The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

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By Topic: Wiretaps

  • From Vol. 6 No.27 (Jul. 11, 2013)

    Second Circuit Rules on Suppression of Wiretap Evidence and Application of the “Knowing Possession” Element of Insider Trading in Upholding Raj Rajaratnam’s Conviction for Insider Trading

    In 2011, Raj Rajaratnam, the founder of the Galleon hedge fund group, was convicted on fourteen counts of securities fraud and conspiracy to commit securities fraud arising out of insider trading in the securities of numerous companies.  He was sentenced to 11 years in prison.  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).  The case was unusual, not only because of the stiff sentence, but also because it turned largely on evidence derived from wiretaps of Rajaratnam’s telephone conversations.  For more on the use of wiretaps, 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).  The trial judge denied Rajaratnam’s motion to suppress that evidence.  On June 24 of this year, the U.S. Court of Appeals for the Second Circuit (Court) upheld Rajaratnam’s conviction and ruled that the U.S. District Court for the Southern District of New York (District Court) correctly refused to suppress the wiretap evidence against Rajaratnam.  The Court also ruled that the District Court properly instructed the jury that it could convict Rajaratnam if it concluded that “material non-public information given to the defendant was a factor, however small, in the defendant’s decision to purchase or sell stock.”  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).  This article summarizes the Court’s decision and, more importantly, its analysis in ruling on the appeal.

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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. 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.24 (Jul. 14, 2011)

    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?

    Much has been said of late about the new investigative and enforcement tools being used by the Securities and Exchange Commission (SEC), Department of Justice (DOJ) and Federal Bureau of Investigation (FBI) to combat insider trading.  See “The SEC’s New Focus on Insider Trading by Hedge Funds,” The Hedge Fund Law Report, Vol. 3, No. 22 (Jun. 3, 2010).  On the civil side, the SEC has restructured its Enforcement Division into industry units, hired former federal prosecutors to serve in the Enforcement Division, authorized Enforcement Division staff to enter into non-prosecution agreements and cooperation agreements and increased its use of technology to analyze trading trends for suspect patterns.  See “SEC’s Hedge Fund Focus to Include Review of Funds That Outperform the Market,” The Hedge Fund Law Report, Vol. 4, No. 14 (Apr. 29, 2011).  On the criminal side, the DOJ and FBI have incorporated into their anti-insider trading efforts tools formerly reserved for the investigation and prosecution of organized crime.  Most notably, the FBI is using wiretaps in its investigations of hedge fund managers for insider trading, and the DOJ is using the fruits of such wiretaps in its prosecutions.  The legal authority for the agencies to use wiretaps in the hedge fund context was affirmed in an important district court decision in November 2010.  See “Federal District Court Upholds the Government’s Right to Use Wiretaps to Investigate Suspected Insider Trading by Hedge Fund Manager Personnel,” The Hedge Fund Law Report, Vol. 3, No. 48 (Dec. 10, 2010).  And, of course, the most notable example (to date) of the government’s successful use of wiretap evidence in an insider trading prosecution in the hedge fund context was the May 11, 2011 conviction of Galleon Group founder Raj Rajaratnam.  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).  Prior to the use of wiretap evidence in insider trading investigations and prosecutions, most insider trading cases were based on circumstantial evidence.  With the advent of the use of wiretap evidence in this context, insider trading cases can now be based on direct evidence.  As some white collar defense attorneys observed, although Rajaratnam elected not to take the stand at his own trial, he nonetheless served as the prosecution’s “star witness.”  Rajaratnam’s voice appeared in hours of recorded phone calls that were played for the jury, discussing what the prosecution characterized as material nonpublic information.  For the defense, these recordings proved insurmountable.  In short, wiretapping by the government has changed the landscape of insider trading law for hedge fund managers.  But the government is not the only party that records phone calls.  With a level of frequency that keeps white collar defense lawyers up at night – although some of them are up thinking about new business rather than worrying – hedge fund managers and other hedge fund industry participants record their own phone calls.  Often, they do this for what they consider practical reasons rather than for legal or regulatory reasons.  For example, a manager that submits frequent trade orders to its brokers may record calls to create a record for any dispute over a trade error.  Or a manager may record an analyst’s calls with an expert found via an expert network for compliance reasons.  However, in the current enforcement climate, any hedge fund manager that records its own phone calls must weigh the perceived benefits of such recordings against the possibility that recorded calls will be admitted into evidence (and invariably taken out of context) in a civil enforcement action or criminal prosecution.  A June 29, 2011 Opinion by U.S. District Court Judge Jed Rakoff illustrates the legal standards that govern admission of phone calls and other communications recorded by a hedge fund manager in a criminal proceeding against a third party alleged to have provided material nonpublic information to the manager.  For discussion of other opinions by Judge Rakoff in the hedge fund context, see “A Prime Broker that Fails to Diligently Investigate the Sources of Funds in a Hedge Fund’s Margin Account May Be Jointly and Severally Liable, with the Fund and Its Manager, for Fraud by the Manager, to the Extent of Funds in the Account,” The Hedge Fund Law Report, Vol. 3, No. 47 (Dec. 3, 2010); “In Refco Securities Litigation, Federal Court Declines to Impute the Bad Acts of Individual Directors of a Hedge Fund Management Company to the Management Company Itself, or its Funds,” The Hedge Fund Law Report, Vol. 4, No. 15 (May 6, 2011).

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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.41 (Oct. 22, 2010)

    Decision in the Galleon Matter Illustrates Application of Wiretap Law in the Hedge Fund Context

    On September 29, 2010, the U.S. Court of Appeals for the Second Circuit issued a writ of mandamus on behalf of Raj Rajaratnam, founder and general partner of Galleon Management, LP and Danielle Chiesi, former manager and consultant of New Castle Funds LLC (Defendants).  The writ vacated a discovery order of the U.S. District Court for the Southern District of New York that had required Defendants to disclose thousands of wiretaps to the Securities and Exchange Commission (SEC) as part of its civil enforcement action.  Defendants had obtained those wiretaps from the U.S. Attorney’s Office (USAO) in a parallel criminal action against them pursuant to Title III of the Omnibus Crime Control and Safe Streets Act of 1968 (18 U.S.C. §§2510-2522) (Title III or the Act).  Recognizing that the USAO had taken the position that the Act prohibits it from disclosing these wiretaps to the SEC, the Second Circuit held that the Act does not prohibit a federal court from ordering the Defendants to disclose that information during discovery in a civil action.  It reasoned that, in this instance, the district court clearly abused its discretion by issuing the order prior to a criminal court “ruling on the legality of the wiretaps and without limiting the disclosure to relevant considerations.”  We detail the background of the action and the Second Circuit’s legal analysis.

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