Former Wells Fargo & Co. (WFC) investment banker John Femenia was charged in Charlotte, North Carolina, last week with leading an $11 million insider trading ring that paid kickbacks in cash and gold for tips on corporate mergers.
In Santa Ana, California, former Major League Baseball player Doug DeCinces was charged last month with making $1.3 million on tips he got from an executive at a medical eye- products company. In Newark, New Jersey, U.S. prosecutors charged executives at three health-care companies Nov. 19 with trading on illegal information.
Insider trading has moved beyond its traditional confines on Wall Street -- and the U.S. government has followed. Investigators and self-regulatory bodies are working more closely and adopting new tactics to detect the lawbreakers wherever they trade.
“I don’t recall a time in history where this many U.S. attorney’s offices and the SEC have brought so many big insider cases in such a short period,” Daniel Hawke, director of the Securities and Exchange Commission’s Market Abuse Unit, said in an interview. “It shows there’s a high level of activity and energy and coordination.”
The number of people sued by the SEC or charged with insider trading by the Justice Department has more than doubled since 2008, data compiled by Bloomberg shows. There were 56 in 2008, 96 in 2009, 67 in 2010, 104 in 2011 and 125 this year. Of those, 22 percent were linked to trading involving health-care stocks.
People in many professions and relationships betrayed trusts to make a quick buck. Bankers, lawyers, accountants, doctors, traders, analysts, hedge-fund managers, company chiefs, pharmaceutical executives and movie producers got into the act, as did lovers, neighbors, classmates and fraternity brothers. Even families: The SEC sued Rex C. Steffes of Manhattan, Illinois, his three sons, his brother, and his brother-in-law over illegal trading.
In New York, Manhattan U.S. Attorney Preet Bharara has been focusing on Wall Street, attacking webs of hedge funds, corporate insiders and expert consultants. He secured 71 convictions since October 2009, including Galleon Group LLC co- founder Raj Rajaratnam and ex-Goldman Sachs Group Inc. director Rajat Gupta. On Dec. 17, jurors convicted Level Global Investors LP co-founder Anthony Chiasson and ex-Diamondback Capital Management LLC portfolio manager Todd Newman.
Bharara’s prosecutors also charged Mathew Martoma, a former SAC Capital Advisors LP fund manager, on Nov. 20 in what they called the most lucrative insider-trading case ever. The SEC sued as well, joining prosecutors in claiming Martoma used leaked data on a clinical drug trial to help SAC net $276 million in illicit profit and avoided losses.
Defense lawyer Charles Stillman has said he expects his client to be exonerated.
The case against Femenia was the first of its type in that area’s history, as the Justice Department and SEC showed an interest in regional banking centers like Charlotte, home of Bank of America Corp. (BAC), the second-biggest U.S. lender by deposits. Prosecutors there brought the Femenia indictment after working with SEC lawyers in Atlanta, who filed their own lawsuit a week earlier.
“The Southern District of New York is insider-trading Ground Zero,” said Anne M. Tompkins, the U.S. attorney for the Western District of North Carolina. “But we have thought for a long time that it happens all over the country, particularly where there is an investment banker.”
Inter-agency cooperation, new technology and old-fashioned squeezing of informants has helped government sleuths penetrate corrupt networks that swapped tips on corporate mergers, earnings results and clinical drug trials.
With help from the SEC, Bharara’s office and the Federal Bureau of Investigation built the Rajaratnam case through tactics traditionally used to combat organized crime, such as court-authorized wiretaps of phones, informants and cooperating witnesses. Jurors heard 45 of the 2,400 secretly taped conversations made during the probe.
Insider trading has offered an opportunity for the SEC to enhance its image. Enforcement division attorneys have worked to overcome the stain of failing to detect Bernard Madoff’s Ponzi scheme, the largest in history. After Madoff’s arrest in December 2008, money manager Harry Markopolos said the SEC failed to heed his repeated warnings about Madoff.
When Robert Khuzami took over as the SEC enforcement director in March 2009, he sought to rebuild the division’s credibility and ability to detect the next waves of fraud. In early 2010, he assigned more than 20 percent of his division to five specialized groups, including Hawke’s Market Abuse Unit.
Hawke, a 13-year agency veteran who runs the Philadelphia office, had already begun to develop better computer technology to detect suspicious traders. In February 2009, his office sued former UBS AG banker Nicos Stephanou and six others in a ring that made $11.6 million in illicit profit. Stephanou pleaded guilty and cooperated with prosecutors.
Stephanou, he said, was in one of several organized rings of financial professionals who systematically ferreted out and traded on inside information. Such rings lack the comfort of trusting leaks to relatives or old friends, so they often cover their tracks through disposable mobile phones, coded e-mails, middlemen and other deceptions, Hawke said.
The Stephanou case was a “direct result of innovative investigative techniques that the SEC is using to identify patterns of unlawful trading and suspicious relationships among traders,” Hawke said in a statement at the time.
With the creation of the dedicated unit, Hawke began to apply those new techniques more broadly. The agency is developing sophisticated computer programs to review trading records and identify relationships among traders and institutions.
While traditional insider-trading probes may have focused on, say, all the buyers of shares of a company purchased in the days before a takeover announcement, the new approach examines traders and the timing and volume of their buying and selling, Hawke said. It also looks for similar trading activity by investors, without being certain if they know each other, he said.
The SEC can request so-called Electronic Blue Sheets to examine U.S. equity order and trade information. The U.S. securities market has 13 stock exchanges and 11 options bourses.
