Circle of Friends

by Charles Gasparino

  But Dowd, a former Marine, was someone Rajaratnam wanted. Like himself, Dowd is a fighter who both knew the law (he headed the criminal defense department of Akin Gump, a large Washington law firm) and knew that the case against his client was weakest at precisely the strongest piece of evidence: the wiretaps.

  As mentioned earlier, wiretapping phones was hardly unprecedented, but prosecutors have rarely relied on that tool to build white-collar cases. According to government statistics, in 2009 drug cases were the most prevalent type of case investigated through wiretaps, followed by homicides, organized crime, and, somewhere near the bottom, white-collar felonies.

  The procedures to get wiretap authority are pretty strict, and given all the various applications in the case, Dowd’s bet was that he could find more than a few procedural mistakes and begin to chip away at the wiretaps that showed Rajaratnam breaking the law all in his own words.

  Streeter knew where Dowd and his people were heading. The government has “limitless resources,” is the old saying, but Rajaratnam was a billionaire. In other words he had the resources to make the government look really silly if the wiretaps were declared inadmissible.

  As the trial date approached, what looked like an easy win started to look somewhat less easy. For starters, Bharara, with his comments about the successful use of wiretaps, had made a crucial error: celebrating a victory that had yet to be won. It was a bad omen, and even worse, some government investigators worried it may have pissed off the judge, Richard Holwell, enough to get him to toss the wiretaps on a technicality.

  A buttoned-down former corporate lawyer, Holwell was appointed to the federal bench eight years earlier by President George W. Bush.Holwell was known as a stickler for details, particularly when something as sensitive as a wiretap application was at issue.

  Put simply, Streeter was worried that for all the mountains of evidence against Rajaratnam, the government could still lose by having the wiretaps thrown out of court. The implications were huge not just for the Rajaratnam case, but for the entire insider trading probe. Traditionally, insider trading had been difficult to prosecute precisely because it was hard to establish the exact nature of the communication between the tipper and the tippee.

  Based on information uncovered by Cam Funkhouser’s computers and those at the SEC, there were literally thousands of potential cases of insider information each year. The trades before major market-moving announcements, such as mergers and acquisitions, painted a fairly compelling picture of how rampant insider trading was in the markets. The problem was proving it. Even with witnesses testifying to the guilt of a tippee, he-said-she-said cases are rarely a slam dunk. Targets can always rely on the concept of a “mosaic,” or a combination of various pieces of (public) information, as the real reason for a trade, rather than any specific piece of nonpublic information. In the Martha Stewart case, prosecutors went for the low-hanging fruit that Stewart lied about her suspicious trades to investigators, rather than the more difficult case of proving that her trades themselves were based on inside information.

  The Rajaratnam wiretaps left no doubt about intent. They showed in his own words how hedge fund traders worried less about their mosaics and more about their access to inside information in doing their jobs. And they were costly. Each wiretap needs at least a half-dozen investigators monitoring calls around the clock. Because the feds had multiple wiretaps going on at the same time, Perfect Hedge was already possibly the most expensive white-collar investigation in recent history—and the biggest waste of money if the wiretaps couldn’t be used.

  John Dowd may not have tried a case—at least not a case of this magnitude—in a while but he proved to be a crafty litigator from the outset. The actual trial of U.S. v. Rajaratnam wouldn’t begin for several months, sometime in the spring of 2011, but the case was basically being decided in federal court in October 2010 when Dowd and Streeter duked it out before Judge Holwell over whether the wiretaps of Rajaratnam’s cell phone—the same phone he used to dish inside trading dirt with Danielle Chiesi and his broader circle of friends—should be suppressed during trial.

  Dowd’s argument was pretty simple: The feds had to show—had to have proved to Judge Lynch back in 2008—that they had exhausted other methods of investigating Rajaratnam in order to get his approval to initiate a wiretap, and that the invasion of privacy that is at the heart of every wiretap was the last resort in catching an alleged bad guy. It was a high bar, albeit not insurmountable given the difficulty of prosecuting insider trading.

