The Hedge Fund Law Report

Articles By Topic

By Topic: Insider Trading

• From Vol. 6 No.18 (May 2, 2013)

  SEC Commissioner Aguilar Discusses Insider Trading by Hedge Fund Managers, Valuation and Other Examination and Enforcement Pressure Points

  In a speech at the Regulatory Compliance Association’s Regulation, Operations and Compliance Symposium, held on April 18, 2013, SEC Commissioner Luis Aguilar described the challenges to be tackled by hedge fund managers and regulators in serving investor interests.  In particular, Aguilar discussed the elements of a culture of compliance; how the SEC thinks about insider trading at hedge fund management companies; best practices in valuing assets; and internal dynamics at the SEC that may impact whether a hedge fund manager becomes an examination or enforcement target.  This article highlights the salient points from Aguilar’s speech.

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• From Vol. 6 No.17 (Apr. 25, 2013)

  U.S. District Court Conditionally Approves CR Intrinsic Settlement with SEC Despite “Neither Admit Nor Deny Liability” Provision

  A hedge fund manager that is negotiating a settlement to terminate an SEC enforcement action should not assume that a U.S. District Court will “rubber-stamp” the proposed settlement.  A recent decision by a U.S. District Court conditionally approving the settlement of the SEC’s civil insider trading action against hedge fund manager CR Intrinsic Investors, LLC shows that even a landmark settlement amount that gives the SEC virtually everything it could have won at trial will not insulate the settlement from close judicial scrutiny when the defendant does not admit any of the SEC’s allegations.  This article summarizes the Court’s decision, which provides an excellent discussion of the policy, legal and practical issues that courts have been considering when asked to approve SEC settlements.

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• From Vol. 6 No.17 (Apr. 25, 2013)

  GAO Report Dissects the Mechanics of the Political Intelligence Market and Highlights Insider Trading Risks for Hedge Fund Managers

  Hedge fund managers and other sophisticated investors are increasingly seeking out political intelligence (as defined below) to inform their investment decision-making.  While political intelligence can give hedge fund managers a trading edge, it also presents insider trading and other legal risks.  See “Former Federal Prosecutors Share Perspectives on Insider Trading Hot-Button Issues and Enforcement Trends Relevant to Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 39 (Oct. 11, 2012).  To address such insider trading risks, Congress passed the Stop Trading on Congressional Knowledge Act (STOCK Act) in 2012 to clarify that insider trading laws, including Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, apply to information derived from members of Congress and their staffs.  See “Political Intelligence Firms and the STOCK Act: How Hedge Fund Managers Can Avoid Potential Pitfalls,” The Hedge Fund Law Report, Vol. 5, No. 14 (Apr. 5, 2012).  The STOCK Act defines political intelligence to include information that is “derived by a person from direct communications with an executive branch employee, a Member of Congress, or an employee of Congress; and provided in exchange for financial compensation to a client who intends, and who is known to intend, to use the information to inform investment decisions.”  As part of the STOCK Act, Congress commissioned the United States Government Accountability Office (GAO) to study the role of political intelligence in investment decision-making and any attendant risks that could require the passage of additional legislation.  The GAO recently published a report detailing its findings (Report).  The Report discusses: (1) what is known about the sale of public and nonpublic political intelligence, including the extent to which investors rely on such information and the effect the sale of political intelligence may have on financial markets; and (2) potential benefits, costs and challenges associated with suggested legislation that would impose disclosure requirements on those who provide, gather, sell or use political intelligence.  The Report offers hedge fund managers a richer understanding of the political intelligence market and the risks involved in using this type of information in their investment decision-making.  This article summarizes key findings of the Report.

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• From Vol. 6 No.16 (Apr. 18, 2013)

  Recent Survey Reveals Hedge Fund Professionals’ Perspectives on the Prevalence of and Pressures to Engage in Unethical Conduct and Illegal Activity in the Hedge Fund Industry

  A recent survey of hedge fund professionals asked respondents various questions to understand their views on the need for and prevalence of unethical conduct or illegal activity (together, misconduct) at their own firms and among their competitors; any temptations or pressure to engage in misconduct; their firms’ likely responses to misconduct; and the SEC’s effectiveness in stamping out misconduct.  The survey results were broken down into various demographic categories, including the respondents’ gender, 2012 earnings and years of work experience, as well as their firms’ assets under management.  This article summarizes key findings from the survey.

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• From Vol. 6 No.14 (Apr. 4, 2013)

  Former Deputy U.S. Attorney and WilmerHale Partner Boyd M. Johnson III Addresses Risk Management Imperatives for Hedge Fund Managers: Insider Trading, Defense Strategy, Crisis Management, Money Laundering, Cyber Security and Tax Shelters

  Risk plays a different role in investments and operations.  In investments, as a general matter, returns are broadly correlated with risk.  In operations, on the other hand, quality tends to be inversely related with risk; there is no greater upside potential from increased operational risk, just a greater likelihood of fundamental error.  At the same time, operational risk is generally more dangerous to hedge fund managers than investment risk.  Investors understand that generating returns inevitably involves mistakes, but operational failures call into question a manager’s basic competence as a steward of capital.  Managing and mitigating operational risk are thus increasingly critical aspects of the hedge fund business.  But doing so is easier said than done.  In the first instance, it is challenging to identify the full range of operational risks facing a manager.  There is a group of usual suspects, but the less obvious and more insidious risks are unique to a manager’s strategy and operations.  Once risks are identified, best practices for addressing risks are hard to come by.  In an effort to assist hedge fund managers on both counts – identifying relevant risks and deciding what to do about them – The Hedge Fund Law Report recently interviewed Boyd M. Johnson III, a partner in the Litigation/Controversy Department and member of the Investigations and Criminal Litigation Practice Group and the Business Trial Group at WilmerHale.  Prior to joining WilmerHale, Johnson served as Deputy U.S. Attorney in the Southern District of New York with supervisory authority over 230 Assistant U.S. Attorneys.  As Deputy U.S. Attorney, Johnson managed the largest crackdown on Wall Street insider trading in history, including the prosecution of Raj Rajaratnam of the Galleon Group; criminal prosecutions and civil forfeiture proceedings related to the Bernard Madoff fraud; the investigation and prosecution of individuals and entities responsible for structuring and promoting international tax shelters; and numerous cyber security and other investigations.  For our interviews with other leading prosecutors in the Rajaratnam insider trading case, see “Former Rajaratnam Prosecutor Reed Brodsky Discusses the Application of Insider Trading Doctrine to Hedge Fund Research and Trading Practices,” The Hedge Fund Law Report, Vol. 6, No. 13 (Mar. 28, 2013); and “Rajaratnam Prosecutor and Dechert Partner Jonathan Streeter Discusses How the Government Builds and Prosecutes an Insider Trading Case against a Hedge Fund Manager,” The Hedge Fund Law Report, Vol. 5, No. 45 (Nov. 29, 2012).  The bulk of our interview with Johnson covered various aspects of insider trading – not surprising, given that insider trading remains primus inter pares among the various risks faced by managers in many strategies.  Specifically, with respect to insider trading, we discussed with Johnson: challenges in defending simultaneous civil and criminal insider trading actions; challenges in coordinating defenses to insider trading charges levied by multiple jurisdictions; considerations in evaluating an insider trading plea deal; strategies for obtaining prosecutorial leniency in insider trading cases; addressing insider trading risks from communications among investment professionals at different managers; maximizing the effectiveness of insider trading training; insider trading crisis management; and strategies for documenting findings from insider trading internal investigations.  Beyond insider trading, we also covered: anti-money laundering and cyber security risks confronting managers; identifying risky tax shelter pitches; and navigating fraud risks in healthcare investing.  This interview was conducted in connection with the Regulatory Compliance Association’s upcoming Regulation, Operations & Compliance 2013 Symposium, to be held at the Pierre Hotel in New York City on April 18, 2013.  That Symposium is scheduled to include a panel covering government investigation and prosecution of hedge fund and private equity fund managers entitled “Post SAC Capital – Investigation, Enforcement & Prosecution of Hedge & PE Managers.”  For a fuller description of the Symposium, click here.  To register for the Symposium, click here.  Subscribers to The Hedge Fund Law Report are eligible for a registration discount.

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• From Vol. 6 No.13 (Mar. 28, 2013)

  How Can Hedge Fund Managers Understand and Navigate the Perils of Insider Trading Regulation and Enforcement in Hong Kong and the People’s Republic of China

  An old Chinese curse states: “May you live in interesting times.”  This proverb is often coupled with a more severe curse: “May you come to the attention of those in authority.”  For institutional investors trading in markets in Hong Kong and Mainland China (People’s Republic of China or PRC), these are indeed “interesting” regulatory times.  More importantly, an evolving legal and regulatory landscape has significantly increased the likelihood that those traders who are not informed and careful in their research and trading on those markets shall eventually “come to the attention of those in authority.”  For a further discussion of regulatory requirements governing establishing a hedge fund manager presence in Asia, see “Primary Regulatory and Business Considerations When Opening a Hedge Fund Management Company Office in Asia (Part Four of Four),” The Hedge Fund Law Report, Vol. 5, No. 3 (Jan. 19, 2012).  In a guest article, Michael A. Asaro and Douglas A. Rappaport, both partners at Akin Gump Strauss Hauer & Feld LLP, and Patrick M. Mott, an associate at Akin Gump, examine the provisions of Hong Kong and PRC insider trading law most important to U.S.-based hedge fund managers.  For the sake of comparison, the authors also discuss the corresponding provisions of U.S. insider trading law.  For a related discussion of U.S. and U.K. insider trading law, see “Perils Across the Pond: Understanding the Differences Between U.S. and U.K. Insider Trading Regulation,” The Hedge Fund Law Report, Vol. 5, No. 42 (Nov. 9, 2012).  Importantly, in some instances, the insider trading laws in the PRC and Hong Kong may require hedge fund managers to proceed more cautiously than they would with regard to similarly-situated U.S. issuers.  Given that corporate and IR executives in Hong Kong and the PRC may lack the training and vigilance of their U.S. counterparts, it is crucial that hedge fund managers understand the rules applicable to trading on selectively disclosed inside information in these jurisdictions.  The risk of civil and criminal liability for foreign investors has increased as regulators push to clean up the laissez-faire attitude towards inside information that has historically prevailed in the Hong Kong and PRC markets.

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• From Vol. 6 No.13 (Mar. 28, 2013)

  Former Rajaratnam Prosecutor Reed Brodsky Discusses the Application of Insider Trading Doctrine to Hedge Fund Research and Trading Practices

  For at least the last five years, Reed Brodsky has been at the epicenter of the evolution of insider trading law as it applies to hedge fund managers.  As an Assistant U.S. Attorney in the Southern District of New York, he was one of the three prosecutors who tried the largest criminal hedge fund insider trading trial in history, U.S. v. Raj Rajaratnam, which resulted in Rajaratnam’s conviction and sentence of 11 years.  See “Implications of the Rajaratnam Verdict for the ‘Mosaic Theory,’ the ‘Knowing Possession’ Standard of Insider Trading and Criminal Wire Fraud Liability in the Absence of a Trade,” The Hedge Fund Law Report, Vol. 4, No. 18 (Jun. 1, 2011).  Also, he was one of two prosecutors who tried the insider trading case against Rajat Gupta, the former McKinsey Chairman, which resulted in Gupta’s conviction; and he worked on the prosecution of former FrontPoint Partners portfolio manager Joseph Skowron for insider trading in connection with a drug trial.  See “Morgan Stanley Sues Former FrontPoint Partners Portfolio Manager Joseph F. ‘Chip’ Skowron III for Losses Allegedly Caused by Skowron’s Insider Trading and Subsequent Cover-Up,” The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  Based on this experience, Brodsky’s command of insider trading doctrine as it applies to hedge fund managers is recent, relevant and deep.  The Hedge Fund Law Report recently had the opportunity to interview Brodsky in connection with the Regulatory Compliance Association’s upcoming Regulation, Operations & Compliance 2013 Symposium, at which Brodsky is scheduled to participate.  (The details of the Symposium are discussed below.)  Our interview did not focus on insider trading doctrine per se, although Brodsky is eminently equipped to discuss doctrine in depth.  Rather, our interview focused on the application of evolving insider trading doctrine to a range of research and trading practices commonly undertaken by hedge fund managers.  Specifically, we explored with Brodsky: how insider trading law should inform the efforts of hedge fund managers with respect to the use of expert network firms, channel checking firms and political intelligence firms; the application of insider trading law to commodities, derivatives and trades in private company stock; the practicability of “walling off” employees with material nonpublic information; trends in investigative methods and enforcement topics; how to generate goodwill from witness cooperation; and the value of self-reporting discovered insider trading violations.  In addition, we posed a number of challenging hypotheticals to Brodsky – which were hypothetical only in the sense that we did not name names, although the fact patterns are quite real.  Brodsky’s answers were insightful, business-minded and candid, and provide invaluable insight into how prosecutors think about the hedge fund industry.  The RCA Symposium will be held at the Pierre Hotel in New York City on April 18, 2013, and is scheduled to include a panel covering government investigations and prosecutions of hedge fund and private equity fund managers entitled “Post SAC Capital – Investigation, Enforcement & Prosecution of Hedge & PE Managers.”  For a fuller description of the Symposium, click here.  To register for the Symposium, click here.  Subscribers to The Hedge Fund Law Report are eligible for a registration discount.  Brodsky will soon join Gibson Dunn & Crutcher LLP as a partner.  See “Rajaratnam and Gupta Prosecutor Reed Brodsky to Join Gibson Dunn,” The Hedge Fund Law Report, Vol. 6, No. 5 (Feb. 1, 2013).

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• From Vol. 6 No.12 (Mar. 21, 2013)

  Five Takeaways for Other Hedge Fund Managers from the SEC’s Record $602 Million Insider Trading Settlement with CR Intrinsic

  On March 15, 2013, the SEC issued a press release announcing a landmark $602 million civil insider trading settlement with hedge fund adviser CR Intrinsic Investors, LLC (CR Intrinsic) and affiliated entities arising out of alleged insider trading engaged in by Mathew Martoma, a co-defendant in the SEC enforcement action and formerly a portfolio manager at CR Intrinsic.  Martoma allegedly caused hedge funds managed by CR Intrinsic and S.A.C. Capital Advisors, LLC (S.A.C. Capital) to trade based on inside information relating to a drug trial conducted by pharmaceutical companies Wyeth and Elan.  See “Fund Manager CR Intrinsic and Former SAC Portfolio Manager Are Civilly and Criminally Charged in Alleged ‘Record’ $276 Million Insider Trading Scheme,” The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  S.A.C. Capital and various funds managed by CR Intrinsic and S.A.C. Capital are also named as relief defendants in the settlement, although they are not charged with any securities law violations.  On the same day, the SEC also announced a $14 million insider trading settlement with Sigma Capital Management, LLC (Sigma), an affiliate of S.A.C. Capital, relating to trading in the shares of Dell, Inc. and Nvidia Corporation.  This article summarizes the background and terms of the settlements in both actions and offers five important takeaways for other hedge fund managers from the CR Intrinsic matter.  In addition, this article highlights the compliance lessons of the Sigma matter, particularly as those lessons relate to conversations between investment analysts employed by different hedge fund managers.

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• From Vol. 6 No.12 (Mar. 21, 2013)

  Recent District Court Decision in Mark Cuban’s Ongoing Insider Trading Case Clarifies the Application of the Misappropriation Theory to Interactions between Investment Professionals and Corporate Insiders

  On March 5, 2013, the U.S. District Court for the Northern District of Texas (Court) allowed the SEC to proceed to trial in its civil enforcement action against Dallas Mavericks owner Mark Cuban for insider trading.  The SEC accused Cuban of selling his shares in Mamma.com after learning material nonpublic information about the company’s planned private investment in public equity (PIPE) offering, thereby avoiding a $750,000 loss.  The Court held that the SEC presented enough evidence to convince a reasonable jury that Cuban could be held liable on the misappropriation theory of insider trading because he agreed, “at least implicitly, to maintain the confidentiality of Mamma.com’s material nonpublic information and not to trade on it or otherwise use it.”  See “When Does Talking to Corporate Insiders or Advisors Cross the Line into Tipper or Tippee Liability under the Misappropriation Theory of Insider Trading?,” The Hedge Fund Law Report, Vol. 6, No. 2 (Jan. 10, 2013).  For reasons described in more detail in this article, this decision helps to further clarify what hedge fund investment professionals should and should not say and do when talking to corporate insiders.  This article summarizes the factual background in the matter and the Court’s legal analysis, and enumerates some of the salient implications of this decision for the investment research process.

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• From Vol. 6 No.11 (Mar. 14, 2013)

  Proskauer Partner and SEC Enforcement Division Veteran Ronald Wood Explains the Implications for Hedge Fund Managers of Structure and Staffing Changes at the SEC

  In the past few years, the SEC’s Division of Enforcement has refocused its efforts with respect to the investment management industry via structure and staffing.  On the structuring side, the Division of Enforcement has established specialized units, such as the Asset Management Unit, devoted to addressing investor and systemic risks raised by private funds and their managers.  On the staffing side, the Division of Enforcement has hired investment management industry professionals – including hedge fund managers, analysts, operating professionals and due diligence experts – to staff these units.  With this new-found expertise, SEC staff not only “know where the bodies are buried,” but also “understand how they got there,” according to Bruce Karpati, Chief of the Asset Management Unit.  See “OCIE Director Carlo di Florio and Asset Management Unit Chief Bruce Karpati Address Examination and Enforcement Priorities for Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 6, No. 4 (Jan. 24, 2013).  On the foundation of its new expertise, the Division of Enforcement initiated 147 enforcement actions against investment advisers and investment companies in fiscal year 2012.  To provide deeper insight and actionable analysis on what the structuring and staffing changes at the Division of Enforcement mean for hedge fund managers, The Hedge Fund Law Report recently interviewed Ronald Wood.  Wood is a partner in the Securities Litigation Group at Proskauer Rose LLP, and prior to Proskauer spent a decade in the Division of Enforcement.  Our interview covered topics including SEC enforcement priorities; the use of reports filed with the SEC to identify enforcement targets; the SEC’s aberrational performance initiative; insider trading best practices; paid access to corporate executives; track record portability; due diligence on Chinese companies; pay to play issues; “big boy” letters; and FCPA concerns for hedge fund managers.  This article contains the transcript of our interview with Wood.  This interview was conducted in connection with the Regulatory Compliance Association’s upcoming Regulation, Operations & Compliance 2013 Symposium, to be held at the Pierre Hotel in New York City on April 18, 2013.  That Symposium is scheduled to include a panel entitled “Post SAC Capital – Investigation, Enforcement & Prosecution of Hedge & PE Managers.”  For a fuller description of the Symposium, click here.  To register for the Symposium, click here.  Subscribers to The Hedge Fund Law Report are eligible for a registration discount.

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• From Vol. 6 No.9 (Feb. 28, 2013)

  RCA Symposium Identifies Best Practices for Hedge Fund Managers on Topics Including Insider Trading, Compliance Reviews, SEC Examinations, Fund Governance, Form PF and Marketing and Advertising (Part Two of Two)

  On December 18, 2012, the Regulatory Compliance Association held its Compliance, Risk & Enforcement Symposium at the Pierre Hotel in New York City.  Participants at the event included leading hedge fund industry professionals, and panels focused on topics including insider trading, compliance programs and reviews, SEC examination priorities, hedge fund governance, Form PF and marketing and advertising issues.  This article – the second installment in a two-part series covering the Symposium – discusses SEC examination priorities (and practical guidance for addressing areas of concern); recent trends in hedge fund governance; lessons learned from initial Form PF filings and strategies for completing Form PF; and marketing and advertising issues, including a discussion of the JOBS Act and related topics.  The first installment covered, among other things: insider trading (including a discussion of manager cooperation, the elements of insider trading, the continuing viability of the mosaic theory, insider trading investigative techniques and the use of expert networks and paid consultants); and compliance programs and reviews (including a discussion of the approach to and framework for hedge fund compliance programs and reviews, and specific policies and procedures designed to address trading risks).  See “RCA Symposium Identifies Best Practices for Hedge Fund Managers on Topics Including Insider Trading, Compliance Reviews, SEC Examinations, Fund Governance, Form PF and Marketing and Advertising (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 8 (Feb. 21, 2013).

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• From Vol. 6 No.8 (Feb. 21, 2013)

  RCA Symposium Identifies Best Practices for Hedge Fund Managers on Topics Including Insider Trading, Compliance Reviews, SEC Examinations, Fund Governance, Form PF and Marketing and Advertising (Part One of Two)

  On December 18, 2012, the Regulatory Compliance Association held its Compliance, Risk & Enforcement Symposium at the Pierre Hotel in New York City.  Participants at the event included leading hedge fund industry professionals, and panels focused on topics including insider trading, compliance programs and reviews, SEC examination priorities, hedge fund governance, Form PF and marketing and advertising issues.  We are covering the Symposium in a two article series.  This first installment addresses, among other things: insider trading (including a discussion of manager cooperation, the elements of insider trading, the continuing viability of the mosaic theory, insider trading investigative techniques and the use of expert networks and paid consultants); and compliance programs and reviews (including a discussion of the approach to and framework for hedge fund compliance programs and reviews, and specific policies and procedures designed to address trading risks).  The second installment will discuss SEC examination priorities (and practical guidance for addressing areas of concern); recent trends in hedge fund governance; lessons learned from initial Form PF filings and strategies for completing Form PF; and marketing and advertising issues, including a discussion of the JOBS Act and related issues.

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• From Vol. 6 No.2 (Jan. 10, 2013)

  When Does Talking to Corporate Insiders or Advisors Cross the Line into Tipper or Tippee Liability under the Misappropriation Theory of Insider Trading?

  As evidenced by the ongoing series of enforcement actions, pleas and settlements of insider trading charges in the hedge fund context, social networks (primarily the old-fashioned kind) play an important role in the movement of corporate information from companies and their advisors to hedge fund managers.  See “Rajaratnam Prosecutor and Dechert Partner Jonathan Streeter Discusses How the Government Builds and Prosecutes an Insider Trading Case against a Hedge Fund Manager,” The Hedge Fund Law Report, Vol. 5, No. 45 (Nov. 29, 2012).  College buddies, club acquaintances and former colleagues often talk investments.  But when one friend works at a company or for one of its advisors, and the other works at a hedge fund manager, such conversations are rife with insider trading risk.  In particular, such conversations create the possibility that the corporate insider or advisor may be considered a “tipper” under the misappropriation theory of insider trading; that the hedge fund manager employee may be considered a “tippee” vis-à-vis the corporate insider or advisor, and a “tipper” vis-à-vis his colleagues; and that everyone in the “chain” of tipping may be liable for insider trading.  In light of the ubiquity of social interactions with an investment component, and the ease with which such interactions can drift from the innocuous to the illegal, a recent federal appeals court decision merits close attention by hedge fund managers.  The decision offers the clearest and most authoritative recent statement of the standard for tipper or tippee liability under the misappropriation theory of insider trading.  In particular, the decision discusses the elements of tipper and tippee liability under the misappropriation theory, with a particular focus on the nature of the personal benefit required to trigger tipper liability; and the application of those elements to a fact pattern common in investment decision-making.  This article provides a comprehensive discussion of the appeals court decision; the trial court decision below; and analysis of what the decision means for the investment analysis process at hedge fund managers.  For a discussion of similar themes and challenges, see “Former Federal Prosecutors Share Perspectives on Insider Trading Hot-Button Issues and Enforcement Trends Relevant to Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 39 (Oct. 11, 2012).

