Last week, the prosecution and the defense filed their sentencing memoranda in the Rajaratnam case.  Raj was convicted of 14 counts in all — 9 counts of securities fraud, and 5 conspiracy counts.  So what do the parties think that’s worth?  The feds asked Judge Holwell to sentence Raj in the range of 19.5 to 24.5 years.  The defense didn’t make a specific request, just said it ought to be “well below” what the feds want.

So 20 years, huh?  Wow, he must have been an awful bad guy.  Must have hurt a whole lot of people, right?

After all, a mugger in a dark alley only takes one person’s wallet.  A “white-collar criminal” can steal from thousands of people — and takes not just their wallet, but their life savings!  Right?

Well, hang on.  Did Raj actually steal from anyone?  How many investors did he really harm?  And did any of them really lose enough money to warrant locking someone up till we all have flying cars and jetpacks?

Judging from the feds’ sentencing memo, you bet.  Just look at this, from the introduction:

Raj Rajaratnam’s criminal conduct was brazen, arrogant, harmful, and pervasive.  He corrupted old friends.  He corrupted subordinates.  He corrupted entire markets.  Day after day, month after month, year after year, Rajaratnam operated as a billion-dollar force of deception and corruption on Wall Street.

Wow, that sounds awful.  So the victims are… who again?

But wait, there’s more:

Rajaratnam repeatedly leveraged the power of money and his position as the head of a 7-billion dollar hedge fund to induce friends, employees, and associates to participate in his criminal activities.  Although already rich, Rajaratnam did this to drive up his personal wealth through profitable trading in his hedge fund.  He did it to make sure that investors did not pull their money out of Galleon and to attract new money to his fund.  And he did it because of his egomaniacal drive to triumph over his competitors on Wall Street.

Again, wow.  (The feds sure like their adjectives, don’t they?  Comes off a tad over-the-top, if not insulting to the intelligence.)  So he was trying to increase his wealth, gotcha.  But at whose expense?  Guess we have to read more:

That was what he cared about: money and success.  What he did not care about, at all, was the extensive harm he left in his wake: harm to the capital markets; harm to the average, ordinary investors who played by the rules; harm to the companies whose secret information was misappropriated; and harm to the lives of those he corrupted.

Well, that sounds a little more like it… but again, who was harmed, and how?

Although particular investors on the other side of Rajaratnam’s illegal trades are not easily identifiable, there should be no question that ordinary investors paid the price for Rajaratnam’s crimes and that public companies were harmed by Rajaratnam’s repeated theft of corporate secrets.

Oh for crying out loud.  Are they joking?  Stripped of its demagogical rhetoric, this translates to “We have not identified any actual victims.  But we shouldn’t have to.  It’s obvious that lots of people must have been harmed, even if we don’t know who they were.”

If they don’t know who — or even whether — anyone was actually harmed here, how in blazes do the feds justify asking for 19.5 to 24.5 years of imprisonment?  Here’s how:

[The feds want that much time because they feel it is] proportionate to the historic nature of his crimes.  He is arguably the most egregious violator of the laws against insider trading ever to be caught.  He is the modern face of illegal insider trading.

That’s it.  That’s all.  “Because this is the first time we’ve ever caught someone so red-handed,” and “because this case got so much press.”  Those are the sole reasons why they are looking to put this guy away until he dies of old age.

Really?

-=-=-=-=-

For the record, we’re predicting something around 180 months — 15 years or so.  We base that prediction on other sentences by this judge that we’re aware of, and a bit of that amorphous experience we call our gut.

But is even that what this case is really worth?  When all is said and done, who really are the victims of insider trading?

-=-=-=-=-

It depends on how the crime was committed, really.  There’s more than one way to skin a cat, and there’s more than one way to commit securities fraud.  Some kinds of insider trading have more obvious victims than others.

For example, let’s say you break into the offices of 3M, and read a secret file that shows they are about to announce the release of a phenomenal new kind of sticky note that will revolutionize office work forever.  You max out your leverage and buy all the 3M call options you can afford.  When the news is announced a week later, you’re an instant millionaire.

Now, did your actions change the profit or loss of any other people?  Nobody else’s stock price went up or down a penny because of your actions.  3M’s shareholders are just as wealthy as they otherwise would have been.

What about the counterparties to your trades?  Didn’t you defraud them by buying at their price when you knew the price would be higher?  Not really.  Fraud implies misrepresentation.  The only thing you represented was that you thought the price was going to go up, which was true.  They did the deal not because of any representation you made, but because they calculated it to be worth it.  So nobody in the market seems to be a victim here.

But you stole.  You out-and-out stole secret information that you weren’t entitled to.  The value of that theft can be calculated a few different ways, but the simplest way is to look at how much you yourself profited from the theft.

It’s not really insider trading, then, so much as a simple act of burglary.  Applying the securities laws doesn’t seem to be called for.  But it is still considered security fraud and insider trading at the moment, and there is certainly an identifiable victim: 3M.  And an easily calculable loss: either your gain, or some other book valuation of the info you stole.

Another example where there is a clear victim and a clear loss is when a short seller gets wind of some confidential information that’s bad for Company X, and the short seller starts shorting Company X all over the place, further driving down the stock price.  Company X’s shareholders are tangibly harmed by this, because their assets just lost a lot of value they probably wouldn’t have but for this trading on inside information.  (If the trader was someone who actually owed a duty to Company X — an executive or other fiduciary — there’s an added sense of disloyalty, but the harm is still the same.)

-=-=-=-=-

But apart from those examples and maybe one or two more, there just aren’t situations where insider trading really has any victims.

So why is it a crime?

“Because it undermines consumer confidence in the markets,” is the official line.  That’s hogwash, of course.  Consumer confidence would only increase if there were more insider trading.  Share prices would be determined, not by guesswork and conjecture, but by actual solid data.  Heck, it ought to be mandatory.  If the information is material, and it’s a publicly traded company, then the information ought to be public.  Theft of trade secrets should be the only law on the books here.

Not only is it beneficial to the markets, to have pricing based on accurate information, but there is no element of fraud involved.  It really isn’t securities fraud.  Nobody is being deceived; everyone is engaged in arms-length trades, buying and selling for precisely what they think the stock is worth.

It’s no different than if I buy a rare book from you for $10.  You think it’s worth maybe a buck on a good day, and you’re happy to sell it to me for what I offered.  I, on the other hand, know it’s worth at least $1000 to a collector I happen to know.  So what?  My purchase isn’t fraudulent or criminal in any way.  (Presuming you hadn’t hired me to assess the value of the book, of course.)  How is this different from insider trading in the stock market?

The simple answer is that, absent outright theft or misappropriation of secrets that don’t belong to you, insider trading doesn’t have any victims.  It doesn’t hurt anyone.  In many cases, it’s probably actually a good thing.

The only reason it’s against the law is because it’s politically fashionable for it to be so.  People love railing against “corporate greed” and “Wall Street crooks,” those amorphous evils of the populist psyche.  When the economy takes a hit, for good and basic economic reasons that have nothing to do with any criminal activity, there’s an outcry for punishment of the financial wizards doing things with money that we don’t understand.  Folks on the left pass more laws and regulations outlawing efficient market behavior.  Folks on the right pass stiffer sentences.  Prosecutors break their legs tripping over each other to indict the next big press case.  And so it goes.

Who are the real victims of insider trading?  In some cases, maybe it’s the people who get charged with it.

-=-=-=-=-

Even so… 20 years?

Really?

Really?

Because we were bored out of our skull this afternoon, we checked this blog’s stats on Google Analytics.  Browsing through the various keywords people have used to find this blog over the past year, all we can say is “The hell is wrong with you people?”

Leaving aside the freaks and weirdos (and possibly some of their clients), however, it seems that most people find this blog by asking Google the same handful of questions.  The number one search engine query that get people here, every month this year, is something along the lines of “why become a lawyer.”  Number two includes variations on a theme of “can a cop lie about whether he’s a cop.”  The top five are rounded out by queries about what crimes Goldman Sachs may have committed, connections between Adam Smith and insider trading, and what one should say to a judge at sentencing.

We’re not sure that we’ve actually discussed all of these topics here.  Then again, we might have, and just forgot it (which is a distinct possibility — these posts are all written in a single pass, without any real editing, and usually are not given another thought once they’re posted.  If you ever wondered what “ephemera” meant, you’re looking at it right now.)

