Wiretaps and Rajaratnam

Originally published in the October/November 2011 issue

“Game done changed’’ says a character early on in the third season of HBO television series The Wire. ‘’Game the same,’’ comes the reply ‘’Just got more fierce’’.

While the UK’s Financial Services Authority has been gaining commendable traction with insider dealing and market abuse enforcement in the last few years, the authorities on the other side of the Atlantic have intensified their own efforts and approach as evidenced by the use of surreptitious wiretaps and multiple targets in the Galleon case. The 11-year sentence handed to Raj Rajaratnam, co-founder of defunct hedge fund Galleon, is the longest ever handed down for a crime of this nature. Indeed, it was considerably less than the 24 years requested by the prosecution and was reduced on account of the disgraced billionaire’s ill health and past charitable donations.

It has been said that an impediment to the successful prosecution of white collar crimes is that juries are unable to understand them. However, this was not a technical infringement with the jury agreeing with the prosecution’s case that Rajaratnam had been guilty of deliberate conduct calculated to profit (to the tune of millions of dollars) from illicitly obtained company information not yet known by the market.

Shorter UK sentences
The 11-year sentence exceeds the current maximum of seven years available to a UK criminal court. Earlier this year in May, the FSA’s Interim Managing Director and former Head of Enforcement, Margaret Cole, asked the UK government to increase the maximum sentence for insider dealing from seven to 10 years in order that insider dealing penalties be put in line with other types of white-collar offences in the UK. Until such an increase, one can envision the FSA eyeing the seven-year maximum as a target to be achieved. Currently, convicted insider trader Christian Littlewood represents the high water mark sentence at 40 months.

Telephone record evidence
The most striking feature of the Galleon case is its use of wiretap evidence revealing private conversations in which Rajaratnam gleaned and shared non-public company information. While evidence of wrongdoing obtained in this way is not admissible in UK court proceedings (material obtained from a wiretap may only be used for background intelligence and is not itself admissible), the UK regulator has had access to mandatory voice records of traders’ calls since March 2009 and this will be extended to mobile phones in November 2011. The requirement is for firms to maintain such records for six months. The FSA’s recently enhanced trade surveillance system, ZEN, enables it to detect dubious transactions which may result in the FSA contacting firms requesting that they preserve voice records beyond the six-month timeframe.

The legal restrictions preventing the FSA from obtaining interception warrants under UK law has meant that the FSA has carefully chosen to focus on other avenues to enhance its evidence gathering ability.

Cold calling

The most intrusive technique divulged in recent years was the revelation by the FSA in early 2008 that it had been cold calling traders and investors that had engaged in transactions that stood out and required fuller explanation. These telephone interviews are made without prior notice to the trader or investor or their employer.

The FSA also lobbied strongly to widen its powers, leading directly to it being granted on 6th April 2010 the position of a ‘Specified Prosecutor’ under the Serious Organised Crime and Police Act. This enables the FSA to offer, in criminal proceedings, immunity or a potential reduction in a possible sentence to suspects in return for hard evidence against others.

The first notable use by the FSA of these powers was the case of Anjam Ahmad in June 2010. The judge stated that Ahmad was saved from immediate imprisonment for insider trading only because the FSA had complied with the Attorney General’s guidelines on plea bargaining with the defendant providing significant information relating to another case.

The FSA’s power to offer partial or full immunity in criminal matters was actually preceded by an amendment to its enforcement rules. This occurred in relation to matters taken down the civil route with the FSA choosing which route best suits the circumstances and evidence available for each investigation. In December 2008, the FSA introduced a leniency policy for dealing with suspects who assist the FSA in investigations. Leniency being a term not usually associated with the FSA and its vocal credible deterrence agenda.

In December 2010, we learned the full extent of the policy in the form of leniency granted to Bertie Hatcher in return for evidence given against the convicted and imprisoned Malcolm Calvert. Formerly an equity marketmaker at Cazenove, Calvert was sentenced to 21 months in prison in March 2010 for insider trading while his co-conspirator Hatcher was fined the precise amount he had made as a result of the behaviour, an extremely favourable outcome for Hatcher in the current climate.
The FSA’s policy on leniency was succinctly summed-up in the Final Notice relating to Bertie Hatcher: “The FSA is mindful of the need to encourage others to provide the FSA with information that may assist in the investigation and prosecution of suspected cases of insider dealing and market abuse, especially where it is suspected that the misconduct has occurred as a result of two or more persons acting in concert to commit market abuse.” Plea bargaining with key witnesses was almost certainly a feature of the Galleon case.

Expert networks
The Galleon case also shone a light on the use of expert networks as a modern technique by which the investment community seeks to obtain company or industry information. Expert networks are commercial research firms which provide their clients, on a subscription basis, with access to experts with experience across a range of industries arising from their past or current employment. The use of these networks is not illegal and can be a legitimate and valuable part of the investment process. However, the Galleon case and the SEC charges brought against six expert network consultants for illegally tipping hedge funds and other investors earlier this year, has heightened regulators’ interest and assumption that expert networks could potentially facilitate the exchange of material non-public information.

The FSA has not yet published any material specifically on expert networks. However, it has published ample views and commentary on necessary anti-market abuse controls to supplement the UK securities legislation itself. As expert networks are an unregulated business, it is essential that subscribers to this service protect themselves from being tainted with the receipt of inside information, either deliberately or negligently by the expert. A firm should consider the quality, effectiveness and transparency of the compliance standards of the expert networks it might seek to engage and remind its employees that fundamental inside information considerations should be taken into account when engaging in any consultation.

Increased ferocity
The increasing ferocity with which securities regulators are targeting capital market misconduct, especially since the financial crisis, is something that market participants everywhere in the world, should take due notice of. The Galleon case serves a stern warning of the likely implications of deliberate misconduct. Let’s not forget that wilful transgression was the defining feature of that case. However, here in the UK, regulated firms need to maintain awareness of and meet the FSA’s expectations with regard to preventative measures and controls.