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• From Vol. 5 No.48 (Dec. 20, 2012)

  SEC Settles Insider Trading Action against Tiger Asia Management

  On December 12, 2012, the SEC charged Tiger Asia Management, LLC (Tiger Asia Management), Tiger Asia Partners, LLC (Tiger Partners) and their principal, Sung Kook (Bill) Hwang, with insider trading and market manipulation relating to their trading in the shares of Bank of China, China Construction Bank and other Chinese companies.  The same day, Tiger Asia Management, Tiger Partners and Hwang agreed to pay $44 million in the aggregate to settle the charges.  This article summarizes the underlying misconduct, the settlement terms and the SEC’s charges.  See generally “Structuring, Regulatory and Tax Guidance for Asia-Based Hedge Fund Managers Seeking to Raise Capital from U.S. Investors (Part Two of Two),” The Hedge Fund Law Report, Vol. 5, No. 32 (Aug. 16, 2012).  Tiger Asia Management faces parallel criminal charges brought by the U.S. Attorney’s Office for the District of New Jersey.  For the details of an action brought by Hong Kong securities regulators against Hwang and Tiger Asia Management arising out of the same alleged insider trading, see “Hong Kong Securities and Futures Commission Wins Appeal of Insider Trading Action Against New York-Based Hedge Fund Manager Tiger Asia Management,” The Hedge Fund Law Report, Vol. 5, No. 10 (Mar. 8, 2012).

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• From Vol. 5 No.45 (Nov. 29, 2012)

  Rajaratnam Prosecutor and Dechert Partner Jonathan Streeter Discusses How the Government Builds and Prosecutes an Insider Trading Case against a Hedge Fund Manager

  Allegations of insider trading in the hedge fund industry are once again front-page news, what with the criminal and civil charges filed against former CR Intrinsic portfolio manager Mathew Martoma on November 20, 2012 and the receipt by SAC Capital Advisors of a Wells notice on the same day.  See “Fund Manager CR Intrinsic and Former SAC Portfolio Manager Are Civilly and Criminally Charged in Alleged ‘Record’ $276 Million Insider Trading Scheme,” The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  But insider trading considerations were never far from the minds of hedge fund managers, lawyers or compliance professionals.  This is because vigorously pursuing important corporate information is central to most hedge fund strategies, yet doing so inherently involves the risk of obtaining material nonpublic information and trading on it.  At the same time, allegations of insider trading usually damage a hedge fund business fundamentally, and often shut it down altogether.  See “Navigating the Patchwork of Global Insider Trading Regulations: An Interview with Adam Wasserman of Dechert,” The Hedge Fund Law Report, Vol. 5, No. 38 (Oct. 4, 2012).  Hedge fund managers need to understand how the government thinks about this critical area, and it would be hard to find someone with better visibility into relevant government decision-making than former Deputy Chief of the DOJ’s Criminal Division and current Dechert partner Jonathan Streeter.  Streeter served as lead trial counsel for the government in the criminal trial of Raj Rajaratnam, founder and principal of the Galleon Group.  See “Galleon Management, LLC Founder Raj Rajaratnam Sentenced to 11 Years in Prison for Insider Trading,” The Hedge Fund Law Report, Vol. 4, No. 36 (Oct. 13, 2011).  Prior to the recent activity involving SAC, the Rajaratnam trial and conviction occasioned the last great crescendo of interest in hedge fund insider trading.  Among other things, the trial highlighted the new centrality of wiretap evidence and caused lawyers to revisit the meaning of the “mosaic theory.”  See “Is the ‘Mosaic Theory’ a Viable Defense to Insider Trading Charges Against Hedge Fund Managers Post-Galleon?,” The Hedge Fund Law Report, Vol. 4, No. 45 (Dec. 15, 2011).  Our interview with Streeter covered, among other things: how the government identifies targets for wiretaps; the communication channels covered by wiretaps (e.g., phones, e-mails); coordination between the DOJ and the FBI in sharing wiretap evidence; the extent to which the SEC can use wiretap evidence in its investigations and enforcement actions; the effectiveness of techniques used to challenge wiretaps; advice to personnel confronted with their wrongdoing and how to respond to government requests for cooperation; the value of cooperating with the government; the utility of a fund manager’s self-reporting of insider trading by an employee; how to handle government requests for information about insider trading by other hedge fund managers; the government’s view of the mosaic theory; how the government determines whether to make an insider trading investigation public; steps fund managers can take to avoid insider trading liability when talking with corporate executives or using expert networks; and the sources used by the government to identify potential insider trading targets.  The following is a complete transcript of our interview with Streeter.  This interview was conducted in connection with the Regulatory Compliance Association’s Compliance, Risk & Enforcement 2012 Symposium, which will take place on December 18, 2012 at the Pierre Hotel in New York.  For more information on the Symposium, click here.  To register for the Symposium, click here.  Hedge Fund Law Report subscribers are eligible for a registration discount.

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• From Vol. 5 No.44 (Nov. 21, 2012)

  Fund Manager CR Intrinsic and Former SAC Portfolio Manager Are Civilly and Criminally Charged in Alleged “Record” $276 Million Insider Trading Scheme

  On November 20, 2012, the SEC filed a civil complaint charging hedge fund manager CR Intrinsic Investors, LLC (CR Intrinsic); one of its former portfolio managers, Mathew Martoma; and a doctor and medical consultant, Dr. Sidney Gilman, with allegedly participating in an insider trading ring in which CR Intrinsic, Martoma and funds managed by an unnamed affiliated hedge fund manager (identified in the financial press as SAC Capital) profited or avoided losses totaling $276 million – a record alleged value derived from an insider trading scheme, according to the U.S. Attorney’s Office.  According to the SEC’s complaint, CR Intrinsic traded ahead of a negative announcement of the results of a Phase II trial of a drug designed to treat Alzheimer’s disease that was being jointly developed by Elan Corporation, Plc and Wyeth.  Martoma allegedly received material nonpublic information through consultations with Gilman that were coordinated by an expert network firm.  Federal prosecutors in the Southern District of New York simultaneously unsealed a criminal complaint charging Martoma with insider trading.  This article summarizes the SEC’s complaint, including the allegations, claims and relief sought by the SEC.  (The factual allegations in the criminal complaint are substantially similar to those in the civil complaint.)

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• From Vol. 5 No.44 (Nov. 21, 2012)

  Morgan Stanley Sues Former FrontPoint Partners Portfolio Manager Joseph F. “Chip” Skowron III for Losses Allegedly Caused by Skowron’s Insider Trading and Subsequent Cover-Up

  In April 2011, Joseph F. “Chip” Skowron III, a former portfolio manager at hedge fund manager FrontPoint Partners, LLC (FrontPoint) pleaded guilty to criminal insider trading and obstruction of justice charges arising out of his trading in Human Genome Sciences, Inc. and his subsequent efforts to cover up that trading.  Morgan Stanley, which owned FrontPoint at the time of Skowron’s trading, paid $33 million to settle the SEC’s enforcement action against Skowron and FrontPoint’s funds.  Morgan Stanley has now commenced a civil suit against Skowron to recover that amount, along with the millions of dollars in compensation it paid Skowron and other substantial expenses and damages it claims it incurred as a result of Skowron’s admitted criminal conduct.  It asserts five separate causes of action against Skowron.  This article summarizes the allegations, claims and relief requested in Morgan Stanley’s complaint.  See also “Former Portfolio Manager of Hedge Fund Manager FrontPoint Partners, Joseph F. ‘Chip’ Skowron, Is Charged with Civil and Criminal Insider Trading Arising Out of Trading in Human Genome Sciences Stock,” The Hedge Fund Law Report, Vol. 4, No. 13 (Apr. 21, 2011); and “SEC and DOJ Commence, Respectively, Civil and Criminal Insider Trading Actions Against a Doctor Who Allegedly Tipped Off a Hedge Fund Manager to Impending Negative Information About a Drug Trial,” The Hedge Fund Law Report, Vol. 3, No. 44 (Nov. 12, 2010).

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• From Vol. 5 No.42 (Nov. 9, 2012)

  Perils Across the Pond: Understanding the Differences Between U.S. and U.K. Insider Trading Regulation

  The ongoing crackdown on insider trading has been front page news for some time now.  Pundits have compared the situation to the 1980s when a wave of similar charges were leveled against Wall Street icon Ivan Boesky and other professional investors, bankers and lawyers of that era.  Unlike the 1980s, however, this latest round of insider trading enforcement is not limited to activity in the United States.  This time, foreign regulators have followed suit, bringing their own string of insider trading cases that, on the surface, seem to mirror what has been going on in the United States.  The leader of this pack has been the U.K.’s Financial Services Authority (FSA), which has cast aside its historical reputation as a “light touch” regulator by bringing a series of aggressive and unprecedented “insider dealing” cases against their own high-profile targets.  The FSA has secured 14 criminal convictions related to insider dealing since 2009 and is currently prosecuting another eight individuals on criminal insider dealing charges.  This recent flurry of international insider trading enforcement, coupled with the globalization of the world’s financial markets, subjects investment professionals to a new and unprecedented set of risks.  The crux of the problem is that the rules governing insider trading can differ significantly from jurisdiction to jurisdiction.  In a guest article, Michael A. Asaro and Douglas A. Rappaport, both partners at Akin Gump Strauss Hauer & Feld LLP, and Patrick M. Mott, an associate at Akin Gump, analyze the differences between U.S. and U.K. insider trading laws, and in the process, identify some of the potential pitfalls faced by U.S. investors who are active in investing in the United Kingdom.

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• From Vol. 5 No.42 (Nov. 9, 2012)

  Competing Briefs in Rajaratnam Appeal Outline the Application of Wiretap Law to Hedge Fund Managers

  The use of wiretap evidence is the most important innovation in insider trading enforcement in the last five years, and nothing illustrates the evidentiary power of wiretap evidence as starkly as the Rajaratnam trial and conviction.  As the hedge fund industry well knows, on May 11, 2011, after a two-month trial, including 12 days of jury deliberations, Raj Rajaratnam, founder of hedge fund manager Galleon Group, was found guilty of nine counts of securities fraud and five conspiracy counts.  In October 2011, he was sentenced to 132 months in prison and ordered to pay a $10 million fine and to forfeit $53.8 million.  Prior to the Rajaratnam trial, most insider trading cases were based on circumstantial evidence.  But the case against Rajaratnam was based in large part on direct evidence – recordings of over 2,200 of Rajaratnam’s telephone conversations with more than 130 individuals.  As Rajaratnam’s defense team found, it is often difficult or impossible to rebut the validity of wiretap evidence.  Given the comprehensiveness of many wiretaps, it is even difficult in most cases to offer competing interpretations of the same wiretap.  There is no substitute from the prosecutor’s perspective – and little as damning – as a defendant explaining his bad acts in his own words.  Accordingly, the legal fight in connection with wiretaps often relates not to the content of the wiretap but to the validity of the wiretap in the first instance – and this is precisely the fight that Rajaratnam is waging in appealing his conviction to the Second Circuit.  Specifically, on appeal, Rajaratnam alleges that the government engaged in a flawed process in obtaining the warrant to wiretap his phones, and those flaws violated his Fourth Amendment rights as well as the federal wiretap statute.  Rajaratnam also challenges a jury instruction relating to the insider trading charges.  This article provides a feature-length analysis of Rajaratnam’s appeal brief and the government’s reply brief.  In doing so, this article provides a comprehensive view of the law governing wiretaps.  For hedge fund managers, general counsels, outside counsel, compliance officers, portfolio managers and others, it is now important to understand this area of law – an area previously applicable primarily in organized crime and conspiracy cases.  Understanding the law of wiretaps is important for many reasons.  Most notably, if the government wiretaps you or one of your portfolio managers, and if the wiretap bears fruit, there is a good chance that the government will approach you about settling before initiating a formal criminal matter.  If you understand the law of wiretaps – particularly if you can identify any infirmities in the process by which the government obtained its warrant – you will have a significant bargaining advantage vis-à-vis an investment management lawyer that is not conversant with this niche of criminal procedure.  You can hire a good white collar lawyer, of course, but if you understand this area, you will know what to ask and better appreciate the answers.  Our review of the appellate papers in the Rajaratnam matter is intended to highlight the primary legal considerations for the growing number of hedge fund industry participants that are concerned with wiretaps but that are not experts in criminal law and procedure.

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• From Vol. 5 No.39 (Oct. 11, 2012)

  Former Federal Prosecutors Share Perspectives on Insider Trading Hot-Button Issues and Enforcement Trends Relevant to Hedge Fund Managers

  At an October 1, 2012 event co-sponsored by The National Law Journal; MoloLamken LLP; Wachtell, Lipton, Rosen & Katz; and Wilmer Cutler Pickering Hale & Dorr LLP, an illustrious panel of former federal prosecutors discussed the current state of insider trading enforcement and reviewed numerous hot-button issues of interest to hedge fund managers and other investors.  This article summarizes the key insights from the panel discussion.

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• From Vol. 5 No.38 (Oct. 4, 2012)

  Navigating the Patchwork of Global Insider Trading Regulations: An Interview with Adam Wasserman of Dechert

  As the investments and operations of hedge fund managers become increasingly global, managers must contend with a growing number and complexity of regulatory regimes.  One of the most complicated and important areas in which regulation varies from jurisdiction to jurisdiction is insider trading.  Insider trading regulation is complex enough domestically.  When you factor in the asymmetry among global regimes; different treatment of the same conduct; the often counterintuitive aspects of insider trading doctrine; and the ease of tripping jurisdictional wires, global insider trading regulation becomes a minefield for the unwary hedge fund manager.  Moreover, non-U.S. regulators – in the United Kingdom, Hong Kong and Japan, among other places – are growing more vigorous in their insider trading enforcement.  To help hedge fund managers identify and address some of the most important issues in global insider trading regulation, The Hedge Fund Law Report recently interviewed Adam Wasserman, a Partner at Dechert LLP.  The interview covered, among other topics: the biggest differences between the insider trading laws of the U.S. and non-U.S. jurisdictions; the unexpected aspects of insider trading doctrine from various jurisdictions; a discussion of the Greenlight Capital U.K. insider trading settlement; the relevance of the scienter element in insider trading claims in non-U.S. jurisdictions; the applicability of U.S. insider trading laws to conduct outside of the United States; the applicability of various jurisdictions’ insider trading laws in complex situations; whether the U.S. Securities and Exchange Commission (SEC) and the U.S. Department of Justice (DOJ) are focusing insider trading efforts domestically or globally; identification of jurisdictions becoming more forceful in insider trading enforcement; the views of hedge fund managers with respect to domestic versus global insider trading issues; and policies and procedures hedge fund managers should implement to understand insider trading regulations where they do business and to prevent violations.  This article provides the complete transcript of our interview with Wasserman.  This interview was conducted in conjunction with the Regulatory Compliance Association’s upcoming Symposium entitled Compliance, Risk & Enforcement 2012.  Wasserman will be one of various asset management industry thought leaders participating at that Symposium, which will take place on October 30, 2012 at the Pierre Hotel in Manhattan.  For more information about the Symposium, click here.  To register for the Symposium, click here.  Subscribers to The Hedge Fund Law Report are eligible for discounted registration.

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• From Vol. 5 No.30 (Aug. 2, 2012)

  Selective Dissemination of Research Through Surveys, Trade Ideas Platforms, Huddles and Desk Research: What Are the Implications for Hedge Funds?

  A July 15, 2012 article in The New York Times originally entitled “In Surveys, Hedge Funds See Early Views of Stock Analysts,” highlighted the topic of selective dissemination of research, alleging that hedge funds are getting early access to ratings changes through surveys and “trade ideas” platforms.  Not to be outdone, The Wall Street Journal published an article on July 25, 2012 titled “Stock Research, For a Select Few” which discussed trade ideas platforms and the rise of “desk analysts” who are not subject to the same dissemination requirements as publishing analysts.  While selective dissemination is a front burner issue for regulators, the compliance implications for hedge funds are less clear.  In a guest article, Sanford (Sandy) Bragg, CEO of Integrity Research Associates, LLC, describes various methods for disseminating research, including surveys, trade ideas platforms, huddles and desk research; reviews recent regulatory activity on and rules governing the selective dissemination of research, particularly as it relates to trade ideas platforms; and discusses how hedge funds might mitigate selective dissemination risks.

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• From Vol. 5 No.26 (Jun. 28, 2012)

  U.S. District Court Approves SEC’s Settlement with Bear Stearns Fund Managers Cioffi and Tannin

  In June 2008, in the wake of the collapse of The Bear Stearns Companies, Inc. (Bear Stearns), the U.S. Department of Justice and Securities and Exchange Commission brought parallel criminal and civil enforcement actions against Bear Stearns hedge fund managers Ralph R. Cioffi and Matthew M. Tannin, alleging that they had misrepresented to investors the precarious state of the funds they managed in an effort to attract new investments and discourage redemptions.  Cioffi and Tannin were acquitted of the criminal charges in 2009.  The SEC and the defendants have now reached a settlement of the civil charges, which has been approved by Judge Frederic Block of the United States District Court for the Southern District of New York (Court).  This article summarizes the Court’s decision, in which Judge Block highlighted the limits of the SEC’s powers in such cases.

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• From Vol. 5 No.24 (Jun. 14, 2012)

  Davis Polk “Hedge Funds in the Current Environment” Event Focuses on Establishing Registered Alternative Funds, Hedge Fund Manager M&A and SEC Examination Priorities

  On May 11, 2012, the New York City Bar Association held its annual “Hedge Funds in the Current Environment” program co-hosted by law firm Davis Polk & Wardwell LLP.  Speakers at this event addressed various topics of current relevance to the hedge fund industry, including: SEC examination priorities, such as insider trading, trade reviews and asset verification; establishing registered alternative funds; trends in hedge fund manager mergers and acquisitions; and hedge fund advertising after passage of the Jumpstart Our Businesses Startups (JOBS) Act.  Notably, Norm Champ, Deputy Director of the Office of Compliance Inspections and Examinations with the SEC, provided an up-to-date view of the SEC’s examination priorities in relation to hedge funds and their managers.  This article summarizes the key points discussed at the conference relating to each of the foregoing topics.

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• From Vol. 5 No.23 (Jun. 8, 2012)

  RCA Symposium Focuses on Hedge Fund Governance, Form PF, Enterprise Risk Management, Regulatory Enforcement, Criminal Prosecution, CCO and GC Liability and Third Party Relationships (Part Two of Two)

  On April 16, 2012, the Regulatory Compliance Association held its Regulation and Risk Thought Leadership Symposium (RCA Symposium) in New York City at the Pierre Hotel.  The RCA Symposium brought together leading practitioners and regulators in a series of panel discussions, each of which offered unique insight on various topics of relevance for hedge fund managers.  This is the second article in a two-part series summarizing the highlights from the RCA Symposium.  This second article discusses the sessions covering: the new paradigm of regulatory enforcement and white-collar prosecution; chief compliance officer and general counsel liability; and re-evaluation of the operating model for third party relationships.  The first article discussed the sessions covering: fund governance issues; interpreting, preparing for and completing Form PF; and enterprise risk management for hedge fund managers.  See “RCA Symposium Focuses on Hedge Fund Governance, Form PF, Enterprise Risk Management, Regulatory Enforcement, Criminal Prosecution, CCO and GC Liability and Third Party Relationships (Part One of Two),” The Hedge Fund Law Report, Vol. 5, No. 22 (May 31, 2012).

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• From Vol. 5 No.20 (May 17, 2012)

  Navigating the Insider Trading Risks in Distressed Debt Trading

  The past two years have seen a dramatic increase in the number and visibility of insider trading cases brought by regulatory and enforcement authorities and private plaintiffs.  If the first few months of 2012 are any indication, this trend will continue.  Indeed, not only are enforcement authorities becoming more active in bringing such actions, they are also becoming more aggressive in their interpretation of the scope of actions which may constitute insider trading.  Thus, insider trading cases have been brought against a “tippee” who found a copy of a presentation about a buyout that a banker mistakenly left behind and against a director who is not even alleged to have traded or otherwise profited from the alleged misconduct.  To date, however, there have been relatively few attempts to pursue insider trading charges or civil claims in the context of bankruptcy claims trading, and those cases that have been brought have been largely limited to situations involving creditors’ committee members.  There are good reasons that such actions should be limited to the context of a creditors’ committee.  However, in light of the increasing activity in this area, it is worth reviewing the complexities involved in the application of insider trading laws to distressed debt trading.  In a guest article, Daniel H.R. Laguardia and K. Mallory Tosch, Partner and Associate, respectively, at Shearman & Sterling LLP, provide a comprehensive analysis of insider trading law as it applies to hedge funds that invest in distressed debt, bankruptcy claims and similar assets.

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• From Vol. 5 No.16 (Apr. 19, 2012)

  Recent SEC Complaint Brings Together Two Headline Enforcement Trends: Insider Trading and China

  The SEC’s Division of Enforcement (Division of Enforcement) has redoubled its efforts to prosecute those engaged in various securities law violations by initiating a record 735 enforcement actions in 2011.  One of the SEC’s key initiatives has focused on ferreting out insider trading, and a number of the targets have been hedge fund managers and their personnel.  See “SEC Files Civil Insider Trading Complaint Against Diamondback Capital Management, Level Global Investors and Seven Individuals Based on Trading in Dell and Nvidia; Diamondback Strikes Non-Prosecution Deal with U.S. Department of Justice and Settles with the SEC for $9 Million,” The Hedge Fund Law Report, Vol. 5, No. 4 (Jan. 26, 2012).  It appears that the Division of Enforcement’s attempts to enhance its subject matter expertise and to upgrade the analytical and technological tools used to sniff out fraud have contributed to these efforts, as recently demonstrated by an action brought by the SEC against six Chinese traders and a British Virgin Islands corporation trader alleged to have engaged in insider trading.  This article describes the factual allegations, causes of action and relief sought by the SEC in the Complaint, as well as the cautionary lessons to be learned by hedge fund managers from the Complaint.  See “Insider Trading – The Long View,” The Hedge Fund Law Report, Vol. 4, No. 38 (Oct. 27, 2011).

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• From Vol. 5 No.14 (Apr. 5, 2012)

  Recent Decision Holds That Hedge Fund Managers Have Some Recourse Against Firm Employees That Engage in Insider Trading and Deceive Their Employers Pursuant to the Mandatory Victims Restitution Act

  Hedge fund managers compensate their employees for services rendered with the expectation that such services will be rendered with competence, integrity and honesty.  However, when employees fail to live up to these expectations, do hedge fund managers have any recourse?  For example, may managers claw back compensation paid to such employees and recoup costs incurred in investigating and defending against securities fraud claims?  A recent decision by the U.S. District Court for the Southern District of New York suggests that, yes, hedge fund managers may in fact have some recourse against rogue employees.