Still, in the interests of alleviating our boredom public service, here are some quick answers to our readers’ most pressing questions:

1. Why Should You Become a Lawyer?

Because you feel a calling to serve others.  Because you want to make a difference in the lives of others.  Because you are genuinely interested in the rules by which human society functions, why people behave the way they do, and the policies and interests underlying it all.  If those are your reasons, then you belong.

Not because you want to make a buck.  Not because you want prestige.  Not because you can’t think of anything else to do.  Not because you want a cool job.  If those are your reasons, you don’t belong.

2.  Can a Cop Lie to You About Whether He’s a Cop?

Of course he can.  Cops are allowed to lie to you about pretty much anything, and that includes whether they’re really an undercover.  Cops are trained to make false statements in order to elicit a confession — it’s not the only way, but it’s a time-honored investigative technique that gets results.  Whether that is ethical or not is not the issue.  But there is no ethical question when it comes to whether an undercover has to admit he’s carrying a badge.  The slightest bit of thought should make that obvious.  An undercover dealing with some dangerous thugs is likely to get shot if they find out he’s a cop.  At the very least, if he himself isn’t killed, the investigation sure will be.  It would be beyond stupid to require undercover officers to announce that fact if someone asked them.  Nevertheless, idiots continue to ask “you’re not a cop, right?” and then go ahead with their crime when the cop says no.

3.  What Crimes did Goldman Sachs Commit?

None that we’re aware of.

Certain people like to rant that there aren’t enough criminal prosecutions to punish the Wall Street types who “caused” the financial meltdown of the last few years.  We’d like to remind those people that stupid business decisions are not a crime.  Neither are smart business decisions undercut by market forces beyond one’s control.  Neither are decisions to hold off on extending credit in uncertain times, especially when the uncertainty is exacerbated and extended by foolish governmental actions.  And neither are those foolish governmental actions criminal.

The one criminal case that was brought, against Bear Stearns executives, was a flop because those guys didn’t commit any crimes either, and the jury saw it pretty clearly.  The case shouldn’t have been brought in the first place, and wiser heads have prevailed against calls for further similar arrests.  The prosecutorial focus has instead shifted to frauds that were exposed once the market turned sour, and to the current fad of insider-trading cases.

4.  Would Adam Smith Approve of Insider Trading?

Depends on which Adam Smith scholar you ask, and on your definition of insider trading.  Speaking generally, he’d probably be in favor of economic decisions being made rationally, taking into account all the relevant information.  He’d probably be opposed to keeping such information secret in the first place.  Still, we’re not an Adam Smith scholar (thank goodness — he’s almost impossible to read).  For a thoughtful and insightful summary of his writings, however, we heartily recommend P.J. O’Rourke’s take “On the Wealth of Nations.”

5.  What Should You Say to the Judge at Sentencing?

It depends on your particular case.  In some cases, especially where there’s been an agreed-upon plea deal, you don’t need to say anything at all.  In some cases, you the defendant opening your mouth is only going to piss off the judge so he gives you a few extra months or years in the slammer.  In other cases, a sincere statement can demonstrate that you’re not the kind of person who ought to get a harsh sentence.  Depending on your circumstances, this could mean a statement of remorse, of change, of compassion, or other things likely to make a difference.

Even if you don’t say anything yourself, and it’s not an agreed-upon plea, it is often a good idea to have a lot of people in your community write letters to the judge showing why you should get a lighter sentence.  These letters should not be sent to the judge, but instead should be sent to your attorney, so he or she can put them together as an appendix to a sentencing memorandum arguing for a lighter sentence.  Letters should be from people who actually know you.  They should state facts about you, specific things you’ve done, as specific as possible.  Provide facts from which the judge can draw conclusions.  The worst letters just provide the conclusory statement that this guy deserves a lighter sentence, without providing any facts to support it.  No, we take that back, the worst letters aren’t about you at all, but are about the writer of the letter — how much they’ll miss you, how hard it will be on them if you go to jail, etc.  Sentencing is not about them, it’s about you.  The judge isn’t going to feel like he’s the one putting them through any hardship; you are.  Just focus on reasons why you shouldn’t get a higher sentence, period.

And if saying anything will just make it worse, then don’t say anything.

-=-=-=-=-

There.  Nothing too in-depth here, but we hope it sorta answers some of your questions.

Dang, that wasn’t as time-consuming as we’d hoped.  Now what else are we going to do this afternoon?

When we were just starting out in the law, we frankly had no problem with the concept of profiling.  Not racial profiling — that’s just a logical absurdity along the lines of “most people who commit crime X are of race Y, therefore it’s reasonable to suspect people of race Y of committing crime X.”  We’re talking about profiling as the concept that a significant number of people who commit crime X exhibit the combination of traits A, B and C, which is a combination rarely encountered otherwise, and therefore if one were to look for people exhibiting traits A, B and C, then one might have a better chance of catching someone guilty of crime X.

Intuitively, this sounds reasonable.  If we were to know, for example, that certain serial arsonists are motivated by a sexual mania, that these arsonists tend to remain near the scene to masturbate or so they can masturbate to the memory later, that they tend to have spotty work and relationship histories, and that they tend to have crappy cars — well then, there’s nothing wrong in letting the cops scan the crowd of spectators at a fire, question any who seem to be getting a kick out of it, and investigate those who are single, unemployed, and drive a beater.  (This is an actual profile, by the way.  We didn’t make this up.)

And emotionally, profiling sounds wonderful.  Catching a psychopath is often difficult, because they don’t play by the same rules as the rest of us.  Wouldn’t it be nice if there were some, er, rules that we could follow — a formula of some kind — that would make it easier to identify and catch them?

As we said, in our early years we thought this was a great concept.  Whenever we encountered some findings that certain traits had been identified with this type of serial killer, or that type of terrorist, we thought it was fantastic.  But we didn’t think too critically about it.  And for sure we never bothered to look for the underlying data, much less examine the methodology used to determine how strongly these traits correlated with perpetrators of that crime.

The problem is, nobody else was doing that, either.

Profiling only works if the profile is accurate.  That should go without saying.  But it has become plain over the years that the various profiles out there are not accurate.  They are not based on actual data, but instead only on anecdotes.  (And as we like to say, the plural of “anecdote” is not “data.”)  Nor are these profiles based on any significant sample size.  No profiling study ever did even a simple regression analysis to determine whether any particular trait happens to be a meaningful variable.

We figured this out soon enough, of course.  After our first couple of years with the DA’s office, we were already joking about the silliness of profiles.  It was almost a party game to figure out which psychopathic profile we and our friends happened to fit (secure in the knowledge that hardly any of us were really psychopaths).

And the rest of the world soon caught on.  The Onion did a piece entitled “Crime Reporter Finds Way of Linking Warehouse Fire to Depraved Sex Act.”  Malcolm Gladwell wrote an outstanding piece in 2007 called “Dangerous Minds: Criminal Profiling Made Easy,” in which he solidly debunked the whole profiling scam, showing how there’s no science or statistics behind it, and even the data it’s based on is mostly useless.

It’s now fairly common knowledge that criminal profiling is about as useful as a Tarot deck.  So of course the FBI has stopped using it, right?

-=-=-=-=-

Wrong.

As a matter of fact, they’re expanding!  Just as the feds have (disastrously) tried to use street-crime investigative techniques like wiretaps to go after white-collar offenders, they are now (equally idiotically) starting to use criminal profiling to go after people for white-collar offenses.

Matthew Goldstein wrote an excellent piece on this for Reuters this week, called “From Hannibal Lecter to Bernie Madoff: FBI profilers famous for tracking serial killers are turning their attention to white collar felons.”  This (and the Gladwell piece linked to above) should be required reading for any white-collar defense lawyer now practicing.  When the Galleon case first came down, we were one of a handful of people doing white-collar defense who also had plenty of wiretap experience; now, of course, more of us are learning it the hard way.  Hopefully, with this new profiling issue, more of us will be prepared to deal with it ahead of time.  (And perhaps even nip it in the bud.  Like Barney Fife, we’re a big fan of bud-nipping.)

