Circle of Friends

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 worked 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.

N
ow 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.