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• From Vol. 5 No.13 (Mar. 29, 2012)

  Recently-Filed SEC Action Demonstrates the Potential Risks of Insider Trading by Investment Consultants Hired by Private Fund Managers

  Private fund managers, including hedge fund managers, often hire investment consultants to help evaluate investments; analyze an investment target company’s operations, management and financial condition; offer strategic and structuring advice; and provide related services.  To provide value, such consultants typically request and receive deep access to confidential target company data.  The company typically grants such access under the terms of a confidentiality agreement between the company and the consultant, or among the company, the consultant and the private fund manager.  Typically, the primary purpose of such confidentiality agreements is to prevent confidential company information from reaching a competitor or from being used by the consultant on behalf of a competitor.  A secondary purpose of such agreements is to prevent insider trading by “temporary insiders” or their tippees, or Regulation FD violations by the company.  However, an enforcement action recently filed by the SEC suggests that confidentiality agreements, standing alone, may not be sufficient to prohibit insider trading by investment consultants.  While the private fund manager involved was not charged, the charges against the manager’s consultant reflect adversely on the manager.  The charges suggest, for example, that the manager did not take adequate precautions to control the conduct of the consultant.  Given the radioactivity of insider trading charges in the current enforcement environment, risk aversion with respect to insider trading is prudent business.  This article discusses the SEC’s factual and legal allegations in the matter, as well as the consultant’s proposed settlement agreement.  This article also details four steps that private fund managers may take to prevent insider trading by their investment consultants.

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• From Vol. 5 No.10 (Mar. 8, 2012)

  Hong Kong Securities and Futures Commission Wins Appeal of Insider Trading Action Against New York-Based Hedge Fund Manager Tiger Asia Management

  On February 23, 2012, the Hong Kong Court of Appeal ruled on a dispute between hedge fund manager Tiger Asia Management LLC and the Hong Kong Securities and Futures Commission.  This ruling adds to the total mix of considerations for any U.S.-based hedge fund manager considering entering the Hong Kong market.  See also “Primary Regulatory and Business Considerations When Opening a Hedge Fund Management Company Office in Asia (Part Four of Four),” The Hedge Fund Law Report, Vol. 5, No. 3 (Jan. 19, 2012).  For a discussion of another matter highlighting the asymmetry between U.S. and non-U.S. insider trading doctrine, see “FSA Imposes £7.2 Million Penalty on Hedge Fund Manager David Einhorn and Greenlight Capital for Unintentional Insider Dealing in Shares of British Pub Owner Punch Taverns Plc,” The Hedge Fund Law Report, Vol. 5, No. 5 (Feb. 2, 2012).

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• From Vol. 5 No.8 (Feb. 23, 2012)

  Trading Practices Session at SEC’s Compliance Outreach Program National Seminar Addresses Need for Holistic Compliance Procedures Dealing with Allocations, Best Execution and Cross Trades

  On January 31, 2012, the SEC hosted its annual, “Compliance Outreach Program National Seminar” (Seminar).  (The program was previously called “CCOutreach,” but it has been “rebranded,” as the SEC explained in a press release, to be more inclusive of all senior personnel at firms.)  The Seminar included five sessions.  The Hedge Fund Law Report recently reported on the session entitled “Enforcement-Related Matters” (Enforcement Session).  See “Enforcement Session at SEC’s Compliance Outreach Program National Seminar Highlights Regulatory Focus on Valuation, Conflicts of Interest and Compliance Shortcomings at Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 7 (Feb. 16, 2012).  This article focuses on the “Trading Practices” session and highlights best practices for addressing the identified compliance concerns.

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• From Vol. 5 No.6 (Feb. 9, 2012)

  Key Legal and Operational Considerations for Hedge Fund Managers in Establishing, Maintaining and Enforcing Effective Personal Trading Policies and Procedures (Part Three of Three)

  One of the principal challenges many hedge fund managers face is effectively and efficiently enforcing a firm’s compliance policies and procedures given limited compliance resources.  This problem has been historically acute with respect to personal trading compliance because of the significant manual effort required to ensure compliance with applicable rules and in-house personal trading requirements.  Nonetheless, in the past decade, technology vendors have made significant progress in developing personal trading compliance solutions that can significantly enhance the effectiveness and efficiency of personal trading compliance programs, at relatively modest prices.  Technological solutions can facilitate personal trading reporting as well as enforcement of a firm’s personal trading restrictions and prohibitions.  Furthermore, vendors can now tailor such solutions to meet the needs of hedge fund managers with varying operational requirements.  As such, hedge fund managers should explore and understand the various personal trading compliance solutions available to them to determine whether any such solutions will further advance the goals of their personal trading compliance programs.  This is the third article in a three-part series on personal trading policies and procedures for hedge fund managers.  The first article in this series discussed general considerations for hedge fund managers in developing effective personal trading policies; the scope of persons that may be covered by such personal trading policies; and the reporting obligations imposed on registered hedge fund managers by Rule 204A-1 under the Investment Advisers Act of 1940 (Advisers Act).  See “Key Legal and Operational Considerations for Hedge Fund Managers in Establishing, Maintaining and Enforcing Effective Personal Trading Policies and Procedures (Part One of Three),” The Hedge Fund Law Report, Vol. 5, No. 3 (Jan. 19, 2012).  The second article discussed various personal trading restrictions and prohibitions, including limitations on the number of brokerage firms covered persons can use to effect personal trades; pre-clearance requirements for personal trades; blackout periods during which personal trades cannot be effected; holding periods applicable to securities owned by covered persons; and other types of personal trading restrictions and prohibitions.  See “Key Legal and Operational Considerations for Hedge Fund Managers in Establishing, Maintaining and Enforcing Effective Personal Trading Policies and Procedures (Part Two of Three),” The Hedge Fund Law Report, Vol. 5, No. 4 (Jan. 26, 2012).  This third article in the series describes various solutions designed to facilitate monitoring of personal trading compliance by hedge fund managers.  Specifically, this article discusses various technological solutions designed to facilitate personal trading reporting, including the various methods for obtaining electronic personal trading data (instead of paper data) from broker-dealers; various solutions for automating personal trade monitoring; automated trade pre-clearance solutions; and a summary of key considerations for hedge fund managers when evaluating personal trading compliance solutions.  See generally “How Hedge Fund Managers Can Use Technology to Enhance Their Compliance Programs,” The Hedge Fund Law Report, Vol. 4, No. 41 (Nov. 17, 2011).

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• From Vol. 5 No.6 (Feb. 9, 2012)

  Does Social Media Have a Place in the Hedge Fund Industry?

  While social media has captivated society and propelled it deeper into the communication age, the hedge fund industry has not yet embraced it on a meaningful scale.  See “Legal Considerations for Hedge Fund Managers that Use Social Media,” The Hedge Fund Law Report, Vol. 4, No. 14 (Apr. 29, 2011).  In fact, a recent survey of hedge fund managers found that the vast majority of hedge fund managers are simply not using social media.  On the one hand, it is surprising that hedge fund managers have been slow to explore social media given the otherwise cutting edge nature of the hedge fund industry.  On the other hand, many compliance professionals are simply stretched too thin by the introduction of new regulatory challenges arising from the Dodd-Frank Act, and thus are unable to devote resources to exploring this new frontier.  In reality, there appears to be very little dialogue regarding whether social media could be used effectively in the hedge fund industry, and if so, how to do so in compliance with applicable laws and regulations.  Therefore, in a guest article, John Herbert Roth, Counsel and Chief Compliance Officer of Venor Capital Management LP, initiates that dialogue by asking whether social media can have a place in the hedge fund industry, and then proposing a comprehensive framework within which hedge fund managers may think about social media and its compliance implications.  See also “SEC Enforcement Action and Bulletins Shine Spotlight on Use of Social Media by Investment Advisers,” The Hedge Fund Law Report, Vol. 5, No. 2 (Jan. 12, 2012).

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• From Vol. 5 No.5 (Feb. 2, 2012)

  FSA Imposes £7.2 Million Penalty on Hedge Fund Manager David Einhorn and Greenlight Capital for Unintentional Insider Dealing in Shares of British Pub Owner Punch Taverns Plc

  The UK Financial Services Authority (FSA) has concluded that hedge fund founder David Einhorn and his Greenlight Capital Inc. (Greenlight) engaged in impermissible “insider dealing” when they sold shares of British pub owner Punch Taverns Plc (Punch) immediately following a conference call with Punch management.  The FSA concluded that, even though Einhorn had refused to sign a nondisclosure agreement before the call and believed that he had not received inside information, Einhorn should have refrained from trading in Punch shares because he should have understood that he had received inside information about the terms and timing of a proposed equity issuance by Punch.  We summarize the FSA’s conclusions and the rationale for its actions.  See generally “Use by Hedge Fund Managers of Restricted Lists, Watch Lists and Ethical Walls to Prevent Insider Trading Violations,” The Hedge Fund Law Report, Vol. 4, No. 37 (Oct. 21, 2011).

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• From Vol. 5 No.4 (Jan. 26, 2012)

  Key Legal and Operational Considerations for Hedge Fund Managers in Establishing, Maintaining and Enforcing Effective Personal Trading Policies and Procedures (Part Two of Three)

  Carefully conceived personal trading restrictions and prohibitions (such as pre-clearance of personal trades and blackout periods) are some of the most valuable tools available to a hedge fund manager to detect and prevent personal trading fraud, including insider trading and front-running.  Such policies prove the adage that an ounce of prevention is worth a pound of cure.  Contrast such personal trading restrictions and prohibitions with the reporting obligations mandated by Rule 204A-1 under the Investment Advisers Act of 1940 (Advisers Act) which only require a firm to review its covered persons’ trades retroactively.  Once a trade has been effected, a firm has few remedial options other than breaking the trade (if it is discovered in time) or disciplining the covered person (potentially including requiring him or her to disgorge any profits).  More often than not, once a personal trading violation has occurred, the damage has been done.  As such, unless a hedge fund manager flatly prohibits all personal trading by its covered persons, it will need to adopt some personal trading restrictions and prohibitions to prevent personal trading fraud.  Unfortunately, the securities laws and rules (including Rule 204A-1) provide only limited guidance in this regard.  This is the second article in a three-part series on personal trading policies and procedures for hedge fund managers.  The first article in this series discussed general considerations for hedge fund managers in developing effective personal trading policies; the scope of persons that may be covered by such personal trading policies; and the reporting obligations imposed on registered hedge fund managers by Rule 204A-1.  See “Key Legal and Operational Considerations for Hedge Fund Managers in Establishing, Maintaining and Enforcing Effective Personal Trading Policies and Procedures (Part One of Three),” The Hedge Fund Law Report, Vol. 5, No. 3 (Jan. 19, 2012).  This article discusses various personal trading restrictions and prohibitions, including limitations on the number of brokerage firms covered persons can use to effect personal trades; pre-clearance requirements for personal trades; blackout periods during which personal trades cannot be effected; holding periods applicable to securities owned by covered persons; and other types of personal trading restrictions and prohibitions.  The third article in this series will describe various solutions designed to facilitate monitoring of personal trading compliance by hedge fund managers.

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• From Vol. 5 No.4 (Jan. 26, 2012)

  SEC Files Civil Insider Trading Complaint Against Diamondback Capital Management, Level Global Investors and Seven Individuals Based on Trading in Dell and Nvidia; Diamondback Strikes Non-Prosecution Deal with U.S. Department of Justice and Settles with the SEC for $9 Million

  The Securities and Exchange Commission (SEC) has continued its push to root out insider trading in the hedge fund industry by leveling charges against two prominent hedge fund managers, certain of their respective principals and a network of analysts who allegedly shared inside information about Dell and Nvidia.  This article details the SEC’s allegations and summarizes the status of the related criminal charges and recent developments.

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• From Vol. 5 No.4 (Jan. 26, 2012)

  SEC Settlement with Diamondback Capital Evidences SEC’s New Practice of Prohibiting Defendants from Settling Cases Without Admitting or Denying Facts Admitted in Parallel Criminal Matters

  On January 23, 2012, Diamondback Capital Management, LLC (Diamondback) entered into agreements with the U.S. Attorney’s Office for the Southern District of New York (U.S. Attorney’s Office) and the SEC to, respectively, avoid criminal prosecution and settle parallel civil charges.  For a thorough discussion of the civil and criminal charges and resolutions to date, see “SEC Files Civil Insider Trading Complaint Against Diamondback Capital Management, Level Global Investors and Seven Individuals Based on Trading in Dell and Nvidia; Diamondback Strikes Non-Prosecution Deal with U.S. Department of Justice and Settles with the SEC for $9 Million,” above, in this issue of The Hedge Fund Law Report.  The settlement with the SEC is important because it represents the first settlement under the SEC’s new policy adopted on January 6, 2012 whereby it no longer permits defendants to settle civil charges in connection with a civil injunctive complaint or an administrative order without admitting or denying allegations of wrongdoing where: (1) a defendant has been the subject of a parallel criminal conviction or; (2) a defendant has signed a non-prosecution agreement or deferred prosecution agreement in a parallel criminal prosecution in which it admits or acknowledges wrongdoing.  This article describes the new SEC policy change as well as the implications for hedge fund managers facing parallel criminal and civil actions.

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• From Vol. 5 No.3 (Jan. 19, 2012)

  Key Legal and Operational Considerations for Hedge Fund Managers in Establishing, Maintaining and Enforcing Effective Personal Trading Policies and Procedures (Part One of Three)

  Most hedge fund managers implement personal trading policies and procedures, that is, rules governing trading by management company personnel for their own accounts rather than for funds or accounts managed by the management company.  Hedge fund managers implement such policies and procedures for either or both of two reasons: because they have to or because they should.  Some hedge fund managers have to implement such policies because they are registered (or required to be registered) with the SEC as investment advisers, and Rule 204A-1 under the Investment Advisers Act of 1940 (Advisers Act) requires registered investment advisers to establish, maintain and enforce codes of ethics that include personal trading policies designed to detect and prevent fraud in connection with personal trading.  Even managers that are not registered and are not required to register frequently implement personal trading policies and procedures as a matter of prudence.  This is because personal trading by management company personnel can violate laws and rules other than Rule 204A-1.  For example, personal trading can – and in the recent past, frequently has – resulted in insider trading violations.  The specific violator in such cases is typically the individual trader, but such violations adversely affect (often dramatically) the management company that employs the violator.  Also, personal trading can result in “front running,” in which an employee of the manager buys or sells a security before engaging in a similar transaction for a managed fund or account.  Similarly, personal trading can result in management company personnel usurping investment opportunities that legally belong to the manager’s funds or accounts.  On usurpation, see “SEC Enforcement Action Against a Private Equity Fund Manager Partner Calls into Question the Value of Self-Reporting in the Private Funds Context,” The Hedge Fund Law Report, Vol. 4, No. 36 (Oct. 13, 2011).  Advisers Act Rule 204A-1 provides minimum standards for registered hedge fund managers in crafting personal trading policies.  But the rule is spare with respect to detail, leaving registered hedge fund managers relatively wide latitude in designing policies and procedures.  That latitude, of course, is constrained by other law and practice, the reality of SEC examinations and expectations on the part of increasingly sophisticated investors.  By the same token, even unregistered hedge fund managers typically look to practice under Rule 204A-1 as a guideline in crafting their own personal trading policies and procedures.  Moreover, once personal trading policies and procedures are in place, they must be, in the language of Rule 204A-1, “maintained” and “enforced” – yet the rule offers little in the way of guidance with respect to maintenance and enforcement.  Accordingly, market practice looms large in the design and implementation of personal trading policies and procedures.  Yet here, as in other areas of hedge fund operations, market practice is challenging to discern reliably.  With an increasing number of hedge fund managers facing an imminent registration deadline, and with substantially all managers facing heightened operating expectations from investors and regulators, The Hedge Fund Law Report is publishing a three-part series of articles that seeks to shed light on market practice with respect to personal trading policies and procedures of hedge fund managers.  This article is the first in the series and addresses: the overarching considerations in establishing a personal trading program; the scope of persons that can and should be covered by the personal trading program; and the reporting obligations that apply to covered persons, including a discussion of the securities covered by the reporting requirements and available exceptions from the reporting requirements.  The second article in this series will highlight various personal trading restrictions, including discussions of restrictions on the number of brokerage firms where covered persons can hold covered securities, the requirement to pre-clear certain transactions, holding periods for investments, blackout periods during which trades cannot be executed and other types of trading restrictions and prohibitions.  The third article in this series will survey recent technological developments designed to facilitate a hedge fund manager’s monitoring of compliance with its personal trading policies and procedures.

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• From Vol. 5 No.2 (Jan. 12, 2012)

  STOCK Act Could Expand Insider Trading Laws to Prohibit Trading by Hedge Funds Based Upon Nonpublic “Political Intelligence”

  Last month the Senate Homeland Security & Governmental Affairs Committee passed the “Stop Trading on Congressional Knowledge Act,” or “STOCK Act,” and the House Financial Services Committee held hearings on similar legislation.  The primary purpose of this Act is to close a loophole in the law that may allow Members of Congress to legally trade securities based upon nonpublic “political intelligence.”  However, hedge fund managers should watch this legislation closely as it could have significant, perhaps unintended, implications.  Depending on what provisions (if any) are ultimately enacted, the legislation could alter the way fund managers conduct basic regulatory due diligence in connection with investments.  The legislation could weaken a key provision of Regulation FD, which confirms the “mosaic theory” defense to federal insider trading charges, and impact the way fund managers use employees, expert networks, lobbyists and political intelligence firms to research federal legislative and political activities in connection with their investments.  In fact, the legislation could fundamentally alter the way that fund managers interact with federal employees, including Members of Congress.  In a guest article, Scott E. Gluck, Of Counsel at Venable LLP, discusses: the background of the STOCK Act; relevant insider trading law; specific provisions of the STOCK Act relevant to hedge fund managers; and seven distinct issues for hedge fund managers to monitor, including the potential impact of the STOCK Act on the “mosaic theory” defense to insider trading charges.

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• From Vol. 4 No.45 (Dec. 15, 2011)

  Is the “Mosaic Theory” a Viable Defense to Insider Trading Charges Against Hedge Fund Managers Post-Galleon?

  When a hedge fund manager pieces together what he or she reads in a recent article, blog or report with other inconsequential nonpublic information previously acquired in such a way that it reveals a material insight into an issuer or its prospects – and the manager trades based on the insight – should that manager be charged with insider trading?  Generally, such “Eureka” moments have been protected under the “mosaic theory,” which has been recognized explicitly both in caselaw and in pronouncements by the SEC.  For example, in October 2011, when SEC Chairman Mary Schapiro was asked for her views on the use of “expert network” firms by hedge fund managers, she noted that “[t]here is nothing wrong with doing tremendous due diligence” when it comes to stock research, and that there “is a . . . pretty bright line” between stock research and illegal insider trading.  See “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks? (Part Two of Three),” The Hedge Fund Law Report, Vol. 4, No. 11 (Apr. 1, 2011).  Recently, however, the SEC has brought a number of insider trading cases suggesting that the “line” separating research and conduct the SEC may seek to punish is far greyer and fainter than Chairman Schapiro indicated.  In a guest article, Perrie Weiner, Patrick Hunnius and Stephanie Smith, partner, senior counsel and associate, respectively, at DLA Piper, examine recent insider trading cases brought by the SEC based on investors having pieced together a mosaic of facts.  These cases provide valuable insight into important questions that should shape a hedge fund manager’s approach to the investment research process and what precautions the fund manager should take.  For example, what mosaic of activities has amounted to an inference of insider trading?  What actions should hedge fund managers take to ensure their conduct does not even give rise to the appearance of insider trading?

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• From Vol. 4 No.41 (Nov. 17, 2011)

  How Do Courts Assess Civil Monetary Fines in Insider Trading Cases Against Hedge Fund Managers?

  On November 8, 2011, Judge Jed S. Rakoff of United States District Court for the Southern District of New York imposed a record civil penalty of $92,805,705 on Galleon Group founder Raj Rajaratnam.  Judge Rakoff’s opinion analyzes the civil penalty provisions of the Securities and Exchange Act of 1934 in a civil insider trading action against a hedge fund manager that has been convicted of insider trading in a parallel criminal case.  The opinion illustrates the factual and legal considerations that influence the calculation of civil penalties; the public policy purpose of civil penalties; whether civil penalties should be based on gross trading profits of a hedge fund or net fees and profits personally gained by the individual defendant; and the time during which relevant profit gained or loss avoided should be measured.  For hedge fund managers, Rakoff’s ruling serves as a reminder that profits from insider trading, if discovered, are in effect a loan from the government with usurious terms.  You have to pay it back, and the interest includes whatever you gained, the full value of your management company and the entirety of your reputation.

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• From Vol. 4 No.40 (Nov. 10, 2011)

  Business Issues with Legal Consequences: A Wide-Ranging Interview with Dechert Partner George Mazin about the Most Important Challenges Facing Hedge Fund Managers

  The Hedge Fund Law Report recently had the privilege of interviewing George J. Mazin, a Partner at Dechert LLP, and a deservedly well-regarded member of the hedge fund bar.  As evidenced by the text of our interview, which is included in this issue of The Hedge Fund Law Report, George has an aptitude for identifying the legal consequences of business issues, and explaining them clearly.  He also has the kind of market color that only comes with years – decades – in the trenches, and experience across business cycles.  Our interview was wide-ranging, reflecting the diversity of George’s experience, which in turn reflects the range of legal issues relevant to hedge fund managers.  In particular, our interview covered: valuation considerations in connection with affiliate transactions; valuations based on fraudulent sales and rigged dealer bids; manager overrides of third-party valuations; whether side pockets remain viable in new hedge fund launches; how even non-ERISA hedge funds can analogize the ERISA model of independent pricing; effective valuation testing programs; the interaction between GAAP and the custody rule; GAAP exceptions to audit opinions; use of counterparty confirmations by the SEC; delayed audits; custody of derivatives and limited partnership interests; insider trading policies with respect to market chatter and channel checking; how to grant side letters in light of selective disclosure considerations; how algorithmic or high-speed trading firms can prepare for regulatory examinations; legal considerations in connection with loans from a hedge fund to a manager; best practices in connection with principal trades; and whether side-by-side investing by manager personnel can pass muster under fiduciary duty and related principles.  This interview was conducted in connection with the Regulatory Compliance Association’s Fall 2011 Asset Management Thought Leadership Symposium, which is taking place today at the Pierre Hotel in New York.