The agents in the FBI’s Behavioral Analysis Unit are the ones who profile serial killers and the like.  ”The hope is,” reports Goldstein, that they “can get into the minds of fraudsters and see what makes them tick.”

“This originally started out as an attempt to find a way to prevent and detect Ponzi schemes,” said Peter Grupe, the FBI’s assistant special agent in New York in charge of white collar investigations.  ”But it developed into something broader.”

The FBI’s profiling strategies are part of an aggressive new approach to financial crimes.  Facing widespread criticism over the lack of criminal cases stemming from the financial crisis, the FBI and federal prosecutors are keen on showing that they are not soft on white collar offenses.

Whoa!  Wait.  Let’s count how many things are wrong with just these few lines.

(1) They’re using profiling, which is not a reliable indicator in the first place.  And for which we would be willing to bet real money the feds have gathered very little actual psychological data, from a sample of offenders that is too small to be meaningful.

(2) They were just going to use profiling to catch Ponzi schemers, “but it developed into something broader.”  Whenever law enforcement says that phrase, it’s time to start screaming “no!”  It’s bad enough when the government says it in the first place, but when it’s that arm of the government that has the power to take away your liberty, property and reputation — to destroy your life almost at whim — only bad things can come of it.

(3) The feds are trying to create more white-collar cases for purely political reasons.  They sense some public pressure to prosecute people because of the financial crisis.  Ignoring the fact that the financial crisis was not caused by any, you know, crimes.  It was the result of stupid business decisions, stupid government actions, dramatic shifts in perceptions of liquidity, and banks shifting from lending to hoarding.  It may have exposed criminal conduct like Madoff’s, but it was not caused by criminal conduct.  Seeking to appease the masses with bread and circuses may have worked for Caligula (actually, it didn’t, did it), but it sure isn’t what the United States ought to stand for.  And it damn well isn’t an ethical or just exercise of the government’s authority.  In fact, it smacks of an offensive abuse.

(4) The feds want to show “they are not soft on white collar offenses,” not by actually catching actual criminals and convicting them, but by the functional equivalent of Captain Renault’s “round up the usual suspects.”  People who did nothing wrong are going to be rounded up, humiliated, their livelihoods destroyed, their savings spent and houses mortgaged to pay legal fees defending themselves against the might of the federal government.  Not because they did anything wrong, but because the feds have a new toy to play with.

(5) They’re using psychobabble to catch a “broader” array of white-collar types.  So apparently there are psychological markers for people who are more likely to commit insider trading, or fail to disclose bad news to shareholders, or take out a fraudulent loan, or swipe some money from the till?  Really?  They must be joking.  There are just too many kinds of people who wind up in these situations.  There is no “profile” of a white-collar offender any more than there is one for any other kind of theft or deceit.  People lie, cheat and steal for all kinds of reasons — and that’s all white-collar crime is.  So we guess the profile is anyone who hasn’t adopted West Point’s honor code as their own.  That really narrows it down, guys.  Nice job.

Don’t even get us started on the rest of what the FBI has to say for itself.  We don’t want this to turn into a rant.  But do read the rest of Goldstein’s article for yourself.

In the meantime, watch out.  Those Behavioral Analysis types might be looking at you.

Wiretaps are arguably the greatest invasion of privacy that the government can do.  They’re listening in on private conversations, not intended to be overheard by anyone else.  So to get a wiretapping warrant, the government has to do more than for a normal search warrant.  There has to be more than just probable cause that they’re likely to find evidence of a crime.  Only certain crimes count.  There has to be good reason to do a wiretap as opposed to some other less-invasive investigative technique.  Only particular conversations can be sought, over particular phones.  Etc. etc. etc.

Not only is there a heavier burden to meet before a wire can be granted, the government has to comply with some very strict rules as they carry out the eavesdropping.  On that issue of particular conversations, for example, they have to do what they can to minimize the amount of non-relevant or privileged conversations that get listened to.  This is called “minimization.”  When it appears that a call isn’t pertinent (i.e., it isn’t evidence of a crime), or that it’s privileged (as a call with one’s attorney, doctor or spouse), then they have to stop listening and recording.  The call gets “minimized.”

The cops or agents who are monitoring the wire have to do more than just act in good faith.  Their minimization has to be objectively reasonable — the law only cares what an ordinarily reasonable person have thought in the circumstances, not what the cop himself happened to think.  So a properly-run wire is going to have minimization procedures that are spelled out at the beginning of the investigation, in writing, signed by every agent before they get to monitor any calls, with a reference copy there at the monitoring location just in case there are any questions later.  The prosecutor is going to be involved throughout, and it’s really the prosecutor’s responsibility to make sure that everyone knows what they can and cannot do.  It’s also the prosecutor’s job to review all the calls that were intercepted and, among other things, make sure that the cops are minimizing properly.

But what happens if the government doesn’t do that?  What happens if oblivious or malicious agents record and listen to all kinds of personal calls that have nothing to do with the crime they’re investigating?  What happens if a lazy or inexperienced prosecutor fails to nip it in the bud, or if a malicious prosecutor allows it to keep happening?

It’s an important issue these days, because the feds have been doing exactly that.

-=-=-=-=-

As we’ve pointed out a few times, the feds have been all gung-ho for doing wires on white-collar stuff these days, but the white-collar teams aren’t exactly the most experienced at doing wiretaps properly.  For one thing, the feds hardly do any wires in the first place, comparatively speaking.  It’s just too much of a bureaucratic hassle to go all the way up the DOJ chain of command to get the bosses to sign off on one.  And staying up on one is even more of a hassle, because you’ve got to do all that in a compressed amount of time to renew the wire before it expires, while at the same time trying to manage the wire itself and figure out just what the heck is being intercepted and whether it means anything.  State-level wiretaps are much more common, and tend to be done by people with more experience in doing them.  Expediting the process only leads to more errors by less-experienced folks without as much oversight.

Because of their relative inexperience, and also because of reduced oversight, the feds have been making a bunch of mistakes in the way they do their wires lately.

But at the same time federal judges are just letting them slide.  There haven’t been any consequences.  There’s no penalty for even the most egregious violations of people’s privacy rights.

-=-=-=-=-

The exclusionary rule, as we’ve said repeatedly, is quite an elegant solution to a sticky problem.  There’s a constitutional line which the police cannot cross in gathering evidence.  Society wants the police to gather all the evidence they are allowed to, all the way up to the line.  Society does not want people to be convicted with evidence that was gathered by crossing the line and violating their rights.  We don’t punish the police officers personally for crossing the line, because then they’d be reluctant to go anywhere near the line, and society would lose lots of perfectly lawful evidence.  Instead, we let the cops go right up to the line and dance on that line.  And if they happen to cross the line, then we just don’t let them use that extra evidence against the defendant.  All of society’s goals are attained with no fuss or muss.

It’s a good thing it’s so elegant, because the exclusionary rule is really the only tool in the courts’ toolbox here.  If the government violated the Fourth Amendment, then the evidence gathered as a result of that violation must be excluded.  The problem is that the courts often decide it’s better to have all the evidence.  Courts routinely say that society wants the truth, or that there is a greater policy in favor of using as much evidence as is known, or stuff to that effect.  And when that happens, the courts get rid of that one elegant tool they have to protect your rights from government excess.

-=-=-=-=-

And so, for example, we get decisions like Judge Holwell’s last November, declining to suppress wiretap evidence in the Galleon case even though the wiretap applications were little more than a fraud on the court.  The judge found that the issuing judge had been misled as to the necessity for the wire.  A situation crying out for suppression — and sanctions — and the defendant was forced to go to trial instead because that was preferable to the court.

And we get decisions like that of Judge Sullivan yesterday, declining to suppress wiretap evidence in another white-collar case even though the feds committed such outrageous and brazen violations of the minimization requirement that it was impossible to believe that it wasn’t completely intentional.

“The court is deeply troubled by this unnecessary, and apparently voyeuristic, intrusion” into the defendant’s private life, wrote the judge.  But that didn’t stop him from ignoring the exclusionary rule altogether, permitting these and other deeply troubling prosecutors to keep on doing whatever they like.

Namby-pamby judges in the past tried to deal with minimization violations by just suppressing the personal conversations.  This served no use whatsoever, because all that did was exclude evidence that wasn’t admissible at trial in the first place.  There was no penalty for violating this fairly important rule.

