Circle of Friends (2 page)

Makol decided to pay a surprise visit to Slaine outside his apartment on Manhattan's Upper East Side. Standing with a fellow agent on 80th Street and Park Avenue, he flashed his badge, introduced himself, and invited Slaine to grab a cup of coffee at a nearby diner. Slaine, seemingly unnerved, agreed.

After they sat down, Makol, in a firm but direct manner, explained the situation: Slaine wasn't the upstanding citizen he wanted everyone to think he was—just another white-collar crook who made his money cheating the system. The trades in question involved Slaine receiving early warnings about downgrades of stocks announced by a big Wall Street firm.

Slaine was part of a larger circle of friends that profited from the inside tips. The feds had all the information, data points on traders, and more than that, cooperating witnesses to ensure a guilty verdict and a long jail sentence.

Makol was always prepared for the worst, as all FBI agents are when confronting possible cooperators. Some targets pass out, some literally wet their pants (or worse), while others get on their knees and beg for mercy. But Makol had done his homework on Slaine and didn't expect any of that

People who know Slaine said the meeting made him sick, as Makol reduced a career of more than twenty-five years in finance into a life of crime. Even so, Slaine sat stoically as Makol rattled off what the government viewed he had done wrong, the list of witnesses who were prepared to testify to as much, and most of all the amount of jail time he could receive—possibly decades of not seeing his wife or daughter, then just about a teenager, except through a glass partition at a federal prison.

That is unless Slaine became a witness himself and agreed to turn in his circle of friends involved in the same dirty business.

Prosecutors will tell you that insider trading cases are not easy to win, particularly when it involves sleazy witnesses looking to save their own skins, and of course trading records that look bad but are not incontrovertible in proving guilt.

There would be additional meetings between Slaine and his soon-to-be FBI handlers, including one a few days later inside his apartment with his wife present to hear the same gory details. There would also be a fair amount of soul searching with family members.

But in the end, the decision was pretty easy for a man who made his fortune taking calculated risks.

“I'm ready to cooperate,” he said.

D
avid Slaine has been described by authorities as not just an important element in what is now regarded as the biggest insider trading case ever, but also as one of the most important informants in the history of white-collar crime. With his help, over the next five years prosecutors snared dozens of arrests (including one of his friends and weight-lifting buddies) and helped establish a perfect record of convictions in the largest insider trading investigation in modern history

Slaine may have started out as a notorious criminal, in the eyes of the feds (friends say an accurate portrait is far more complicated and much less corrupt), but he ended up as a demigod; there was almost nothing he wouldn't do to help with their cause. He wore wires, and entrapped co-workers in corrupt business ventures. According to friends, his success at undercover work came at a severe personal cost; he suffered from depression along the way, and tried on several occasions to convince the FBI that he had done enough. With the constant threat of jail time hanging over him, he spent more than two years of his life as a government insider-trading spy, and he did it with the poise and purpose of a veteran undercover agent. People who knew him during this time say he acted like the same old David Slaine: the self-confident high school football player, basketball star from Malden, Massachusetts, who had made a name for himself on Wall Street for his trading acumen as well as for his toughness, even if inside his head he felt like he was about to explode.

For his assistance in catching other crooks, Slaine didn't spend a day in jail. He now runs a small business, about a half dozen stores that specialize in grooming dogs. He never did reconcile with his wife, but according to one of his FBI handlers he's currently “doing very well,” a role model for someone who commits crimes and then does the right thing in the eye of the government. Through his lawyer, Slaine declined several requests to be interviewed for this book.

As
Circle of Friends
will demonstrate, Slaine was important to the success of Perfect Hedge, but he wasn't the only cooperator. Several months after they approached Slaine, another longtime FBI agent schooled in the art of witness flipping, B. J. Kang, secured the cooperation of a woman named Roomy Khan, a former hedge fund trader and Silicon Valley bon vivant, whose circle of friends included various market analysts, technology company officials, and billionaire hedge fund mogul Raj Rajaratnam.

Many more would succumb to the government's deal: cooperate or get ready for jail. And it worked. As this book goes to press, federal criminal authorities have convinced dozens of hedge fund managers and traders to turn against their colleagues. The feds have done this through examining trading records, emails, and documents as well as by gathering direct testimony from cooperators and secretly recorded conversations where dirty information is shared. In the process, the government has racked up more than seventy convictions without a single loss, including nailing Rajaratnam—one of the world's largest hedge fund managers—and later a man named Rajat Gupta, a former CEO of consulting giant McKinsey & Co., who as a board member of Goldman Sachs supplied Rajaratnam with some of his most lucrative inside tips.

Other similarly sized targets are still waiting nervously, including the biggest one of them all: hedge fund impresario Steve Cohen of SAC Capital, the giant hedge fund that has confounded regulators for years with its ability to beat the law of averages in cranking out a steady stream of market-busting returns.

Cohen, known around Wall Street as “Stevie,” has proven to be a particularly elusive target, though not for a lack of effort on the part of the government. As of publication of this book, as many as nine former or current SAC traders, analysts, or money managers have been either charged or in some way tied to various insider trading cases; at least one has gone to jail, while others have agreed to cooperate in building a case against higher ups at SAC, including potentially their old boss. Still others, such as SAC star trader and close Cohen associate Michael Steinberg, have chosen to fight. As I write this in April 2013, Steinberg has been indicted on conspiracy to commit securities fraud and four counts of insider trading and faces many of the same decisions faced by people like David Slaine. Unlike Slaine, so far Steinberg has chosen to fight, pleading not guilty, but that could change as it has with others.

