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U.S. Said to Target Wave of Insider-Trading Networks (Update2)
By Joshua Gallu and David Scheer

Oct. 19 (Bloomberg) -- 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 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 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 millions of trades. The case against Rajaratnam, built on recorded conversations within a web of alleged conspirators, offers a glimpse of how U.S. 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 law partner at Baker Botts LLP 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.”

Intel, McKinsey, IBM

SEC spokesman John Nester declined to comment, as did Alejandro Miyar, a spokesman for the Justice Department.

Rajaratnam, who founded the Galleon Group in 1997, was arrested with five alleged conspirators on Oct. 16 in what prosecutors called the biggest insider-trading ring targeting a hedge fund. Prosecutors said he and his firm reaped as much as $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. IBM said today it put executive Robert Moffat, one of Rajaratnam’s alleged conspirators, on temporary leave following the charges.

Rajaratnam, born in Sri Lanka’s capital, Colombo, has a net worth of $1.3 billion, making him the 559th richest person in the world, according to Forbes Magazine. In the early years of this decade, Galleon ranked among the world’s 10 largest hedge funds, managing $7 billion at its peak in 2008.

No Plea Entered

Rajaratnam hasn’t yet entered a plea. His lawyer, Jim Walden, said last week that prosecutors are misconstruing the evidence and that the case isn’t as strong as they allege.

U.S. senators including Pennsylvania Democrat Arlen Specter have pressed regulators 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.

Blue Sheets

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.

Data Mining

The data-mining strategy yielded one of its first cases in February, when the SEC and U.S. prosecutors charged takeover advisers at UBS AG and Blackstone Group LP with taking part in an $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 Federal Bureau of Investigation, according to charging documents. Prosecutors also obtained warrants for wiretaps, a level of surveillance typically reserved for organized crime, drug syndicates and terrorism prosecutions.

Prosecutors are also being helped by at least three of Rajaratnam’s former colleagues, the Wall Street Journal reported today, citing people familiar with the criminal investigation. Those people include California hedge-fund managers Ali Far and Choo Beng Lee, the Journal said.

Further Surveillance

Surveillance during the probe of Rajaratnam, 52, led investigators to other suspects and more charges are likely, people familiar with the matter said. U.S. Attorney Preet Bharara said Oct. 16 the Justice Department will continue using wiretaps to root out insider-trading.

The SEC is adopting other strategies to crack difficult cases. SEC Enforcement Director Robert Khuzami, a former federal prosecutor who joined the agency in March, said last week that he’s seeking greater access to grand-jury evidence and wants to expand deal-making and cooperation with informants.

“Insider-trading cases are notoriously difficult to prosecute because the evidence is often circumstantial,” said Bill Mateja, a former Justice Department lawyer now at Fish & Richardson PC in Dallas. “If law enforcement is actively going to go out and target this with covert investigative techniques, I think it’s going to keep people on their toes.”

The filed cases are U.S. v. Rajaratnam, 09-02306, and U.S. v. Chiesi, 09-02307, U.S. District Court for the Southern District of New York (Manhattan).

To contact the reporters on this story: Joshua Gallu in Washington at [e-mail]; David Scheer in New York at [e-mail].
Last Updated: October 19, 2009 11:43 EDT


LINK: http://www.bloomberg.com/apps/news?pid=20601087&sid=apNewkPGwwrE