So there has been pressure on the courts to actually enforce the rule in a meaningful way, by suppressing all conversations that were intercepted on a wire where there were blatant violations of the minimization requirement.  Instead, the courts appear to have gone in the opposite direction.  ”We can’t suppress,” they seem to be saying, “because then we’d lose all that lovely lovely evidence.”

Well, they’re not being namby-pamby about it.  But that doesn’t make their decisions any less abhorrent.

First, a shameless plug: Tomorrow, we’ll be participating in a Dow Jones webinar for Private Equity and VC types, discussing how the current environment of insider-trading prosecutions affects them, and what they might do about it.  (Link here, if you’re interested.)  Of course, those guys aren’t so much the focus these days as, say, hedge funds and the expert networks that help them make investment decisions.  ”In the spotlight” doesn’t begin to describe it.  Not a week goes by without some major news about insider trading allegations in the hedge fund world.

With all that reporting, and all the various cases that are going on, one might think the issues are pretty well understood by now.  But they’re not.  Not even by the very people who are doing the prosecuting and investigating, it seems.  It so unclear that a month ago the Managed Funds Association formally asked the SEC for guidance on what is and is not kosher when dealing with expert networks.  “Our industry would like to know where the sidelines are right now so that we can stay well within them,” MFA president Richard Baker said at the time.  “The trouble is the referees aren’t quite clear where those lines are.”

Amen.  Nobody knows where the line is between lawful and unlawful conduct.  The feds themselves admit it.  And yet they are prepared to prosecute people for crimes, when the public has no way of knowing that such conduct was criminal.  Even an investigation is enough to destroy a reputation, wipe out a career, erase a business.  A conviction will take away a real person’s liberty and rights.  Americans don’t allow their government to do that in a gray area.  But it is happening.  How that is not a serious violation of basic due process is beyond us.

-=-=-=-=-

Expert networks are a fairly new thing.  It used to be that research was conducted by analysts who were more akin to investigative journalists than anything else.  They poked around, talked to people, and tried to piece together useful information about a company’s value or where an industry was headed.  The goal was to gain an insight that had value — something that wasn’t obvious to everyone else analyzing the public information.  Then along came Regulation FD, and all that changed.

Reg FD came about in 2000 as an attempt to clarify what buy-side research analysts could and could not do.  Research analysts served a useful function, of getting pertinent information out there into the market, resulting in more efficient pricing, and a more efficient allocation of capital.  The problem was that this information was not generally broadcast, but only shared with a select few.  And a company’s management only talked to the analysts they liked, which often enough meant those who gave favorable reviews of the company.  There was a kind of tit-for-tat relationship, where analysts only got access if their reporting helped the company’s stock price.  (The journalism analogy is fairly strong.)  Management was making information public, but only to those who had gotten access.  Reg FD basically says you can’t do that, any more.  If the info is material, then it cannot be disclosed selectively.  It has to be generally broadcast.

Trying to suck up to management is still okay, under Reg FD.  You can still invest shoe leather, phone minutes and greens fees in trying to winkle out some better information.  But if the information is material, management is going to have to disclose it in an FD-compliant manner, basically making it public to everyone.  (If it’s not material, then it’s still okay to disclose selectively — even if it’s the last piece of a puzzle that enables you to come up with a highly material insight.  ”Immaterial” nonpublic info is something that’s not important to the normal, reasonable investor.  But this is still a huge gray area.  This is essentially the “mosaic” theory, that many bits of immaterial info can be pieced together to form a mosaic that is material as hell, but that still doesn’t mean the individual disclosures were material.  It’s debatable whether this theory is going to prevent the SEC or DOJ from launching an investigation, but there’s a strong argument to be made that the person disclosing the info, at least, cannot be liable.)  Anyway, the idea is that requiring info to be disclosed in an FD-compliant manner basically undercuts the whole point of using analysts in the old-fashioned way.

At about the same time, hedge funds started doing business a lot differently.  There were more of them, transacting dramatically higher volumes than ever before, and trades were happening way faster and more often.  Old-fashioned analysts aren’t as compatible with large-scale rapid-fire trading.  Using analysts in the old-fashioned way just didn’t make as much sense as it used to.

So the “expert networks” came along as a replacement.  These were essentially consulting services that would get experts from various fields, and get them analyzing what’s going on in their respective niches.  Hopefully, they’d be able to piece together valuable insights from the public information that’s already out there, and help the funds place better bets.

That’s not a bad idea.  Seems pretty good, in fact.  Everyone’s working off the same public information, but you can pay for insights from people who can better interpret what that information means.  You might be buying or selling with a counterparty who has a better insight than you, but that’s not the same as being defrauded by a buyer/seller who has secret information that you don’t have access to.  In other words, it’s not insider trading.

But, of course, there’s a wrinkle.  Some of the experts in these expert networks were still employed by their respective companies.  There was a risk that some of them might be disclosing nonpublic information to those paying for their analyses.  That can potentially turn into an insider-trading situation.

That risk can certainly be minimized.  Public companies can and should have controls and oversight to ensure that no nonpublic info gets disclosed by employees who are moonlighting as experts.  And buyers of the information, like hedge funds, can have policies of not buying info about company X from someone who works for company X.  (A weaker solution, adopted by some hedge funds, is to get a written promise that the experts won’t violate the securities laws.  That’s not going to be much protection if the law still gets violated.  It’s not going to make the insider information any less insider.)

Still, there’s a risk of wrongdoing.  And there’s a big uncertainty as to whether expert networks are inherently suspect.  One might think that they are, given the surprising number of insider charges the feds have filed in the past few months involving expert networks.  And it’s no secret that the entire industry is freaked out at the possibility of being investigated or charged just because of the use of expert networks.

The feds did make some statements recently, in an attempt to assuage these fears.  For some reason, these statements haven’t gotten a lot of press (though businessinsider.com had a nice summary a couple of days ago).  Though the reason might be that the feds didn’t really clear anything up.

On Feb. 3, an SEC press release about yet another expert network case said that “it’s legal to obtain expert advice and analysis through expert networking arrangement.”  So far so good.  But right before that, it said this case was part of “the SEC’s ongoing investigation into the activities of expert networks that purport to provide professional investment research to their clients.”  (Emphasis added.)  That’s a loaded sentence, and reveals a predisposition to think that expert networks are bad.  All this does is increase the fear that the feds are going to see insider trading where none occurred.

Similarly, in a Feb. 8 press conference for the latest roundup of insider trading charges, the SDNY U.S. Attorney Preet Bharara made a prepared statement that expert networks are not “inherently wrong or bad.”  It’s just that these particular defendants had a business practice that was inherently wrong.  But he opted not to discuss what is wrong or right about a situation where an expert network uses an employee of company X, even with company X’s permission.  He acknowledged that it’s still a “gray area.”

So Robert Khuzami spoke up.  Khuzami, the head of enforcement for the SEC, sent a warning that hedge funds dealing with expert networks had better do some serious due diligence, to find out whether the expert network uses employees of company X.  And if so, to make sure no material nonpublic information gets received.

In other words, there’s an affirmative burden to make sure the information you receive is not private.  Which is bizarre when there is no way to know that, in many cases, unless you’re privy to inside information.  It’s a Catch-22.

-=-=-=-=-

So there’s a huge “gray area” as to whether expert networks are kosher or criminal, as they currently exist and have existed for the past decade or so.  In theory, they’re lawful, but in practice the government sees them as only “purportedly” lawful.  And if you happen to use them, and you get inside information — info you couldn’t have known was secret if you weren’t an insider — too bad, so sad.  You had a duty to know the unknowable.  Maybe.

There are far too many unknowables here.

Isn’t this a classic due process violation?  For the government to be allowed to use its might to deprive individuals of their liberty, property and livelihood, the public had better damn well be on notice that the conduct is something that’s going to get punished.  If the public could not have known that certain conduct was unlawful, the government cannot be allowed to punish it.

And if the government itself doesn’t know where to draw the line…?

This’ll be quick, because we’re pretty busy working on a wiretap case, which is always time-consuming if done right.  But as our mind’s on that topic anyway, we thought we’d quickly point out that the latest round of insider-trading cases is again largely derived from wiretaps.  Here’s a roundup over at the WSJ’s law blog.

