Hedge Fund Insider Trading Prosecutions Rely On Suspects Turned Informant

David Glovin


January 11, 2011

UBS AG investment banker Nicos Stephanou, facing more than 10 years in prison for insider trading, made a quick decision following his arrest two years ago: He decided to become a government informant.

For months, Stephanou secretly recorded telephone calls with four friends about pending deals and told investigators all he knew about their insider trading. After his testimony at a trial put one of them behind bars for six years, prosecutors helped him stay out of prison for his own crimes.

As the U.S. government cracks down on insider trading at hedge funds, technology companies and expert-networking firms, more than a dozen traders, lawyers and executives are following in Stephanou’s footsteps. In bids for leniency, they’ve turned on friends and associates. While prosecutors have touted the use of wiretaps in the case of Galleon Group LLC’s Raj Rajaratnam, convictions in such cases may rest on testimony by accomplices who point a finger at confederates to save their own skin.

“Our criminal-justice system works in part because of bargaining with people like yourself,” U.S. District Judge Lewis A. Kaplan in Manhattan told David Glass, a government witness in an insider-trading case in 2008, as he granted the day trading firm-owner probation. “It isn’t pretty,” the judge added. “It just serves a utilitarian purpose without which other people couldn’t have been brought to justice. You happen to have the goods and get the goods on them. And so, frankly, in the words of the street, you get to walk.”

Nguyen Plea

Yesterday, Bob Nguyen, who worked at Primary Global Research LLC, a Mountain View, California-based expert- networking firm that links employees of public companies with traders, pleaded guilty to insider trading and agreed to cooperate with prosecutors. He is the latest of the firm’s former employees and consultants implicated in a federal investigation of trading by hedge funds.

Next month’s insider trading trial of Rajaratnam may feature testimony from several cooperators, including one who befriended him a quarter of a century ago.

At his Feb. 8 guilty plea, Rajiv Goel, who had been a managing director in Intel Corp.’s treasury group, said he leaked tips to Rajaratnam “because of my friendship for him.” Goel’s lawyer, David Zornow, declined to comment.

Rajaratnam, 53, denies wrongdoing and said he didn’t trade on inside information. At the trial in Manhattan federal court, prosecutors also plan to present wiretaps of his phone calls.

Double Cooperator

At least one Rajaratnam cooperator also worked for the government in its related probe of expert-networking firms. Richard Choo-Beng Lee, co-founder of hedge fund Spherix Capital LLC, is a cooperator in both cases, according to court papers.

“He is and will continue to do his best to provide accurate information to the U.S. government,” Jeffrey L. Bornstein, Lee’s lawyer, said of his client.

The investigation of expert-networking firms led to charges against at least eight people associated with Primary Global. Prosecutors also subpoenaed documents from hedge funds including New York-based Level Global Investors LP; Stamford, Connecticut- based Diamondback Capital Management LLC and Boston-based money manager Wellington Management Co.

Among those cooperating with prosecutors is a research analyst at a New York-based hedge fund that prosecutors didn’t identify, according to a criminal complaint against Winifred Jiau, a Primary Global consultant.

Avoiding Prison

Defense lawyers typically rush to win cooperation deals to save clients from prison, said James Cohen a New York defense lawyer on the Fordham Law School faculty.

Clients sometimes balk at joining the government side. Fund manager Danielle Chiesi, arrested with Rajaratnam on Oct. 16, 2009, testified in November that Federal Bureau of Investigation agents who came to her apartment demanded that she make an immediate decision on whether to cooperate.

Confronting her with transcripts of her telephone conversations, she said, they wanted her to make a “monitored phone call” to a person in another time zone, whom she didn’t identify.

“They said that you have a special opportunity to help yourself,” she testified. “You’re going to be arrested at some point — maybe not right this minute, if you cooperate,” she quoted the agents as saying.

Chiesi refused, and was subsequently arrested. She faces an April trial in Manhattan.

Cooperators at Hub

Cooperators often sit at the hub of cases being assembled, said Barry Pollack, a white-collar criminal-defense lawyer at Miller & Chevalier in Washington.

They explain how a conspiracy worked, identify its leaders, interpret documents, describe meetings and otherwise “provide a roadmap” to the government, Pollack said.

For juries, cooperators “give an insider’s view of what happened,” he said.

The case of Stephanou, who is no longer at Zurich-based UBS, sheds light on how valuable cooperators can be. He agreed not only to testify for the government but also to keep playing the role of co-conspirator.

Stephanou and his lawyer, Christopher J. Morvillo, declined to comment. The details of his cooperation are spelled out in a filing in Manhattan federal court before his Dec. 22 sentencing.

A graduate of the University of California at Berkeley and Columbia Business School, Stephanou, 36, joined UBS in 2002 after working in the corporate finance department of Coopers & Lybrand LLP and the mergers group at Credit Suisse. In the spring of 2006, he became a UBS director. According to his court filing, he was promised he’d be promoted to executive director in early 2009. By that point, he was already an insider-trading suspect.