  Title III of the Omnibus Crime Control and Safe Streets Act of 1968 is the federal law that allows the government to wiretap private citizens. There are rules and procedures that must be followed before wiretap authority is granted by a federal judge, including utilizing all other investigatory techniques before going for a wiretap.

  The problem for Streeter was, Dowd claimed, that those rules and procedures were not followed, at least not that closely. In Dowd’s words, the “FBI went straight to tapping the phones” before fully utilizing conventional techniques to investigate their targets.

  Streeter was well prepared to make the argument that the wiretapping was necessary since Rajaratnam had been investigated for years without success. It was harder to defend against a procedural mistake made on the part of Goldberg and Kang when in their initial wiretapping application before Judge Lynch they failed to even mention that the SEC was investigating Galleon Group—and had yet to conclude that investigation.

  Worse than making it look like the government was hiding stuff, it helped make Dowd’s argument, namely that the government was so scared about not meeting the Title III test that it left out what the court needed to know to render a decision.

  Kang took the stand and did his best to try to explain why he would leave out a key fact—namely that he didn’t see it as necessary since the SEC and Justice Department always work together on cases. Any federal judge would know that, so it was unnecessary to put it in writing. Streeter tried to pass it off as an innocent mistake and one that wasn’t material in granting the application. “There was nothing nefarious about it. . . it would be bad government if we didn’t work with the civil authorities.”

  When Holwell first granted Rajaratnam’s request for a hearing on the wiretaps he said the government had “recklessly or knowingly misleadingly omitted several key facts” in the initial application. Streeter and Bharara had met at least once during this time. They agreed that despite Holwell’s initial bluster—they were prepared to be “smacked around” a bit by Holwell—they weren’t going to lose and the wiretaps would be safe. Streeter was confident that he had provided enough evidence to prove that nothing Kang and Goldberg had done was “reckless.” It was a mistake, plain and simple, and there was no way Holwell would upend the biggest post-financial crisis white-collar case on a simple mistake.

  What they didn’t know was how close they came to being wrong and watching Rajaratnam possibly walk away free. Holwell is a judge who is hard to read. He displays little if any emotion when weighing evidence on such pretrial matters. Streeter and Bharara didn’t know it but nothing Holwell heard during the hearing changed his initial assessment of the wiretap application. In fact, Holwell has told people it only reinforced the need to “suppress,” or throw the wiretapped evidence out of court.

  The hearings lasted four days, but they could have lasted four minutes as far as Holwell was concerned; he was ready to side with the defense and throw out the wiretaps. It would be a huge blow to the government. In a sense, if Rajaratnam’s taped conversations were thrown out, one could make the case that most of the ensuing telephone wiretaps of all the other people investigated in the mammoth roundup were so-called fruit of the poisonous tree (and hence inadmissible in court) since they had grown out of an illegal wiretap.

  “Okay, this is a real mess,” Holwell thought as he began to scope out the reasons for upending what was possibly the biggest insider trading case in history. Without the wiretaps, the g
overnment had to resort to conventional means such as witnesses and circumstantial evidence, the stuff that makes insider trading so difficult to prove in court, since witness memories fade and markets are full of rumors that are hard to differentiate from inside information.

  The government’s efforts on the broader issue would be dealt a huge blow. Defense attorneys would be given a road map to have evidence thrown out of court. Forget nailing Rajaratnam; cases against lesser subjects could be thrown out, including those against many of the current cooperators. It was unclear how many of the other wiretap applications excluded the same information, but it was a good bet this wasn’t an isolated example.

  As Holwell prepared to suppress the best evidence against Rajaratnam—indeed, possibly against any white-collar criminal in recent memory—he alerted his clerk, a bright Harvard Law grad named Justin Raphael, to start the work to prepare the opinion. In Holwell’s mind, the courts were pretty clear when it came to anything that looked like government misbehavior: They don’t tolerate it and evidence tainted by it is inadmissible.