We just wanted to jump in and point out that just because there were wiretaps, by no stretch of the imagination does that mean the case is a slam dunk.  There are all kinds of ways that agents and prosecutors can and do screw up wire cases.  If properly challenged, the recordings and all evidence gotten as a result of them can get thrown out, which pretty much kills the case.  Don’t go saying this can’t happen, because we happen to see it plenty.  (The one we’re working on right now is a prime example of how not to conduct a wiretap investigation, for example.)

But even if the evidence doesn’t get suppressed, that doesn’t mean it can’t be successfully attacked at trial.  Cross-examining taped evidence isn’t the easiest skill to master, but it’s definitely doable.

If you’re really interested, you can go take our CLE lecture on how to defend these kinds of cases over at West Legal Ed Center (shameless plug).  Or if you prefer, here’s a quick cut-and-paste from a longer post we put up the first time this happened, when the Galleon case broke (original post here):

Wiretap evidence is anything but a sure thing. We know. We did wires for years in the Rackets Bureau of the Manhattan DA’s office, and now we defend them. We’ve taught a nationwide CLE on how to successfully defend them for West LegalEdCenter. Wiretaps are not a sure thing.

They can be defeated with technicalities. Eavesdropping is probably the greatest invasion of privacy that the government can inflict, and so we make law enforcement jump through all kinds of hoops before they are allowed to get an eavesdropping warrant. There are so many i’s to dot and t’s to cross, that the feds hardly use wiretaps in the first place. You’d think otherwise, but it’s so. Plus, they have to go through so many steps in the chain of command to get permission to apply for a warrant, that by the time they could have done so the need or probable cause has evaporated. State prosecutors do way more wires than the feds do.

Because the feds rarely do them, they’re not necessarily as on the ball as certain state-level offices might be. And except for those few high-caliber state offices, the locals can be even more error prone.

That’s big, because little errors in wiretaps have big consequences. Usually, they mean the government loses the case. A little oversight leads to the suppression of all the evidence derived from that point forward in the case, and a multimillion-dollar investigation just went down the toilet. No bullshit.

What kinds of technicalities are there? Tons. Some are just stupid. One particularly stupid requirement is the “sealing” requirement. The idea is that we don’t want to risk having the tapes or CD-ROMs of the intercepted conversations tampered with. We don’t want Nixonesque 17-minute gaps in the evidence. We want the assurance that the evidence never had a chance to be fucked with, and is as pristine now as when it first came in. And so the law requires that the tapes or CDs be sealed immediately, which usually means having them wrapped in evidence tape and having a judge sign and date the tape with a Sharpie.

But “immediately” doesn’t mean “immediately.” Instead of sealing the tapes right after they were recorded, the law says they have to be signed within 24 hours after the expiration of the warrant. Warrants are typically good for 30 days. So the whole month’s worth of tapes or CDs have to be assembled and sealed no later than 24 hours to the minute after the expiration of the wire. And that can be a tough deadline to meet. Especially when, say, it’s 5:04 on a Friday afternoon and all the judges are on their way out of town for the weekend. Or when, out of the hundred or so tapes for that month, one of them by accident didn’t make it into the group to be sealed, which can easily happen. Or when the judge took forever reading that 160-page renewal application, and the deadline passed when he’d only signed half the tapes.

This 24-hour rule is not a “good faith” or “close enough” rule. 24 hours and one minute means the evidence on those tapes cannot be used, and any evidence that resulted from what was heard on those tapes must be suppressed. The case is over. It’s technicalities like these that make prosecutors sweat and cross their fingers and hope the defense attorney won’t be paying attention.

Another technicality, believe it or not, is who signed the warrant application in the first place. The law is very particular about who is allowed to sign the application. Only certain enumerated DOJ officials, or the elected head of the DA’s office, are allowed to do it. We once had to work pretty hard when a very good defense attorney named Marty Adelman noticed that we’d had a substitute sign on behalf of Mr. Morgenthau when the boss was out of town. We had to prove that he really was legitimately unavailable, not merely at a function or indisposed, and that the substitute was the legitimate second-in-line. We’d done it right, of course, but others don’t. At one point, about a gazillion wiretaps had to be thrown out because the U.S. Attorneys in D.C. were having them signed by someone not on the authorized list.

The big thing, of course, when trying to controvert an eavesdropping warrant, is not the technicalities but the probable cause.

There has to have been probable cause to believe that a particular crime, listed in the wiretap statute, was being committed. That evidence of that crime would be found by listening in on a particular phone. That a particular named person would be using that phone, whose conversations would be evidence of the crime. And traditional investigative methods like surveillance, undercovers, informants, subpoenas, etc. wouldn’t get the job done.

That’s a lot to prove. The warrant applications have a heavy burden to meet. A good defense attorney is going to look for chinks in the armor, weaknesses in the alleged probable cause, and is going to fight hard to get the warrants and all their fruits thrown out.

And doing that work, and making the prosecution work hard to defend itself, and letting them know that they’re going to be working this hard for the rest of the case, can convince them to rethink their plea position at the very least.

When looking at probable cause, a decent attorney is going to notice whether the warrant application sections laying out the arguments are just boilerplate, cut-and-pasted from earlier applications, or whether they actually are tailored to the investigation as it then stood. Boilerplate, if it doesn’t really apply here, is a fraud on the court! That warrant and everything thereafter just got thrown out.

-=-=-=-=-

Well, what if the defense litigated the eavesdropping, but it’s all still coming in? They’ve got a trial on their hands. What do they do now? They can’t fight the tapes in front of a jury can they? How can you possibly cross-examine taped evidence?

It ain’t easy, but a smart lawyer can do it.

First of all, you have to realize how wires get started. They don’t come out of the blue. Probable cause does not land in some cop’s lap.

There’s an easy way, and a hard way, to start a wire. The hard way is to have all this suspicion, based on historical intel about your players, surveillance of their movements, and scuttlebutt from the community. Then you track down their phone numbers, and subpoena tons of call records to see who they’re calling and when. Then you look for patterns, and see what you can dig up about the people they call. And you try to put together a res ipsa argument that this criminal activity must be going on over that phone. That ain’t the easy way.

The easy way, like with any investigation, is to flip an informant. Someone screws up, and now needs to work off a likely sentence. The only way they can do that is by getting someone else in trouble. So they agree to wear a body wire, or introduce an undercover, or (usually) consent to the recording of their own phone calls with the target.

Bang. Right there, we’ve got all kinds of arguments for reasonable doubt. Arguments to piss the jury off at the government and want to acquit our client.

Because what is the informant trying to do? He’s trying to get our client in trouble. He’s trying to elicit an incriminating statement over the phone that’s going to let the government tap that number. That doesn’t just happen.

No, that call is going to be scripted. Or rehearsed. Or both. That call is going to have a purpose, and Mr. Informant is going to do whatever he can do to manipulate that conversation so he gets the incriminating words he wants. Or at least words that sound incriminating.

You see where this is going, don’t you? You may never use the word “entrapment” itself, but by golly you’re going to plant that concept in the jury’s mind. That informant was out to save his own skin. That informant did not tell our client the truth. That informant lied about what that conversation was about. Those lies were scripted and rehearsed with the agents beforehand. This whole case is built on lies. And the conversation didn’t go according to plan. Our client was not about to incriminate himself. So that informant manipulated him, changed the subject, hounded him, cajoled him to say things he otherwise never would have said. Throw some in-check indignation, and you can have one pissed-off jury.

And you fight the recordings themselves. “But look at the transcripts, they’re cut and dried,” you say? Poppycock. Those transcripts are nothing but interpretation. Any defense lawyer who sits back and relies on the government’s own interpretation of what is on those tapes needs to find another line of work.

Because everything on those recordings is open to interpretation. Nobody in the real world speaks in clear prose, with footnotes explaining their jargon and inside references. Nobody talks like that.

People throw ideas around. They talk things through. They change their mind. Taken out of context, a statement on Day 1 can sound really incriminating. But in context with a statement on Day 2, it’s perfectly innocent.

