Will a Criminal Court Admit into Evidence a Recorded Telephone Conversation Between a Hedge Fund Manager Charged with Insider Trading and an Alleged Co-Conspirator?

Much has been said of late about the new investigative and enforcement tools being used by the Securities and Exchange Commission (SEC), Department of Justice (DOJ) and Federal Bureau of Investigation (FBI) to combat insider trading.  See “The SEC’s New Focus on Insider Trading by Hedge Funds,” Hedge Fund Law Report, Vol. 3, No. 22 (Jun. 3, 2010).  On the civil side, the SEC has restructured its Enforcement Division into industry units, hired former federal prosecutors to serve in the Enforcement Division, authorized Enforcement Division staff to enter into non-prosecution agreements and cooperation agreements and increased its use of technology to analyze trading trends for suspect patterns.  See “SEC’s Hedge Fund Focus to Include Review of Funds That Outperform the Market,” Hedge Fund Law Report, Vol. 4, No. 14 (Apr. 29, 2011).  On the criminal side, the DOJ and FBI have incorporated into their anti-insider trading efforts tools formerly reserved for the investigation and prosecution of organized crime.  Most notably, the FBI is using wiretaps in its investigations of hedge fund managers for insider trading, and the DOJ is using the fruits of such wiretaps in its prosecutions.  The legal authority for the agencies to use wiretaps in the hedge fund context was affirmed in an important district court decision in November 2010.  See “Federal District Court Upholds the Government’s Right to Use Wiretaps to Investigate Suspected Insider Trading by Hedge Fund Manager Personnel,” Hedge Fund Law Report, Vol. 3, No. 48 (Dec. 10, 2010).  And, of course, the most notable example (to date) of the government’s successful use of wiretap evidence in an insider trading prosecution in the hedge fund context was the May 11, 2011 conviction of Galleon Group founder Raj Rajaratnam.  See “Implications of the Rajaratnam Verdict for the ‘Mosaic Theory,’ the ‘Knowing Possession’ Standard of Insider Trading and Criminal Wire Fraud Liability in the Absence of a Trade,” Hedge Fund Law Report, Vol. 4, No. 18 (Jun. 1, 2011).  Prior to the use of wiretap evidence in insider trading investigations and prosecutions, most insider trading cases were based on circumstantial evidence.  With the advent of the use of wiretap evidence in this context, insider trading cases can now be based on direct evidence.  As some white collar defense attorneys observed, although Rajaratnam elected not to take the stand at his own trial, he nonetheless served as the prosecution’s “star witness.”  Rajaratnam’s voice appeared in hours of recorded phone calls that were played for the jury, discussing what the prosecution characterized as material nonpublic information.  For the defense, these recordings proved insurmountable.  In short, wiretapping by the government has changed the landscape of insider trading law for hedge fund managers.  But the government is not the only party that records phone calls.  With a level of frequency that keeps white collar defense lawyers up at night – although some of them are up thinking about new business rather than worrying – hedge fund managers and other hedge fund industry participants record their own phone calls.  Often, they do this for what they consider practical reasons rather than for legal or regulatory reasons.  For example, a manager that submits frequent trade orders to its brokers may record calls to create a record for any dispute over a trade error.  Or a manager may record an analyst’s calls with an expert found via an expert network for compliance reasons.  However, in the current enforcement climate, any hedge fund manager that records its own phone calls must weigh the perceived benefits of such recordings against the possibility that recorded calls will be admitted into evidence (and invariably taken out of context) in a civil enforcement action or criminal prosecution.  A June 29, 2011 Opinion by U.S. District Court Judge Jed Rakoff illustrates the legal standards that govern admission of phone calls and other communications recorded by a hedge fund manager in a criminal proceeding against a third party alleged to have provided material nonpublic information to the manager.  For discussion of other opinions by Judge Rakoff in the hedge fund context, see “A Prime Broker that Fails to Diligently Investigate the Sources of Funds in a Hedge Fund’s Margin Account May Be Jointly and Severally Liable, with the Fund and Its Manager, for Fraud by the Manager, to the Extent of Funds in the Account,” Hedge Fund Law Report, Vol. 3, No. 47 (Dec. 3, 2010); “In Refco Securities Litigation, Federal Court Declines to Impute the Bad Acts of Individual Directors of a Hedge Fund Management Company to the Management Company Itself, or its Funds,” Hedge Fund Law Report, Vol. 4, No. 15 (May 6, 2011).

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