Circle of Friends (8 page)

They didn't have the swagger of the deal makers—or garner the press attention of the men who put together giant mergers. Most of them kept a low profile even as they were earning salaries in excess of $20 million a year. But they had a never-ending thirst for making more of it and a never-ending thirst for what became known as “actionable” information that couldn't be downloaded off the Internet but did move stocks.

The new Wall Street that emerged in the mid to late 1990s was a business centered on
information
—and getting the best of it to produce those outsized returns to satisfy a new generation of the superrich. These investors were demanding something better than the stock market averages and they were willing to pay for it.

Enter expert networks: boutique firms that hired consultants specializing in industries like health care and technology that were paid to share their knowledge with Wall Street traders. Heart surgeons suddenly became Wall Street researchers, as did computer programmers.

A well-paid doctor could bring home an income of $500,000 a year, but in helping a trader on a successful market bet he could easily add another $100,000 to his salary. Wall Street “sell side” analysts who worked at banks quit to set up independent research shops that catered to hedge funds. Technology industry consultants worked with the analysts and the expert networks. These circles of friends were growing in size far beyond the networks that existed during the boom years of the 1980s, and as the benefits of this kind of coziness became clear—higher profits, lower losses—the incentive to stretch the limits of legality and share illegal inside information became impossible to resist.

By the end of the 1990s law enforcement was big and increasingly well funded. Even with Levitt crying poverty, the SEC increased its ranks as well. It had O'Hagan on its side to deal with insider trading, and a federal law known as the Racketeer Influenced and Corrupt Organizations Act (RICO). Used to stamp out the mob, under U.S. Attorney Rudy Giuliani the RICO law was extended to include white-collar crimes. Under RICO, the feds could demand longer sentences for actions that were part of a larger organized effort to commit fraud.

RICO seemed tailor-made for crushing the circles of friends, and Giuliani had certainly used it effectively in the 1980s to turn informants like Ivan Boesky on the ultimate target of his probe, former junk-bond king Michael Milken (who by the mid-1990s was just finishing his jail time and returning to society).

The various market regulators had also developed increasingly sophisticated tools to track suspicious trading patterns. And here's what they saw: increased trading of stocks and options before mergers and acquisitions. The volume of the suspicious trading was now far greater than ever before.

It was as if the great wave of insider trading arrests of the 1980s never happened, and Wall Street was back to business as usual: cheating.

I
t's like you're walking down the street and we've got ten different cameras on you,” Cameron “Cam” Funkhouser likes to say when asked about the market surveillance system he created for an agency known as the Financial Industry Regulatory Authority, or FINRA.

FINRA is the new and updated model of Wall Street's attempt at “self-regulation,” a modern version of the National Association of Securities Dealers, the regulatory arm of the Nasdaq stock market.

It may seem odd but the nation's securities laws call for the banks and Wall Street investment houses to regulate themselves, before the SEC or the Justice Department gets involved.

These self-regulators—one working on behalf of the Nasdaq stock market, and the other working out of the New York Stock Exchange—were ridiculed a lot over the past three decades for missing various frauds and scandals that involved trading of stocks listed on the exchange. But by the 1990s, and particularly at the Nasdaq, they had become surprisingly good at one thing: spotting people who engaged in insider trading.

And you can thank Cam Funkhouser for that. Funkhouser likes to describe himself as one of those old shoe-leather investigators from the detective movies, and he certainly plays the part. He talks about going “Catholic school” on his targets, the Wall Streeters he suspects to be lying, by barraging them with questions about their alleged crimes before they fold from exhaustion, like a strict old-school Catholic priest with misbehaving students.

When he isn't playing one of the Christian Brothers, Funkhouser falls back on his best imitation of a white-collar Detective Clouseau and plays dumb, which lets him capitalize on the widely held belief among Wall Street crooks that Wall Street cops are stupid.

But, he'll tell you, he ain't that dumb and the crooks aren't that smart. In fact, he says, the guilty ones almost always fall for the act just enough for him to make a case.

A graduate of Georgetown with a degree in business, followed by a law degree at George Mason, Funkhouser began his career at the Nasdaq's regulatory unit in the 1980s right out of school and became an expert in using increasingly sophisticated computer tracking systems to identify and eventually catch insider traders.

It's fair to say that many of the recent big insider trading cases found their roots in Funkhouser's computer tracking system. In its simplest form, the system tracks every trade—and flags instances of unusual trading, namely sales of stocks around major corporate events. Funkhouser didn't invent the program—he just helped perfect it over the years, adding new tracking devices that allow investigators to find nearly any questionable stock sale no matter how seemingly insignificant.

His inspiration, oddly, is Ivan Boesky. Funkhouser wasn't involved in the Boesky case—he was still fetching coffee for his supervisors at the Nasdaq when the scandal hit. But it was the driving force of a career dedicated to eradicating insider trading from the markets through the use of computers. To this day Funkhouser says he hates everything Boesky stood for—he married money for the sake of marrying money; he made a lot of money illegally utilizing a like-mindedly arrogant circle of friends to carry out his scheme, and most of all, Boesky and his cronies all thought they could get away with it. And Funkhouser thinks most insider traders carry the same basic traits.

M
ost of these guys can't help themselves. And they don't really think they will get caught,” is how Funkhouser described the mindset of the typical inside trader. Yes, they are all different in skill sets and intelligence: Some of the people he has nabbed could best be described as “the loser brother-in-law who gets a tip during a family dinner.” Others are MBAs from the most prestigious schools “who think no one is watching them.” Still others are first-time offenders who get away with it once—“they dip their toe in”—get hooked on the money, and keep coming back for more.

Funkhouser has seen them all and that's why he knows they all carry the same basic trait: arrogance.