Steinberg's arrest came in classic Perfect Hedge fashion—in the early morning hours, and with FBI agents equipped with bulletproof vests and guns at their side providing their targets with a grim introduction to what it's like going up against the federal government's vast white-collar crime fighting apparatus. It is meant as a warning to both Steinberg and anyone else targeted in the inquiry that fighting the government comes at a price, legal experts say.

One thing seems clear: Since 2007, civil and criminal authorities have spared almost no expense trying to snare the man who on paper at least is considered among the world's greatest investors. Steve Cohen and his advisers say SAC's investment record—nearly 30 percent annual returns since the fund began in 1992—is the result of research and skill, flowing from the man at the top of the firm through the best traders, investors, and analysts in the business. Federal investigators, however, appear convinced that same success is the result of having—at least at times—an illegal edge over public investors through the use of inside information gleaned from various confidential sources.

So convinced are they, in fact, that at one point, the FBI even received court approval to wiretap Cohen's home telephone—one of the first times in law enforcement history that wiretaps would be used in a white-collar case. While the wiretaps were unhelpful in making a case against Cohen, the scrutiny continues. SAC recently paid more than $600 million to settle a civil inquiry by the Securities and Exchange Commission without admitting or denying wrongdoing. The inquiry involved a former portfolio manager who allegedly traded on inside information regarding a pair of drug stocks. Just before Christmas of 2012, that former portfolio manager, Mathew Martoma, was himself indicted for allegedly trading on inside information. A key aspect of the indictment was a section where Martoma holds a 20-minute telephone call with Cohen—and then SAC abruptly sells hundreds of millions of dollars of the drug stocks in question.

What exactly was said during that telephone conversation is unclear; what isn't is the fact that the Justice Department has told Martoma that it is willing to trade leniency for his cooperation against Cohen.

Martoma—as he awaits trial—has taken the Steinberg route, both by declaring his innocence of the charges and at least for now refusing to characterize that what he told his old boss was anything but aboveboard. That might change as well since Martoma is facing a similarly long jail term if he doesn't cooperate. With that, SAC remains on edge; the fund has produced some of the biggest returns in the investing world for more than two decades, but investor cash is starting to drain out amid the scrutiny. Cohen, for his part, has declined repeated attempts to be interviewed for this book. Through a spokesman, he has maintained his innocence, saying he has acted properly at all times. But prosecutors aren't impressed. The indictment of Martoma went to great lengths to point to Cohen as the possible recipient of one of the profitable insider tips that are central to the case. The indictment stopped short of saying Cohen knew the tip was dirty, or mentioning Cohen specifically by name (it referred to him as the hedge fund “owner” and “portfolio-manager A”).

But the message was delivered loud and clear.

W
hite-collar law enforcement authorities will tell you that one of the reasons—and maybe the
biggest
reason—that they have approached insider trading with such zeal, particularly since the start of Perfect Hedge in 2007, is to make the investing world safe for the average investor.

They will talk nonstop about the virtues of ridding the investing world of insider trading. To hear it from these folks, getting information that's not available to the public through a high-level connection or by paying for it—the basic definition of insider trading—perverts the very essence of what a market is all about: a level playing field where everyone, regardless of wealth or status, has access to the same information from which they can make educated choices about buying and selling stocks.

And they will tell you that the fundamental purpose of the laws governing the markets is to democratize those markets. They will point out, and rightly so, that the Securities and Exchange Commission, the main law enforcement agency in charge of monitoring Wall Street behavior, was created in the aftermath of the stock market crash of 1929, precisely to level the playing field between the sophisticated investor who buys stocks for a living and has the means to buy information not available to the average person, and that very same average Joe, who has a day job and is investing for retirement.

The two main bodies of law from which most of the rules of investing are derived, the Securities Acts of 1933 and 1934, demand disclosure of information broadly and equally, meaning that the very act of trading on a piece of information that is obtained before it is formally disclosed to the general public is anathema to the notion of fairness that permeates these statutes.

They will also tell you that when someone trades on an inside tip that isn't available to the public, that trade is being made often on stolen or “misappropriated” information, and there are plenty of laws against theft.

These are strong and convincing arguments, which is why insider trading rouses so much anger among average people. The notion that someone has an unfair advantage over someone else seems un-American; after all, our nation is built on fundamental ideas of equality and fairness (indeed, “that all men are created equal”).

But step back and consider the following: Are markets
really
supposed to be democratic, and does having better information than the next guy really constitute a fraud that should send someone to jail for almost as long as someone who robs a bank?

In the course of writing
Circle of Friends
it was not difficult to find at least a few academics (Duke law professor James Cox among them) who have concluded that it
doesn't
constitute such a fraud, at least not to the extent that insider trading should be an obsession of federal law enforcement punishable by many years in jail. This obsession, I might add, has diverted resources from real and direct thefts, such as the Bernie Madoff Ponzi scheme, which regulators at the SEC all but ignored for years, until Madoff turned himself in in December 2008.

Madoff's activities cost actual investors real money—nearly $50 billion, depending on how much can be recouped by investigators. Lured by his promises of steady returns, people gave Madoff their life savings; charitable trusts handed him money to fund good causes. They were heartened by the fact that investigators at the SEC had done past inquiries into Madoff and found him to be clear—that is, until reality came calling. And in a flash all the money was gone, since Madoff stole it all right under the noses of investigators, who later conceded they were stretched too thin to conduct a thorough probe.

As you will see in
Circle of Friends
, the SEC or the Justice Department never appears stretched too thin to eradicate insider trading. The question is, why? What is the
real damage
to individuals from David Slaine's having that information, trading on it, and making a profit?