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• From Vol. 4 No.40 (Nov. 10, 2011)

  SEC Charges Hedge Fund Founder and His Friends and Family with Insider Trading

  On August 31, 2011, the United States Securities and Exchange Commission (SEC) continued its war on “family and friends” insider trading when it filed a civil complaint in the United States District Court for the District of New Jersey against Clay Capital Management, LLC; one of its founders, James F. Turner, II; his neighbor, Mark Durbin; and Mr. Turner’s alleged accomplices, Scott Vollmar and Scott Robarge (together, defendants).  The complaint accuses Turner of insider trading in early 2008 on information obtained from his brother-in-law Vollmar, a director of business development for Autodesk, Inc., and his college friend Robarge, a recruiting technology manager for Salesforce.com, Inc.  It also accused Turner of passing that information to the Clay Capital Fund, LP (the Fund) and other family members and friends, and accuses Vollmar of doing the same for his neighbor Durbin.  The complaint does not accuse his unnamed associates, including his partners in the Clay Fund, of participating in or having any knowledge of the scheme.  The accusations again Robarge and Durbin have already resulted in settlements with the SEC.  We detail the allegations in the complaint, which provide further insight into what information flows among friends and family constitute insider trading in the view of the current SEC Enforcement Division.

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• From Vol. 4 No.38 (Oct. 27, 2011)

  Insider Trading – The Long View

  Meyer “Mike” Eisenberg has experienced the evolution of insider trading doctrine and enforcement over decades, and from diverse vantage points.  He worked at the SEC during an era when some of the seminal cases were litigated.  Then he experienced the impact of those cases on industry participants in private practice.  And he has taught about the intersection of the cases and their practical import in various academic appointments.  Eisenberg is expected to participate at the Regulatory Compliance Association’s Fall 2011 Asset Management Thought Leadership Symposium, to be held on November 10, 2011 at the Pierre Hotel in New York.  (For a fuller description of the Symposium, click here; to register for the Symposium, click here; subscribers to The Hedge Fund Law Report are eligible for a registration discount.)  In particular, while each of the expected participants at the upcoming RCA Symposium – including private side and public side thought leaders – will have a firm grasp of current regulatory developments and their impact on hedge fund managers, Eisenberg is unique in his ability to provide what might be called the “long view.”  He has lived insider trading law for decades, from different angles.  He knows how the current crop of cases is similar to and different from what has come before – and how hedge fund managers can put that context into practice; he can credibly discern regulatory trends; and he knows what motivates and matters to regulators.  In anticipation of the RCA Symposium, The Hedge Fund Law Report had the opportunity to interview Eisenberg on insider trading and related topics.  Our interview specifically covered, among other things: Eisenberg’s background; some hoary but still relevant case law; why the SEC may bring an enforcement action where only a small dollar amount is at issue; interaction between OCIE and Enforcement; whether the SEC or private parties may bring aiding and abetting insider trading claims; whether the SEC must prove scienter when it brings a fraud claim against a hedge fund manager under Advisers Act Section 206; what hedge fund managers should do in response to the new use of wiretaps in insider trading investigations; whether the DOJ is likely to use wire fraud charges to “criminalize” activity that does not satisfy the elements of criminal securities fraud; how hedge fund portfolio managers can safely talk to corporate insiders; and compliance policies and procedures hedge fund managers should implement regarding use of consultants, channel checking firms and similar persons.  The full text of our interview with Eisenberg is included in this issue of The Hedge Fund Law Report.

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• From Vol. 4 No.37 (Oct. 21, 2011)

  Use by Hedge Fund Managers of Restricted Lists, Watch Lists and Ethical Walls to Prevent Insider Trading Violations

  Information management is at the core of the hedge fund business.  If managed properly, information can generate outsized returns.  If managed improperly, information can lead to insider trading and other securities law charges, and criminal liability.  Hedge fund managers, accordingly, work hard to compile mosaics of information that can serve as the basis of legal trading, and that do not include material nonpublic information (MNPI).  See “Investment Research and Insider Trading on ‘Outside Information’,” The Hedge Fund Law Report, Vol. 4, No. 29 (Aug. 25, 2011).  In doing so, one of the more popular and potent tools is the restricted list.  A close cousin of the restricted list is the watch list, and a related technique is the ethical wall.  This article provides a guide for hedge fund managers in creating, disseminating, updating and enforcing a restricted list.  In particular, the article discusses: the definition of a restricted list; the legal, regulatory and practical sources of the obligation to maintain a restricted list; relevant issues raised by the simultaneous management of hedge funds that invest in public and private securities; when a name should be added to and removed from a restricted list; whether subsidiaries, affiliates and various parts of the capital structure should be included in a restricted list; access to and dissemination and updating of a restricted list; two SEC enforcement actions highlighting compliance concerns that may motivate the SEC to bring an action against a hedge fund manager in this context; and eight techniques for enforcement of a restricted list.  The article also provides a chart of six fact patterns in which names may be added to a restricted list, listing, for each, the event that may require addition to the restricted list and the event that may justify removal.  In addition, the article contains a detailed discussion of “wall crossing” scenarios in the hedge fund context and concludes with a discussion of what watch lists are and how they are used by hedge fund managers.

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• From Vol. 4 No.36 (Oct. 13, 2011)

  Galleon Management, LLC Founder Raj Rajaratnam Sentenced to 11 Years in Prison for Insider Trading

  On October 13, 2011, U.S. District Judge Richard J. Holwell sentenced Galleon Management, LLC founder Raj Rajaratnam, 54 years old, to 11 years in prison.  See “Implications of the Rajaratnam Verdict for the ‘Mosaic Theory,’ the ‘Knowing Possession’ Standard of Insider Trading and Criminal Wire Fraud Liability in the Absence of a Trade,” The Hedge Fund Law Report, Vol. 4, No. 18 (Jun. 1, 2011).  About five months ago, on May 11, 2011, Rajaratnam was convicted of all 14 counts of conspiracy and securities fraud with which he was charged, following an eight-week jury trial.  See “On Motion to Set Aside Verdict, Trial Court Upholds All Fourteen Counts of Rajaratnam Insider Trading and Conspiracy Conviction,” The Hedge Fund Law Report, Vol. 4, No. 30 (Sep. 1, 2011).  According to the U.S. Attorney’s Office for the Southern District of New York, Rajaratnam’s sentence is the longest sentence to be imposed for insider trading in history.  See “Strategies for Avoiding Insider Trading Violations: A Perspective Informed by SEC Service, Private Law Firm Practice and Work as General Counsel of a Hedge Fund Manager,” The Hedge Fund Law Report, Vol. 4, No. 34 (Sep. 29, 2011).  In addition to his prison term, Rajaratnam was sentenced to two years of supervised release, ordered to pay forfeiture in the amount of $53,816,434 and ordered to pay a $10 million fine.  Rajaratnam is scheduled to surrender to authorities on November 28, 2011.  See “How Can Hedge Fund Managers Update Their Insider Trading Compliance Programs to Reflect the SEC’s Focus on Systemic Violators, Gatekeepers, Trading Patterns, Profitable Trades and Expert Networks?,” The Hedge Fund Law Report, Vol. 4, No. 28 (Aug. 19, 2011).

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• From Vol. 4 No.35 (Oct. 6, 2011)

  WaMu Bankruptcy Judge Allows Equity Committee’s Action for Equitable Disallowance of Hedge Fund Noteholders’ Claims to Proceed on the Ground that Equity Committee Stated a “Colorable Claim” that those Noteholders Engaged in Insider Trading

  In a shot across the bow of investors who trade in the debt of bankrupt companies, a U.S. bankruptcy court has held that the Equity Committee of Washington Mutual, Inc. (WaMu) has stated a “colorable claim” that four hedge funds that held WaMu debt and participated in bankruptcy settlement negotiations engaged in insider trading when they traded WaMu’s debt.  Hedge funds Appaloosa Management, L.P., Aurelius Capital Management LP, Centerbridge Partners, LP, and Owl Creek Asset Management, L.P. (together, Noteholders), acquired enough WaMu debt that they were in a position to block approval of portions of WaMu’s plan of reorganization.  As a result, they were allowed to participate in negotiations among the various stakeholders in the bankruptcy.  WaMu’s Equity Committee alleged that the Noteholders had engaged in insider trading using information they received during settlement negotiations and that, as a result, their claims should be equitably disallowed.  In a wide-ranging decision denying confirmation of WaMu’s sixth amended reorganization plan, the Court ruled that the Equity Committee had alleged a colorable claim of insider trading by the Noteholders that could support equitable disallowance of their claims.  This article provides a feature length synopsis of the facts that gave rise to the insider trading charges, and the Court’s reasoning.

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• From Vol. 4 No.34 (Sep. 29, 2011)

  Strategies for Avoiding Insider Trading Violations: A Perspective Informed by SEC Service, Private Law Firm Practice and Work as General Counsel of a Hedge Fund Manager

  The Hedge Fund Law Report publishes frequently on the topic of insider trading.  It is, perhaps, the most important topic we cover, for at least six reasons.  First, it is complex and at times counterintuitive.  Second, it is particularly difficult to apply the doctrine to the day-to-day facts of investment analysis, research and trading.  Third, while the bedrock doctrine remains relatively constant, the outside contours of the law and the fact patterns in which the law applies are changing continuously.  Fourth, insider trading considerations are pervasive: they apply across strategies and geographies, in funds and in personal accounts.  Fifth, investigative techniques and technology are evolving rapidly.  And sixth, insider trading violations – or even suspicions thereof – can promptly bring down the curtain on a hedge fund management business.  The list goes on, but the point is that for hedge fund managers, insider trading is a virtually inexhaustible topic, an ongoing concern.  Like The Hedge Fund Law Report, the Regulatory Compliance Association (RCA) regularly includes in-depth analysis of insider trading at its Symposia.  Consistent with that focus, the RCA’s Fall 2011 Asset Management Thought Leadership Symposium (to be held on November 10, 2011 at the Pierre Hotel in New York) will feature a session on insider trading.  (For a fuller description of the Symposium, click here; to register for the Symposium, click here; subscribers to The Hedge Fund Law Report are eligible for a registration discount.)  We have interviewed various of the speakers expected to participate in the insider trading session, and we have published the full transcripts of some of those interviews.  For the transcript of our interview with Scott Pomfret, Regulatory Counsel for a Boston-based institutional money manager and a former branch chief in the SEC’s Division of Enforcement, click here.  And for the transcript of our interview with Kevin O’Connor, Partner at Bracewell & Giuliani and Chair of the firm’s White Collar Practice Group, and previously Associate Attorney General of the United States and United States Attorney for Connecticut, click here.  This week’s issue of The Hedge Fund Law Report includes a transcript of our interview with Scott Black.  Black is General Counsel and Chief Compliance Officer at Hudson Bay Capital Management LP.  He previously served as Assistant Regional Director in the Division of Enforcement of the SEC’s New York Regional Office and practiced law at Wachtell, Lipton, Rosen & Katz.  Our interview with Black covered, among other things: characteristics of a hedge fund manager that make it more likely to become the target of an insider trading investigation; steps that hedge fund managers can take to diminish the likelihood that they will become such a target; selective disclosure considerations; how hedge fund managers should respond to the increasing use of wiretaps in insider trading investigations; whether the government will use wire fraud charges to criminalize activity that would not constitute criminal securities fraud; steps hedge fund managers can take to avoid insider trading violations when talking to company insiders; best practices for engaging expert network firms; best practices for using experts, consultants, channel checking firms and others outside of the context of an expert network; steps to prevent insider trading violations when hedge fund manager personnel serve on a creditors’ committees; and the practical implications of the SEC’s recent cooperation initiative.

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• From Vol. 4 No.33 (Sep. 22, 2011)

  Fifth Annual Hedge Fund General Counsel Summit Covers Insider Trading, Expert Networks, Whistleblowers, Exit Interviews, Due Diligence, Examinations, Pay to Play and More

  On September 13, 2011, ALM Events hosted its fifth annual Hedge Fund General Counsel Summit at the Harvard Club in New York City.  Participants at the event discussed how the changing regulatory landscape is impacting the day-to-day policies, procedures and practices of hedge fund managers.  Of particular note, discussions focused on insider trading in the post-Galleon world; best compliance practices for engaging and using expert network firms; how to motivate employees to report wrongdoing internally rather than filing whistleblower complaints; the interaction between non-disparagement clauses in hedge fund manager exit agreements and the whistleblower rule; best practices for exit interviews; best practices for responding to initial and ongoing due diligence inquiries; consistency across DDQs and other documents; standardization of DDQs versus customized answers; whether to disclose the existence or outcome of regulatory actions; how to deal with government investigations and examinations; and strategies for complying with the pay to play rule.  This article summarizes the most noteworthy points made at the event.

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• From Vol. 4 No.33 (Sep. 22, 2011)

  Wiretaps, Whistleblowers, Expert Networks and Insider Trading: A Conversation with Kevin O’Connor, Former Associate Attorney General of the U.S. and Former U.S. Attorney for Connecticut

  Hedge fund managers remain a prime target for civil and criminal insider trading charges.  This is so for at least five reasons.  First, regulators and prosecutors have been emboldened by the May 11, 2011 conviction of Galleon Group founder Raj Rajaratnam on 14 counts of conspiracy and securities fraud.  See “Implications of the Rajaratnam Verdict for the ‘Mosaic Theory,’ the ‘Knowing Possession’ Standard of Insider Trading and Criminal Wire Fraud Liability in the Absence of a Trade,” The Hedge Fund Law Report, Vol. 4, No. 18 (Jun. 1, 2011).  Second, wiretapping has become a viable tool for investigating insider trading by hedge fund manager personnel, and a source of persuasive evidence.  See “Will a Criminal Court Admit into Evidence a Recorded Telephone Conversation Between a Hedge Fund Manager Charged with Insider Trading and an Alleged Co-Conspirator?,” The Hedge Fund Law Report, Vol. 4, No. 24 (Jul. 14, 2011).  Third, in the course of examinations of hedge fund managers, SEC examination personnel are looking for (among other things) evidence of insider trading that can serve as the basis of referrals to the SEC’s Enforcement Division.  See “Are Hedge Fund Managers Required to Disclose the Existence or Outcome of Regulatory Examinations to Current or Potential Investors?,” The Hedge Fund Law Report, Vol. 4, No. 32 (Sep. 16, 2011).  Fourth, the staff of the SEC’s Enforcement Division can now use tools developed in the criminal context in bringing, negotiating and settling insider trading charges against hedge fund managers.  See “Entry by SEC into a Non-Prosecution Agreement with Clothing Marketer Illustrates How Hedge Fund Managers May Survive Discovery of Certain Insider Trading Violations,” The Hedge Fund Law Report, Vol. 3, No. 50 (Dec. 29, 2010).  And fifth, budgetary constraints have led the SEC to place a higher priority on deterrence, and insider trading actions against hedge fund managers are thought to have a powerful deterrent effect.  See “Key Insights for Registered Hedge Fund Managers from the SEC’s Recently Released Study on Investment Adviser Examinations,” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  In light of the vigor with which civil and criminal authorities are pursuing insider trading actions – and the ongoing susceptibility of hedge fund managers to insider trading charges – the Regulatory Compliance Association’s Fall 2011 Asset Management Thought Leadership Symposium will feature a session entitled “Insider Trading – The New Enforcement Paradigm.”  That RCA Symposium will take place on November 10, 2011 at the Pierre Hotel in New York.  (For a fuller description of the Symposium, click here.  To register for the Symposium, click here.  Subscribers to The Hedge Fund Law Report are eligible for a registration discount.)  One of the speaking faculty members expected to participate in the insider trading session is Kevin J. O’Connor.  O’Connor is a Partner at Bracewell & Giuliani and Chair of the firm’s White Collar Practice Group.  Previously, O’Connor was Associate Attorney General of the United States, the third-ranking official at the U.S. Department of Justice, and United States Attorney for Connecticut.  In anticipation of the upcoming RCA Symposium, The Hedge Fund Law Report interviewed O’Connor regarding insider trading considerations for hedge fund managers and related topics.  Specifically, our interview covered: implications for hedge fund managers of the increased use of wiretap evidence in insider trading investigations; the use of criminal wiretaps in civil proceedings; wiretaps of mobile phones and Voice over Internet Protocol lines; “tapping” of Blackberries and social media; how to incentivize internal reporting under the new SEC whistleblower rule; whether hedge fund service providers can be whistleblowers; activities other than insider trading that may serve as the basis of a whistleblower complaint; best compliance practices for engaging expert network firms; compliance training with respect to the use of expert networks; due diligence on expert network firms; and how to avoid FCPA violations when engaging third-party placement agents to solicit investments from sovereign wealth funds.  The full text of our interview with O’Connor is included in this issue of The Hedge Fund Law Report.

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• From Vol. 4 No.32 (Sep. 16, 2011)

  How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks in Connection with Leveraged Loan Market Transactions?

  On July 27, 2011, compliance software provider Compliance11 hosted a webinar entitled, “Best Practices for use of Expert Networks and the Leveraged Loan Market.”  The purpose of the event was to provide “solutions, tactical input and strategies” designed to avoid insider trading pitfalls when hedge fund managers use expert networks in connection with leveraged loan trades.  For more on this general topic, see “Insider Trading and Debt Securities: Practical Tips for Hedge Funds in Coping with Regulatory Enforcement,” The Hedge Fund Law Report, Vol. 4, No. 20 (Jun 17, 2011).  The webinar was moderated by Tracey Straub, Vice President of Strategy at Compliance11.  Laurence Herman, General Counsel and Managing Director of Gerson Lehrman Group (GLG), spoke about the use of expert networks, and Tim Houghton, Founding Principal of Cortland Capital Market Services (CCMS), spoke about trading in the leveraged loan market.  See “From Lender to Shareholder: How to Make Your Equity Work Harder for You,” The Hedge Fund Law Report, Vol. 3, No. 20 (May 21, 2010).  This article summarizes the most important points made during the webinar.  In particular, this article discusses: the ways in which expert networks can diminish the opportunities for inappropriate conveyance of material nonpublic information (MNPI); four recommended steps for hedge fund managers to take prior to engaging an expert network firm or expert; seven best practices for using expert network firms; nine compliance policies and procedures for using experts; whether leveraged loans are “securities” for insider trading purposes; and how to manage MNPI at hedge fund managers that participate in the leveraged loan market.  See “Big Boys Don’t Cry: How ‘Big Boy’ Provisions Can Help Hedge Fund Managers Avoid Liability for Insider Trading Violations,” The Hedge Fund Law Report, Vol. 2, No. 48 (Dec. 3, 2009).

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• From Vol. 4 No.30 (Sep. 1, 2011)

  On Motion to Set Aside Verdict, Trial Court Upholds All Fourteen Counts of Rajaratnam Insider Trading and Conspiracy Conviction

  Raj Rajaratnam, founder of hedge fund manager Galleon Group, was convicted on May 11, 2011 of fourteen counts of securities fraud and conspiracy to commit securities fraud arising out of years of alleged insider trading.  He moved for a judgment of acquittal on all counts on the basis that the government failed to present sufficient evidence to convict him.  The Trial Court has upheld the conviction in its entirety.  This article offers a comprehensive overview of the Court’s decision and legal analysis.  See also “Investment Research and Insider Trading on ‘Outside Information’,” The Hedge Fund Law Report, Vol. 4, No. 29 (Aug. 25, 2011).

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• From Vol. 4 No.29 (Aug. 25, 2011)

  Investment Research and Insider Trading on “Outside Information”

  Recent high-profile prosecutions, including the Galleon and “expert network” criminal cases, have once again reminded the investment community of the perils of trading on material nonpublic information, or “MNPI.”  These cases have been sensational, but they have not made new law.  At the heart of each case was MNPI that unscrupulous traders allegedly knew had come from within the public companies whose shares they traded.  The focus on expert networks, however, has placed a spotlight on how hedge funds and other investment professionals conduct their investment research.  Many firms have reacted to this new reality by reconsidering how they use industry experts and by fashioning policies to address these latest concerns.  This is an important step, but investors must also anticipate new issues that will arise in the future from today’s heightened focus on investment research.  In a guest article, Michael A. Schwartz, a Partner at Willkie Farr & Gallagher LLP, starts by discussing “inside” versus “outside” information.  Schwartz then analyzes – via a hypothetical that can easily describe a real-world situation – the circumstances in which information obtained by a hedge fund manager from an expert about one company may prohibit trading by the manager’s funds in securities of another company in the same industry.  This article is important in understanding the implications of recent insider trading enforcement activity for day-to-day investment research by hedge fund managers.

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• From Vol. 4 No.29 (Aug. 25, 2011)

  Failure to Follow Investment Guidelines, Manipulative Trading and Misleading Investors Leads British FSA to Impose Steep Civil Penalties and Ban Principals of Defunct Hedge Fund Manager Mercurius Capital from Securities Industry

  From July 2006 through January 2008, the manager of Cayman Islands hedge fund Mercurius International Fund Limited (Fund) repeatedly violated the Fund’s investment guidelines by over-concentrating investments in thinly-traded companies.  When the values of those investments began to drop, the Fund’s director and chief executive officer, Michiel Visser (Visser), and its chief financial and compliance officer, Oluwole Modupe Fagbulu (Fagbulu), engaged in market manipulation to inflate artificially the Fund’s net asset value (NAV), engaged in sham trades to increase NAV and conceal money borrowed at exorbitant rates and concealed all these machinations, and the Fund’s perilous financial position, from existing and prospective investors.  The Fund collapsed in January 2008 and is now in liquidation.  The British Financial Services Authority (FSA) charged Visser and Fagbulu with market manipulation and other violations of the Financial Services and Markets Act of 2000.  It banned the defendants from the securities industry and imposed steep financial penalties on them.  Visser and Fagbulu appealed to the Upper Tribunal of the British Tax and Chancery Chamber.  We summarize the Tribunal’s decision.

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• From Vol. 4 No.28 (Aug. 19, 2011)

  How Can Hedge Fund Managers Update Their Insider Trading Compliance Programs to Reflect the SEC’s Focus on Systemic Violators, Gatekeepers, Trading Patterns, Profitable Trades and Expert Networks?