  Raphael was hardly an expert on the inner workings of Wall Street though as an undergraduate, he wrote a magazine piece where he tried to explain why so many college graduates chose a career there. While “money is the sole rule of the Street,” he wrote, “it is far from its only allure.” The essay went on to say that people on Wall Street love the “adrenaline rush” they get at work, and they “relish the competition” of deal making. Raj Rajaratnam couldn’t have said it better.

  Raphael graduated from Harvard Law in 2009, and now just a year later he was advising a federal judge whose decision could upend the biggest inside trading case since Ivan Boesky. Raphael knew that Holwell worried broadly about the invasion of privacy issues that wiretaps presented. He was also aware that wiretaps were rarely used in white-collar law enforcement. Insider trading might be bad, but was it worth trampling on the U.S. Constitution?

  Title III appears to be pretty clear on one important matter: The government needs to show a federal judge that before it can invade a private citizen’s privacy it has exhausted all conventional techniques. And at least in this case, the government left out a key piece of evidence. Simply put, Goldberg and Kang screwed up, and when it comes to privacy rights, you’re not supposed to screw up.

  That’s when the twenty-five-year-old clerk pressed the sixty-five-year-old Holwell to reconsider what he described as the judge’s antiquated notion of privacy. The notion of what is and isn’t private has been changing in recent years. He urged Holwell to consider all the personal information that appears on the Internet, and accordingly to temper his views about privacy to reflect modernity; with technology very little of our lives is truly private.

  He also urged Holwell to consider what a Title III application is all about and put himself in Judge Lynch’s shoes: Would he have really said no to the wiretap even if he knew the SEC was still looking into Rajaratnam’s trading? Of course not. The evidence against Rajaratnam was significant, maybe not enough to put him in jail, but clearly enough to approve a wiretap and a necessary ingredient to convict someone who might otherwise get away with fraud.

  Insider trading is a crime of communication; if you don’t know how Rajaratnam is making his communications, how can you properly investigate his activities? All told, maybe one in ten wiretap applications had been denied in recent years, Holwell discovered. Based on all of that, Raphael asked, was he really ready to let Raj Rajaratnam and countless others off just because of a procedural mistake?

  In the end Holwell wasn’t. On November 24, 2010, he issued his sixty-page decision denying the requests of Rajaratnam and his fellow defendant Danielle Chiesi to suppress the wiretaps as evidence in the case.

  Holwell mentioned the failure of the government to cite the SEC’s investigation in its wiretap application. But, he pointed out, the SEC’s long-standing interest in Rajaratnam was the reason that a wiretap was necessary. Conventional investigative techniques had been used and “nevertheless,” he wrote, they had “failed to fully uncover the scope of Rajaratnam’s alleged insider trading ring and was reasonably unlikely to do so because evidence suggested that Rajaratnam and others conducted their scheme by telephone.” Even if Kang and Goldberg had included the SEC probe in the application, “it would ultimately have shown that a wiretap was necessary and appropriate.”

  In the opinion, Holwell clearly sided with the government, but in granting approval, he put investigators on notice that they had better do things right if they wanted to tap a target’s phone. In fact, the judge used the word reckless in his decision more than twenty times. Bharara read the decision with a mixture of anger and relief, according to people who know him. Anger because based on what he had heard this wasn’t nearly the slam-dunk Streeter had predicted. His relief came because with the admission of the tapes into evidence, he was all but assured his biggest victory since being appointed as Manhattan U.S. Attorney, even if he had no idea his margin of victory (and Rajaratnam’s margin of defeat) came thanks to a recent Harvard Law graduate who had once written an essay about working on Wall Street.

  Jonathan Hollander had just left the gym, feeling the usual high that comes after a good workout, when he was approached by a couple of FBI agents, including David Makol. According to Hollander’s account, they said he wasn’t under arrest, but the agents also indicated he was under suspicion as a member of the “SAC crime family” engaging in insider trading.