People talk in code. Not just spies and crooks, but everyday folks. Nobody spells it all out, that would infuriate the listener. Stuff that the other person also knows goes unsaid. People use jargon that outsiders can easily misinterpret. Phrases like “you’re going to put me in jail” could really be a schtick between friends for “my boss isn’t going to like this,” rather than the literal meaning. But taken out of context, perfectly innocent words can sound damning. Any one of us could face prosecution if our own conversations were selectively lifted out of context.

So it is critical that the defense listen to all of the intercepts, not just those highlighted as the prosecution’s greatest hits. The defense needs to get the whole context, and be able to explain ostensibly incriminating conversations as being perfectly innocent. The client should help as much as possible.

Other room for interpretation is what the freaking words were in the first place. We had plenty of occasions where we listened to a tape and heard one phrase, our detectives heard at least two different phrases, and our trusted paralegals heard it yet another way. Nobody enunciates every consonant. Speech is casual. It’s rushed. It’s muddled. It’s amazing that our brains can separate out as much as we do. But in doing so, we often see patterns where they don’t exist, and hear words and meanings that were never said. It’s like optical illusions for the ear, and they happen all the time. Have an inaudibility hearing if you have to, and get the statement tossed altogether if need be.

So any fool who relies on the government’s transcripts deserves to be called a fool. Make your own dang transcript, and make sure you can sell it to the jury. Youwant to be the voice they trust.

There are tons of other ways to tear the intercepts apart. These are just a starter. But this post is already getting far too long…

The feds are really ramping up their insider-trading enforcement.  But instead of going after real insiders, they’re going after consultants and investors who use them.  This is a big risk for the feds, and they could lose big.

It started a year ago, when the feds indicted a bunch of people in what we collectively refer to as the “Galleon” case.  For the first time ever, the feds had used wiretaps in a white-collar investigation.  It looked like the gloves were coming off, and the feds were going to start getting down and dirty, using street-crime law enforcement techniques to go after Wall Streeters.

Then in May, Lanny Breuer announced a “new era of heightened white-collar crime enforcement — an era marked by increased resources, increased information-sharing, increased cooperation and coordination, and tough penalties for corporations and individuals alike.”  In the wake of an economic bubble bursting, they were gunning for the suits who had profited.  And unlike the last time they tried, in the wake of the dot-com bubble, now there was no 9-11 to divert their resources.

To some extent, such a strategy is like shooting fish in a barrel.  Real frauds like Ponzi schemes and the like, which can hide amidst a rising market, come to light pretty easily when the market collapses.  And we saw a lot of those prosecutions in the past couple of years.

But to a larger extent, it’s a political strategy.  Going after those who make money by moving it around, instead of creating something of value, is always going to be a populist move.  It wins brownie points for the DOJ and the president.

And now comes the takedown.

On Saturday, the Wall Street Journal reported that the feds had been conducting a 3-year investigation into possible insider trading.  They had been approaching people out of the blue, telling them they were in trouble, and suggesting that they wear a wire (with at least a couple people refusing to do so, and then emailing all their clients to tell them what had just happened).  The feds had been subpoenaing records for a while.  The targets seemed to be Goldman Sachs and consultants who matched knowledgeable industry leaders with hedge fund managers looking for an edge.

That seems to have forced the feds’ hand, and on Monday they started executing search warrants at Diamondback Capital Management and Level Global Investors, which had been identified in the Saturday story.  Then they raided Loch Capital Management later in the day.  We hear that more raids are coming, and as we speak a lot of investment firms are doing some heavy internal reviews, to figure out if they might be on the list.

Because nobody knows what kind of behavior the feds are going after.  And if past performance is any indicator of present results, the feds may just well be going after perfectly innocent behavior.

-=-=-=-=-

The reason is that the feds don’t seem to understand the difference between illegal insider trading and lawful sharing of information.  In a conference yesterday, while the raids were going on, an associate director of the SEC’s enforcement division said that “there’s a lot more patterns and serial insider trading than we previously thought had occurred.”

Translated, this means that the feds are suddenly taking note of all the consultants and analysts out there, who give hedge fund managers insights into where an industry or company is going.  As one would expect, plenty of those consultants used to be high-ups at such companies.  Hence their ability to provide insights.

But that’s not insider trading.

Insider trading is a fairly new crime, one of the countless new federal crimes created in the last decade.  One commits the crime of insider trading by first, knowing some secret, non-public information.  Second, one must have a fiduciary duty to the owner of that secret information, a duty not to disclose it.  Third, one must divulge that secret in violation of that duty.  And fourth, the person who uses that secret information had to know that it had been shared in violation of that duty.

That last step is bloody hard to prove.  You have to be able to prove actual subjective knowledge on the part of the recipient of the information, that it was a secret.  “Knowledge” is not the same as “this sounds like a secret” or “this is probably a secret.”  “Knowledge” is “I know this really is a secret.”

And even if the information being divulged to hedge fund managers was secret at one point, it’s not as if the information is coming directly from the executive with the fiduciary duty.  He spilled the beans to someone else, who shared that info with a consultant, who mentioned it to one of these firms that matches consultants with investors, and eventually the information got shared with the hedge fund manager.

In that case, the executive sure committed a crime.  But that’s not who the feds are targeting!  They’re going after the consultants, the hedge funds, and the firms that match them up.  None of them breached a fiduciary duty, the end user had zero privity with the one who did breach the duty, and it’s going to be hard to prove any actual knowledge by any intermediary or investor.

That’s a lot of room for reasonable doubt.  A good defense lawyer will have a heyday with this kind of case.

-=-=-=-=-

And don’t forget, a hedge fund manager (or any other trader)’s primary function is to gather information.  You keep your ear to the ground, listen to rumors, and try to predict what’s going on.  A good trader has a network of sources to rely on, and everyone and their mother has a tip.  Most of the “sure thing” tips one hears are utter bullshit, but every now and then one is worthwhile.  The trick is being able to spot the gold.

This “relentless pursuit of data,” as it has been characterized, is completely normal and perfectly legal.  It is what the market is supposed to do.  It is precisely what the law is supposed to encourage.

It’s not the same thing as an insider profiting from his own knowledge at the expense of the market.  It is the market trying to make the best judgment call from the available data.  If a real insider happens to seed the market’s data with secret information, it is not the market’s fault, and it’s not a crime to use it if one learns it from a third party, without knowing it was a secret.

There’s all kinds of room for reasonable doubt here.  And don’t even get us started on the way the feds are all of a sudden using wiretaps and body wires to gather evidence.  Forget the suppression issues we keep seeing — a good defense lawyer with experience with these things can often fight such evidence successfully at trial.  It’s not always as strong as you might think.  But that’s a topic for a whole nother post.

Suffice it to say, for now, that the feds are taking a huge risk here.  A very expensive, three-year investigation, could very well go down the toilet, because they’re going after the wrong people, for the wrong activity, with the wrong tools.

The other day, we drew a contrast between the Manhattan DA’s new public integrity unit and the way the feds go after FCPA violations, and some folks asked just what exactly the feds do in these cases.  That’s a good question.  Especially now, as the FCPA has become a major star of the feds’ redoubled efforts to fight white-collar crime.

The Foreign Corrupt Practices Act, among other things, says it’s against the law for any U.S. citizen or business to pay a bribe to a foreign official.  The penalties can be staggering, with fines calculated as the amount of income the briber hoped to receive down the road as a result of paying the bribe.  “Any” U.S. citizen means just that: anybody, not just a corporate executive.  A “foreign official” means anyone with a government job — including people working in industries that are government-owned or government-controlled.

“Bribery” includes giving anything of value in the hopes of getting something in return.  It’s really a broad standard.  A bribe doesn’t have to be an explicit tit-for-tat, and it doesn’t have to be just for the purpose of landing a choice contract.  A bribe can be just a nice dinner at a fancy restaurant that might make get you looked on with more favor next time contracts are being awarded.  A bribe can be a “facilitation payment” to a petty bureaucrat, some grease to ensure that you are allowed to do what you are already entitled to do (this, by the way, is an example of where Wikipedia, at least as of today, get things wrong).  See here for a more thorough discussion.

As with many white-collar offenses, this one is enforced by both the SEC and the DOJ.  As of this year, the SEC now has a special unit dedicated to investigating and punishing suspected offenders.  As we mentioned the other day, the point is to keep as much expertise in the institutional memory, and also to better coordinate investigation and enforcement.  On the criminal side, the DOJ’s Frauds Section is the main enforcer as a matter of law, though some local U.S. Attorney’s offices like the SDNY will handle most of the work in-house.

