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To catch a thief: How the FBI targets insider trading

Inside the FBI and SEC crackdown


When it comes to insider trading, you probably first think of the SEC and the Department of Justice. But the FBI has been vital in improving the SEC's ability to target insider trading schemes—and they've done it using the same tools they used to target organized crime in the 1980s and 1990s.

In the early years of hedge fund trading, many managers got away with using inside information, but since the financial crisis and most notably the Madoff scandal, the FBI has been embedded with the SEC to catch criminals. And it has worked.

"Over 100 analysts and portfolio managers have been arrested over the past seven years for insider trading," says David Chaves, special agent at the FBI. "Only 1 percent of the industry has been caught up in a situation like this, but it does reflect badly on the industry. The overwhelming majority of the industry is responsible, but supervision is important."

The FBI gets involved

The FBI first got involved with tracking insider trading when people they were arresting for market manipulation started informing them about insider trading schemes. Informants told them that people inside the hedge fund industry were stealing millions by trading on nonpublic information. Burner cellphones, bunkers in PlayStation war games and encoded emails were just a few of the ways insiders were trading illegal information.

"When we first started looking into this, we didn't have insiders in these companies telling us how information was moving, and they were also lightly regulated," Chaves says. Once the FBI started taking a crash course in hedge funds, the agency quickly developed a plan to go after insider trading.

The agency started by clearing out expert networks, which at that time were one of the key sources of nonpublic information. They did this by developing informants within these networks. Some 32 arrests have come from those networks to date.

When it came to targeting specific managers, agents went so far as to follow them for months until they knew everything they needed to make their move. "We'd be behind the person at Starbucks when they went to place their order, and we'd step in and say "he'll have a coffee with two sugars.' Then we'd take them over to a table and explain that we knew what was happening and tell them they had the opportunity to cooperate or face arrest. 9.9 times out of 10 they cooperated. That opened the door for us in the hedge fund industry."

Those cooperators provided clear information about who knew about nonpublic information and when. The FBI was also able to get wiretaps into the industry for the first time. Once the first 100 arrests for insider trading happened, Chaves says, "Those created a significant deterrent."

The FBI also used its behavioral science unit, the same unit the agency uses to track serial killers and terrorists, to work up a profile of insider traders. "This gave us a better picture into their motives and how they normally act," Chaves explains. "We started to learn what would trigger these individuals and what we could say to get them to work with us."

Teaming up with the SEC

With a clear plan of attack in place, the FBI has been working closely with the SEC to track insider trading and make arrests when necessary. Chaves does not feel that the Newman case, which overturned convictions in some key insider trading cases, will limit the ability of the FBI and SEC to go after insider traders. "I think a lot of people thought that with that ruling, it would be harder for us to go after people suspected of insider trading, but we have a variety of tools at our disposal."

The Foreign Corrupt Practices Act (FCPA) also represents a new area of financial services enforcement for both the SEC and the FBI. FCPA enforcement has typically involved companies engaged in supply-chain related bribery schemes, but now regulators are taking a closer look at a range of business practices that may violate FCPA. The SEC has already brought the first enforcement action under FCPA against BNY Mellon over its hiring practices. Other cases could be brought against the industry for a range of issues, including bribery and money laundering.

In all, Chaves says the FBI is keeping a close eye on the industry. "I want to emphasize that I don't think the industry itself is criminal, but there is criminal element within the industry. Ultimately, all information has to be communicated and we are prepared to find out if the way that information was communicated violates the law. We are incredibly patient at the FBI. We will sit back and wait for those opportunities and allow those things to unfold as we build our cases."

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