Rengan told his brother about his efforts to extract confidential information from a friend who was a McKinsey consultant. Rengan referred to the consultant as “a little dirty” and touted that he “finally spilled his beans” by revealing non-public information about a corporate client. Other powerful evidence obtained from wiretapped calls was used to place Rajaratnam squarely in the forefront of the insider trading scheme: “I heard yesterday from somebody who’s on the board of Goldman Sachs that they are going to lose $2 per share,” Rajaratnam said to one of his employees ahead of the bank’s earnings announcement. 

Rajaratnam was found guilty on all 14 counts levied against him, and was sentenced to 11 years in prison and fined $10 million. It was the longest-ever prison sentence for insider trading, a watershed moment in the government’s aggressive campaign to rout out the illegal exchange of confidential information on Wall Street. He is currently appealing his conviction to the Second Circuit. 

Gupta, for his part, was accused of passing a flurry of illegal tips to Rajaratnam, including advance news that Warren Buffet was going to invest $5 billion in Goldman Sachs. Gupta received a two-year prison sentence and was ordered to pay $5 million in fines. 

More recently, in what federal prosecutors describe as the most lucrative insider trading scheme, prosecutors and the SEC filed separate insider trading charges against Mathew Martoma, a portfolio manager at CR Intrinsic Investors. CR Intrinsic is an affiliate of SAC Capital Advisors, a $10 billion hedge fund founded by billionaire Steven Cohen, one of Wall Street’s most successful and prominent investors. 

Martoma is accused of illegally trading on confidential information ahead of a negative public announcement poised to disclose the results of a clinical trial for an Alzheimer’s drug jointly developed by Elan Corporation and Wyeth Ltd. Armed with confidential information, Martoma allegedly emailed Cohen requesting that they speak (“Is there a good time to catch up with you this morning? It’s important.”). Martoma and Cohen subsequently spoke by phone for approximately 20 minutes. The next day, Cohen and Martoma instructed SAC’s senior trader to quietly begin selling the Elan position. At day’s end, the trader e-mailed Martoma that he had sold 1.5 million shares of Elan, and that “obviously no one knows except you me and [Cohen].” A few days later, the senior trader e-mailed Cohen the results of the week’s activity: “We executed a sale of over 10.5 million ELN for [four internal Hedge Fund account names] at an avg price of 34.21. This was executed quietly and effectively over a 4 day period through algos and darkpools and booked into two firm accounts that have very limited viewing access. This process clearly stopped leakage of info from either in [or] outside the firm and in my viewpoint clearly saved us some slippage.” 

From one end of Wall Street to the other, people are wondering whether Martoma, facing the likelihood of serious jail time, will “flip” on Cohen, creating probably the most sensational insider trading case ever. There is no doubt that Martoma is facing intense pressure: reportedly, when confronted by an F.B.I. agent in his front yard, Martoma fainted. If Martoma is convicted of the charges, federal guidelines call for a stiff 15-19 year sentence. And, while no SEC charges have yet been brought against Cohen, the Commission recently issued a Wells notice to SAC Capital, indicating that the staff is probably going to recommend that the SEC take action against SAC.