Circle of Friends (15 page)

Meanwhile, investigators believed the deterrent value of nailing a Wall Street trader was huge. Indeed, Babcock fancied himself as a tough jock, particularly in the macho atmosphere of the Wall Street trading desks where he worked. But rather than go to jail, the former college lacrosse player agreed to cooperate as well, wearing a wire and helping the feds nail down others involved in both the UBS trades and in passing along Morgan Stanley's pre-merger deal information.

Like Franklin, Babcock was rewarded for his cooperation and pleaded guilty to a felony but no jail time. Guttenberg wasn't so lucky; he was sentenced to seventy-eight months in a federal prison.

Babcock has told friends that while working as an informant at one point he tried to get his boss Butenhoff to concede to knowledge of the illegal activities, but without any luck. “He kept asking me weird questions,” was how Butenhoff later described Babcock's efforts. To date, Butenhoff hasn't been charged, much less questioned by federal authorities about being part of the ring.

Babcock, for his part, has also told friends that he recently touched base with Franklin to patch things up. “Rob basically told Erik that he harbors no hard feelings because Rob helped catch others,” said one mutual acquaintance. “It was kind of like an Alcoholics Anonymous meeting with everyone 'fessing up to their sins.”

“Greed is at work,” Manhattan U.S. attorney Michael Garcia announced as the feds unveiled the case in March 2007, calling it the biggest insider trading bust since the infamous Ivan Boesky case back in the 1980s. To illustrate the sweep of the investigation—including the sheer number of people involved and the number of stocks that were traded illegally—Garcia stood in front of the large board of names and photos with lots of arrows diagramming the various schemes at work by this particular circle of friends. The illegality was breathtaking in its scope; it occurred at major Wall Street firms (Morgan Stanley and Bear Stearns, even though the firms weren't directly charged) and at hedge funds. Lawyers and traders were involved. Taken together, it appeared that insider trading was rampant across the financial business—not just inside hedge funds, which were only now facing heightened supervision from the SEC through new inspection laws, but also in places that the SEC and a host of regulators had been watching for years: the big investment banks.

As the feds were announcing the breaking of the Franklin-Babcock ring in March 2007, the first rumblings of the financial crisis had begun, and ironically at Bear Stearns, which was holding mountains of debt tied to the increasingly fragile housing market.

Still during the first quarter of 2007, Wall Street firms posted record profits sustained by taking massive risks in the trading of complex securities. Working anywhere in the financial business meant a huge pay day, from the trader to the chief executive. Steve Cohen earned roughly $1 billion in 2006. Jimmy Cayne, who ran the smallest of the big banks, Bear Stearns, earned a salary and bonus of $34 million for 2006, in a check that was delivered and announced in early 2007.

The difference between SAC Capital and Bear was of course in how they each managed risk. Cohen would take the necessary precautions to protect SAC and its investors from the worst that the looming financial crisis would offer. “You're all idiots!” Cohen screamed one morning to his portfolio managers as he implored them to begin selling out of their positions and start hoarding cash in the face of the coming financial storm.

Cayne, meanwhile, did almost nothing until it was too late. Mortgage bonds on the balance sheet of Bear and the rest of the big banks were falling in value, and their implosion set in motion a chain of events that in about a year's time would lead to the demise of Bear itself. The rest of the banking industry's largest players would have also collapsed were it not for a historic bailout financed by the American taxpayer.

Likewise, the first glimmers of the financial crisis had barely made an impression on government regulators as insider trading had now emerged officially as public enemy number one for the white-collar cops. That was the warning made by the prestigious law firm Skadden, Arps, Slate, Meagher & Flom to its clients, many of them Wall Street traders and hedge fund traders, around this time. It didn't matter that the then SEC chairman, Chris Cox, a former congressman from Orange County, California, and an appointee of President Bush, was known as a libertarian on most matters involving the economy, meaning he favored low taxes and less government regulation, except in the matter of insider trading. According to the firm, Cox adopted the SEC's long-held position that trading on material nonpublic information was a threat to the “integrity of the markets.” As such he created a “working group” inside the commission dedicated specifically to tracking down insider trading cases, and particularly among hedge funds, where the feds believed for good reason that problems continued to fester.