Airport Arrest

On Dec. 27, 2008, when his Cancun-to-London flight stopped at Newark Liberty International Airport, Stephanou was arrested by FBI agents. He spent the next 19 months in a federal lockup in Lower Manhattan, after being charged with leaking information on deals he learned of while at the accounting firm where he worked, one of which yielded him $973,000.

After hiring a lawyer and learning that as a citizen of Cyprus he wouldn’t be freed on bail, Stephanou immediately decided to aid the government, Morvillo wrote.

Stephanou described illegal tips he made to friends dating to 1997, when he was at Coopers & Lybrand, now a unit of PricewaterhouseCoopers LLP.

From the moment of his arrest, Stephanou “told me that he wanted to do whatever it took to make it right,” Morvillo told the sentencing judge. “It was not a statement to avoid punishment. He wanted to correct his errors.”

Dinner With Friends

In an early talk with FBI agents, Stephanou described a 2006 dinner he had with two friends, Jonathan Hollander, an analyst at SAC Capital Advisors LP, the Stamford, Connecticut, hedge fund company run by Steven A. Cohen, and Ramesh Chakrapani, a managing director at New York-based Blackstone Group LP, according to a letter in court files by Assistant U.S. Attorney Andrew L. Fish.

According to Fish’s letter, Stephanou said Hollander told him that he’d received alleged secret tips from Chakrapani about a joint venture’s acquisition of Albertsons Inc., then the second-largest U.S. grocer.

Since Stephanou’s arrest wasn’t yet public, the agents asked him to record telephone conversations with friends. Stephanou did, and the recordings were “a significant factor” in spurring two of them to later plead guilty to insider trading, Fish said.

Contorinis Convicted

Stephanou spent two days on the witness stand as the government’s chief witness at the trial of Joseph Contorinis, a former Jefferies Paragon Fund money manager. Contorinis, convicted by a jury in October, was sentenced last month to six years in prison.

Prosecutors brought and later dismissed criminal charges against Chakrapani, whose lawyer, Michael Sommer, didn’t return calls seeking comment. Hollander wasn’t charged with a crime. His lawyer, Aitan Goelman, also declined to comment.

“No amount of money can restore my self-respect and good name in society,” Stephanou wrote to U.S. District Judge Richard J. Sullivan before being sentenced to time served. “There is no doubt in my mind that crime does not pay.”

Cohen, the Fordham law professor, said prosecutors make deals with cooperators who have valuable information. They must agree to come clean about their own crimes and those of “everyone else, including parents and siblings,” he said.

Even ringleaders of white-collar conspiracies have won cooperation deals by implicating their underlings or others targeted by the government, Cohen said.

“The worst place you can be is marginal — someone who has done something wrong who really doesn’t know the inner workings of whatever is going on,” he said. “You have nothing to offer.”

Lenowitz, Franklin

The cases of Mark Lenowitz and Erik Franklin show how witnesses in one case can help prosecutors in another.

The two traders were among 13 people arrested in 2007 who pleaded guilty to trading on inside tips. Various schemes in the case stretched back as far as five years, prosecutors said.

Franklin’s and Lenowitz’s cooperation led prosecutors to another trader, David Slaine, and he in turn pleaded guilty and told the government about activities of Zvi Goffer, prosecutors said.

Goffer, a former Galleon Group employee, was arrested in November 2009 and accused of leading an insider-trading ring tied to the Rajaratnam investigation.

Franklin and Lenowitz won probation for their assistance. Slaine, who hasn’t been sentenced, is to be a government witness at Goffer’s trial in Manhattan in May, Fish said. Slaine’s lawyer, Stephen Kaufman, declined to comment.

On the Stand

When they reach the witness stand, cooperating witnesses can expect to be subjected to harsh cross-examination by defense attorneys. Typically they are called liars and accused of fabricating evidence to save themselves from jail.

Michael S. Weinstein, a former prosecutor, said he would constantly ask himself how his cooperators would perform on the stand and what secrets lurked in their backgrounds.

Stephanou was repeatedly asked by Contorinis’s lawyer whether he was a liar who brought shame upon his family. He admitted that he had disgraced them.

Among government witnesses at Rajaratnam’s trial next month may be Roomy M. Khan, a former employee at Santa Clara, California-based Intel who cooperated with prosecutors in two separate investigations of the Galleon co-founder.

Her disclosures about his trading helped the government win a judge’s permission to wiretap his phone calls, according to court papers. Khan’s lawyer, Stanislow German, didn’t return a call seeking comment. Jim McCarthy, a spokesman for Rajaratnam, declined to comment.

John Dowd, Rajaratnam’s lawyer, has assailed Khan in a court filing, previewing his cross-examination at the trial.

He claimed in court papers that she repeatedly lied to investigators, including a “preposterous” claim that she bought shares in Hilton Hotels Corp. because she thought the jailing of Paris Hilton, the celebrity heiress and reality television star, would generate publicity.