At the same time that the United States was entering into the worst recession since the Great Depression, many hedge funds were reporting surges in profits. A massive criminal investigation is uncovering growing evidence that, for a number of those hedge funds, such profits were, indeed, too good to be true.
On January 18, 2012, the Federal Bureau of Investigation arrested seven hedge fund professionals allegedly involved in an insider trading scheme. Those individuals, all connected by friendship or business association, are alleged to have traded in the stock of Dell Inc. and Nvidia Corp. based upon non-public information provided by employees of those companies, thereby generating roughly $62 million in illegal profits. Three of the men charged already have pled guilty.
These arrests are merely the latest developments in a widespread, ongoing government investigation targeting systematic insider trading in the hedge fund industry. More than four years ago, the FBI received intelligence that insider trading might have been responsible for the surge in profits at certain hedge funds. In response, the FBI and the United States Attorney for the Southern District of New York initiated "Operation Perfect Hedge." The first wave of arrests as a result of the investigation began more than two years ago. Thus far, "Operation Perfect Hedge" has resulted in charges being filed against at least 63 people in the hedge fund industry and 56 convictions, including the widely publicized conviction of Raj Rajaratnam, the founder of Galleon Group, who was convicted of 14 counts of securities fraud and conspiracy and sentenced to 11 years in prison in October 2011.
The success of the investigation has been due in large part to the government's controversial utilization of the same techniques typically used to dismantle organized crime organizations, including court-authorized wiretaps of phones and intercepts of electronic communications, informants, and cooperating witnesses.
In a pre-trial motion, Rajaratnam moved to suppress certain material gathered by the government through court-authorized wiretaps. See United States v. Rajaratnam, 2010 U.S. Dist. LEXIS 143175, at *1 (S.D.N.Y. Nov. 24, 2010). Rajaratnam argued that the wiretaps should not have been authorized because insider trading is not a crime specified in Title III of the Omnibus Crime Control and Safe Streets Act of 1968, 18 U.S.C.S.§ 2510 et seq., which restricts the use of wiretaps and provides that courts only may authorize their use to investigate certain offenses. Id. at *8-*9. Judge Richard Holwell disagreed, holding that the government had made a sufficient showing that it sought to use the wiretaps in connection with an investigation of offenses that are specified in Title III, namely wire fraud and money laundering. Id. at *11. The court did not hold that investigating insider trading is always good grounds for obtaining a court-authorized wiretap. Rather, according to the court, "when the government investigates insider trading for the bona fide purpose of prosecuting wire fraud, it can thereby collect evidence of securities fraud, despite the fact that securities fraud is not itself a Title III predicate offense." Id. at *19.
Similarly, in United States v. Goffer, 756 F. Supp. 2d 588 (S.D.N.Y. 2011), the court permitted evidence obtained from a court-authorized wiretap to be admitted at the trial of Galleon trader Zvi Goffer. In seeking suppression of the evidence, Goffer argued that the monitoring agents violated Title III by failing to minimize privileged calls between himself and his wife. Id. at 589. The court denied Goffer's motion because it found that, on the whole, the court-authorized wiretap was professionally conducted and that the majority of the government's monitoring of Goffer's spousal communications was reasonable Id. at 597.
Signaling that "Operation Perfect Hedge" will continue to rely heavily on these techniques, the FBI released a statement in connection with the January 18 arrests, advising that "the evidence delineated in the complaint consists of court-authorized interceptions of e-mails, instant messages, and phone calls among the defendants and others; as well as material obtained in the execution of several search warrants last year; and information from three of the defendants who chose to cooperate with the FBI."
"Operation Perfect Hedge" is continuing with full force. In the same statement, the FBI issued a stern warning to others in the hedge fund industry that it will not abandon its pursuit: "if you are engaged in an insider trading conspiracy . . . what distinguishes you from the dozens who have been charged is not that you haven't been caught; it's that you haven't been caught yet."
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