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Insider Trading and the Birth of the Perfect Hedge

Five years ago, FBI agents David Chaves and Patrick Carroll received intelligence that “a surge in profits at hedge funds might be the result of an epidemic of insider trading,” reports Bloomberg. “Informants had told them the hedge fund industry was similar to organized crime: insular and distrusting of outsiders.” Without having people on the inside, “the government would have a tough time gathering enough evidence to prosecute.” Chaves said, “It was reminiscent of that scene in ‘Jaws’ where they get their first look at the shark.” He told Carroll, “We’re going to need a bigger boat.” And, like that, the ‘Perfect Hedge’ was born.

Raj Rajaratnam thinking

Chaves and Carroll’s solution was to infiltrate the industry by putting people in place who would report to them daily, in some cases even “wearing wires to record incriminating statements by targets.” Chaves says that the evidence obtained from those instances, “could then be used to provide us enough probable cause to obtain a wiretap.” According to Bloomberg, “To date, at least 56 people have been charged with insider trading and more than 50 have either pleaded guilty or been convicted after trial as part of the probe.” In many of these cases, wiretaps played a role, such as the case of the Galleon Group’s Raj Rajaratnam.

Unfortunately, it may also be the downfall of the investigation, at least in Rajaratnam’s case. “Rajaratnam, who recently began an 11-year prison sentence — the longest in U.S. history for insider trading — has argued federal laws don’t authorize the use of wiretaps for such an offense.” writes Bloomberg. “His lawyers claimed that the government didn’t show, as required by law, that conventional techniques couldn’t have been used to achieve similar results.”

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