New England Biz Law Update
When the U.S. Securities and Exchange Commission filed federal fraud charges against the powerful New York hedge fund Galleon Management and its billionaire owner, officials seized the opportunity to issue a warning to those working in the industry.
“Today, tomorrow, next week, the week after, privileged Wall Street insiders who are considering breaking the law will have to ask themselves one important question: Is law enforcement listening?” U.S. Attorney Preet Bharara of the Southern District of New York said at a recent press conference, calling the Galleon case a “wake-up call” for hedge fund managers, traders and corporate executives around the country.
In the wake of the charges against Galleon, which has sparked the largest insider trading case in U.S. history to date, white-collar lawyers say the government is casting an increasingly wider net in enforcing securities fraud.
The high-profile charges, which implicated 21 defendants including a Westwood, Mass., hedge fund manager and two associates from Ropes & Gray’s New York office, have had a ripple effect on securities professionals everywhere.
“The case has drawn a lot of attention because it doesn’t strictly involve the kind of Wall Street players we typically see in an insider trading investigation,” said Timothy W. Mungovan of Nixon Peabody, which has offices in Providence and Boston. “You’re talking about people at major law firms, leading corporations and consulting firms who could just as easily be working here as opposed to Wall Street.”
It also marks the first time the government has used wiretaps in a securities case.
“One of the most interesting — if not ominous — aspects of this is the application of wiretapping and insider dealing techniques that are typically used in criminal investigations of … mafia and racketeering” activities, said Robert G. Flanders Jr., who heads the litigation department at Hinckley, Allen & Snyder in Providence.
Instead of the usual after-the-fact efforts to prosecute insider trading, Flanders said, SEC investigators are now able to track conversations as they happen, a strategy that has proven very successful in taking down organized crime.
“It definitely widens the conspirators’ net of people. They’re not playing catch-up; they’re responding in real time, even planning for the future,” Flanders said.
Although the courts have long held that an individual can be liable for misappropriating confidential material, Matthew N. Kane, of Donnelly, Conroy & Gelhaar, said the Galleon case shows that the SEC has decided “to expand the goalposts” for establishing what constitutes insider trading.
“People in the hedge fund industry have always understood that they have some responsibility,” the Boston lawyer said. “But looking at Galleon, there is a new recognition and understanding of just how expansive that duty can be.”
Tough questions
Kane said the most difficult question lawyers are being asked post-Galleon is where to draw the line between permissible exchanges of information that form the basis for everyday trades, and illegal insider trading that can lead to severe civil and criminal penalties.
“That line is very gray, and it is getting increasingly grayer,” Kane said. “The thing that you can do is set up a process to deal with the questions when they inevitably arise, but I don’t think anyone can set up a program at this point that gives absolute answers under any circumstances.”
Where securities laws do not provide an express definition of insider trading, its meaning has evolved over the years on a case-by-case basis, Kane said. In general, the term has been defined as the buying or selling of a security in violation of a fiduciary duty while in the
possession of material, non-public information.
But part of what has made Galleon noteworthy, Kane said, is the government’s new, expansive theory that “anyone who knew or should have known they were receiving information in breach of a duty, even if they themselves did not owe a duty,” can now be on the hook under Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5.
The group of potential wrongdoers who can be impacted includes attorneys, consultants, underwriters and hedge fund traders.
“I think we’ve all seen that there are new questions being raised and new things happening because of Galleon,” Kane said. “In the end, some of this will turn out to be good for everyone because it’s prophylactic. People are making sure that they are doing the right things now who might not have ever thought that they even had a duty.”
Sweeping allegations
In October 2009, the SEC filed a civil injunction in U.S. District Court in New York against Raj Rajaratnam and his hedge fund advisory firm, Galleon Management, alleging they had engaged in a massive insider trading scheme that illegally generated more than $25 million.
The SEC, and eventually the Department of Justice, charged a large group, including executives at IBM, Intel Capital and two intellectual property associates from the New York office of Ropes & Gray, with misappropriating material, non-public information.
In its complaint, the government claimed that Rajaratnam had tapped into his network of
friends and business contacts to obtain insider tips and confidential information about corporate earnings and takeover activity at companies such as Google, Hilton and Sun Microsystems.
Relying on more than 2,400 wiretapped phone recordings, which are now the subject of a defense motion to suppress, the government accused Rajaratnam of using the information to illegally trade on behalf of Galleon.
Although Rajaratnam has denied the allegations, more than half the defendants charged, including Ropes & Gray’s Brien Santarlas, have admitted to wrongdoing.
A judge in New York recently entered a consent order and judgment against a defendant accused of acquiring and passing on to Rajaratnam information he had obtained while working as a consultant at McKinsey & Co.
A spokesman for Rajaratnam declined to comment, as did the SEC.
Tapping into the evidence
Thomas M. Hoopes, of Boston’s LibbyHoopes, said wiretaps can clearly be relevant in proving intent, which is typically one of the most difficult elements of an insider trading prosecution.
“With such a cutting-edge case like Galleon, [the government] clearly wanted to be in a position where they were shooting to kill and not just relying on one witness’s word against another,” Hoopes said. “They wanted to have the words on tape.”
Allison D. Burroughs, of Nutter, McClennen & Fish in Boston, added that wiretaps are resource intensive and expensive. In order to get one, the former federal prosecutor said, the government must make a showing of necessity. One of the elements of necessity is that there cannot be any other way to obtain the evidence.
“In most white-collar cases, there is generally a paper trail that makes it harder to get a wiretap,” she said. “The fact that [the government] viewed an insider trading investigation to be big enough to warrant one here is obviously very significant.”