Still, the length of time it took to crack the Franklin-Babcock-Guttenberg circle of friends only underscored just how difficult breaking the code of insider trading had become. It had taken five years for the most sophisticated surveillance systems in the world—now employed not just by Funkhouser's crew but also at the SEC and the Justice Department—to snare a bunch of Wall Street frat kids who traded high-level insider information hidden in bags of Doritos.

H
ell hath no fury like a women scorned,” agent B. J. Kang must have thought as he listened intently to the story of Patricia Cohen, the ex-wife of Steve Cohen, and the allegations she made about her ex-husband.

Patricia Cohen had many axes to grind against her ex-hubby, including the fact that when they divorced in 1992 and she received her share of Steve Cohen's wealth, he wasn't a billionaire—indeed, far from it. He had just launched SAC Capital, a firm devoted, as he would later say, to “information arbitrage,” a fancy way to describe the practice of finding out the best information available, and trading on it all day and every day to extract the maximum amount of profit.

When he started with the chunk of money he made while at Gruntal, no one outside the Wall Street trading community really knew who Steve Cohen was. His claim to fame in the popular culture: a 1992 appearance on a tabloid show called
Christina
, where he discussed how he was sleeping with his soon-to-be-ex-wife, Patricia, while he was dating his soon-to-be-new-wife, Alexandra.

Cohen, then with a full head of hair (an odd sight to those who've only seen him since he made his fortune), described his philandering this way: “A lot of these things occurred in the first year when I still wasn't committed to Alex and maybe I used the ex as a wedge. . . . I had gone through a pretty messy divorce and wasn't ready. . . . It wasn't a clean separation. . . . We went back and forth for a while,” he said, before adding that he and his first wife had “some financial difficulties.”

Times had changed, obviously. Some fifteen years later, Steve Cohen never appeared on television (unless clandestinely filmed) and gone were the financial difficulties. He had built one of the world's largest hedge funds and made a lot of money. He lived with wife number two and seven children in a mansion in Greenwich, Connecticut.

And Patricia Cohen merited only a few sentences in the Wikipedia bio of her now famous and famously rich ex-husband. Patricia and Steve Cohen had been married for ten tumultuous years. The couple were married during the stock-market boom of the 1980s and divorced in 1990. They had two children together. Like all married couples, they fought, though at least once, according to Patricia, it was violently. When they divorced, Patricia got custody of the children, their apartment, and $1 million on top of child support, which Cohen believed was more than a fair deal.

Patricia Cohen never thought it was all that fair, particularly after her millionaire ex-husband became a billionaire ex-husband. Cohen, meanwhile, moved on with his new and relatively happy life. Patricia never quite moved on, remaining single, and according to Cohen's friends, envious of the life Steve had created.

That's one side of this messy story. The other side, outlined in a
New York
magazine account, went something like this: Patricia was watching a
60 Minutes
profile of Steve Cohen, which alleged, among other things, that he manipulated shares of a company called Biovail. After some digging through old records, she had what she believed was proof that Steve hid assets from her during their divorce. She decided to file a lawsuit to recover $8 million she said was rightfully hers.

The case would have been just another footnote in Steve Cohen's Wikipedia page were it not for what else made it into the court documents: Not only had he shortchanged her, but, she said, during their ten-year marriage Cohen engaged in insider trading and money laundering.

The case would be thrown out of court and then successfully appealed by Patricia's lawyer. The charges were denied by Steve Cohen; his press handlers privately described Patricia as a loose cannon looking to cash in on her ex-husband's fame and fortune. But the insider trading charges were big news, even bigger for the various law enforcement groups investigating what they considered suspicious trading at SAC.