  Insider trading enforcement remains a top priority for regulators and prosecutors.  For example, just this month to date: (1) Joseph F. “Chip” Skowron III, a former healthcare portfolio manager at FrontPoint Partners LLC, pleaded guilty to conspiracy to engage in insider trading and obstruction of justice; (2) the DOJ brought conspiracy to commit securities fraud and wire fraud charges against Stanley Ng, the former SEC Reporting Manager at Marvell Technology Group, Ltd., for allegedly providing material nonpublic information to Winifred Jiau; (3) the SEC charged a former professional baseball player and three others with insider trading ahead of the early 2009 buyout by Abbott Laboratories Inc. of Advanced Medical Optics Inc.; and (4) the SEC charged a California man with purchasing Marvel Entertainment call options while in possession of material nonpublic information obtained from his girlfriend (who worked at the Walt Disney Company) regarding Disney’s acquisition of Marvel.  In this still-heightened insider trading enforcement climate, hedge fund managers remain a prime target for civil and criminal insider trading charges.  This is so for at least five reasons.  First, regulators and prosecutors have been emboldened by the May 11, 2011 conviction of Galleon Group founder Raj Rajaratnam on 14 counts of conspiracy and securities fraud.  See “Implications of the Rajaratnam Verdict for the ‘Mosaic Theory,’ the ‘Knowing Possession’ Standard of Insider Trading and Criminal Wire Fraud Liability in the Absence of a Trade,” The Hedge Fund Law Report, Vol. 4, No. 18 (Jun. 1, 2011).  Second, wiretapping has become a viable tool for investigating insider trading by hedge fund manager personnel, and a source of persuasive evidence.  See “Will a Criminal Court Admit into Evidence a Recorded Telephone Conversation Between a Hedge Fund Manager Charged with Insider Trading and an Alleged Co-Conspirator?,” The Hedge Fund Law Report, Vol. 4, No. 24 (Jul. 14, 2011).  Third, in the course of examinations of hedge fund managers, SEC examination personnel are looking for (among other things) evidence of insider trading that can serve as the basis of referrals to the SEC’s Enforcement Division.  See “Is a Hedge Fund Manager Required to Disclose the Existence or Substance of SEC Examination Deficiency Letters to Investors or Potential Investors?,” The Hedge Fund Law Report, Vol. 4, No. 18 (Jun. 1, 2011).  Fourth, the staff of the SEC’s Enforcement Division can now use tools developed in the criminal context in bringing, negotiating and settling insider trading charges against hedge fund managers.  See “Entry by SEC into a Non-Prosecution Agreement with Clothing Marketer Illustrates How Hedge Fund Managers May Survive Discovery of Certain Insider Trading Violations,” The Hedge Fund Law Report, Vol. 3, No. 50 (Dec. 29, 2010).  And fifth, budgetary constraints have led the SEC to place a higher priority on deterrence, and insider trading actions against hedge fund managers are thought to have a powerful deterrent effect.  See “Key Insights for Registered Hedge Fund Managers from the SEC’s Recently Released Study on Investment Adviser Examinations,” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  In light of the vigor with which civil and criminal authorities are pursuing insider trading actions – and the ongoing susceptibility of hedge fund managers to insider trading charges – the Regulatory Compliance Association’s Fall 2011 Asset Management Thought Leadership Symposium will feature a session entitled “Insider Trading – The New Enforcement Paradigm.”  That RCA Symposium will take place on November 10, 2011 at the Pierre Hotel in New York.  (For a fuller description of the Symposium, click here.  To register for the Symposium, click here.  Subscribers to The Hedge Fund Law Report are eligible for a registration discount.)  Scott Pomfret – Regulatory Counsel for a Boston-based institutional money manager and a former branch chief in the SEC’s Division of Enforcement – participated in the insider trading session during the RCA’s Spring 2011 Symposium and is expected to participate in the RCA’s Fall 2011 Symposium.  As a former regulator and current in-house counsel, Pomfret has a unique, and uniquely relevant, perspective on insider trading enforcement trends as they relate to hedge fund managers.  By way of revisiting some of the topics that Pomfret discussed during the last RCA Symposium, and by way of preview of some of the topics that he may discuss at the next RCA Symposium, The Hedge Fund Law Report recently conducted an interview with Pomfret.  Our interview covered: Pomfret’s background; a shift in the focus of the SEC’s insider trading enforcement efforts; the rationale for and implications of the SEC’s focus on “gatekeepers”; how the SEC collects and uses hedge fund trading data; the role of trade profitability in allocating SEC enforcement resources; how hedge fund managers can answer investor questions about SEC inquiries; specific steps hedge fund managers can take to mitigate insider trading risk when using expert networks; three specific ways in which hedge fund managers are revising their insider trading compliance policies and procedures; and insider trading concerns for hedge fund managers that typically invest in “private” securities and assets.  The full text of our interview with Pomfret is included in this issue of The Hedge Fund Law Report.

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• From Vol. 4 No.20 (Jun. 17, 2011)

  Insider Trading and Debt Securities: Practical Tips for Hedge Funds in Coping with Regulatory Enforcement

  Recent events have brought increased regulatory and judicial focus on the world of debt instruments.  The stock market crash of the fall of 2008 was largely precipitated by the implosion of debt instruments linked to sub-prime mortgages loans.  These market crises put into relief the relative size and power of the bond markets.  The equity markets were, at least as of mid-2009, less than half the size of the debt markets, $14 trillion versus $32 trillion in the U.S. and $44 trillion versus $82 trillion globally.  Perhaps understanding this, since 2008, the SEC has begun new, unprecedented investigations of insider trading in the realm of debt instruments.  In a guest article, Mark S. Cohen, Co-Founder and Partner at Cohen & Gresser LLP, and Lawrence J. Lee, an Associate at Cohen & Gresser, discuss: hedge funds and the debt markets; the law of insider trading; potential sources of inside information; relationships that are likely to give rise to duties of confidentiality in connection with a debt trading strategy; types of insider trading cases concerning debt securities and credit, including discussions of specific cases involving derivatives, bankruptcy, distressed debt, government bonds and bank loans; and practical steps that hedge fund managers can take to avoid insider trading violations when trading various types of debt and debt-related instruments.

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• From Vol. 4 No.18 (Jun. 1, 2011)

  Implications of the Rajaratnam Verdict for the “Mosaic Theory,” the “Knowing Possession” Standard of Insider Trading and Criminal Wire Fraud Liability in the Absence of a Trade

  For a decade, Raj Rajaratnam, the founder and principal partner of the much heralded Galleon Group hedge fund, forged a reputation as one of Wall Street’s most accomplished traders.  Galleon managed over $7 billion in assets at its peak and Rajaratnam’s personal wealth, estimated at $22 billion dollars at one point, made the first generation Sri Lankan immigrant one of the wealthiest individuals in the United States.  Not surprisingly then, Rajaratnam’s May 11, 2011 conviction on 14 counts of conspiracy and securities fraud has roiled the hedge fund industry.  The government’s unprecedented use of wiretapping in a securities fraud case serves notice that a powerful and invasive investigative tool will be unleashed against suspected inside traders; there are also strong indications that the unraveling of the Galleon empire and the 25 other indictments flowing from it foreshadow other charges and investigations in the New York investment sector.  As legal precedent, however, the far flung Galleon case has not generally been considered significant.  The prosecution’s theory – that Rajaratnam and his network of associates obtained confidential corporate information from company insiders and then parlayed their knowledge into millions of dollars of gains from stock transactions – is a classic insider trading scenario that has not moved the boundaries of established law.  But beyond the verdict in United States v. Rajaratnam are legitimate questions about the state of insider trading law, most of which is made by judges and bureaucrats rather than lawmakers.  For example, what is the nexus that the government must prove between illegal inside information and specific stock transactions, and what should it be?  For the white collar defense bar and the hedge fund industry, the Rajaratnam verdict also portends trouble for the viability of the “mosaic theory” that the defendant pinned his hopes on at trial.  The jury’s rejection of that defense, and Rajaratnam’s contention that Galleon’s trades were based on a “mosaic” of legitimate, non-confidential pieces of information, raises new uncertainties for a range of investment analysts whose business model depends on the accumulation of information.  Finally, as the government more vigorously pursues insider trading cases, new cutting edge claims of liability are emerging: defendants are being ensnared even when stocks were not actually bought or sold, as occurs in at least some of the December 2010 charges in United States v. Shimoon, et al.  In a guest article, former Congressman and current SNR Denton Partner Artur Davis provides a detailed analysis of: the implications of the Rajaratnam verdict for the mosaic theory; the nexus between inside information and a specific trade required for insider trading liability to attach; the judicial – as opposed to regulatory – basis for the “knowing possession” standard; practical consequences of the verdict for hedge fund investment analysis and trading; how the verdict will impact the ongoing expert networks investigation; potential strategies for a legal challenge to the theory of causation espoused by the SEC in insider trading enforcement actions; the relevance of the “honest services” doctrine for insider trading jurisprudence; and the potential for “wire fraud” charges to criminalize breaches of corporate confidentiality agreements.

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• From Vol. 4 No.18 (Jun. 1, 2011)

  Are Side Letters Granting Preferential Transparency and Liquidity Terms to One Investor Ipso Facto Illegal?

  We recently analyzed a decision of an SEC administrative law judge (ALJ) holding that fund-level information, as opposed to portfolio-level information, can constitute material nonpublic information (MNPI) for insider trading purposes.  See “SEC Administrative Decision Holds That, For Insider Trading Purposes, Fund-Level Information, as Opposed to Investment-Level Information, May Constitute Material Nonpublic Information,” The Hedge Fund Law Report, Vol. 4, No. 14 (Apr. 29, 2011).  Specifically, the ALJ held that information regarding a major fund redemption, fund management’s decision to increase cash levels and efforts to sell a large portion of the bonds in the fund’s portfolio each constituted MNPI.  Accordingly, the ALJ found that the fund manager’s recommendation to his daughter to sell fund shares while the manager was aware of the foregoing three categories of MNPI constituted insider trading under a tipper-tippee theory.  On the scope of the tipper-tippee theory, see the heading “Insider Trading Law” in “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks?  (Part One of Three),” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  As explained in our analysis, while that decision arose in the mutual fund context, it has direct relevance for hedge fund managers and investors.  One of the more provocative questions raised by the decision is: are side letters granting preferential transparency and liquidity terms to one investor ipso facto illegal?  For more on side letters, see “What Is the Legal Effect of a Side Letter That Contains Specific Terms More Favorable Than a Hedge Fund’s General Offering Documentation?,” The Hedge Fund Law Report, Vol. 4, No. 16 (May 13, 2011).

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• From Vol. 4 No.14 (Apr. 29, 2011)

  SEC Administrative Decision Holds That, For Insider Trading Purposes, Fund-Level Information, as Opposed to Investment-Level Information, May Constitute Material Nonpublic Information

  In the vast majority of insider trading cases involving fund management, the material nonpublic information at issue relates to a company whose securities the fund may buy or sell.  However, in a provocative recent initial decision (Decision), an SEC Administrative Law Judge (ALJ) held that information about a fund itself may constitute material nonpublic information for insider trading and breach of fiduciary duty purposes.  This article explains in detail: the factual background of the Decision; the ALJ’s legal analysis; what specific categories of fund-level information may constitute material nonpublic information in the hedge fund management context; the disclosure implications of the potentially expanded scope of material nonpublic information; the interplay between the potentially expanded scope of material nonpublic information and the idea (most notably enunciated in Goldstein v. SEC) that a hedge fund is a manager’s “client”; the implications of the Decision for drafting, negotiating and performing under side letters and managed account agreements; the importance for hedge fund managers of internal investigations; how chief compliance officers (CCOs) can point to the “human toll” in this matter to capture the attention of investment personnel during compliance training; and a new category of monitoring of family relationships to be performed by hedge fund manager CCOs.

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• From Vol. 4 No.13 (Apr. 21, 2011)

  Former Portfolio Manager of Hedge Fund Manager FrontPoint Partners, Joseph F. “Chip” Skowron, Is Charged with Civil and Criminal Insider Trading Arising Out of Trading in Human Genome Sciences Stock

  The Securities and Exchange Commission (SEC) has amended its complaint in its insider trading action against Dr. Yves M. Benhamou to name Joseph F. “Chip” Skowron III as an additional defendant.  Skowron allegedly traded on inside information provided by Benhamou about the results of a clinical trial of a hepatitis drug manufactured by Human Genome Sciences, Inc. (HGSI).  Skowron had served as portfolio manager for six funds sponsored by hedge fund manager FrontPoint Partners LLC.  Benhamou is a doctor who was on a steering committee overseeing a clinical trial of HGSI’s drug Albumin Interferon Alfa 2-a.  The U.S. Attorney for the Southern District of New York has brought parallel criminal insider trading charges against Skowron based in large part on the testimony of Benhamou, who has already pleaded guilty to similar charges and is now a cooperating witness.  We provide a detailed summary of the amended complaint.  For a summary of the SEC’s original complaint, which referred to Skowron only as “Co-Portfolio Manager 1,” see “SEC and DOJ Commence, Respectively, Civil and Criminal Insider Trading Actions Against a Doctor Who Allegedly Tipped Off a Hedge Fund Manager to Impending Negative Information About a Drug Trial,” The Hedge Fund Law Report, Vol. 3, No. 44 (Nov. 12, 2010).

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• From Vol. 4 No.12 (Apr. 11, 2011)

  U.S. District Court Rules on Statute of Limitations Issues in Civil Insider Trading Action against Prominent Hedge Fund Managers Sam and Charles Wyly, and Their Advisers

  In July 2010, the Securities and Exchange Commission (SEC) commenced a civil enforcement action against investor-entrepreneurs Samuel Wyly and Charles J. Wyly, Jr., their attorney Michael C. French, and one of their brokers, Louis J. Schaufele III.  The SEC alleges that the defendants committed various securities laws violations, including insider trading, through “a labyrinth of offshore trusts and subsidiary entities” that enabled them to conceal their true holdings and trading in various public companies.  The defendants moved to dismiss certain of the SEC’s causes of action for insider trading and securities fraud on the grounds that those claims were barred by the applicable statutes of limitations and that they failed to state claims upon which relief could be granted.  The U.S. District Court for the Southern District of New York has denied the defendants’ motion in its entirety and ruled that equitable tolling principles apply to the statute of limitations governing the civil penalty provisions of the Securities Exchange Act.  As a result, the applicable limitations period did not begin to run until the SEC had reason to know of the alleged fraud.  We provide a detailed summary of the Court’s decision, with an emphasis on the statute of limitations ruling.

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• From Vol. 4 No.11 (Apr. 1, 2011)

  How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks? (Part Two of Three)

  This is the second article in our three-part series intended to assist hedge fund managers in avoiding insider trading violations when using expert networks.  The broad structure of our series is: law, facts, analysis.  That is, the first article in the series provided a detailed discussion of the law of insider trading.  See “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks? (Part One of Three),” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  This article – the second in our series – includes a detailed summary of the factual and legal allegations in the relevant civil and criminal complaints.  The third article in this series will apply the law to the facts, and will incorporate our extensive research and conversations with industry participants, to yield practical insights on expert network compliance strategies for hedge fund managers.  In light of the importance of the ongoing expert networks insider trading investigation to the hedge fund industry, and in light of the importance of the alleged facts in understanding the investigation, this article provides a comprehensive discussion of the alleged facts.  This article is long – over 25 pages – but is important reading for anyone who wants to understand the investigation, and its implications for hedge fund managers, at a granular level.  Specifically, this article provides: links to the primary civil complaint and the eight primary criminal complaints; a chart listing, with respect to the defendants and relevant uncharged parties: name, job category, background information, civil and criminal charges and plea status (where applicable); public companies about which experts in the network of Primary Global Research, LLC (PGR) allegedly passed inside information to PGR clients; language of selected public company compliance policies; PGR revenues during the relevant period and the sources of those revenues; compensation of PGR experts and employees; and the sources of information included in the criminal complaints.  The core of this article is a series of detailed summaries of the material civil and criminal allegations against the various defendants.  The allegations are organized by defendant, and for each defendant, are listed chronologically.  Also, for each allegation, we have included a citation to the specific paragraph of the specific complaint containing the allegation.  (For HFLR subscribers that wish to undertake a review of the original documents, these citations, along with our links to the relevant complaints, will save hours of research time.)  Our summaries of the factual allegations focus on the specific information allegedly conveyed by PGR experts to hedge fund managers, the timing of communications relative to public earnings announcements, the methods and channels through which information was communicated and the interconnections between the nine documents under analysis.  This article is a significantly expanded version of a prior article published in our March 11, 2011 issue.  See “The Hedge Fund Law Report Provides Due Diligence Roadmap for Institutional Investors Examining Use by Hedge Fund Managers of Expert Networks,” The Hedge Fund Law Report, Vol. 4, No. 9 (Mar. 11, 2011).  For HFLR subscribers who have read that prior article, we have included in this article a redline highlighting the new information in this article.  Also, it should be noted that this article focuses on the civil and criminal allegations relating to trading in shares of public technology companies based on material nonpublic information allegedly obtained via one expert network firm or its employees or experts.  This article does not cover another category of complaints involving drug trials and alleged insider trading allegedly facilitated, directly or indirectly, by expert networks.  However, the HFLR has covered those other matters.  See “Massachusetts Commences Civil Securities Fraud Enforcement Action against Hedge Fund Investment Adviser Risk Reward Capital Alleging that the Hedge Fund Traded on Inside Information Provided through an Expert Network,” The Hedge Fund Law Report, Vol. 4, No. 10 (Mar. 18, 2011); “SEC and DOJ Commence, Respectively, Civil and Criminal Insider Trading Actions Against a Doctor Who Allegedly Tipped Off a Hedge Fund Manager to Impending Negative Information About a Drug Trial,” The Hedge Fund Law Report, Vol. 3, No. 44 (Nov. 10, 2010).

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• From Vol. 4 No.9 (Mar. 11, 2011)

  The Hedge Fund Law Report Provides Due Diligence Roadmap for Institutional Investors Examining Use by Hedge Fund Managers of Expert Networks

  Hedge fund managers have responded to the ongoing expert networks investigation by revisiting their insider trading compliance policies and procedures generally, and their expert networks policies specifically.  See “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks?  (Part One of Three),” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  Institutional investors have responded by updating their due diligence questionnaires and approaches.  At a minimum, investors are asking their current or prospective managers: whether they use expert networks and if so which; what compliance policies and procedures they have in place with respect to the use of expert networks; and whether they are under investigation for insider trading in connection with expert networks.  But investor due diligence on this topic can get significantly more granular.  According to one well-regarded industry source with whom we spoke, some institutional investors, or their third-party due diligence service providers, are asking their current or prospective managers for records of trades (in hedge funds and personal accounts) in securities of companies mentioned in the primary civil and criminal expert network complaints, around the dates mentioned in those complaints.  The goals of this exercise are to uncover trading patterns that resemble the patterns described in the complaints, to discover spikes in advance of earnings releases mentioned in the complaints and to find other fund or personal trading that is suspicious in light of the allegations in the complaints.  Regulators have undertaken similar analyses of trading patterns for some time, usually with the goal of identifying evidence of insider trading or market manipulation; and those efforts have improved in speed and effectiveness as the relevant technology has improved.  But institutional investors generally have not undertaken due diligence of this sort because it has been considered too attenuated – too much of a search for a needle in a haystack.  The key difference here is that the expert networks insider trading complaints provide a roadmap to potentially problematic issuers, dates and events.  The practical problem is that those issuers, dates and events are buried in hundreds of pages of legal papers.  We at The Hedge Fund Law Report have solved this problem by: analyzing the primary civil and criminal complaints alleging the use of expert networks to facilitate insider trading in technology company shares (as distinct from the biotechnology-related matters); extracting the salient facts; and organizing them in a manner that can serve as a due diligence roadmap for institutional investors.  This article contains the results of that analysis.  This article is long – close to 20 pages – but shorter than the source documents, and a ready-made framework for hedge fund due diligence.  Specifically, this article contains: a chart listing the names of the key civil and criminal defendants, their employers and job descriptions during the relevant periods and the charges brought against them; a list of the public companies about which Primary Global Research, LLC (PGR) experts allegedly passed material nonpublic information (MNPI) to PGR clients; the language of PGR and relevant public company compliance policies; PGR revenues and revenue sources; compensation numbers of PGR experts and employees; and sources of the data and information underlying the allegations in the criminal complaints.  In addition, this article contains a detailed summary of the allegations in the primary civil and criminal complaints against various categories of defendants, including: employees or former employees of PGR; experts in PGR’s network who also worked at technology companies; and employees or principals of hedge fund management companies that were also clients of PGR.  To enhance the utility of this article, we have listed the allegations chronologically in each category and emphasized the specific types of information alleged to have been improperly communicated.  Also, for each material allegation mentioned in this article, we have included references to the specific paragraphs of the relevant complaint containing the allegation, and we have included links to the relevant complaints.  Finally, it should be emphasized that this article is intended for use not only by institutional investors, but also by hedge fund managers.  That is, just as institutional investors can use this article as a framework for performing due diligence, managers can use this article to prepare for due diligence requests that may be in the offing.  While such preparation likely would not rise to the level of an “internal investigation,” managers may consider an internal review of fund and employee trading based on the issuers, dates and events mentioned in the complaints in this article.  Just as it is preferable for a manager to uncover bad facts before the SEC does so in an examination, it is better for a manager to uncover bad facts before an investor does so in due diligence.

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• From Vol. 4 No.9 (Mar. 11, 2011)

  Implications for Hedge Fund Managers of Recent Insider Trading Enforcement Initiatives (Part Three of Three)

  Recent criminal and civil enforcement actions allege that hedge fund manager personnel obtained material nonpublic information from employees and experts of expert network firms.  See “The Hedge Fund Law Report Provides Due Diligence Roadmap for Institutional Investors Examining Use by Hedge Fund Managers of Expert Networks,” above, in this issue of The Hedge Fund Law Report.  While the merits of these actions largely remain to be determined, the impact of these actions on the hedge fund industry has already been considerable.  At least one hedge fund management firm that was raided by the FBI has announced that it will wind down, and other firms that were raided by the FBI have sustained sizable redemptions.  Even for managers that have not been directly involved, the renewed focus of the SEC, DOJ and FBI on insider trading has caused hedge fund managers to revisit their insider trading compliance policies and procedures.  See “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks?  (Part One of Three),” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  While the legal principles and theories of insider trading have not changed, the application of those principles and theories to new methods of investment research may be redefining the scope of permitted activity.  To assist hedge fund managers in understanding what is permitted and what is prohibited in the current environment, how to conduct investment research without violating insider trading law and how to design compliance policies and procedures that reflect the new enforcement reality, the Regulatory Compliance Association’s 2011 Spring Asset Management Thought Leadership Symposium will feature a session entitled “Insider Trading – Analyzing and Addressing the Latest Enforcement Initiatives.”  That RCA Symposium will take place on April 7, 2011 at the Marriott Marquis in Times Square in New York.  (For a fuller description of the Symposium, click here.  To register for the Symposium, click here.)  The Hedge Fund Law Report recently conducted detailed interviews with three of the thought leaders scheduled to participate in the Insider Trading Enforcement session at the RCA’s April Symposium: Robert B. Van Grover, Partner at Seward & Kissel LLP; John Robbins, Managing Director and Global Head of Compliance at Babson Capital Management LLC; and Adam J. Wasserman, Partner at Dechert LLP.  The goal of these interviews is to enable hedge fund managers to continue performing rigorous and productive research while avoiding insider trading violations.  We are publishing these interviews as a three-part series.  The full text of our interview with Robert Van Grover was included in the February 25, 2011 issue of The Hedge Fund Law Report, and our interview with John Robbins was included in last week’s issue.  Our interview with Adam Wasserman, included in full below, covered a wide range of relevant topics, including but not limited to: a taxonomy of the categories of potentially problematic information as revealed in the current criminal and civil complaints alleging insider trading in connection with expert networks; the government’s evolving view of what constitutes improper information; the definition of channel checking and how it is performed; the level of risk associated with various types of channel checks; whether hedge fund managers have been prohibiting their personnel outright from using expert networks; which categories of experts, consultants or entities should be covered by a hedge fund manager’s expert networks compliance policy; whether compliance policies should prohibit the use of an expert employed by a company in which the hedge fund has an investment, or within a certain period of the expert’s employment by the company; whether hedge fund investment personnel should be limited in the number of experts with whom they can consult in a certain period; the use of scripts or certifications; when to obtain certifications; how to prevent improper communications in informal settings; next steps in the ongoing insider trading investigation; potential RICO charges; how to talk to corporate insiders; and what to do when the FBI comes knocking.

