The October 9 Milbank Tweed Forum, “Insider Trading: Hedge Funds in the Crosshairs,” featured a panel of experts analyzing recent developments in insider trading prosecutions. Moderated by Vice Dean Kevin Davis, Beller Family Professor of Business Law, the discussion delved into the more ambiguous aspects of defining insider trading and pursuing those suspected of engaging in it. The panel, Davis noted, served as one of the lead-off events for a new Program on Corporate Compliance and Enforcement, directed by one of the Forum panelists, Jennifer Arlen ’86, Norma Z. Paige Professor of Law.
When it comes to hedge funds, Davis said, a certain fine line comes into play. “On the one hand, no one wants to trade in a market where the big guys have the insurmountable advantage because they’ve basically stolen the information,” he said. “On the other hand, especially when it comes to insider trading by hedge funds, we’re concerned because we want investors to go out there and dig up all the information they can about issuers and securities to make sure that the price of the securities reflects all possible information.”
New York Times Dealbook reporter Peter Lattman pointed to the government’s “extraordinary campaign” over the past four years to root out insider trading, with many of the cases undertaken in the Southern District of New York. The prosecution of Raj Rajaratnam, founder of the Galleon Group, was a watershed case from which the indictments of 80 or so other individuals emanated.
In July, the U.S. Securities and Exchange Commission filed a civil suit against SAC Capital Advisors; at the same time, the Department of Justice brought criminal charges. It was a rare instance of an entire entity being prosecuted, as opposed to individual wrongdoers within a firm.
Arlen, an expert on corporate criminal liability, explained two different ways in which the threat of liability could be used: to bring the firm to the government’s side in working to prosecute individuals in exchange for greater leniency toward the overall firm, and, conversely, to bring to account the leadership of a firm—who may have looked the other way—by prosecuting the entire organization when the evidence does not allow for an individual prosecution of the people at the top.
Arlen explained that individual liability for failure to oversee was harder to prosecute than corporate criminal liability. “All you need to show is what the government can probably prove quite easily with SAC: an employee of SAC committed insider trading in order to trade his clients’ funds for the profit of the fund and for SAC,” she said.
Bonnie Jonas, deputy chief of the Criminal Division and assistant U.S. attorney in the U.S. Attorney’s Office for the Southern District of New York, added that such corporate prosecutions were rare. U.S. attorneys must consider nine different factors, she said, before pursuing that route, including the pervasiveness of wrongdoing within a corporation, the level of the firm’s cooperation, remedial actions that the firm had undertaken, and the collateral consequences of a prosecution on shareholders and other relevant parties.
John Nathanson, a partner at Shearman & Sterling who has defended numerous clients in insider-trading cases, joined several other panelists in pointing out the recent trend in wiretapping in these investigations. The development originated with a former narcotics prosecutor who decided to apply the tool of wiretapping to insider trading. While it was not the first time wiretaps had figured in a white-collar case, Nathanson said, “It was novel to use it against an otherwise legitimate business and legitimate businesspeople.”
Jonas called wiretaps “the gold standard of evidence,” explaining, “There’s nothing like presenting to a jury the defendant’s voice on a tape saying something incriminating.” She also acknowledged the argument that cases without wiretap evidence might now be more challenging to win before juries, but added that emails, texts, and cooperating witnesses were equally powerful tools in her arsenal.
Arlen pointed out that, by their very nature, hedge funds operate at the edge of legality by seeking information their competitors lack, creating the danger of breaking the law either by accident or by design. Nathanson echoed this idea: “You have all this information coming into hedge funds…. A lot of that is fairly specific, and a lot of it is arguably immaterial. But the hedge fund portfolio manager, with an understanding and knowledge of markets and companies, can put that seemingly immaterial information together through something usually termed the mosaic theory to make an investment decision.”
In the end, the panelists suggested that, whatever one’s view of recent insider trading prosecutions, a more robust compliance culture had been a positive result, with innovative use of wiretapping and the collection of digital evidence creating new deterrents for potential insider trading. Of the 70 prosecutions Jonas’s officer has brought, 60 defendants have pleaded guilty and 10 have been convicted at trial.
Given that excellent track record, Jonas suggested that, contrary to some opinion, her office’s cases were much more bright-line than gray. Nevertheless, Nathanson argued, when it came to defining material non-public information, “there is difficulty in understanding where those lines are.”
Watch the full video of the event (1 hr, 21 min):
Posted on October 15, 2013