The FBI files spell it out: An analyst at Citadel LLC, the hedge fund with $23 billion in capital invested globally, told agents he made millions of dollars trading on information from a company insider.
It was December 2011, and the Justice Department was deep into a seven-year investigation into illegal stock tips. As authorities homed in on people at several other hedge funds over leaks from a Dell Inc. employee, agents at the Federal Bureau of Investigation began questioning the Citadel analyst about the friendship he formed with the same Dell insider.
In confidential FBI reports summarizing those interviews, agents recounted how the Citadel analyst received market-sensitive information from the Dell employee in 2008 and 2009. In one trade he told agents he made, the analyst bet against Dell after learning it would announce disappointing earnings, bringing in $5 million to $6 million when the company’s shares fell by more than 10 percent. He told agents he later discarded records.
The analyst discussed helping the Dell employee hunt for a Wall Street job, the agents wrote. “It became an ‘I’ll scratch your back if you scratch mine’” relationship, the agents wrote in a summary of a Jan. 4, 2012, interview with the analyst.
Nine people at five investment firms were eventually convicted in part for trading on tips from inside Dell.
Neither the analyst, Richard Farmer, nor the Dell employee, Rob Ray, was sued by regulators or prosecuted. Chicago-based Citadel hasn’t been accused of wrongdoing.
Four people familiar with the probe said U.S. authorities investigated Farmer. Those people, who spoke confidentially because the matter isn’t public, said authorities didn’t have evidence to charge him. They declined to elaborate.
Both Farmer and Ray have since left their jobs. The previously undisclosed relationship described in the FBI documents recapping agents’ interviews -- two with Farmer and five with Ray -- were among dozens of such summaries reviewed by Bloomberg News.
Those documents offer a glimpse into how authorities mounted their insider-trading investigation starting in 2007, an effort that led to more than 80 convictions, brought down at least five hedge funds and resulted in more than $2 billion in payments from defendants as part of the largest such action in U.S. history. The Dell tips from Ray were part of Manhattan U.S. Attorney Preet Bharara’s highest-profile prosecution, against Steven A. Cohen’s SAC Capital Advisors LP, which Bharara branded a “veritable magnet for market cheaters.”
By the Rules
Insider trading had become rampant on Wall Street, Bharara has said, eroding trust in financial markets and harming honest people who make trades based on publicly available information.
“Part of our job is to make sure that the world understands,” Bharara said in a Jan. 7, 2014, interview on PBS’s Frontline, “that it doesn’t matter who you are, how much money you have, who you’re connected to, that you have to play by the same rules as everyone else.”
The FBI summaries show how investigators’ work took them down a previously unreported path into Citadel.
The Chicago fund’s name surfaced once in connection with Bharara’s probe. The July 2013 indictment of SAC Capital said Cohen received a warning about someone he wanted to hire. An unnamed employee of an unidentified hedge fund told Cohen that the prospective hire was part of an “insider trading group” where he worked. That fund was Citadel, people familiar with the prosecution said.
Citadel, in a statement at the time, called the claim baseless. SAC hired the person, who had worked in a different part of Citadel than Farmer, as a portfolio manager. He was later convicted of insider trading at SAC.
Farmer, approached at his home in July when he was still working for Citadel, declined to comment. He has since left the firm “on amicable terms,” according to his lawyer, David Stetler.
“When contacted by the government, my client truthfully and candidly answered any and all questions, allowing the U.S. Attorney to conclude that no charges were warranted,” Stetler wrote in a statement. “In fairness, that should be the end of the story.”
Chris Sinos, a spokesman for the FBI in New York, declined to comment on the investigation. Jerika Richardson, a spokeswoman for Bharara, declined to comment on the government’s actions.
Bloomberg News reviewed information about the investigation with Citadel officials, none of whom commented for this article.
Breach of Duty
Insider-trading cases can be complicated to make. Courts keep refining what prosecutors must prove. Among the things they must show is that the person giving the information received a benefit, and that people trading on the tips knew the tipper breached a duty of confidentiality.
At the center of the Dell-leaks story was Ray, who in 2008 was a junior member of the computer-maker’s investor-relations team.
Ray shared tips with Sandeep “Sandy” Goyal, a Wall Street analyst who in turn passed along the information to others. That’s according to testimony from Goyal, which the government used to build part of its case against several hedge-fund managers. Ray was identified in trials against three of those people but didn’t testify.
A federal court in Manhattan is now weighing the appeals of two of those convicted for trading on Dell tips. The FBI documents don’t address issues before the appeals court. They do show that Ray’s tips to Goyal weren’t isolated -- flowing, too, to Farmer at Citadel.
An attorney for Ray told prosecutors, in a confidential 2012 letter, that Ray didn’t believe he’d done anything illegal. Ray hired the lawyer, Joanna Hendon, after he and a different attorney met with the FBI. In the letter, addressing Ray’s alleged leaks to Goyal, Hendon said it was her speculation that if her client indeed leaked Dell information, it was because he was manipulated.