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• From Vol. 4 No.8 (Mar. 4, 2011)

  Implications for Hedge Fund Managers of Recent Insider Trading Enforcement Initiatives (Part Two of Three)

  Recent criminal and civil enforcement actions allege that hedge fund manager personnel obtained material nonpublic information from employees and experts of at least one expert network firm.  See “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks?  (Part One of Three),” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  While the merits of these actions remain to be determined, the impact of these actions on the hedge fund industry has already been considerable.  At least one hedge fund management firm that was raided by the FBI has announced that it will wind down, and other firms that were raided by the FBI have sustained sizable redemptions.  Even for managers that have not been directly involved, the renewed focus of the SEC, DOJ and FBI on insider trading has caused hedge fund managers to revisit their insider trading compliance policies and procedures.  See “The SEC’s New Focus on Insider Trading by Hedge Funds,” The Hedge Fund Law Report, Vol. 3, No. 22 (Jun. 3, 2010).  While the legal principles and theories of insider trading have not changed, the application of those principles and theories to new methods of investment research may be redefining the scope of permitted activity.  To assist hedge fund managers in understanding what is permitted and what is prohibited in the current environment, how to conduct investment research without violating insider trading law and how to design compliance policies and procedures that reflect the new enforcement reality, the Regulatory Compliance Association’s 2011 Spring Asset Management Thought Leadership Symposium will feature a session entitled “Insider Trading – Analyzing and Addressing the Latest Enforcement Initiatives.”  That RCA Symposium will take place on April 7, 2011 at the Marriott Marquis in Times Square in New York.  (For a fuller description of the Symposium, click here.  To register for the Symposium, click here.)  The Hedge Fund Law Report recently conducted detailed interviews with three of the thought leaders scheduled to participate in the Insider Trading Enforcement session at the RCA’s April Symposium: Robert B. Van Grover, Partner at Seward & Kissel LLP; John Robbins, Managing Director and Global Head of Compliance at Babson Capital Management LLC; and Adam J. Wasserman, Partner at Dechert LLP.  The goal of these interviews is to enable hedge fund managers to continue performing rigorous and productive research while avoiding insider trading violations.  We are publishing these interviews as a three-part series.  The full text of our interview with Robert Van Grover was included in last week’s issue of The Hedge Fund Law Report.  See “Implications for Hedge Fund Managers of Recent Insider Trading Enforcement Initiatives (Part One of Three),” The Hedge Fund Law Report, Vol. 4, No. 7 (Feb. 25, 2011).  The full text of our interview with John Robbins is included in this issue, and our interview with Adam Wasserman will be published in next week’s issue.  Our interview with John Robbins, included in full below, covered a wide range of relevant topics, including but not limited to: typical ways in which a hedge fund manager might acquire material nonpublic information (MNPI) about an issuer that would inhibit trading; designing “wall crossing” policies and procedures; the possibility of automating analysis of wall-crossing inquiries; points that CCOs should keep in mind when designing and implementing effective information walls; what exactly inclusion of a name on the restricted list means; how managers can enforce the prohibition on trading names on the restricted list in funds and personal accounts; the utility of Big Boy letters in SEC and private actions (including a reference to an important SEC enforcement action involving Big Boy letters); the possibility of complying with SEC Rule 10b5-1 through the use of “information walls”; the difference between a restricted list and a watch list; who at a hedge fund management company should have access to a watch list; and how to determine when a name should be added to or removed from a restricted list.

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• From Vol. 4 No.7 (Feb. 25, 2011)

  Implications for Hedge Fund Managers of Recent Insider Trading Enforcement Initiatives (Part One of Three)

  Recent criminal and civil enforcement actions allege that hedge fund manager personnel obtained material nonpublic information from employees and experts of at least one expert network firm.  See “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks?  (Part One of Three),” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  While the merits of these actions remain to be determined, the impact of these actions on the hedge fund industry has already been considerable.  At least one hedge fund management firm that was raided by the FBI has announced that it will wind down, and other firms that were raided by the FBI have sustained sizable redemptions.  Even for managers that have not been directly involved, the renewed focus of the SEC, DOJ and FBI on insider trading has caused hedge fund managers to revisit their insider trading compliance policies and procedures.  See “The SEC’s New Focus on Insider Trading by Hedge Funds,” The Hedge Fund Law Report, Vol. 3, No. 22 (Jun. 3, 2010).  While the legal principles and theories of insider trading have not changed, the application of those principles and theories to new methods of investment research has redefined the scope of permitted activity.  To assist hedge fund managers in understanding what is permitted and what is prohibited in the current environment, how to conduct investment research without violating insider trading law and how to design compliance policies and procedures that reflect the new enforcement reality, the Regulatory Compliance Association’s 2011 Spring Asset Management Thought Leadership Symposium will feature a session entitled “Insider Trading – Analyzing and Addressing the Latest Enforcement Initiatives.”  That RCA Symposium will take place on April 7, 2011 at the Marriott Marquis in Times Square in New York.  (For a fuller description of the Symposium, click here.  To register for the Symposium, click here.)  The Hedge Fund Law Report recently conducted detailed interviews with three of the thought leaders scheduled to participate in the Insider Trading Enforcement session at the RCA’s April Symposium: Robert B. Van Grover, Partner at Seward & Kissel LLP; John Robbins, Managing Director and Global Head of Compliance at Babson Capital Management; and Adam J. Wasserman, Partner at Dechert LLP.  The goal of these interviews is to enable hedge fund managers to continue performing rigorous and productive research while avoiding insider trading violations.  We are publishing these interviews as a three-part series.  The full text of our interview with Robert Van Grover is included in this issue of The Hedge Fund Law Report; our interview with John Robbins will be published in next week’s issue; and our interview with Adam Wasserman will be published in the following week’s issue.  Our interview with Robert Van Grover, included in full below, covered a wide range of relevant topics, including but not limited to: steps that hedge fund analysts, traders or portfolio managers should take when talking to corporate insiders in order to avoid insider trading violations; whether hedge fund analysts, traders or portfolio managers may be charged with aiding and abetting a breach of Regulation FD by a corporate insider; the definition of “market color,” and how it differs from material nonpublic information; how to handle rumors; what a CCO should do upon discovery of insider trading by junior or senior personnel; what a hedge fund manager should do if the FBI comes knocking; what managers should do about the increasing use of wiretaps in insider trading investigations; trends with respect to banning the use of expert networks outright; terms that managers are negotiating in their engagement letters with expert networks; how to mitigate improper informal communications; best practices with respect to electronic communications; implications of increased flexibility in the SEC’s Enforcement Division with respect to issuing subpoenas; interaction between the SEC examination and enforcement processes; and considerations for hedge fund manager personnel considering entering into immunity agreements with the SEC under the new cooperation initiative.  Notably, Van Grover recently sought and obtained no-action relief under the amended custody rule.  See “SEC Temporarily Permits Hedge Fund Managers to Avoid Surprise Examination Requirement with Audits by Auditors That Are Registered with, but Not Subject to Inspection by, the PCAOB,” The Hedge Fund Law Report, Vol. 3, No. 42 (Oct. 29, 2010).

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• From Vol. 4 No.5 (Feb. 10, 2011)

  How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks?  (Part One of Three)

  The investment returns of hedge funds often depend directly on the depth of their managers’ understanding of companies, industries and trends.  Expert network firms exist to enhance that understanding by providing investment managers with efficient access to persons with deep and difficult-to-replicate domain expertise – persons including corporate managers across a range of industries, doctors, engineers, lawyers, accountants, academics and others.  Specifically, expert network firms provide at least three services on behalf of their investment manager clients: they compile networks; they make relevant connections; and they structure interactions to comply with relevant law, most notably, insider trading law.  These services have generated a range of benefits for a range of parties: hedge fund managers have obtained more relevant and granular research, which has enabled them to allocate capital more effectively, which has improved the efficiency of capital markets generally; experts in expert networks – and there are hundreds of thousands of them – have commercialized expertise and experience that was heretofore confined to their direct job functions; and, recent sound and fury to the side, there is a persuasive argument that expert networks have reduced insider trading on a systemic basis.  Nonetheless, the regulatory investigation of insider trading and expert networks is far from complete.  More broadly, since the line between insider trading and diligent research can be blurry, many hedge fund managers have used the current investigation as an occasion to revisit their insider trading compliance policies and procedures generally, and their compliance policies and procedures with respect to expert networks specifically.  This article is the first in a three-part series undertaken to assist hedge fund managers and others as they revisit and revise their compliance policies and procedures relating to the use of expert networks.  This article provides a detailed overview of the law of insider trading, including detailed discussions of the following subtopics: the definition of “materiality” for insider trading purposes; three SEC pronouncements that provide guidance in making materiality determinations; the definition of “nonpublic” for insider trading purposes; breach of duty as a prerequisite for insider trading liability; the three theories of insider trading: classical, misappropriation and tipper-tippee; the “mosaic” theory (and two very important caveats to the mosaic theory); criminal enforcement of insider trading laws, including a brief discussion of substantially all of the civil and criminal insider trading actions brought in the course of the recent investigation, along with links to the underlying documents; and an underappreciated section of the Sarbanes-Oxley Act of 2002 that may offer regulators a potent enforcement tool.  The second article in this series will provide a detailed analysis of substantially all of the civil and criminal filings alleging insider trading in connection with expert networks.  And the third article in the series – the analytic culmination of the series – will detail a range of compliance recommendations that hedge fund managers may implement to avoid insider trading violations when using expert networks.

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• From Vol. 4 No.4 (Feb. 3, 2011)

  Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Hedge Fund Manager Perspective (Part Three of Three)

  This is the third installment in our three-part series on the movement of talent from bank proprietary (prop) trading desks to hedge fund managers.  The series focuses on the legal and business considerations raised by such moves, and highlights the different considerations faced by the different constituencies.  The first article in the series focused on the talent perspective, that is, the considerations that investment and non-investment personnel should address when moving from a bank to a hedge fund manager.  See “Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Talent Perspective (Part One of Three),” The Hedge Fund Law Report, Vol. 3, No. 49 (Dec. 17, 2010).  The second article in the series focused on the bank perspective, and demonstrated that while banks face many of the same issues as talent in this context, banks often face those issues from a different perspective, and weight those issues differently.  See “Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Bank Perspective (Part Two of Three),” The Hedge Fund Law Report, Vol. 4, No. 2 (Jan. 14, 2011).  This article focuses on the perspective of the hedge fund manager to which talent moves.  While the legal and business issues faced by such recipient managers are complex, at a broad level, they can be broken down into a simple binary question: Are your hiring decisions motivated by the goal of buying talent or access?  Generally, if you are looking to buy talent, you are okay, but if you are looking to buy access, you are in trouble.  Put slightly differently, while a variety of legal disciplines govern the relationships between hedge fund managers and their employees, the unifying theme among those disciplines is ensuring that business success or failure is based on merit commercialized on a level playing field.  If this sounds too pious to be plausible, read on – and also read some of our cautionary tales of recent access-buying in the hedge fund arena.  To illustrate this general idea, this article discusses the following categories of considerations for hedge fund managers receiving talent: avoiding insider trading violations based on material, non-public information possessed by incoming talent; the three-step process for avoiding liability for aiding and abetting a breach by a new employee of that employee’s employment or post-employment covenants with his or her former bank employer, including non-competition agreements (non-competes), non-solicitation agreements (non-solicits), termination, severance and option agreements; special considerations in connection with the movement of teams (as opposed to individuals); avoiding liability for unauthorized use by an incoming employee of trade secrets or other intellectual property owned by a former bank employer; use of data regarding employee performance at a prior bank employer; avoiding pay-to-play violations; and what to look for when performing background checks.

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• From Vol. 3 No.50 (Dec. 29, 2010)

  Entry by SEC into a Non-Prosecution Agreement with Clothing Marketer Illustrates How Hedge Fund Managers May Survive Discovery of Certain Insider Trading Violations

  By and large, and subject to the inequities of resources and circumstances, individuals in the U.S. are still innocent until proven guilty.  Not so entity defendants, for whom that time-honored axiom is reversed.  In practice, entity defendants are guilty until proven innocent; the law moves deliberately, but markets and investors move quickly.  And in the rare circumstances where the law vindicates an entity defendant (Andersen comes prominently to mind), it is often too late.  Hedge funds and their managers are uniquely susceptible to this guilty until proven innocent phenomenon.  Raj Rajaratnam and Galleon, and Art Samburg and Pequot, are exhibits A and B.  Granted, Rajaratnam, Samberg and their respective management companies have not been "proven innocent" of the insider trading with which they were charged.  But nor have they been proven guilty or liable.  Yet the reputations of the individual defendants have been irrevocably tarnished, and both of those seafaring management companies have sailed into the hedge fund graveyard.  Indeed, it has effectively become a truism in the hedge fund industry that an accusation of insider trading by the SEC or DOJ against a hedge fund management company or any of its personnel constitutes a "death knell" for that management company and its funds.  However, a recent development suggests that an insider trading charge need not be fatal to hedge fund managers that appropriately prepare for and respond to discovered or suspected insider trading.  On December 20, 2010, the SEC entered into a non-prosecution agreement with Carter's Inc., a publicly traded clothing marketer, based on the company's response to discovery of accounting fraud and insider trading by one of its sales executives.  In doing so, the SEC exercised for the first time one of the tools added to its enforcement arsenal as part of its cooperation initiative announced in January 2010.  See "Katten Muchin Rosenman Hosts Program on 'Infected Hedge Funds' Highlighting Rights and Remedies of Investors in Hedge Funds Whose Managers are Accused of Insider Trading or of Operating Ponzi Schemes," The Hedge Fund Law Report, Vol. 3, No. 12 (Mar. 25, 2010); "Paul Hastings Hosts Program on Securities Litigation and Enforcement in Light of New SEC Initiatives to Enhance Enforcement Efforts and Encourage Witness Cooperation," The Hedge Fund Law Report, Vol. 3, No. 6 (Feb. 11, 2010).  Although the Carter's matter arose in the public company context, the SEC's stated rationale for entering into a non-prosecution agreement with Carter's − as opposed to initiating an enforcement action against Carter's (as it did against the sales executive) − would apply with equal strength to a scenario where a hedge fund manager discovers, responds vigorously to and had prepared for an isolated instance of insider trading by one of its employees.  Accordingly, this article examines the Carter's matter as a precedent for how hedge fund managers can discover an insider trading violation by one of their employees, yet live to fight another day.  Specifically, this article: briefly reviews the relevant facts and legal allegations of the Carter's matter; discusses the SEC's stated rationale for entering into the non-prosecution agreement with Carter's; details four important lessons for hedge fund managers to be drawn from that rationale; then details the relevant provisions of the non-prosecution agreement (which are quite rigorous; the SEC does not give up good enforcement facts for a peppercorn).

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• From Vol. 3 No.48 (Dec. 10, 2010)

  Federal District Court Upholds the Government’s Right to Use Wiretaps to Investigate Suspected Insider Trading by Hedge Fund Manager Personnel

  On November 24, 2010, the United States District Court for the Southern District of New York handed the United States Attorney’s Office (USAO) and the FBI (together, the government) a major victory in their ongoing criminal prosecution of Raj Rajaratnam, founder of Galleon Management, LP, and Danielle Chiesi, a former manager of New Castle Funds, LLC (defendants), for their alleged participation in a massive insider trading conspiracy.  In a precedential decision, the court upheld the government’s authority to secretly record phone calls under Title III of the Omnibus Crime Control and Safe Streets Act of 1968 (Title III or the Act) to investigate insider trading schemes using interstate wires, even though the Act does not specifically authorize wiretaps to investigate insider trading alone.  It also rejected defendants’ specific challenges to the government’s underlying search warrant applications, notwithstanding what it considered a “troubling” lack of government candor, because disclosure of the details “the government recklessly omitted would ultimately have shown that a wiretap was necessary and appropriate.”  As a result of its decision, the government may now present these recordings – likely the most persuasive evidence it will offer – at the trials of Rajaratnam and Chiesi, now tentatively scheduled to start on January 17, 2011.  We detail the background of the action and the Southern District’s legal analysis, primarily as it pertains to Rajaratnam’s claims, because the opinion heavily redacted the facts relating to Chiesi’s prosecution.  See also “Decision in the Galleon Matter Illustrates Application of Wiretap Law in the Hedge Fund Context,” The Hedge Fund Law Report, Vol. 3, No. 41 (Oct. 22, 2010).

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• From Vol. 3 No.48 (Dec. 10, 2010)

  SEC Commences Civil Insider Trading Action Against Deloitte Mergers and Acquisitions Partner and Spouse Who Allegedly Tipped Off Relatives to Impending Acquisitions of Seven Public Companies

  On November 30, 2010, the Securities and Exchange Commission (SEC) commenced a civil insider trading action against Deloitte Tax LLP (Deloitte) partner Arnold A. McClellan and his wife, Annabel McClellan, after they allegedly passed to their London-based relatives material, non-public information about pending acquisitions by Deloitte clients.  Those relatives, and the brokerage through which they traded, made millions of dollars trading ahead of the announcements of those acquisitions.  Arnold McClellan allegedly told his wife about seven acquisition deals on which Deloitte had been retained as an adviser.  Annabel McClellan, in turn, passed those tips to her sister and brother-in-law, Miranda and James Sanders.  The Sanders then took equity positions in the target companies and made substantial profits when the deals were announced.  The SEC charges that the McClellans violated the antifraud provisions of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.  This article summarizes the SEC’s Complaint.

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• From Vol. 3 No.46 (Nov. 24, 2010)

  Participants at Hedge Fund Compliance Summit Detail Best Practices with Respect to Insider Trading, SEC Examinations, Risk Mitigation, Marketing Materials, Valuation and Avoiding Investor Lawsuits: Part One of Two

  On November 15 and 16, 2010, Financial Research Associates, LLC and the Hedge Fund Business Operations Association presented a Hedge Fund Compliance Summit at the Princeton Club in New York City.  The substance of the Summit was relevant – even prescient – and the timing was fortuitous.  Insider trading was a prominent topic of discussion at the Summit, and on November 20, 2010, about two weeks after the Summit, insider trading received a stunning boost on the list of concerns of hedge fund managers.  That day, The Wall Street Journal and other sources disclosed the existence of a wide-ranging civil and criminal insider trading probe being jointly conducted by the SEC and the U.S. Attorney’s Office in Manhattan.  Then, on Monday, November 22, 2010, the Federal Bureau of Investigation raided the offices of three hedge fund managers.  According to press reports, at least one purpose of those raids was to gather documents in connection with the insider trading investigation reported by the Journal.  Following the raids, a number of well-known hedge fund and mutual fund managers received subpoenas from the U.S. Attorney’s Office in Manhattan.  According to press reports, those subpoenas are very broad and include requests for documents and information relating to use of expert networks and soft dollar practices.  See “For Hedge Fund Managers, Expert Networks Offer Access to Corporate Insiders While Mitigating (Though Not Eliminating) the Likelihood of Insider Trading Violations,” The Hedge Fund Law Report, Vol. 2, No. 48 (Dec. 3, 2009).  Insider trading is a topic that The Hedge Fund Law Report has covered in depth, and that we intend to cover in even more depth in the coming months.  Notably, Harry S. Davis (who participated at the Summit), Richard Morvillo and Justin Mendelsohn, all of Schulte Roth & Zabel LLP, published an article on insider trading in the HFLR earlier this year that we think should be required reading for hedge fund manager personnel.  See “Hedge Funds in the Crosshairs: The Law of Insider Trading in an Active Enforcement Environment,” The Hedge Fund Law Report, Vol. 3, No. 7 (Feb. 17, 2010).  Also, Michael D. Trager, Richard L. Jacobson and Christopher Rhee, of Arnold & Porter LLP, published an article in the HFLR that can – and should – be read as a companion piece to the Schulte article.  See “The SEC’s New Focus on Insider Trading by Hedge Funds,” The Hedge Fund Law Report, Vol. 3, No. 22 (Jun. 3, 2010).  Our coverage of the Summit complements these and other HFLR articles on insider trading by highlighting the more important and nonintuitive insights offered by Summit participants on insider trading.  In particular, we discuss points raised by panelists on consultants and expert networks, sharing of information among personnel at different hedge fund managers, rumors and insider trading considerations in connection with bank debt trading.  Beyond insider trading, this article summarizes key insights from Summit participants regarding SEC examinations and identification and mitigation of key risks.  A follow-up article will discuss points made by Summit participants on compliance considerations in connection with preparing and using marketing and advertising materials, valuation and avoiding investor lawsuits.

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• From Vol. 3 No.46 (Nov. 24, 2010)

  SEC Sanctions Buckingham Capital Management, Its Chief Compliance Officer and Its Research Affiliate for Inadequate Handling of Material, Non-Public Information

  As further evidence of the renewed focus of the Securities and Exchange Commission (SEC) on insider trading, especially within the hedge fund and investment management industries, the SEC has issued an Order imposing fines and a cease and desist order on research boutique The Buckingham Research Group, Inc. (BRG), investment manager Buckingham Capital Management, Inc. (BCM) and Lloyd R. Karp (Karp).  BCM is a wholly-owned subsidiary of BRG and shares an office suite with it.  Karp served as chief compliance officer for both BCM and BRG.  The SEC claimed that, commencing at least as early as 2005, BRG and BCM failed to have in place adequate procedures “to prevent the misuse of material, non-public information,” as required by both the Investment Advisers Act of 1940 and the Securities Exchange Act of 1934.  In addition, BRG, BCM and Karp failed to follow the limited procedures that they did have in place and fabricated data in response to an SEC examination of those procedures.  We summarize the SEC’s Order and the remedial measures it requires.

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• From Vol. 3 No.44 (Nov. 12, 2010)

  SEC and DOJ Commence, Respectively, Civil and Criminal Insider Trading Actions Against a Doctor Who Allegedly Tipped Off a Hedge Fund Manager to Impending Negative Information About a Drug Trial

  The Securities and Exchange Commission (SEC) has commenced a civil insider trading action against Dr. Yves M. Benhamou (Benhamou) after a hedge fund allegedly traded on inside information provided by Benhamou about the prospects of Human Genome Sciences, Inc. (HGSI).  Benhamou is a doctor who was on a steering committee overseeing a clinical trial of HGSI’s drug Albumin Interferon Alfa 2-a (Albuferon).  An unnamed hedge fund manager, through six separate funds (Funds), owned over six million shares of HGSI.  One of its investment managers was a friend and business acquaintance of Benhamou.  According to the Complaint, Benhamou revealed material nonpublic information about the Albuferon trial to the investment manager from December 2007 through January 2008.  During that same period, the Funds sold all of their HGSI shares, including a block trade of the Funds’ remaining two million shares at the close of trading on January 22, 2008, the day before HGSI announced negative information about the Albuferon trial.  By selling prior to that announcement, the Funds avoided a $30 million loss on the HGSI shares.  The SEC charges that Benhamou violated the antifraud provisions of the Securities Act of 1933 and the Securities and Exchange Act of 1934.  The U.S. Attorney for the Southern District of New York has also brought criminal insider trading charges against him.  Benhamou was arrested in Boston on November 2, 2010.  We summarize the SEC’s civil complaint.