“When you start with the trader and ask what stocks are common to the traders, you open up the potential for the number of stocks that could be common between them,” Hawke said. “You could detect patterns and relationships among people who appear to be trading in concert. The trader-based approach relies on a constant querying of that data.”
Hawke’s 57-person unit includes attorneys and supervisors, as well as quantitative analysts and specialists in trading strategy, securities operations, market structure and high- frequency trading. The unit seeks to focus on those cases that are difficult to detect and need close coordination with the criminal authorities, he said.
The Financial Industry Regulatory Authority, which oversees 4,500 brokers, and the Options Regulatory Surveillance Authority, also conduct analyses of trading patterns and alert the SEC and the Justice Department.
“Because of the increased diagnostic skills of our colleagues at the SEC, we’re able to drill much deeper into insider trading in ways that weren’t previously accessible to us,” said Douglas Leff, assistant special agent in charge at the FBI’s New York office.
The FBI also has hired its own analysts, forensic accountants and others with Wall Street experience, Leff said.
“The insider traders evolve into more cutting-edge ways to conceal their activities,” Leff said. “So we work more closely than ever with our friends at the SEC and Finra.”
While the trader-based approach to detecting suspicious trades may offer powerful suggestions of relationships, SEC lawyers and FBI agents still need to build cases through phone records, bank statements and trading records, Hawke said.
While the SEC had typically asked people why they made certain trades, which locked them into an explanation, that approach doesn’t work with rings, Hawke said.
“In many cases, we don’t call up people now and ask them why they trade,” Hawke said. “The people who are being arrested in many instances are learning about the investigation for the first time on the day of their arrest.”
Hawke’s approach bore fruit last year in the investigation of New York trader Garrett Bauer, who had long come under SEC suspicion as the possible recipient of inside information. After a 2007 investigation of Bauer, the agency continued to monitor Bauer’s trades to try to establish his possible source.
By 2009, the agency determined that Bauer often traded in the same stocks as Kenneth Robinson, a mortgage broker and his friend. After watching Robinson’s trades, the SEC came to suspect that his source may have been at Wilson Sonsini Goodrich & Rosati PC, a law firm involved in deals.
The SEC took their suspicions to the U.S. prosecutors in New Jersey, who worked with the FBI to approach Robinson. He agreed in March 2011 to cooperate. Robinson confessed that his friend, Wilson Sonsini attorney Matthew Kluger, was the source. Robinson said Kluger stole merger tips from four law firms where he had worked over a 17-year span. Robinson passed the tips to Bauer, who made trades and rewarded the other two with cash.
Robinson agreed to make secret recordings of Bauer and Kluger, who incriminated themselves before their arrest in April 2011. Prosecutors later said the scheme netted $37 million in illicit profit, with Bauer making the most by far.
All three men pleaded guilty. Kluger was sentenced to 12 years in prison, the longest ever in an insider trading case; Bauer got nine years; and Robinson received 27 months.
“The automated trading analysis helped us to establish the relationship and gave us the pattern evidence to take to the criminal authorities to go to Robinson,” Hawke said.
Hawke’s office also filed a lawsuit over the novel insider trading case of Timothy McGee, a financial adviser from Malvern, Pennsylvania. McGee learned in 2008 from a friend who worked at Philadelphia Consolidated Holding Corp., an insurer, that it would be bought by Tokio Marine Holdings Inc. (8766), according to the SEC.
The friend was a Philadelphia Consolidated executive who met McGee through Alcoholics Anonymous. The men had known each other for a decade, sharing personal and professional confidences, according to the agency. The friend returned to AA meetings in July 2008. He told McGee he was helping to negotiate the sale and was under great pressure, the SEC said.
McGee, 48, then bought shares of Philadelphia Consolidated and sold them after the July 23, 2008, announcement of the $4.7 billion acquisition. McGee made illicit profit of $292,128, according to the SEC.
McGee, who was also charged criminally, was convicted Nov. 15 of securities fraud and perjury after a trial in Philadelphia. Jurors rejected McGee’s argument that the friend never disclosed any material nonpublic information to him, which meant he couldn’t have engaged in insider trading.
His lawyers have asked the judge for a new trial.
“Prosecutors had to prove that they had a history of sharing this particular type of business information, and the testimony made clear that the friend had never shared confidential business information with Mr. McGee in the past,” said McGee attorney John J. Rice in an interview. “AA certainly did not create any duty of confidentiality between the men.”
Femenia’s indictment in Charlotte accuses him of stealing information from Wells Fargo about mergers and acquisitions, which he sold to friends in exchange for kickbacks of cash and gold bars. Eight others were indicted, including Shawn Hegedus and his girlfriend, Danielle Laurenti. Both are considered fugitives, according to prosecutors.
The six other defendants -- Matthew Musante, Frank Burgess Jr., Aaron Wens, Roger Williams, Kenneth Raby and James Hayes -- have agreed to plead guilty and cooperate with the government, according to court records. Wens entered his guilty plea today.
Femenia, 31, appeared today in federal court in Charlotte, where he pleaded not guilty. He remains free on bail. At the hearing today, a judge ordered him to keep a written log of all of his phone calls and all of the phones he is using.
His attorneys, Mark Jones and Scott Morvillo, declined to comment.
“This was an insider trading phone tree to friends for the purpose of everybody making some money and the banker getting some kickbacks,” Tompkins, the top federal prosecutor in Charlotte, said in an interview this week.
She said her office and the SEC may bring different cases as well through a task force they’ve formed.
“If we can get on these cases, work them hard, and bring them to conclusion quickly, it sends a strong a message, that this activity’s not just happening in New York,” Tompkins said. “The message that it sends to citizens and potential defendants is that there are a large number of eyes upon them.”
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