The FBI documents represent federal agents’ retelling of the interviews with Farmer and Ray. Agents typed up official reports from interviewers’ handwritten notes, sometimes weeks later. Information ascribed to the subjects, including dates of conversations or trades that took place roughly three years earlier, were at times imprecise. The reports generally don’t specify whether passages that appear inside quotation marks are the agents’ words or those of the interview subjects.
The FBI interviews with Ray and Farmer -- as well as portions of Goyal’s trial testimony and interviews he gave to the FBI -- provide similar accounts. Both Farmer and Goyal got what they believed was nonpublic information from Ray ahead of Dell announcements and offered to help him find an investment-management job, agents wrote.
Ray, now 39, and Farmer, 42, came to authorities’ attention more than four years after agents in the government’s insider-trading probe secured their first cooperating witnesses, and two years after prosecutors made their first big public splash with the arrest of Galleon Group LLC co-founder Raj Rajaratnam.
By late 2011, when the FBI began interviewing Ray and Farmer, the government already had gained the secret cooperation of at least three men who said they were part of a group swapping inside tips about technology companies. Among these government witnesses was Goyal, an analyst at New York-based Neuberger Berman.
Goyal’s testimony in a 2012 insider-trading trial outlined a relationship with Ray that stretched back to their university days. They later worked together at Dell.
Goyal told jurors he had relayed “confidential information” about Dell to an analyst at Stamford, Connecticut-based Diamondback Capital Management LLC. The tips came from Ray, Goyal said, adding that Ray had sought resume advice and help getting a job in investment management.
He didn’t identify Ray to the Diamondback analyst, he testified, telling the analyst the tips came from a Dell insider who worked in investor relations and then corporate development. To Ray, Goyal said he was using the Dell data for his own financial analysis and didn’t reveal that he was passing the information to others.
Ray’s lawyer, Hendon, speculated in her 2012 letter to U.S. prosecutors that “if Mr. Goyal obtained material nonpublic information from my client, he may have done so by out-maneuvering a relatively junior I.R. professional.”
Goyal and four others pleaded guilty in part to trading on the Dell tips. His testimony, along with accounts of others in the group and e-mails of members swapping tips on tech firms including Dell, helped convict three hedge-fund managers.
Ray’s Dell tips had also been reaching someone at Citadel, Goyal told agents during his own FBI interviews.
Goyal said Ray had spoken of being contacted by a Citadel employee, Farmer, who “was very aggressive” and “trying to get numbers and data points from Ray,” FBI agents wrote in summarizing the interviews with Goyal.
On Dec. 8, 2011, two FBI agents approached Ray, who was no longer working at Dell, near his new offices.
“Ray stated that he knew what he did was wrong and that he wanted to do whatever he can to cooperate and help the government,” FBI agents wrote in a summary of that meeting. “Ray stated that he got caught up in getting into the buy-side and that he crossed the line.”
The agents encouraged him to attend an interview at a U.S. Attorney’s Office.
The next day, Ray told the FBI about how he met Farmer at a Dell investor-relations dinner at the Marriott Hotel near Dell’s Round Rock, Texas, headquarters in late 2007 or early 2008. Soon after, Ray began sharing guidance on Dell results, including projected gross margins. He said he “would have been reprimanded if Dell listened into his calls with Goyal and Farmer,” agents wrote in a summary of the Dec. 9 interview.
Ray gave that and the previous day’s comments without a lawyer present. During three interviews in January 2012, he was accompanied by attorney Richard Langweber, who declined to comment.
Some of the summaries of agents’ interviews with Ray and Farmer were marked as proffers. Under such agreements, authorities interview potential witnesses, defendants or others to build investigative leads while agreeing generally not to use interviewees’ own statements as evidence against them.
Prosecutors may grant immunity to the people interviewed, offer a plea deal, let the matter drop or pursue a case based on other evidence. Those found lying to federal agents can be prosecuted. During the insider-trading probe, scores of people sat for interviews with the FBI.
On Dec. 30, 2011, the last day of a slack holiday trading week, an FBI agent and two assistant U.S. attorneys met with Farmer and his lawyer.
Farmer, a Colorado native with a Dartmouth College psychology degree and a University of Chicago MBA, covered technology stocks at Merrill Lynch until 2007. Citadel then hired him as an analyst, an agent wrote.
Farmer began calling Ray with questions about the industry shortly after the two met at the Dell dinner, agents cited both men as saying. Farmer told the FBI he eventually acted as a mentor, editing Ray’s resume and talking about job leads.
Ray said his investor-relations work gave him access to a “nitty gritty level” of detail about Dell’s finances. Ray said he and Farmer chatted on mobile phones, with some of the conversations occurring during the quiet period ahead of Dell’s quarterly earnings releases, a time when companies must limit the information they make public. The conversations included financial details, agents wrote, such as “percentages, tight ranges, gross margins and which parts of Dell’s business was going well.”