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• From Vol. 3 No.43 (Nov. 5, 2010)

  Office Depot Settles SEC Charges that It Violated Regulation FD by Indirectly Signaling Its Quarterly Estimates Privately to Analysts and Institutional Investors

  On October 21, 2010, the U.S. Securities and Exchange Commission (SEC) filed a Complaint in the Southern District of New York and simultaneously settled enforcement actions against Office Depot, Inc., its CEO, Stephen A. Odland, and its former CFO, Patricia A. McKay (collectively, the Defendants).  The SEC charged the Defendants with violating Section 13(a) of the Securities Exchange Act of 1934 (Exchange Act), and SEC Regulation FD, in 2007, for selectively communicating to analysts and institutional investors that Office Depot would not meet the analysts’ quarterly earnings estimates.  The settlement is noteworthy because Office Depot did not directly inform analysts that it would not meet expectations, a classic Regulation FD violation, but signaled that fact through references to recent public statements of comparable companies and its prior cautionary public statements.  This matter is of particular importance to the hedge fund community because it highlights the risks involved when hedge fund managers, analysts and traders gather information from corporate insiders in small group meetings or other private settings.  For more on situations in which hedge fund managers speak to corporate management, see “How Can Hedge Fund Managers Distinguish Between Market Color and Inside Information,” The Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009).  This article discusses the legal principles underlying Regulation FD, the background of the action and the settlement.

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• From Vol. 3 No.38 (Oct. 1, 2010)

  SEC’s Insider Trading Case Against Nelson Obus of Hedge Fund Wynnefield Capital Thrown Out on Summary Judgment Motion Because SEC Failed to Prove that GE Capital Tipper Acted Deceitfully or in Violation of a Confidentiality Duty

  The U.S. District Court for the Southern District of New York has thrown out the SEC’s insider trading case against three individuals, the “tipper,” the “tippee” and the tippee’s superior, who allegedly traded in the securities of SunSource, Inc. (SunSource) after receiving inside information about the potential sale of SunSource.  In early 2001, Allied Capital Corporation (Allied) began exploring the possibility of acquiring SunSource and spinning off one of SunSource’s subsidiaries.  GE Capital was one of several lenders that were approached about the possibility of financing the transaction.  Defendant Thomas Strickland worked for the commercial finance group of GE Capital and was assigned to the SunSource deal team.  Strickland noticed that hedge fund Wynnefield Capital, Inc. (Wynnefield) owned SunSource stock.  In May 2001, Strickland had a conversation about SunSource with defendant Peter Black, an analyst at Wynnefield who happened to have been a college classmate of his.  Black advised his boss, defendant Nelson Obus, of Strickland’s interest in SunSource.  Obus then purchased additional shares of SunSource stock.  After Allied merged with SunSource, the Securities and Exchange Commission (SEC) brought civil insider trading charges against Strickland, Black and Obus.  On the defendants’ motion for summary judgment, the District Court dismissed the case against them.  It reasoned that, in mentioning the SunSource financing to Black, Strickland had not violated any fiduciary duty to GE Capital or SunSource, had not breached any duty of confidentiality to either company and had not acted deceptively.  Therefore, Strickland’s tip did not give rise to liability.  We outline the facts of the case and the Court’s reasoning.

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• From Vol. 3 No.38 (Oct. 1, 2010)

  Fifth Circuit Holds that SEC’s Allegations Against Mark Cuban Provide a Plausible Basis for Finding that Cuban Traded in Violation of an Agreement Not to Trade

  On September 21, 2010, the SEC won a significant victory in the United States Court of Appeals for the Fifth Circuit.  The Circuit Court reversed the SEC’s loss in its insider trading civil action against entrepreneur and Dallas Mavericks owner Mark Cuban.  The real question, however, and one highlighted by the Circuit Court, remains whether the SEC has sufficient facts to survive summary judgment or win at trial.  We summarize the background of the action, the Court’s legal analysis and Cuban’s related Freedom of Information Act request.

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• From Vol. 3 No.27 (Jul. 8, 2010)

  After Bench Trial of First-Ever Credit Default Swap Insider Trading Action, U.S. District Court Rules that Swaps Referencing Bonds Are “Securities-Based Swap Agreements” Under Antifraud Provisions of Securities Exchange Act, but Holds that SEC Failed to Prove Insider Trading

  The Securities and Exchange Commission (SEC) has succeeded in bringing credit default swaps under its jurisdiction over insider trading, but has lost its securities fraud suit against Jon-Paul Rorech (Rorech), a Deutsche Bank bond and credit default swap salesman, and Renato Negrin (Negrin), a portfolio manager employed during the relevant period by hedge fund manager Millennium Partners, L.P.  The SEC had alleged that Rorech and Negrin engaged in insider trading of the credit default swaps of VNU N.V. (VNU), a Dutch media conglomerate.  Rorech allegedly revealed to Negrin non-public information about a proposed bond offering by VNU that would result in an immediate increase in the value of certain credit default swaps that referenced VNU bonds.  As a result of that disclosure, Negrin allegedly purchased VNU credit default swaps shortly before the bond offering was announced and made a substantial profit when the value of those swaps increased following the announcement of the proposed offering.  The District Court determined that, while the SEC did have the power to prosecute its insider trading claims arising out of trading in the VNU credit default swaps, the SEC failed to prove that Rorech revealed material non-public information to Negrin.  We offer a comprehensive summary of the factual findings and legal reasoning in the court’s 122-page opinion.

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• From Vol. 3 No.26 (Jul. 1, 2010)

  AKO Capital LLP Options Trader and Risk Manager Pleads Guilty to One Count of Insider Dealing for Directing Preferential Trades to a Broker in Exchange for Cash and Gifts

  On May 18, 2010, former AKO Capital LLP options trader and risk manager Anjam Saeed Ahmad pled guilty to one count of insider dealing after entering into an agreement with the U.K.’s Financial Services Authority (FSA) under the Attorney General’s Guidelines on Plea Discussions in Cases of Serious or Complex Fraud.  On June 22, 2010, the Southwark Crown Court sentenced him to a suspended prison term, community service and a £50,000 fine.  That same day, the FSA issued a Final Notice requiring that Ahmad disgorge an additional £131,000 as restitution for profits he made from regulatory misconduct unrelated to his insider dealing.  We describe the conduct that led to the guilty plea, the relevant statutes and regulations and the FSA’s analysis of the proposed sanction (including its consideration of Ahmad’s cooperation as a mitigating factor in determining the appropriate sanction).

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• From Vol. 3 No.22 (Jun. 3, 2010)

  The SEC’s New Focus on Insider Trading by Hedge Funds

  The Securities and Exchange Commission (SEC) has attempted to stop insider trading since its creation.  Eliminating this misconduct has proven to be an elusive goal, as the Boesky scandal of the 1980s demonstrated.  The growth of the hedge fund industry has heightened the SEC’s challenge.  There is a longstanding and widespread belief among law enforcement personnel that insider trading involving hedge funds is a systemic problem.  Until recently, however, very few of the SEC’s insider trading cases involved hedge funds.  Today, the SEC is committed “to root[ing] out insider trading on Wall Street and in the hedge fund industry.”  It is bringing to bear more resources and new investigative tools to do the job.  A restructured Enforcement Division has new units ramping up that will concentrate on, among other things, insider trading by market professionals, including hedge funds.  In addition, joint investigations with the Department of Justice (DOJ) are now more common, allowing the SEC to take advantage of investigative strategies and tools long used in criminal cases.  Several insider trading cases involving hedge funds were brought in the past year, and more can be expected.  It has been reported that the SEC sent “at least” three dozen subpoenas to hedge funds and brokerages in “an expanding sweep of potential insider trading violations” relating to health care mergers in the past three years.  Also, the SEC filed charges in May 2010 against a Walt Disney Company executive and her companion, who allegedly shopped confidential earnings information about the company to over 30 hedge funds (some – but not all – of which reported the overture to the government).  Given this unprecedented level of enforcement attention, hedge funds and their investment advisers need to make sure that adequate procedures, customized for their particular business models and strictly enforced, are in place to minimize the risk of insider trading violations.  Fund managers that fail to consult counsel now may discover, only when it is too late, that they are the target of an extensive undercover government investigation.  In a guest article, Michael D. Trager, Richard L. Jacobson and Christopher Rhee, respectively, Senior Partner, Counsel and Partner at Arnold & Porter LLP, offer a comprehensive analysis of the current developments in insider trading law most relevant to hedge funds and hedge fund managers.

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• From Vol. 3 No.20 (May 21, 2010)

  Richards Kibbe & Orbe LLP and ACA Compliance Group Webcast Highlights Developments in SEC Examinations of Registered Investment Advisers, and How to Prepare for a Surprise Visit from the SEC

  Hedge fund advisers represent a significant priority for the Securities and Exchange Commission (SEC) in its rulemaking, enforcement and examination efforts.  For hedge fund managers registered with the SEC as investment advisers, the SEC’s examination program has become increasingly important; and significantly more hedge fund managers are likely to be required to register with the SEC in light of the Senate's passage of the Financial Stability Bill.  Pursuant to Section 204 of the Investment Advisers Act of 1940 (the Advisers Act), the books and records of any registered investment adviser (RIA) may undergo compliance examinations by SEC staff.  These examinations aim to protect investors by determining whether RIAs are complying with the law, adhering to the disclosures that they have provided to their clients and maintaining appropriate compliance programs to ensure compliance with the law.  If the SEC examines an RIA, the RIA must provide examiners with access to all requested advisory records that it maintains.  The RIA must also provide the SEC with access to the written policies and procedures required by law to prevent violations of federal securities laws.  The policies and procedures, once implemented, should prevent violations from occurring, detect violations that have occurred and promptly correct any past violations.  The RIA should also prepare for the examination staff to review communications with investors for consistency and accuracy.  The failure of this examination program to detect several high-profile investment adviser frauds, including the Ponzi scheme perpetrated by Bernard Madoff, has led to criticism of the SEC and increased the significance of the examination itself.  On April 22, 2010, Richards Kibbe & Orbe LLP partner Eva Marie Carney co-presented a webcast entitled “SEC Examinations of Investment Advisers” with Joel Sauer of the ACA Compliance Group.  The webcast focused on some of the most important developments in RIA examinations.  It addressed topics such as how to prepare for the visit, asset verification tests, e-mail requests, common exam deficiencies, and the SEC’s enhanced subpoena powers.  It also addressed various “polling questions” or hypotheticals as tutorials for the audience.  This article summarizes the salient details of the presentation, including a step-by-step analysis of how an RIA can best prepare for and effectively manage an SEC examination, and the most common areas of focus during the examination.

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• From Vol. 3 No.12 (Mar. 25, 2010)

  Katten Muchin Rosenman Hosts Program on “Infected Hedge Funds” Highlighting Rights and Remedies of Investors in Hedge Funds Whose Managers are Accused of Insider Trading or of Operating Ponzi Schemes

  The discovery, duration and depth of Ponzi schemes and insider trading rings uncovered during the last two years have altered, to a degree, the assumptions of institutional investors.  While investors do not presume that every hedge fund manager is engaged in illicit activity, they have expanded their due diligence checklists to include questions intended to identify and avoid bad actors.  Investors also realized that due diligence can never be perfect, and accordingly, have refocused on the legal rights and remedies available to parties invested with managers that are or are alleged to be operating Ponzi schemes or engaged in insider trading.  See “Hedge Funds in the Crosshairs: The Law of Insider Trading in an Active Enforcement Environment,” The Hedge Fund Law Report, Vol. 3, No. 7 (Feb. 17, 2010).  In recognition of these abiding concerns among institutional investors, and the concomitant interest among hedge fund managers in demonstrating their commitment to compliance, law firm Katten Muchin Rosenman LLP hosted a seminar on March 16, 2010 titled “Infected Hedge Funds: Rights and Remedies.”  The Katten Partners that served as panelists discussed various relevant topics, including the categories of claims and defenses available to investors in hedge funds whose managers are accused of Ponzi scheme operation or insider trading; differences in remedies available to direct and indirect investors; the SEC’s new enforcement initiatives and cooperation measures (including cooperation agreements, deferred prosecution agreements and non-prosecution agreements); and prophylactic measures hedge fund managers can take to prevent accusations of insider trading or running a Ponzi scheme.  This article describes in detail the most relevant topics discussed and points made at the Katten seminar.

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• From Vol. 3 No.8 (Feb. 25, 2010)

  U.K Financial Services and Markets Tribunal Upholds Findings of Market Abuse Against Individuals for Using Inside Information to Make Spread Bets

  In a rare, circumstantial case for the U.K., a London tribunal has found that two close friends colluded in using confidential information to make quick profits from so-called spread betting.  On December 29, 2009, the U.K.’s Financial Services and Markets Tribunal (Tribunal), an executive agency of the U.K. Ministry of Justice which rules on disputes between the Financial Services Authority (FSA) and individuals and firms facing regulatory action, upheld the FSA’s case against Robin Chhabra and Sameer Patel.  In confirming the FSA’s findings, the Tribunal agreed that both Chhabra and Patel had engaged in market abuse under the Financial Services and Markets Act 2000 because Patel placed bets “on the basis of restricted information not generally available which was disclosed to him by Chhabra.”  This article analyzes the Tribunal’s decision including the facts of the civil case, the relevant laws and arguments made by the parties.

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• From Vol. 3 No.7 (Feb. 17, 2010)

  Hedge Funds in the Crosshairs: The Law of Insider Trading in an Active Enforcement Environment

  As the Securities Exchange Commission and federal prosecutors continue their crackdown on what they perceive to be “systemic” insider trading within the hedge fund industry, now more than ever it is critical for all industry participants to be aware of the line between good research, including entirely lawful information-gathering, and impermissible insider trading.  In a guest article that should be required reading for investment, legal, compliance, marketing, operational and other professionals at hedge fund managers and their service providers – in short, for everyone in the hedge fund industry – Harry S. Davis and Richard Morvillo, both partners at Schulte Roth & Zabel LLP, and Justin Mendelsohn, an associate at Schulte, examine some of the commonly misunderstood areas of the law of insider trading in the context of the current, unprecedented regulatory environment.  Understanding the subtleties in the statutory framework is fundamental to protecting hedge fund management firms because, as we have all observed, mere allegations of insider trading can wipe out a multi-billion dollar hedge fund operation through massive investor redemptions.  In particular, this article discusses: the current regulatory environment; the definition of an “insider”; the broad scope of what constitutes a “trade in securities”; the meaning of a trade which is “on the basis of” material, non-public information; determining whether information is “material”; and the “mosaic theory” and its relationship to “materiality”.  Three among many critical points highlighted by this article are: (1) the definitions of “insider” and “security” for insider trading purposes are broader than you may think; (2) you do not have to actually use the information you receive in trading for a trade to be “on the basis of” that information; and (3) the “mosaic theory” does not permit a firm to trade in the securities of an issuer while a person at that firm is in possession of material, non-public information about that issuer.

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• From Vol. 3 No.6 (Feb. 11, 2010)

  Paul Hastings Hosts Program on Securities Litigation and Enforcement in Light of New SEC Initiatives to Enhance Enforcement Efforts and Encourage Witness Cooperation

  On February 2, 2010, law firm Paul, Hastings, Janofsky & Walker LLP hosted a Securities Litigation & Enforcement Roundtable focusing on key current enforcement and witness cooperation initiatives at the Securities and Exchange Commission (SEC).  The SEC Enforcement Division, led by Director Robert Khuzami, recently introduced new investigative units designed to enhance and revamp its investigation efforts, as well as to encourage witness cooperation in investigations.  See “SEC Names New Co-Chiefs of Enforcement Division Asset Management Unit and Other Specialized Unit Chiefs,” The Hedge Fund Law Report, Vol. 3, No. 3 (Jan. 20, 2010).  The speakers also discussed the implications of these initiatives and current enforcement trends for financial institutions and alternative investment vehicles, such as hedge funds.  One of the key points of the discussion was the SEC’s increased emphasis on insider trading enforcement, in particular in the hedge fund context.  The SEC has increased the number of insider trading enforcement actions recently initiated, and the techniques used by the regulator to investigate suspected insider trading have become increasingly aggressive and sophisticated.  For a comprehensive discussion of practice points that can help hedge fund managers avoid insider trading allegations, including links to relevant articles from The Hedge Fund Law Report, see “Regulatory Compliance Association Hosts Program on Increased Risk for Hedge Fund Directors and Officers in the New Era of Heightened Regulation and Enforcement,” The Hedge Fund Law Report, Vol. 2, No. 50 (Dec. 17, 2009).  This article summarizes the most relevant topics discussed at the Paul Hastings Roundtable, focusing on the SEC’s new enforcement initiatives and cooperation measures (including cooperation agreements, deferred prosecution agreements and non-prosecution agreements), and emphasizing the potential impact of those measures on hedge funds and their managers.

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• From Vol. 2 No.52 (Dec. 30, 2009)

  SEC Accuses Former Associates at Global Financial Institutions of Tipping Friends in “Serial” Insider Trading Scheme

  On December 16, 2009, the Securities and Exchange Commission (SEC) filed suit in the U.S. District Court for the Northern District of California against Vinayak Gowrish, a former associate at private equity firm TPG Capital L.P., formerly Texas Pacific Group.  The complaint accuses Gowrish of providing his friends with tips including confidential business information in a “serial insider trading scheme.”  The SEC alleges that the friends used the illegally communicated and obtained information to trade profitably in the stocks of companies engaged in mergers and acquisitions.  Gowrish’s friends – Adnan Zaman, a former vice president and investment banker at Lazard Freres & Co. LLC; Pascal S. Vaghar, who is currently unemployed; and Sameer N. Khoury, a mortgage broker – have settled with the SEC by collectively paying approximately $310,000 in disgorgement for their part in the purported scheme.  This article summarizes the SEC’s allegations in its civil suit against Gowrish, and details the terms of the SEC’s settlement with Zaman, Vaghar and Khoury.

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• From Vol. 2 No.51 (Dec. 23, 2009)

  SEC’s First-Ever Credit Default Swap Insider Trading Case Survives Motion to Dismiss

  On May 5, 2009, the Securities and Exchange Commission (SEC) commenced an insider trading enforcement action against Jon-Paul Rorech, a Deutsche Bank bond and credit default swap salesman during the relevant period, and Renato Negrin, a portfolio manager employed during the relevant period by hedge fund adviser Millennium Partners, L.P.  This case is the first insider trading case the SEC has brought with respect to credit default swaps, which are not registered securities.  The SEC alleged that Rorech and Negrin engaged in insider trading of the credit default swaps of VNU N.V., a Dutch media conglomerate.  The defendants moved to dismiss the complaint primarily on the basis that credit default swaps were not “securities based swap agreements” for purposes of insider trading law.  Rorech also argued that the relevant information was not confidential and that the SEC lacked jurisdiction over foreign bonds.  The court rejected their contentions and allowed the SEC’s case to proceed.  We review the arguments made and the court’s rationale for its decision.  See also “SEC Brings First-Ever Credit Default Swaps Insider Trading Case,” The Hedge Fund Law Report, Vol. 2, No. 19 (May 13, 2009).

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• From Vol. 2 No.50 (Dec. 17, 2009)

  Regulatory Compliance Association Hosts Program on Increased Risk for Hedge Fund Directors and Officers in the New Era of Heightened Regulation and Enforcement

  On December 9, 2009, The Regulatory Compliance Association (RCA) hosted a teleconference titled “Director and Officer Liability Escalate in the New Era of Heightened Regulation,” as part of its CCO University Outreach Series.  Walter Zebrowski, CIO and COO for Hedgemony Partners and Chairman of the RCA, explained in his introductory remarks that the “aftermath of the financial collapse coupled with the new era of heightened regulation shall significantly intensify the scrutiny and liability for directors and officers.”  The event was moderated by Richard Maloy, CIC, CRM, Chairman and CEO of Maloy Risk Services.  The panelists included Peter Welsh, a Partner at Ropes & Gray LLP; Ingrid Pierce, a Partner at Walkers Global; and Michael Pereira, Publisher of The Hedge Fund Law Report.  The panelists discussed issues including: the increased effectiveness on the part of regulators, especially the SEC; pending legislation relating to registration of hedge fund managers, and the practical burdens that registration would (and would not) entail; liquidity and regulation of the insurance industry; demands from institutional investors and insurance underwriters for transparency from hedge funds and managers; the role of independent directors; claims trends, including insider trading (and 12 specific strategies that may be used to avoid insider trading allegations); the institutionalization of the hedge fund industry; and the changing directors and officers (D&O) insurance landscape.  This article summarizes the speakers’ insights on the foregoing issues, and highlights the salient points raised by the speakers on related topics.

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• From Vol. 2 No.48 (Dec. 3, 2009)

  For Hedge Fund Managers, Expert Networks Offer Access to Corporate Insiders While Mitigating (Though Not Eliminating) the Likelihood of Insider Trading Violations

  Portfolio managers, investment analysts and others with investment decision-making responsibility at hedge fund managers – especially those managing funds invested in public equity – face an ongoing predicament: the most valuable information from an investment perspective would be material, nonpublic information, but trading while in possession of material, nonpublic information is illegal.  Accordingly, hedge fund investment decision-makers routinely seek to compile a mosaic consisting of material, public information; immaterial, nonpublic information; and other information that broadly falls under the rubric of “market color.”  See “How Can Hedge Fund Managers Distinguish Between Market Color and Inside Information?,” The Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009).  Generally, trading on the basis of such a mosaic is legal.  But knowing whether you have a legal mosaic or illegal inside information is complex.  In particular, determining materiality involves an assessment of the relevant facts in light of a daunting volume of statutes, rules, cases, SEC pronouncements and other formal and informal guidance.  In a word, the “better” a piece of information from the perspective of a hedge fund manager, the more scrutiny it merits (from at least the manager’s general counsel, chief compliance officer and outside counsel) to determine whether the manager’s funds may trade based on the information (or whether manager personnel may trade in their personal accounts while in possession of the information).  Nowhere is this predicament more pronounced than in situations in which hedge fund manager personnel talk to corporate insiders, in particular, executives of companies whose securities are owned or may be purchased or sold by the manager’s funds.  Talking to corporate insiders is essential in light of the competition in the investment world.  However, such communications are also fraught with the opportunity to acquire and inappropriately use material, nonpublic information.  In an article in our October 29, 2009 issue, we discussed a number of specific strategies that hedge fund managers can implement to minimize the likelihood that communications with corporate insiders may result in insider trading violations.  See “How Can Hedge Fund Managers Talk to Corporate Insiders Without Violating Applicable Insider Trading Laws?,” The Hedge Fund Law Report, Vol. 2, No. 43 (Oct. 29, 2009).  One of the techniques discussed briefly in that article is the use by hedge fund managers of expert networks.  Expert networks generally are companies that broker and structure communications between buy-side investors, such as hedge fund managers, and experts in designated areas, including corporate insiders and others with domain expertise.  This article expands substantially on the discussion in our previous article, describing in detail: what an expert network is; how such networks operate; the categories of experts available via networks; fees charged for membership in a network and periodic access to experts; the mechanics of communications with experts in a network; the benefits and limits of expert networks in preventing insider trading charges; eight specific steps taken by expert network companies to prevent insider trading violations; and Regulation Fair Disclosure (Reg FD) concerns.  One of the basic insights of this article is that expert networks have both offensive and defensive uses: they can be used to locate and glean information from experts who otherwise may be hard to find or hesitant to talk (the offensive use), and they provide a structure for communication that would be difficult to replicate in ad hoc or informal settings (the defensive use).

