Circle of Friends

by Charles Gasparino

  DEDICATION

  To Don Ryan, my friend,

  my professor who taught me the world

  ACKNOWLEDGMENTS

  I could not have written this book without the help of numerous people. They include government officials directly involved in the insider trading investigations who have taken time out from their busy schedules to help me get my facts right. Some of these folks are currently employed by the government, while others have left for the private sector. All of them would like to remain anonymous because investigations remain ongoing.

  Jonathan Gasthalter, the chief spokesman for SAC Capital Advisors, went out of his way to confirm facts and figures about the hedge fund. Nancy Condon, the spokeswoman for the Financial Industry Regulatory Authority, Judy Burns and John Nester, press officials for the SEC, Peter Donald from the FBI’s press office, and Ellen Davis, of the Manhattan U.S. attorney’s office, were invaluable in helping me understand key aspects of the insider trading crackdown.

  Hollis Heimbouch of HarperCollins deserves special thanks, not just for guidance and support but also for patience; Circle of Friends took more than two years to finish as the size and shape of the insider trading probe grew, and the book changed to reflect that new reality. Ethan Friedman worked long and hard to shape the manuscript and Max Meyers was a source of great insight. My longtime literary agent Todd Shuster must curse the day he took me on as a client. I, on the other hand, owe him many thanks for helping with this project and others.

  I also would thank some people at Fox News, including Kevin Magee, Brian Jones, Dianne Brandi, Sital Patel, and my television agent, Wayne Kaback. Bruce Levy, my old friend from the Wall Street Journal, deserves special thanks for fact-checking much of the material in this book. Last but not least, I want to thank my wife, Virginia Juliano, for putting up with my book writing and much more.

  CONTENTS

  Dedication

  Acknowledgments

  Introduction

  1 Perfectly Legal

  2 Ten Different Cameras on Every Trader

  3 Do Whatever It Takes

  4 A Regular Guy

  5 What Friends Are For

  6 Bigger Fish

  7 The Flip

  8 The Feds Might Be Listening

  9 Odd Couples

  10 Something Good Is Going to Happen

  11 Pounce Hard

  12 Never Let a Good Scandal Go to Waste

  13 The Luckiest Men in Law Enforcement

  14 Stevie Is Worried

  15 Harpooning the Whale

  Cast of Characters

  Notes

  Index

  About the Author

  Also by Charles Gasparino

  Credits

  Copyright

  About the Publisher

  INTRODUCTION

  “I know this guy who’s got an ironclad way to make money. I can’t lose and I can’t get hurt.”

  —Bud Fox, Wall Street

  I can’t believe this is happening to me,” David Slaine thought one morning in mid-2007 as special agent David Makol of the FBI explained to him that his life as he knew it had changed. Slaine, he said, should be prepared to spend “a long time in jail,” unless that is, he confessed to his crimes and agreed to help the government catch others engaged in the same dirty dealings.

  Slaine had been nabbed for a crime the veteran stock trader knew all too well: insider trading. Slaine worked two decades on Wall Street for a variety of firms and made a lot of money. He wasn’t a household name, but many of the market’s successful traders aren’t—and they like it that way. To invite press attention is to draw attention to the way they earn their money, which government investigators increasingly believed involved trading on confidential, top-secret information about companies, also known as insider trading.

  Slaine is a tall man with broad shoulders and a macho temperament. He was known both as a skilled and intense trader but also as a brawler—someone who had at least one trading-floor fight. He also was a man known to Federal investigators as something else: a fat cat willing to skirt the rules, looking for edges over his competition, even if that edge involved an inside tip about a stock before it had been made public.

  Slaine came onto the radar screen of the FBI the way most people do—from another cooperator. The feds had busted a ring of traders—a circle of friends—at UBS, Bear Stearns, and Morgan Stanley, one of the firms, where Slaine had worked, for passing inside information to each other, mainly tips about upcoming deals that are supposed to be kept secret—or at least not acted upon—until they’re made public. One of those friends, not unlike a mob rat looking for leniency, ratted out Slaine for allegedly doing the same thing. As his name circulated through the FBI, agents realized he had worked with one of their main targets in the burgeoning probe, Galleon Group founder Raj Rajaratnam. FBI agents, skilled at putting together connections and relationships, soon thought they were on to something huge.

  Based on the initial pieces of information they were receiving from informants and witnesses, investigators became convinced that a massive circle of friends existed on Wall Street; that men and a few women, mainly at some of Wall Street’s biggest trading outfits, known as hedge funds, were using and trading on insider information with impunity.