Over the past few years, the number of FCPA cases has risen dramatically, in part because the SEC and DOJ have been working together so closely on these cases.  They don’t have to reinvent the wheel so much, which leads to efficient use of resources and manpower.  At the same time, far more resources, lawyers and special agents are being focused on FCPA cases.  In the 2011 budget, the funds allocated to these cases is up 23%.

But that reallocation of resources is a lagging factor, merely reacting to the fact that so many more cases are coming in.  The number of bribes is not changing, so far as anyone can tell — there aren’t more bribes to report, and enforcement isn’t reducing the number that take place — but the number of cases are definitely on the rise.  The reason for more cases is not a bigger budget, however.  As with any investigative law enforcement (as opposed to the fait-accompli street-level policework) the vast majority of cases come from informants.  And now we’re seeing a lot more informants.

FCPA informants can be defendants trying to shave a few months off their sentence, as with other kinds of cases.  But there’s more than that going on in FCPA cases.  There’s a whistleblower provision that awards a first-come-first-served prize of nearly 1/3 the penalties extracted.  With fines that can easily add up to many millions or even billions of dollars (the Siemens fines were something like $1.6 billion), the mercenary temptation has become a huge factor here.

The sharks are already out in force.  A number of plaintiffs’ lawyers are already out there trolling for tipsters, hoping to cash in on the next big score.  A third of a third is still pretty damn big, when you look at some of the fines that get handed down.  The SEC is creating an Office of the Whistleblower just to handle the process.

Informants can also be the companies themselves, once they find out that a bribe took place, and they want to get in the SEC’s good graces and minimize their exposure.  The official term for this is “self-reporting.”  The unofficial term of art used by the SEC and the DOJ to refer to self-reporters is “grovelers.”  This should give some indication of how much respect is given by law enforcement to self-reporters.

As the number of investigations and criminal prosecutions here has risen, prosecuting individuals has become a major priority.  So it’s not just corporations at risk here.  Individuals have some massive potential exposure now.

So lots more informants are coming in, for a variety of reasons.  And more and more of them are (wisely, very wisely) coming in with lawyers.

This is just a bare-bones summary, but already you’ve probably spotted some serious problems with the way we enforce the FCPA.

-=-=-=-=-

You may be asking yourself what possible harm is done to the United States when a business pays a bribe in order to get equal treatment in a foreign country, when not paying the bribe would mean the business (and potential tax revenue therefrom) is going to be awarded to a Chinese or Russian firm.  That’s a good question.  But that’s more of a problem with the FCPA itself, than with the way it’s enforced.

One major problem is that our enforcers have created a strong disincentive for anyone to ever self-report.  The costs of hiring Kroll or whomever to do an internal investigation, overseas, can easily set you back somewhere in the tens of millions of dollars.  And once you do self-report, it’s not as if the SEC is going to forgive all and say “go forth and sin no more.”  You may avoid fines, but you’re still going to have to withdraw from the deal, lose the benefit of any associated deals.  The SEC can impose a monitor, claw back the revenue you earned (or expect to earn) from the bribed deal.  And the SEC might go ahead and issue a fine, anyway.  And if you do self-report, it’s not as if the SEC is going to limit its investigation to that one deal — no, they’re going to look at other contracts you got, and see if any bribery was involved there (the presumption being that if it happened here then it must have happened there before), and you’re going to get penalized for not self-reporting any other bribes they uncover.  Only in the rarest of cases will a self-reporter avoid prosecution, and then only if they have already taken care of the matter completely to the SEC’s satisfaction internally, with full documentation and reporting, and it was only a one-off exception that slipped past a strict regime of controls to prevent it, and new stronger controls have now been implemented at great cost, etc.

As a result, more and more companies are just going ahead and taking the chance that the SEC will never find out.  After a serious and thoughtful cost-benefit analysis, it just doesn’t make a lot of economic sense to be a “groveler.”  The feds will screw you.  Being a straight shooter has real, severe consequences.

Well, it’s not as certain as that.  There is no certainty at all about what the feds will do in a given case.  The outcome of every case can be viewed on the Frauds Section’s website here, and if you can spot an underlying principle or rule that makes their behavior even slightly predictable, then do it and go make a lot of money advising corporations on what to do.  Because there is no certainty at all right now, and that’s even worse than the certainty of getting screwed.

The whole whistleblower thing is just a disaster.  Companies have no chance of self-reporting if they don’t find out about the wrongdoing in the first place.  The briber isn’t bloody likely to tell on himself, so the company’s only going to find out about it from a whistleblower.  But there is no incentive to tell the company about it, when there’s a fantastical, unimaginably huge payday out there for whichever tattletale makes it to the SEC’s door first.  The incentive is to report it to the feds, not the company.  Companies and their shareholders (like you, your school, your pension) are justifiably afraid of getting socked by the feds before they ever even had a chance to do something about it.

Corporations are putting all these resources into compliance programs, internal investigations, Sarbanes-Oxley controls, and it doesn’t matter.  A whistleblower can just bypass all that, and take it straight to the feds.  Anyone except for an auditor can be a whistleblower, so the incentive for an employee or manager is to not bother with any investigation, and just report it.  Even with its own mercenary bounty, there’s no way a corporation can compete with the payday offered by the feds.

Meanwhile, what counts as a bribe is getting more and more idiotic.  You sent flowers to the official’s wife on her birthday?  You’re screwed.  You took the officials out for a purely marketing dinner or other social occasion?  No, you didn’t.  The SEC is going to decide for themselves whether the product you were marketing merited such a nice restaurant or the expense of that event.  That training course you offered?  The SEC has decided it was a bribe.  Your day-to-day business decisions are going to be second-guessed by a bunch of lawyers who in all likelihood have never run a business.

It’s no surprise that executives and marketing reps and sales managers are afraid of doing the wrong thing.  Folks are calling in the lawyers and blowing an insane amount of time, money and well-being on little nonsense matters like these that, a few years ago, nobody would have thought twice about.  There are too many FCPA cases these days, and too much is at risk, so it is imperative to stress out about it now.

At the same time, as we mentioned in passing above, the enormous costs of dealing with the FCPA, all the cases, all the fines, all the tax dollars and manpower thrown at enforcement… none of it is having the slightest effect on the underlying problem.  The actual amount of bribery is unchanged.  The law is not deterring any unlawful conduct that wasn’t already deterred.  (Though it is deterring a lot of perfectly lawful conduct, depressing lawful revenues, and forcing a lot of money to be wasted on non-productive things like lawyers.)

Another huge problem is how the feds decide what the fines and disgorgement ought to be.  There are no consistent internal policies on how to calculate these things.  As with most other economic calculations in the white-collar arena, the feds tend to be appallingly simplistic, exhibiting not even rudimentary familiarity with the kind of financial calculations that would render a meaningful and accurate amount.  As with USSG intended loss calculations on the DOJ side, the SEC’s disgorgement calculations can be pure conjecture, of what they estimate your future revenues would have been had you gotten that deal.  And including other downstream deals that you might not have gotten “but for” that initial nice dinner.  The potential fines are unpredictable, and so disproportionate to the amount of any bribe that “disproportionate” isn’t even the right word to describe them.  (For more on defending against such calculations by the feds, see our CLE lecture at West Legal Ed Center on the subject.

The whole topic of foreign bribery can be confusing.  The kind of bribery the FCPA is concerned with is precisely the kind of bribery that is created and caused by the foreign government.  A morass of regulations and bureaucracy — especially in a place with a high proportion of government employment — creates an incentive to cut through the red tape.  Government functionaries are always paid little, and some countries pay them even less with the full expectation that they’ll be making up the difference in baksheesh.  Prohibiting Americans from paying that baksheesh doesn’t stop the civil servant in Cairo or Juarez from taking his bribes.  All it does is mean that someone else is going to get the contract, or be able to fulfill their contract, instead of the American company.

But let’s say we just want to hold American citizens up to a higher standard.  There’s nothing that says we shouldn’t.  And maybe we’re arrogant enough to think that doing so will raise the standards of the rest of the world.  (Yeah, how’s that going for you, USGAAP?)  Even if we stipulate that the law is necessary and proper, the feds are going about enforcing it in exactly the wrong way.