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• From Vol. 2 No.48 (Dec. 3, 2009)

  Big Boys Don’t Cry: How “Big Boy” Provisions Can Help Hedge Fund Managers Avoid Liability for Insider Trading Violations

  Various factors recently have increased the sensitivity of hedge fund managers, lawyers, compliance professionals, investors and others to insider trading concerns.  Those factors include, but are not limited to: insider trading allegations against Galleon Group founder Raj Rajaratnam and others; remarks delivered by SEC Enforcement Division Director Robert Khuzami on November 23 indicating that the Division will increase its enforcement activity with respect to insider trading by hedge funds, and in particular will focus on insider trading in the derivatives context; and press reports that the SEC has sent at least three dozen subpoenas to hedge fund managers and broker-dealers during November 2009 relating to communications in connection with healthcare industry transactions closed during the past three years and certain retail industry transactions.  See “For Hedge Fund Managers in a Heightened Enforcement Environment, Internal Investigations Can Help Prevent or Mitigate Criminal and Civil Charges,” The Hedge Fund Law Report, Vol. 2, No. 47 (Nov. 25, 2009).  In light of the increased regulatory scrutiny of activity that may constitute insider trading, hedge fund lawyers, compliance professionals and others are re-examining how and where to draw the line between permissible and impermissible information, and how to police that line effectively.  See “How Can Hedge Fund Managers Distinguish Between Market Color and Inside Information?,” The Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009); “How Can Hedge Fund Managers Talk to Corporate Insiders Without Violating Applicable Insider Trading Laws?,” The Hedge Fund Law Report, Vol. 2, No. 43 (Oct. 29, 2009).  In addition, hedge fund industry participants are refocusing on the promise and limits of tools they may employ to prevent or mitigate allegations of trading on material, nonpublic information.  One such tool is the so-called “Big Boy” provision, or disclaimer of reliance.  In our November 19, 2009 issue, we published the first part of a two-part analysis of Big Boy provisions in the hedge fund context by Brian S. Fraser and Tamala E. Newbold, Partner and Staff Attorney, respectively, at Richards Kibbe & Orbe LLP.  That first part discussed the duty to disclose material, nonpublic information (or refrain from trading) and the differences between the federal securities laws and New York common law on that issue, in particular, the “superior knowledge” trigger for the duty to disclose under New York law which has no federal counterpart.  See “When Do Hedge Fund Managers Have a Duty to Disclose Material, Nonpublic Information?,” The Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009).  This second part expands on that analysis, focusing in depth on the enforceability of Big Boy provisions in securities and non-securities transactions, with a special emphasis on the enforceability of such provisions under New York law in the context of trading in bank loans.  In addition, this part includes a detailed discussion of, and a comprehensive review of the caselaw relating to, specific steps that hedge fund managers can take to increase the likelihood that a court will enforce a Big Boy provision.

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• From Vol. 2 No.48 (Dec. 3, 2009)

  Best Practices for a Hedge Fund Manager General Counsel or Chief Compliance Officer that Suspects or Discovers Insider Trading by Manager Employees or Principals

  A confluence of factors – including Galleon; Madoff, and in particular the SEC’s failure to catch the Ponzi scheme earlier; other discovered frauds; the credit crisis; etc. – have enhanced scrutiny by regulators of actions at hedge fund managers that may constitute insider trading.  See “Another Hedge Fund Manager, Former Jefferies Group Manager Joseph Contorinis, Indicted for Insider Trading,” The Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009); “For Hedge Funds and Their Managers, the SEC’s New Enforcement Initiatives May Increase the Likelihood, Speed and Vigor of Inspections and Examinations,” The Hedge Fund Law Report, Vol. 2, No. 33 (Aug. 19, 2009); “What Can Hedge Fund Managers Learn From the SEC’s Failure to Catch Madoff? An Interview with Charles Lundelius, Senior Managing Director at FTI Consulting, Inc.,” The Hedge Fund Law Report, Vol. 2, No. 40 (Oct. 7, 2009).  In light of this increased regulatory scrutiny, many hedge fund managers are reviewing their policies, practices and procedures with respect to insider trading.  For any hedge fund manager, whether registered or unregistered, it is critical to have an insider trading policy that is comprehensive, legally accurate, practicable and effective.  See “Key Elements of a Hedge Fund Manager’s Insider Trading Policies and Procedures,” The Hedge Fund Law Report, Vol. 2, No. 43 (Oct. 29, 2009).  Beyond having a best-of-breed insider trading policy, though, hedge fund management firms also have to think about how they would respond to suspicion or discovery of insider trading by an employee or principal of the manager.  Within hedge fund management firms, the general counsel (GC) and chief compliance officer (CCO) are on the front lines of investigation, discovery and response.  Accordingly, this article offers guidance and a review of best practices with respect to what a hedge fund manager GC or CCO should do in the event of suspicion or discovery of insider trading.  Specifically, the article discusses: the corporate charging guidelines of the Department of Justice (DOJ); internal investigations; the advisability of suspending suspected violators; how and when to preserve the record; what to do in the event of an actual discovery of insider trading; and how to prepare for surprise government interviews.

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• From Vol. 2 No.47 (Nov. 25, 2009)

  For Hedge Fund Managers in a Heightened Enforcement Environment, Internal Investigations Can Help Prevent or Mitigate Criminal and Civil Charges

  In the public company context, internal investigations have become an accepted and expected adjunct of good corporate governance.  In response to even the remotest whiff of a violation of law, regulation or internal policy, prudent public company managers generally initiate a thorough investigation with the twin goals of fact-finding and precluding or mitigating civil or criminal charges.  As responses by some notable hedge fund managers to the Galleon allegations have demonstrated, the purposes, goals and many of the techniques of internal investigations developed in the public company context apply, albeit with some variation, in the hedge fund world.  That is, for hedge fund managers whose current or former principals or employees have been or may be charged with civil or criminal violations, or may simply be in the zone of suspicion, an internal investigation can uncover relevant evidence, identify the absence of evidence and can credibly demonstrate to regulators and prosecutors that the hedge fund manager has an independent commitment to compliance and thus does not require any external prodding in that regard.  In light of the explicitly stated plan on the part of the SEC’s Enforcement Division to step up enforcement of insider trading laws and regulations applicable to hedge fund managers, internal investigations are expected to become a more standard aspect of hedge fund legal and operational practice.  However, hedge fund managers as a group have a relatively short track record with internal investigations, at least compared to public company managers, and internal investigations in the hedge fund context raise specific concerns.  Accordingly, this article seeks to acquaint hedge fund industry participants with the primary issues to be considered when initiating and conducting an internal investigation, and in doing so discusses: recent examples of internal investigations initiated by operating companies and hedge fund managers in response to the Galleon allegations; the eight most common contexts in which a hedge fund manager may consider initiating an internal investigation; the purpose of an internal investigation; when and how to define the scope of an internal investigation; whether the fact and any findings of an investigation must be disclosed; retention of documents and records; whether an investigation should be conducted by internal personnel or outside law and accounting firms; who outside counsel represents; whether or not an investigation report should be written; and what to do if the investigation uncovers a violation.

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• From Vol. 2 No.46 (Nov. 19, 2009)

  How Can Hedge Fund Managers Distinguish Between Market Color and Inside Information?

  All hedge fund managers, in a manner of speaking, are in the information business – the business of collecting, analyzing and acting on a significant volume of complex information.  At a similar level of generality, many of the federal securities laws and rules govern the use that may and may not be made of certain categories of information.  At one end of the spectrum of permissibility is material, nonpublic information.  Generally, hedge fund managers may not trade securities based on such information where it is obtained from someone with a fiduciary duty to the issuer of those securities.  At the other end of the spectrum is public information, such as that gleaned from public filings such as annual or quarterly reports.  Somewhere in the middle is so-called “market color,” generally understood to refer to information that is more specific to a company, industry or market than public information, but that does not rise to the level of material, nonpublic information.  In other words, if information is market color, a hedge fund manager can trade on it, whereas if information crosses the line from market color to inside information, a manager cannot trade on it.  However, the distinction is easier to draw in hindsight, and the line is often blurry.  Moreover, as recent insider trading charges have demonstrated, the practical standard of proof in the court of institutional investor opinion is significantly lower than in a civil or administrative proceeding: insider trading charges alone, even if unproven, are sufficient to unravel a hedge fund business that may have taken years to build.  See “Billionaire Founder of Hedge Fund Manager Galleon Group, Raj Rajaratnam, Charged in Alleged Insider Trading Conspiracy,” The Hedge Fund Law Report, Vol. 2, No. 42 (Oct. 21, 2009); “SEC Sues Hedge Fund CFO and Venture Capital Fund CFO Alleging Insider Trading in Tempur-Pedic and Acxion Stock,” The Hedge Fund Law Report, Vol. 2, No. 45 (Nov. 11, 2009); “A Pequot Postmortem: What is Headline Risk and How Can it be Avoided or Mitigated?,” The Hedge Fund Law Report, Vol. 2, No. 24 (Jun. 17, 2009).  At the same time, many traders, analysts and others at hedge fund managers have to determine on a day-to-day basis whether certain categories of information they receive, alone or in combination with other information possessed by them or their firms, constitutes market color that may be acted upon, or material, nonpublic information that may not be acted upon.  Given that distinguishing between market color and inside information can have profound consequences, is infamously difficult and is a labor routinely practiced by many in the hedge fund industry, this article seeks to provide guidance in making that distinction in various contexts.  In particular, this article discusses: the definition of market color; who provides market color and the channels via which it is provided; the interaction of soft dollars and market color; factors to consider in determining whether and when a particular piece of information crosses the line from market color to inside information; and regulatory precedents that may provide insight into how the SEC may treat market color.

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• From Vol. 2 No.46 (Nov. 19, 2009)

  Another Hedge Fund Manager, Former Jefferies Group Manager Joseph Contorinis, Indicted for Insider Trading

  On November 6, 2009, the United States Attorney’s Office for the Southern District of New York announced the indictment of Joseph Contorinis, a former Jefferies Group, Inc. hedge fund portfolio manager, on charges of conspiracy and securities fraud relating to his alleged participation in an insider trading conspiracy ring.  See United States v. Contorinis, Case No. 09 Maj 289 (S.D.N.Y., filed Nov. 5, 2009).  According to the indictment, Contorinis, who acted as managing director and portfolio manager for the Jefferies Paragon Fund, allegedly received material, nonpublic information from UBS Investment Bank investment banker Nicos Stephanou (Stephanou), regarding merger and acquisition activity that led to Contorinis making profits of about $7 million for his hedge fund.  The indictment capped a series of insider trading cases announced since the beginning of November by the U.S. Attorney’s Office.  On November 5, 2009, the U.S. Attorney’s Office announced the indictment of fourteen other individuals for insider trading as part of a widening investigation of the alleged insider trading scheme by Galleon Group founder Raj Rajaratnam, a scheme federal law enforcement officials describe as the largest ever hedge fund-related insider trading conspiracy.  For more background on the Galleon Group insider trading case, see “Billionaire Founder of Hedge Fund Manager Galleon Group, Raj Rajaratnam, Charged in Alleged Insider Trading Conspiracy,” The Hedge Fund Law Report, Vol. 2, No. 42 (Oct. 21, 2009).  We detail the allegations in the Contorinis indictment and a related action.

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• From Vol. 2 No.45 (Nov. 11, 2009)

  Confidentiality, Standstill and Insider Trading Considerations Relevant to Hedge Funds Investing in PIPEs

  In November 2007, Scott Friestad, Associate Director of the SEC’s Enforcement Division, announced that trading abuses would be a priority for the then-newly-launched Hedge Fund Working Group.  He defined “trading abuse” to include abuses of private investments in public equity (PIPE) transactions, as well as insider trading and improper short sales under Regulation M.  But the advertised crackdown was already underway.  For example, that September, the SEC had initiated an enforcement action against Robert A. Berlacher and others alleging that the defendants had engaged in unlawful insider trading in connection with the Radyne ComStream Inc. PIPE offering of 2004, by selling short Radyne securities prior to the public announcement of the PIPE.  As an alternative theory of liability, the SEC also alleged that the trading violated Section 5 of the Securities Act of 1933 (Securities Act).  Section 5 generally requires that every offer or sale of securities must be either registered or exempt from registration.  The SEC claimed in Berlacher and analogous cases that the use of PIPE shares after the effective date of the relevant registration statement to cover short sales made prior to the effective date of the relevant registration statement effectively constituted an unregistered sale of securities that required registration.  The SEC has since suffered a series of setbacks in connection with PIPEs, especially with respect to its Section 5 theory of liability.  The various dismissals of claims under Section 5 are, in turn, part of a broader pattern of setbacks for the SEC in its enforcement efforts in connection with PIPEs, and the decisions that have resulted from this effort have affected the practices of issuers, placement agents and investors.  This article reviews the mechanics of PIPE transactions and the informal confidentiality arrangements traditionally entered into by PIPE issuers and investors.  The article then surveys the insider trading caselaw applicable to investors in PIPEs (many of whom are hedge funds); the insider trading claims against Mark Cuban, which were dismissed in July of this year, including insights from the lawyer who successfully represented Cuban in that matter; the changing dynamics of the PIPE marketplace, including the entry of more sophisticated issuers, and the concomitant new emphasis on the terms of confidentiality and standstill agreements; and the materiality of PIPEs in any insider trading analysis.

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• From Vol. 2 No.45 (Nov. 11, 2009)

  SEC Sues Hedge Fund CFO and Venture Capital Fund CFO Alleging Insider Trading In Tempur-Pedic and Acxiom Stock

  On October 30, 2009, the Securities and Exchange Commission (SEC) commenced a civil enforcement action against a group of seven individuals who allegedly engaged in insider trading in the securities of Tempur-Pedic International, Inc. (Tempur) and Acxiom Corporation (Acxiom).  Defendant King Chuen Tang (Chen Tang) was Chief Financial Officer of an unnamed hedge fund.  He allegedly conveyed confidential information about Tempur to five co-defendants, and traded on that information for his own account, through funds that he controlled, and through accounts held in the names of friends and family members.  His brother-in-law, defendant Ronald Yee, was Chief Financial Officer of a venture capital fund.  He is said to have been the tipper who provided Chen Tang with non-public information about Acxiom.  The SEC is seeking a permanent injunction, disgorgement of profits and civil penalties against the seven defendants involved in the scheme.  It is also seeking disgorgement of profits and an accounting from the investment funds controlled by the defendants and from the friends and family members of the defendants in whose names the illicit trades were conducted.  We summarize the details of the scheme, as pleaded in the SEC’s complaint, and the SEC’s legal allegations.

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• From Vol. 2 No.44 (Nov. 5, 2009)

  As Criminal Trial Looms, Small Victory for Bear Stearns Hedge Fund Manager Matthew Tannin

  The notable indictment, arrest and prosecution of Matthew Tannin and Ralph Cioffi, two hedge fund managers for the now-defunct Bear Stearns Asset Management (BSAM) has, at least for Tannin, taken a momentarily beneficial turn.  Accused of conspiracy, securities fraud and wire fraud, and with trial looming, Tannin moved to suppress a purportedly damaging e-mail the Federal Bureau of Investigation (FBI) had recovered from his personal e-mail account with a search warrant.  The Honorable Frederic Block, who presides over the case in the United States District Court for the Eastern District of New York, agreed with Tannin that the search warrant was deficient, the resulting search unconstitutional and that the United States Attorney’s Office could not cure the error.  As a result, on October 26, 2009, the court ordered the e-mail suppressed on the eve of trial.  We describe the background of the action and the court’s legal analysis with respect to Tannin’s motion to suppress.

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• From Vol. 2 No.43 (Oct. 29, 2009)

  How Can Hedge Fund Managers Talk to Corporate Insiders Without Violating Applicable Insider Trading Laws?

  The recent insider trading allegations against Raj Rajaratnam, founder of Galleon Group, and others highlight a predicament faced by many in the hedge fund industry: absent a seer-like insight (a la Buffett) or superior computers (a la Renaissance Technologies and others), the only way to consistently generate alpha is to consistently obtain information that is not available to others, or to apply information that is available to others in unique ways.  See “Billionaire Founder of Hedge Fund Manager Galleon Group, Raj Rajaratnam, Charged in Alleged Insider Trading Conspiracy,” The Hedge Fund Law Report, Vol. 2, No. 42 (Oct. 21, 2009).  Especially after promulgation of Regulation Fair Disclosure (Reg FD), everyone can read and internalize the same disclosure documents at roughly the same time.  Therefore, hedge fund managers – especially those that invest in public equity or debt – have to talk to corporate insiders to stay competitive; to stay ahead, they have to talk to a lot of corporate insiders.  And hence the predicament: how to talk to corporate insiders without violating the insider trading laws?  Those laws generally prohibit trading while in possession of material, nonpublic information.  But what constitutes “materiality” for insider trading purposes, and what information is considered “nonpublic”?  For a hedge fund manager, analyst or trader who spends a good portion of each work day talking to corporate insiders, the line can often be blurry, and the consequences can be dire.  Galleon, for example, liquidated in record time in response to as yet unproven allegations of insider trading by its principal.  In recognition of the importance to hedge fund managers of avoiding insider trading allegations, this article examines the facts and allegations of the Galleon case; the statutory and regulatory bases for the prohibition of insider trading; 10b5-1 plans; the categories of financial instruments to which the prohibition applies; insider trading policies and procedures at hedge fund managers; specific best practices that hedge fund managers can employ to prevent insider trading or mitigate its impact; the “mosaic theory” of information gathering and use; and the utility and limitations of expert networks.

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• From Vol. 2 No.43 (Oct. 29, 2009)

  Key Elements of a Hedge Fund Manager’s Insider Trading Policies and Procedures

  While the insider trading allegations against Raj Rajaratnam of Galleon Group and others remain to be proved or disproved, the case has already confirmed the fundamental importance to hedge fund managers of having, enforcing and training personnel with respect to comprehensive and strategy-specific insider trading policies and procedures.  See “Billionaire Founder of Hedge Fund Manager Galleon Group, Raj Rajaratnam, Charged in Alleged Insider Trading Conspiracy,” The Hedge Fund Law Report, Vol. 2, No. 42 (Oct. 21, 2009).  The SEC requires registered investment advisers to have written compliance policies and procedures and written codes of ethics – either may contain the adviser’s written policies and procedures regarding insider trading (or the code of ethics may be part of the compliance manual).  However, the prohibition against insider trading – a broad legal framework based in caselaw, regulatory pronouncements and statutory provisions – applies to all investment advisers and all hedge fund managers, not just registered managers.  Therefore, most hedge fund managers have written insider trading policies and procedures, those that do not should and even those that do should revisit them.  The importance and urgency of focusing or refocusing on written insider trading policies and procedures is based on at least two trends.  First, the allegations against Galleon are part of a renewed enforcement effort on the part of the SEC and DOJ against hedge funds specifically and insider trading generally.  See “For Hedge Funds and Their Managers, the SEC’s New Enforcement Initiatives May Increase the Likelihood, Speed and Vigor of Inspections and Examinations,” The Hedge Fund Law Report, Vol. 2, No. 33 (Aug. 19, 2009).  Second, most hedge fund managers likely will be required to register with the SEC within a relatively short time.  On Tuesday, October 27, 2009, the Private Fund Investment Advisers Registration Act, which generally would require registration by most hedge fund managers, passed the House Financial Services Committee.  See “U.S. House of Representatives Holds Hearing on Hedge Fund Adviser Registration,” The Hedge Fund Law Report, Vol. 2, No. 42 (Oct. 21, 2009); “Hedge Fund Association Hosts Capitol Hill Symposium Focused on Hedge Fund Adviser Registration and Hedge Fund Industry Regulation,” The Hedge Fund Law Report, Vol. 2, No. 42 (Oct. 21, 2009).  In light of the fundamental importance to hedge fund managers of having apt and thorough written insider trading policies and procedures, and making such policies part of the firm’s “culture of compliance,” this article examines the nuts and bolts of what should be in such policies and procedures and why.  In particular, we examine the statutory, regulatory and practical requirements for having an insider trading policy; certain key definitions typically included in an insider trading policy, including the definitions of “insider,” “nonpublic information,” “materiality” and “security”; remedies and penalties for violations of insider trading laws and insider trading policies; guidelines for avoiding violations, including watch lists and ethical walls; related categories of market manipulation; personal trading policies and procedures; the critical importance of training; and the utility of filtering information through the Chief Compliance Officer.

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• From Vol. 2 No.42 (Oct. 21, 2009)

  Billionaire Founder of Hedge Fund Manager Galleon Group, Raj Rajaratnam, Charged in Alleged Insider Trading Conspiracy

  On October 16, 2009, the United States Attorney for the Southern District of New York and the Federal Bureau of Investigation announced the filing of criminal charges against several people involved with the Galleon Group family of hedge funds and New Castle Funds, LLC, for allegedly engaging in a massive insider trading scheme.  Specifically, the government accuses Raj Rajaratnam, founder and manager of Galleon, Mark Kurland, a top executive at New Castle, and Danielle Chiesi, a New Castle employee, of contacting a network of close business associates, including Rajiv Goel, a managing director at Intel Capital, Anil Kumar, a director at McKinsey & Company, Robert Moffat, an IBM senior executive, and one another to obtain confidential information about corporate earnings and takeover activity at several public companies.  The complaints also accuse Rajaratnam of using that non-public information to illegally trade on behalf of funds under his management to obtain more than $20 million in profits.  According to federal prosecutors, this criminal action, brought in two separate, but interconnected criminal complaints, is the largest ever against a hedge fund for insider trading, and it represents the first time that the government has used wiretaps to target “significant insider trading on Wall Street.”  In a related action, the Securities and Exchange Commission (SEC) also filed a civil injunctive action in the United States District Court for the Southern District of New York against Rajaratnam, Galleon Management L.P., and the aforementioned executives based on the same allegations.  Nonetheless, this case implicates far more than just the run-of-the-mill SEC civil complaint.  Instead, as the United States Attorney remarked, it “should be a wake up call” for the entire hedge fund community.  We detail the factual allegations and legal claims in the criminal and civil complaints.

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