  The crime family reference wasn’t hyperbole, Hollander would later concede. Hollander accompanied Makol to a nearby diner, as Makol so often takes his targets. They sat down and ordered coffee, and before Hollander took his first sip, Makol produced a piece of paper. It showed a chart in the style of those iconic depictions of Mafia families, with Steve Cohen’s face displayed at the top and arrows pointing below to a host of other SAC people.

  Hollander has told people the experience was jarring, particularly because Makol was clear and direct in his approach. They knew Hollander was trading on inside information.

  Also jarring was the chart Makol handed him. He has told people it bore a startling similarity to one of those used to describe organized crime families with the capo di tutti capi, in this case Cohen, at the top of the alleged criminal enterprise, followed by his captains and soldiers. Hollander said he recalled seeing his own photograph somewhere near the bottom left-hand corner, as if he were a low-level soldier in the bigger criminal conspiracy.

  SAC is actually a multitude of hedge funds operating in a semi-autonomous manner, though Cohen has final say over key trading strategies. One unit is said to be different: CR Intrinsic, a subsidiary inside SAC that operates as Cohen’s private hedge fund, where most of his money has been kept. Hollander had worked at CR Intrinsic for four years.

  Cohen had managed money directly for the fund where a chunk of his net worth has been held. Analysts like Hollander and traders know they receive their biggest bonuses by funneling investment ideas to Cohen and cranking profits for CR Intrinsic. An analyst or trader who works for this division could have direct access to Steve Cohen himself.

  In late 2008, Hollander left SAC after his supervisors told him he was laid off to save money following financial-crisis related losses that led to SAC’s first down year since its inception. Not long after, the FBI came calling. If the intent of the meeting was to scare Hollander into some kind of cooperation agreement, it was successful. Makol said the proof of Hollander’s insider trading was significant; an informant had led them to trades in Hollander’s personal account in shares of Albertson’s food store chain.

  The informant, an investment banker at the firm UBS, said that he had witnessed Hollander being given a tip about Blackstone’s pending buyout of Albertson’s. Hollander made an easy $3.5 million by snapping up shares of Albertson’s in his personal account.

  Hollander ultimately agreed to two “proffer sessions” with government investigators. Such interviews with law enforcement allow the targ
et to speak freely; the testimony receives immunity, and it’s an indication that the feds are interested in bigger fish.

  In this case, there was little doubt who the feds were interested in as Assistant U.S. Attorney Reed Brodsky quizzed Hollander not just on the Albertson’s trade (Hollander said he hadn’t shared that tip with anyone at SAC) but on the inner workings of the hedge fund, namely how information flows from traders and analysts to the man at the head of the organizational chart.

  Unlike Streeter, who had focused on other white-collar cases before taking in the Rajaratnam prosecution, Brodsky had been working on insider trading cases for years. He was in his early forties, and had joined the Southern District after a stint in private practice. He’s known as a tireless and smart worker. If he has a fault it’s in his overpreparedness, which can hurt him at trial, where juries respond best to simple, linear cases from prosecutors.

  But this wasn’t a trial, merely an attempt to get Hollander to tell him everything he knew about Cohen’s operation. Overpreparedness didn’t matter. Brodsky knew going into the proffer sessions the key elements of how SAC worked. Cohen, of course, ran things, but many buffers stood between him and the information source. It was known as a hub and spoke structure, in which portfolio managers and analysts fed him the best ideas that they were trading on.

  This happened all day, every day, since Cohen rarely took a day off. The competition was fierce to get Cohen’s attention, Brodsky knew, because of the rewards for profitable trades. SAC bragged that it had created the first stand-alone compliance department in the hedge fund business. By the time Hollander was approached by the government, the compliance unit was among the hedge fund industry’s largest such operations with 36 people watching its trades. Brodsky, like others involved in the probe, believed SAC’s efforts to detect dirty trades weren’t enough given all the trading at the firm, and they probably came too late. After spending some time on the Albertson’s trade, prosecutors seated across from Hollander made it pretty clear what they thought of the hedge fund by asking their witness to tell them “everything you know, firsthand or secondhand about insider trading at SAC,” according to a person who was present.