Funkhouser's first case came in 1984, about two months after he graduated from law school. The NASD's fairly basic market surveillance methods of the time showed a bunch of unusual trading in shares of the fast-food chain Carl Karcher Enterprises, named after its founder, who parlayed a single hot dog cart in Los Angeles back during the Depression into the Carl's Jr. franchise.

At the time, Karcher was a millionaire many times over—but that didn't stop him from unloading shares of his company right before some bad earnings came out—and on top of that, from alerting friends and family, about the bad news so they could sell their holdings as well.

“I was looking at all these trades and there were all these relatives who sold right before the bad news hit,” Funkhouser recalls. The announcement was that profits from the fast-food chain were down significantly from the company's public projections after it had spent gobs of money on advertising for the 1984 Olympics, which were to be held in Los Angeles.

Karcher and six family members were charged by the SEC with insider trading. In the end, they all settled with the SEC for a combined $664,000 in a civil settlement without admitting or denying wrongdoing.

“When I saw all of this my first reaction was ‘this can't be happening,' ” Funkhouser said. He couldn't get his hands around how rich people would openly break the law to get just a few bucks richer. Karcher's net worth dwarfed the amount of money his family saved on selling their stock—an estimated $300,000 combined.

Yet they all seemed perfectly at ease with flouting the law to save a few bucks.

The techniques Funkhouser used to nail the Karcher clan would be considered pretty rudimentary by today's standards. Suspicious trading patterns were often shown on “blue sheets,” or computer records used to spot unusual trading activity before major corporate events. Corporate mergers were a big starting point; Funkhouser noticed almost from the time he joined the Nasdaq that buying of target companies almost always spiked just before deals.

Funkhouser couldn't have picked a better time to get educated on how the circle of friends worked. A raft of insider trading cases reached the highest levels of Wall Street convincing regulators and prosecutors that the dissemination of illegal tips went beyond the Carl Karcher types—that illegality was systemic on Wall Street. Initially, Martin Siegel, Ivan Boesky, Michael Milken, and even Dennis Levine didn't fit the prevailing image among regulators of the typical white-collar criminal who either operated on the fringe of the mainstream investment banks, or, like the Karchers, were corporate executives looking to cut a corner. They were part of the establishment—the places where compliance departments and pedigree were supposed to root out criminality. And what the 1980s crackdown taught people like Funkhouser as well as his counterparts in law enforcement was that the education and pedigree of the establishment Wall Street crook meant that he operated at a higher level through a circle of intermingled professional and personal relationships.

Boesky and Siegel, for instance, met at the Harvard Club in midtown Manhattan. They developed code words when making drops of cash in exchange for insider tips. “Your bunny has a good nose,” was the signal Siegel gave to one member of his circle that a corporate takeover was indeed about to go down. Levine, who met Siegel while they both worked at Drexel Burnham Lambert, created a trading account in an offshore bank where he carried out his illegal trades. They exchanged cash through couriers to better hide their illicit payments.

In other words, business and illegality were being commingled easily and effortlessly at the highest levels of Wall Street, which had the money and the means not to get caught.

T
he 1980s insider trading crackdown wouldn't be duplicated for at least two decades, even though the practice remained high on regulators' list of crimes. By the late 1990s, Funkhouser had risen through the ranks of the Nasdaq to run its surveillance unit—and perfect its system of catching the bad guys.

The old blue sheets that regulators used to track unusual trading activities were replaced by a vast computer system located at the Nasdaq's offices in Bethesda, Maryland; with the advancement of technology, Funkhouser's investigators were able to pinpoint with even greater accuracy even more trading that had the taint of illegality, leading them on the trail to making some of the most sensational insider trading cases ever.

Such was the case in 1997, when Funkhouser's computers helped SEC investigators charge some traders at J. P. Morgan and Salomon Smith Barney for trading on bank deals just before the mergers were announced, essentially buying the acquisition target and profiting when shares soared.

The traders were throwing down big chunks of money and earning hundreds of thousands of dollars a trade—and their trades were glaring to Funkhouser and his staff, who by this point had a practiced eye for such conduct.

Investigators broke down the data even further and found several small brokerage accounts mirroring those trades. When Funkhouser first started his career, finding suspicious trading in an account of this size was like finding a needle in a haystack. No longer. The system he had helped construct searched for many more variables than a merger or market-moving corporate event, and at infinitely more granular levels.

By 1999 it had become increasingly difficult for insider trading to fly under or through the radar, which accounts for what happened when investigators came across an unusual pattern of trades made by a woman from Miami, an actress best known for her roles in
Babewatch
,
Marylin Does Miami
, and
Marylin Whips Wall Street
.

“I don't know what you are talking about,” a somewhat flustered Kathryn Gannon told officials from the SEC when they asked her how she could know how to pick stocks before their prices spiked on merger news.

By the end of the interview Gannon offered up all the implausible explanations SEC officials have heard from the beginning of time: She's so good at trading because she reads the
Wall Street Journal
, talks to people in the business, and is just good at stock picking.

Making the excuse even more implausible was Gannon's occupation, easily confirmed by SEC investigators after a simple Web search: She was an adult film actress who went under the name Marylin Star.

She never went to business school, much less college. According to her online profile, she did, however, plan to have sex with two thousand men for a film to be released on the eve of the millennium called
Gang Bang 2000
.

Investigators believed Gannon's involvement was just the tip of the iceberg and was part of a bigger circle that led to some major player on Wall Street. Their working theory was that Gannon must have some sugar daddy or several sugar daddies at the big banks who supplied their porn-star girlfriend with insider tips, a circle of friends motivated by money and sex—only fitting, perhaps, for an era in which a sitting president had received oral sex from a young intern in the Oval Office.