Hey, you asked.

As we were coming out of court the other afternoon, we got a call from one of the nice folks over at the WSJ, asking us what we thought about the Manhattan DA’s new Public Integrity unit.  We didn’t even know it had been formed — though we had heard Vance talk about the idea on the campaign trail.  The soon-to-be new DA had talked of ideas for a variety of new units, some of which we thought were good ideas (like the Wrongful Convictions unit, which would create office-wide policies while also investigating innocence claims), and some of which we thought were more public-relations than practical (like the Public Integrity unit).

As proposed by Vance, we said to the reporter, the Public Integrity unit didn’t really seem necessary.  It was to be a sub-unit of the Rackets Bureau, which has already been investigating and prosecuting public corruption cases with a fair amount of success for many years.  Carving out a specialty unit isn’t going to increase the number of cases they get, or improve their success rate, or have any extra effect on corruption beyond the usual.  It’s not like this is an area of crime that was being ignored.  Far from it.

It’s not going to increase the number of cases coming in, because that has nothing to do with whether there’s a special unit or not.  Public corruption cases are hard to come by, because usually the only people who know about the bribery are the ones benefiting from it.  And they’re not likely to self-report.  The DOI does what it can with the resources it’s got to ferret out a case here and there, but the reality is that (for the most part) law enforcement sort of lucks into these cases.

If you want to have an effect on public corruption, the trick is to either get magical surveillance powers to spot all the bribes going on, or else solve the root of the problem itself.  We have so much public corruption in NYC because we have a truly byzantine labyrinth of regulations, rules, laws, permits and procedures that serve as a massive impediment to doing business and getting things done.  Name an industry, and we can name any number of stupid rules or procedures in the way.  Businesses have a huge incentive to grease the wheels.  And the petty functionaries who stand in the way of doing business tend to be very poorly paid (few government workers actually make enough here relative to the cost of living here), so they have a huge incentive to accept money to look the other way.  The system is set up to guarantee bribery, not prevent it.

And of course, that’s a huge invitation to organized crime.  Which is why the Rackets Bureau is involved in the first place.  (Though many of these cases don’t really have an o.c. component these days.)

If you want to have a more noticeable effect on public corruption, the way to do it is systemic change.  A new sub-unit of the Rackets Bureau just doesn’t seem like a practical solution, though it may have some public-relations benefit in sending a message that the new DA is indeed focused on this problem.

We said all this and more to the reporter, a nice enough fellow.  We’re saying it now, though, because the way it came out (link here) isn’t quite what we were saying — especially after the piece got expanded and revised — and the comments page there won’t let us post a comment to clarify our statements.  So we’re saying it here.

-=-=-=-=-

That said, there are a couple of ways the new unit could actually be worthwhile.  The best way would be to focus in one place those prosecutors with real experience investigating and trying these kinds of cases.  Then keep them there and build up a substantial institutional memory, so experience doesn’t evaporate with the fairly high turnover of ADAs who leave to go make enough elsewhere to pay for rent and kids and things.  If the ADAs assigned there were to work hand-in-hand with the folks over at DOI, it’s conceivable that there could be improvements to efficiency in doing what they do.  An ideal situation might be something analogous to the way the feds deal with FCPA cases — there’s a special unit at the SEC, and in the Fraud Section of the DOJ, which coordinate fairly closely to deal with international bribery.  The federal units benefit from that synergy and their institutional memory, developing more consistent policies than if the cases were handled by all and sundry.  So that could be a good way to take this new unit.

And, on reading the WSJ piece, we learned not only that the unit was in fact announced that day, but that our former colleague Dan Cort will be heading it up.  And we like Dan a lot.  He’s smart and fair-minded, and he’s got plenty of high-level experience with this stuff, so he’s an excellent choice to lead the unit.

UPDATE: While in court today, we bumped into Mike Scotto, and learned that he’s just been made the Chief of the Rackets Bureau.  For those defense attorneys who haven’t worked opposite him before, let us tell you he’s a great pick for boss there.  Culture comes from the top, and with Mike there, we have every reason to expect the highest levels of professionalism and good judgment from his people.  He’s down-to-earth, decent, and knows what he’s doing.

The news is full of reports today about the hung jury in the Blagojevich trial — they found the governor guilty of a single count of lying to federal agents something like five years ago, and hung 11-1 in favor of conviction on the remaining counts.  All kinds of pontificators are pontificating about why this happened.  Scott Turow, for example, says it’s because corporations have too much freedom to contribute to political campaigns, so bribery becomes perceived as the norm. 

That’s a bit of a stretch.  It’s hardly likely that the jurors were considering such things as the corrupting consequences of the extension of First Amendment protections to corporate campaign contributions.  Like most commentors, Turow seems to be slapping his own politics on top of a more prosaic observation — that to some, the governor’s actions just don’t seem criminal.  This observation, without all the other nonsense attached to it, was actually quite astute.  According to the jury foreman, the holdout appears to have thought Blagojevich’s actions were “just talk,” and nothing criminal.

From what we’ve seen in the newspapers, that’s not an insane perspective here.  It sure reads as if Blagojevich was just thinking out loud sometimes, or bouncing stupid ideas off people that never got carried out.  And the forman says the other jurors respected the holdout’s right to her position here.  It doesn’t seem like an unprincipled, irrational vote.

But other reports highlight a different take on the holdout’s position.  Another juror is on record saying that the holdout wanted more clear-cut evidence, tantamount to a videotape of a murder, before she’d ever have convicted.  And if, as is likely, the holdout was Jo Ann Chiakulas, then she had already made up her mind weeks beforehand that the governor was innocent.

Both takes ring true to us, and are not mutually exclusive.  It seems probable that the holdout had decided weeks ago, after the close of the prosecution’s case, that the government hadn’t given her that whatever-it-is she would have needed to vote to convict.  Jurors vote to acquit all the time, in even the most solid rock-crusher cases, and the most common reason given is that “there just wasn’t enough evidence,” or they “needed more.” 

Jurors can never articulate what “more” they would have needed.  That’s because this is humanspeak for ”you could never have convinced me to convict.”  It’s a rationalization of a gut feeling. 

It can happen for all kinds of reasons — perhaps the criminal statute is seen as unjust, perhaps the defendant is sympathetic, perhaps the juror just doesn’t want to see another young black man go to prison, perhaps the alleged conduct is just not seen as criminal regardless of the law.  All of these are forms of jury nullification. 

When a juror says “there wasn’t enough,” in a seemingly strong case, that’s code for jury nullification.

-=-=-=-=-

As we wrote last year, this seems to be happening more and more lately.  There has been a massive rise in the number of hung juries in recent years, leading some to call for majority-vote verdicts instead of requiring unanimity.  That’s not the solution.  The solution is to realize why you get holdouts, and try to adapt your jury selection accordingly.  The burden falls to the prosecutors to try to keep them off — especially in stronger cases where the defense might actively desire a holdout (as we once heard Brendan Sullivan say, “the government needs all twelve… I only need one”).  That’s not always true though — once when we were a young prosecutor we won a case because of a holdout for conviction (who everyone else thought we were nuts not to have excluded) who wound up doing a 12 Angry Men in reverse and convincing the other 11 to convict over several days of deliberations.

-=-=-=-=-

So what does this mean for the inevitable retrial?  Does it signify that Blagojevich is probably going to get convicted the second time around, because the odds of another holdout are slim to none?  Should he cut his losses and take a plea, hoping for more lenity than he’d get after a second trial?  Not at all.

Each jury is separate and unique, just like a coin toss.  Just because the last toss of the coin was heads, that doesn’t change the 50-50 odds of the next toss.  You never know what you’re going to get with a jury.  We have zero faith in jury consultants and those who think they can pick ‘em — all jury prognostication is bunk.  You never know what you got until it’s all over.  You can try to keep out the most obvious potential difficult personalities, you can try to identify those who are likely to nullify, but you can never tell with most people.  People are just too complex.  Apart from the most obvious, you’ll never know, and only a fool believes he can.

So the odds of success next time around are just as good as they were this time around.  Presumably, both sides are going to try to make their cases better, but who knows how well they can?

Who knows, maybe next time it’ll be 11-1 to acquit?  Anything can happen.