  It was a sea change in the thinking of the federal regulatory apparatus designed to monitor and prosecute insider trading. For years the operating assumption in the law enforcement community was that the illegality was contained largely among boiler rooms—small firms that operated on the fringes of the more established Wall Street companies—or the occasional dumb (and greedy) celebrity and a few sharks who know how to game the system. But what they were finding now was that insider trading was more systemic; almost daily, regulators noticed massive trading volume preceding mergers and other market-moving corporate announcements, with the suspicious trading patterns emanating like a bad odor from the fastest-growing part of the investing business—hedge funds. Once a backwater business catering to “accredited investors,” meaning those with more than $1 million in assets, both the size and the importance of the hedge funds had grown enormously in recent years. Because it catered to the rich, the hedge fund industry has until recently evaded the regular supervision of investment banks or even mutual funds, which count as their customers the average investor and are known on Wall Street simply and somewhat derisively as “retail.”

  This exclusivity did little to hamper the hedge funds’ growth, since the ranks of the millionaire class continued to expand through much of the 1990s and into the next decade. And it did something else: It made the hedge fund ripe for abuse. Hedge funds now controlled about $2 trillion in assets (and growing) and the pressure to raise money is intense with each fund bragging that it had an information “edge” over the other. Big funds like Raj Rajaratnam’s Galleon Group or Steve Cohen’s SAC Capital controlled much of the daily trading volume of stocks. They were Wall Street’s best customers, meaning that they got early reads on research and other market intelligence—and maybe more.

  That edge, regulators had come to believe, was code for trading on illegal insider information, passed along through various cliques and contacts that the funds had in corporate America, on Wall Street, in the hedge fund business, or in a combination of all three. The information was often paid for, government officials discovered, or passed along as part of a quid pro quo of traders sharing inside tips.

  The question was how to break into this vast criminal conspiracy that regulators believed was baked into the business model of some of Wall Street’s biggest and most profitable hedge funds.

  Slaine represented immense possibilities in this regard. He worked for Galleon and two other major Wall Street firms and now work
ed for himself. He didn’t rub shoulders with the likes of Steve Cohen, but Slaine knew some of Cohen’s foot soldiers as well as those at other big hedge funds to be helpful to the feds if they could get him to flip.

  The feds had named their investigation “Perfect Hedge” for its double meaning: Insider trading was the perfect hedge in making money in uncertain markets because the trader knows what’s going to happen before the rest of the market. His cheating ensures a perfectly hedged trade that could never lose.

  But its other meaning involved what people like Slaine represented if they cooperated: a perfect witness in creating the perfect case that broke the biggest insider trading ring in recent history.

  Breaking such a case was not unlike breaking the mob, FBI officials reasoned, and it would take the same tactics: aggressive (albeit fully legal) pursuit of evidence and witnesses. Playing rough with witnesses was something the FBI agents were good at. One way they play rough is to lay out in stark terms what is waiting for the witness if he or she doesn’t cooperate: a long jail term and all the dark consequences of spending a chunk of time living with career criminals.

  Ironically, one of the men leading the FBI probe was anything but a tough guy. David Chaves was known as the “Velvet Fist” inside the bureau because he had both a soft touch with cooperators and because he truly believes in redemption—if, of course, the target is willing to cooperate first. If not, he’ll throw them in jail like anyone else, where, as he is fond of saying, “you will have no friends to help you.”

  Chaves and his team spent months examining Slaine’s trading patterns. Other teams simultaneously focused on the trading at Galleon and SAC Capital. The trades all had something in common: Each successful bet in the string occurred before key corporate events were made public. Moreover these guys produced investment returns that beat the market with regularity, something the vast regulatory apparatus designed to rid the markets of insider trading had come to believe is nearly impossible to do on a consistent basis—unless, of course, you know something the market doesn’t.

  Now they just needed to sell Slaine on the idea. Chaves believed Slaine was “flippable” despite his tough-guy reputation. Some of this judgment was just gut instinct on the part of the bureau; some of it was common sense. Slaine was in his mid-forties—not so young, particularly after adding a prison sentence that could span ten years or more for insider trading, based on the sentencing guidelines. He was married (though heading for divorce), with a young daughter, so the last thing he needed was a decade or more in prison.

  But if he cooperated he was still young enough to start a new life, even if he was forced to serve a reduced sentence that often follows a plea deal. And Chaves’s biggest selling point would be that Slaine could avoid jail altogether depending on how good a witness he turned out to be.

  Chaves didn’t handle the task of turning Slaine the crook into Slaine the cooperator. That would be handled by David Makol, considered one of the best “flippers” in the bureau, and Chaves’s go-to guy on such matters. He was tough when he had to be, and soft when he thought the target would appreciate a gentle hand, at least according to colleagues. People who have experienced Makol’s work have a less benign view. They describe him as manipulative, and at times, abusive, someone who while staying within the limits imposed on him by the bureau will use threats and intimidation to achieve his overarching goal of flipping witnesses and making them compliant in every possible way.

  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.

  David 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.