The insider traders who got away

Insider trading is a notoriously hard crime to pin down, but legal shifts in the US show just how little other countries are doing to combat the problem.

They take enforcement seriously at the Federal Bureau of Investigation. They get Gordon Gekko to warn off hedge fund managers from trading on inside information, and they tap the phones of suspects.

Compared with that, hedge fund managers in Mayfair and Geneva, where Philippe Jabre moved after being fined £750,000 for market abuse at the GLG hedge fund in 2006, have things easy. The small minority that breaks the rules has a much lower chance of either being caught or, when caught, jailed.

Legitimate banks choose financial centres according to national loyalty, tax and regulation but an insider trader will logically settle outside New York or Greenwich, Connecticut. Hedge funds are well versed in risk and reward, and the risks of illegality are now greater in the US than in Europe.

The sight of Michael Douglas reprising his role on Wall Street in an FBI video aimed at discouraging insider trading is a symbolic difference. More significant are the methods being used by the FBI, the Department of Justice and the Securities and Exchange Commission – and the results. Since 2009, the New York authorities have prosecuted 66 people for insider trading, with 57 convictions or guilty pleas.

That scares people, while wrongdoers in the UK and elsewhere have less to worry about despite the efforts of the Financial Services Authority to step up its criminal inquiries. Other jurisdictions can still learn from the US, both about how to fight white-collar crime and about how to frighten insider traders.

The biggest shift in the US – impossible under current law in the UK – is the use of phone-tapping to gain convictions in court. That has brought down a swathe of hedge fund managers including Raj Rajaratnam, the founder of Galleon Group, who is now serving an 11-year prison sentence for insider trading and securities fraud.

"That has been a game-changer because it is very difficult to investigate hedge fund professionals through traditional means,” said Christopher Garcia, a partner at Weil, Gotshal & Manges, the US law firm, and former head of the securities fraud task force at the US Attorney’s office in Manhattan.

Calls on bank trading floors are usually recorded but the ability of the FBI and the SEC to tap mobile phone calls and conference calls makes it possible to trace the exact terms on which inside information is passed informally. Without the tapes, they would rely on documents and circumstantial evidence.

Insider trading is a notoriously hard crime to pin down because investigators must link the passing of tips to securities trades and prove that the offender was acting illicitly. In a hedge fund, where professionals constantly trade huge blocks of securities, and usually have extensive files of research and analysis to support every decision, it is especially difficult.

Yet it is vital to do so. Some scholars have argued that insider trading should be made legal because it is a way of getting all available information about a security into markets as quickly as possible. But to accept that would be to accept that a privileged class of financiers can exploit their insider status to make millions – an outcome that would revolt most people.

Given how much information traders have, and how easy it is for them to benefit illicitly, the step-change in the authorities’ ability to catch criminals and inflict long prison sentences on them (rather than simply a civil fine that they can write off as the cost of doing business) is essential.

It has been far slower going in London, where many hedge funds operate, let alone in Geneva. The FSA gained criminal prosecution powers in 2001 but it secured its first conviction for insider trading only in 2009, having relied on civil remedies, such as its 2006 action against Jabre and GLG, and the recent £7.2m fine on David Einhorn and his fund Greenlight Capital.

Lack of will to take on complex and tough cases is one reason why the FSA lags. "The sheer amount of effort that goes into investigation and prosecution makes it a difficult law to enforce,” Clifford Chance partner, and former FSA head of wholesale enforcement Carlos Conceicao said.

The FSA also faces higher barriers than in the US. The wiretap evidence that proved vital in the Galleon case, and in the FBI’s 'Perfect Hedge' investigation into hedge fund abuse of inside information, would be inadmissable in a UK court. Indeed, recent US use of wiretaps is being challenged on appeal.

Furthermore, the maximum UK sentence for insider trading is seven years – half of that for theft or fraud, which ought to be comparable offences. Only when it is combined with a money laundering conviction can a UK judge impose a sentence in line with the 11 years handed down to Rajaratnam.

The FSA is attempting to ramp up criminal enforcement and it gained a significant scalp last year when Christian Littlewood, a former banker at Dresdner Kleinwort, was given a 40-month jail sentence for insider dealing. A fund manager at Legal & General was also arrested in February in an inquiry that started with a set of arrests two years ago.

It remains a meagre haul compared with convictions on the other side of the Atlantic and the swagger of the FBI, which declared this week that it is targeting a further 120 suspects and expects this round of inquiries to continue for another five years. More than a few must now covet a safer life in London.

If the UK is to match the US, it must reconsider the use of phone-tap evidence and its sentencing policy. If not, the Gordon Gekkos of the world could move to Mayfair.

Copyright The Financial Times Limited 2012.

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