In his interviews, Ray said Farmer would provide a gross margin range, such as 17 percent to 18 percent, and Ray would say more specifically what the margin would be. Farmer, in his interviews, said he had asked Ray if operating margins “could be worse than ‘X,’” the agents wrote.
The analyst said he understood he was receiving confidential information that wasn’t available to everyone, agents wrote. He “got inside information from Ray for three or four quarters,” they wrote.
Hendon, Ray’s current lawyer, said her client didn’t break the law.
“Ray told the agents he provided analysts with information and ‘color’ vetted by his supervisors, that he did not believe he had done anything wrong, and that he was unaware of insider trading by anyone,” Hendon said in a statement.
“Under pressure, he agreed with the suggestion -- advanced many times by the agents and rejected as many by Ray -- that it was ‘possible’ he had ‘crossed a line’ when speaking to analysts. (Getting to the buy side was another of the agents’ suggestions.) The next day, Ray told the agents he wanted to recant that statement, because it was not true,” Hendon said.
Lawyers for three of the men who were convicted in part for trading on Dell tips that traveled through Goyal -- Level Global Investors’ Anthony Chiasson, Diamondback Capital’s Todd Newman and Michael Steinberg of Stamford, Connecticut-based SAC Capital -- argued at trials that prosecutors didn’t show that what their clients did was illegal.
Attorneys for Chiasson and Newman said their clients didn’t know whether the source of the Dell data divulged confidential information or received a benefit for doing so, as they say prosecutors must show. These lawyers argued at trials that Dell’s investor-relations unit was “leaky” -- giving out advance word about finances to build relationships with firms that might invest in Dell.
At the trials, a Dell official denied the firm was leaky. “Dell would not authorize providing confidential financial information or any other confidential information outside the company,” David Frink, a Dell spokesman, said in a statement. He declined to comment on Ray.
The government also undermined the cases it built on the Dell tips by not prosecuting Ray himself, attorneys for Chiasson and Newman argued in their appeal. Whether or not Ray was charged shouldn’t affect the appeal, prosecutors have said.
Steinberg’s appeal hasn’t yet been heard and is pending the court’s ruling on Chiasson and Newman. Attorneys for Chiasson, Newman and Steinberg declined to comment for this article.
At Citadel, analysts such as Farmer could trade portions of a portfolio and share in the gains and losses stemming from their picks. Farmer said a superior had berated him for his performance and urged him to take some “swings” trading stocks, the agents wrote.
Agents described trades that Farmer said he made, starting in 2008, using the Dell tips. It wasn’t clear whether he was working from memory during the interviews.
Farmer recalled that he used Ray’s tips in the summer of 2008, according to the FBI memos. In July, agents wrote, Farmer held a short position in Dell, a bet that the shares’ value would fall. Ray helped Farmer to confirm his view about Dell’s weakness, the agents wrote. Farmer told the agents that he brought in $5 million to $6 million, they wrote, when the shares dropped 15 to 18 percent.
It was the next month -- after markets closed on Aug. 28, 2008 -- that Dell announced its gross margin, and profit, had missed analysts’ projections. Shares fell 13.8 percent the next day and Dell lost $7 billion market value as roughly 100 million shares changed hands, more than twice the trading in the days before and after. Prosecutors characterized trades that Chiasson, Newman and Steinberg made on the gross-margin miss, based on information that came through Goyal, as “the big shorts.”
Farmer also told the agents that before Dell’s 2009 meeting with analysts, Ray -- who had by then moved from his job in investor-relations to corporate development -- had “volunteered that there was margin pressure.” Farmer reversed his small bet that Dell shares would rise and shorted them instead, agents wrote in the interview summary. The trade brought a six-figure profit when the news became public, they wrote.
When Dell publicly released its worse-than-projected figures after markets closed on July 13, 2009 -- the eve of Dell’s analyst day -- the company’s shares fell 8.1 percent.
Farmer had another conversation with Ray after analyst day in which Ray advised Farmer that margins were even worse than reported, the agents wrote. Farmer made his short position larger, they wrote.
Another trade by Farmer described in the FBI documents wasn’t consistent with events at the time.
By the second half of 2009, federal lawmakers were at work on legislation, which became known as the Dodd-Frank Act, laying down new rules on how banks and hedge funds should retain trading records. The October 2009 arrest of Galleon’s Rajaratnam, meanwhile, sent shock waves through the hedge fund world.
Shortly after returning from a trip in late 2009, Farmer erased electronic notes, in Microsoft Word format, that were stored on thumb drives, Zip drives and a shared drive at Citadel, agents wrote in a summary of one of the interviews with him. Farmer also threw away his handwritten notes because that was his normal practice and because they were incriminating, agents wrote.
Farmer got rid of e-mails as well, according to their summary.
“This,” they wrote, “wiped the slate clean.”