Opinion: Ring around the White Collar – The Aftermath of Raj
By Ken Springer
As Raj Rajaratnam departs from society in handcuffs and the trial has come to a conclusive and dramatic end, what impact will the jurors’ decision have on the investment community? Is Raj the symbol of the end of insider trading or merely the unfortunate soul who got caught? And, if this is the demise of securities fraud, is it also the beginning of an awareness that the government may forever be peeking over your trading shoulder? In my opinion, the answer is really a spumoni of the three.
The most overwhelming aspect of the Galleon trial was not the amount of money illegally profited or the number of people who pleaded guilty (21 out of 26 co-defendants), but rather that the government had expended vast resources and focus on the Raj insider-trading ring. The secretly recorded conversations were the first time ever that the government used wiretaps in a white-collar crime case; it was their “shock and awe” campaign. And, the root of those wiretaps? Tipsters (also known as friends and associates of Raj).
The wiretaps played a pivotal role in not only swaying the jurors (and the public) of Raj’s guilt but also in showing the investment community that the government is taking insider trading quite seriously. And their efforts do not end with Raj.
In 1999, Garrett Bauer, a trader, was sued by a broker-dealer that accused him of insider trading. The suit was dismissed because the judge said the plaintiff did not show enough evidence of the origin of Bauer’s sources (on which he received illegal information). The SEC apparently looked into Bauer as well but the case never materialized … at least not until April 2011 when Kenneth Robinson, a mortgage broker, pleaded guilty to securities fraud and conspiracy in New Jersey and, in doing so, sold out his counterparts, Garrett Bauer and Matthew Kluger (an attorney). Robinson admitted to the government that he had engaged in insider trading for over 17 years and the scheme allegedly reaped over $32 million in illegal profits. Bauer was only (and finally) charged by the government when they had information from an inside source (a cooperator).
OK, so do two insider-trading cases that relied on tips make a trend? No, but three certainly drives the point home….
In April 2011, the former SAC Capital analyst, Jonathan Hollander, reached a settlement with the SEC on allegations of insider trading. Without admitting or denying guilt, Hollander received a $222,000 fine. (And, yes, Hollander is a different case than Donald Longueuil, the other former SAC Capital analyst who pleaded guilty to insider trading as part of the Raj ring). Hollander’s charges appear connected to the case against Joseph Contorinis, a hedge fund manager for Jefferies Group who was convicted of making more than $7 million in illegal profits through insider trading in October 2010. In December 2010, Contorinis was sentenced to six years in prison.
Both Contorinis and Hollander were charged with insider-trading based on information reportedly given to the government by Nicos Stephanou, a banker involved with the case who pled guilty and agreed to cooperate with prosecutors. There is also speculation that charges against these individuals related to statements made by Ramesh Chakrapani, a former Blackstone Group banker who cooperated with the government after pleading guilty to securities fraud. The SEC case and criminal case against Ramesh Chakrapani were ultimately dismissed and it appears these dismissals are based on Chakrapani’s cooperation with the government.
Each of these cases relied on tips from other guilty parties. What if there was a way for a tipster, or anyone who knows about wrongdoing, to comply with his/her inner fiduciary duties (moral compass) and report this suspicious activity to someone other than the government? Wouldn’t this save a privately-held firm a lot of public embarrassment if they could control the information first, address it with outside counsel/board members first and then decide if the allegations were true and the malfeasance needed to be punished or handled by the government? Of course it would. Which is why hedge funds and others should implement an independent ethics hotline.
The Ethics Hotline allows managers, employees, vendors and others to anonymously report any fraud they have witnessed (or suspect). The complaint would go straight to an independent third-party who would vet the legitimacy of the complaint and then discuss the issue with outside counsel or board members to determine how to handle the matter. This obviously does not mean that the individual charged with wrongdoing will avoid being indicted by the government; the hotline is not designed to protect the guilty parties but rather the innocent firms who become ensnared in the messy publicity that walks side-by-side with the government when an investigation is announced or charges are filed.
A hotline also tells employees, investors and others that the firm is serious about maintaining a kosher work environment. A “no tolerance” policy for fraud is critical for individuals involved with the firm and for the government to notice should anything go wrong. As is the case with violations of the Foreign Corrupt Practices Act, the government has a proven pattern of leniency when it is aware that a firm has gone to great lengths to prevent fraud by various methods, to include a hotline. Sarbanes-Oxley requires publicly traded companies to have a whistleblower component, so it is only a natural progression for privately-held firms to proactively do the same to prevent their involvement in any compromising ethical and illegal situations.
The government certainly used the Raj trial to let the financial community know that not only will the illegal and informal sharing of information not be ignored but also that people who engage in this behavior should certainly second-guess the loyalty of their circle of friends.
Raj may be the biggest example to date of the ills of insider trading. But even if Raj was the government’s way of publicly sending a message, the Raj ring will surely not be the end of the government’s prosecution of insider-trading rings. And hedge funds and investment firms must realize that in order to succeed, they must understand and abide by the regulator’s playbook.
Educating hedge fund managers, analysts and traders with the SEC’s guidelines on acceptable business practices, Sarbanes-Oxley and the upcoming Dodd-Frank bill, will strengthen any firm’s sustainability. Enforcing these rules and regulations will allow a firm to fortify itself and avoid vulnerability to any individuals who engage in unauthorized behavior.
Circling back to the question I originally asked: what impact will Raj’s conviction have? The honest answer is we don’t know until we see what else the government will do to prove their point. In the interim, it is best for firms to address now the reality that regulators are most likely watching. Keeping employees informed and armed with the right tools of prevention, such as a hotline, is the best way to guarantee you and your company stay out of the courtroom.
Kenneth Springer is President and Founder of Corporate Resolutions Inc., a business investigations firm that conducts background checks and business intelligence globally and offers a suite of other specialized investigative services, to include an Ethics Hotline. Springer is a Certified Fraud Examiner and former Special Agent of the FBI and co-author of “Digging for Disclosure: Tactics for Protecting Your Firm’s Assets from Swindlers, Scammers and Imposters” (FT Press; January 2011). For more information about Kenneth Springer and Corporate Resolutions visit the company website at: www.corporateresolutions.com.