Keep in mind that for all the noise surrounding SAC, Steve Cohen's record was remarkably scandal free. He was sanctioned once by the New York Stock Exchange in 1995 for a trade deemed manipulative that he had made back during his last days at Gruntal, in 1991. It would be Cohen's first regulatory infraction and, as I write this in the spring of 2013, the only one. But Kang and others inside the SEC were convinced he and people at his fund weren't playing by the rules, and it wasn't long after Patricia went public with her lawsuit that the FBI sat down to hear her story, people with knowledge of the conversation say.

Patricia Cohen spoke with Kang, sources say, on at least two occasions, elaborating on many of the facts she had laid out in her lawsuit. Those facts were pretty embarrassing. Cohen had been deposed back in 1986 by the SEC, which was investigating suspicious trading while he was working at Gruntal. The commission focused on General Electric's acquisition of RCA.

According to Patricia Cohen's lawsuit and the account she gave to the FBI, Cohen snapped up shares of RCA before the deal was announced in 1985—and shares soared. He was tipped off by a college buddy who worked at the infamous Drexel Burnham Lambert—one of the firms working on the transaction, and which employed both Marty Siegel and Dennis Levine, two of the principal figures in the 1980s insider trading crackdown. In fact, according to Patricia Cohen, the RCA deal tip that made its way to her ex-husband had originated with Levine himself.

Just to underscore her point, she said Cohen asserted his Fifth Amendment right against self-incrimination several times during an SEC deposition about the trade, something SAC's press handlers still won't deny.

After the deposition, she told FBI officials that Cohen was petrified that he had been caught and was about to be charged. “His ex-wife told the FBI that in private he's far different than his public persona as a master of the universe. She said he was basically crying,” according to a person with direct knowledge of the matter. “He was afraid he was about to get locked up, at least that's what she said.”

Cohen was never charged. The SEC dropped the case even after Cohen's refusal to answer questions. And for all the juicy details Patricia Cohen spewed about her ex, she was essentially a witness with a huge axe to grind, and she had no real proof, just her own word, of his misdeeds.

Kang knew he needed more. Given all the money Cohen paid out to consultants and expert networks, getting one of those guys to flip might prove impossible—at least until this point it had. Investigators toyed with the idea of putting someone inside SAC, a Wall Street version of Donnie Brasco—the FBI agent who implicated the mob. They quickly dropped the idea for the simple fact that they believed it was easier to get inside the mob than the close-knit financial community, where experience in the business trumps bonds of ethnicity.

By now government investigators were coming to the conclusion that a more effective weapon was needed, such as an informant with long years in the business who could pass the smell test with Cohen, or a court order to tap Cohen's phone. All of that would have to wait as federal investigators turned their full attention in this increasingly target-rich area to nailing a suspect they thought might go down if not bigger, then at least faster.

S
anjay Wadhwa developed a little trick when taking depositions from Wall Street master-of-the-universe types accustomed to having and getting their way. Not long after joining the SEC, he noticed that targets became more compliant, more willing to 'fess up to bad behavior, when they were ushered into one of the group of large conference rooms at the SEC's headquarters in lower Manhattan and forced to face the windows.

What they were confronted with was an imposing site: a phalanx of government interrogators dressed in dark suits with the lower Manhattan skyline in the background. The message Wadhwa wanted to deliver was pretty straightforward: You have done something wrong, and you're up against a foe with unlimited resources, so think twice before lying under oath.

That was the position Raj Rajaratnam, the biggest target in the government's insider trading crackdown, found himself in one afternoon in June 2007.

It was an odd technique coming from Wadhwa, who was at the time a midlevel SEC enforcement agent known for his quiet, albeit steady, determination. Most SEC investigators come to the agency to get experience before moving on to lucrative jobs at the big banks. The revolving door between Wall Street and Washington is a source of constant criticism. It is no wonder regulators ignored credible evidence that Bernie Madoff, a longtime fixture of the Wall Street trading establishment, had been conducting a massive Ponzi scheme. Many wanted to work for Bernie and triple their salaries.