SPECIAL REPORT – Philadelphia SEC unit, where rogue traders dare not tread

By Reuters Staff
February 19, 2010

By Matthew Goldstein

PHILADELPHIA, Feb 19 (Reuters) – An office building that sits atop an upscale shopping mall in downtown Philadelphia is not the sort of place that would ordinarily strike fear into the hearts of bad guys on Wall Street.

But that is home turf for the little-known regulator who has built a better mousetrap: an increasingly sophisticated computer database which is already helping the U.S. Securities and Exchange Commission catch insider traders.

Last month, Daniel Hawke, an energetic, guitar-playing 46-year-old lawyer, was named head of a new task force charged with cracking down on a variety of market abuses.

Even before the promotion, Hawke, who remains director of the SEC’s Philadelphia office, cast a surprisingly long shadow over the financial industry from his perch a two-hour or so drive from the canyons of Wall Street.

A few weeks after hedge fund billionaire Raj Rajaratnam was arrested in New York last October in the most significant insider trading investigation in two decades, Hawke and his team of lawyers were busy working to reel in the next big catch.

In mid-November, his crew handed out more than a dozen subpoenas to hedge funds and Wall Street investment firms seeking information about trading activity in shares of several drug manufacturers and consumer products companies that were buyout targets in 2006 and 2007.

Hawke, who has more than a decade of regulatory work under his belt, won’t discuss the details of the subpoenas or the nature of the ongoing investigation.

But the flurry of activity last fall is indicative of the new, aggressive approach Hawke said he and his team are using to unearth cases of insider trading. And in the months to come, Wall Street firms and hedge funds likely will receive more of these regulatory calling cards from Philadelphia.

“Our focus is on conducting trader-based investigations, rather than going security by security,” said Hawke, who has run the Philadelphia office since 2006 and will now also serve as director of the new market abuse unit.

The goal, he said was to discover “hard-to-detect frauds.”

 

CYBER SLEUTHS

Much of the initial detective work that Hawke’s group is doing relies heavily on computers. The team cross-checks trading data on dozens of stocks with personal information about individual traders, such as where they went to business school or where they used to work.

Hawke said his investigators are looking for patterns of “behavior by traders across multiple securities” and seeing if there are any common relationships or associations between those traders.

His stock sleuths then try to determine whether those traders who are wheeling-and-dealing in the same group of securities are doing so because they are simply smarter and luckier than other investors, or have benefited from improper access to confidential information.

Looking for connections and past associations among traders at hedge funds and Wall Street firms may not sound like an entirely novel way to conduct an investigation. But it is a marked departure from the way insider trading investigations tended to get going at the SEC.

Historically, the agency has pursued such cases only after being tipped off by an informant or receiving a referral from a market surveillance team at a particular exchange about unusual trading in some stock.

“Our goal is to be better masters of our own destiny by making the most informed decision about what conduct to investigate,” said SEC Enforcement Chief Robert Khuzami, in a recent interview. “And one way to accomplish that is to have the broadest and deepest information about what is going on in the markets.”

Even the sprawling Galleon Management insider trading investigation, which has led to criminal charges filed against against Rajaratnam and 21 others, began with a tip from an exchange and the help of an informant. Federal prosecutors didn’t begin placing wiretaps on some of the defendants’ cell phones until well after the SEC began gathering evidence of potential wrongful trading by Galleon co-founder Rajaratnam and others.

“A decade ago there wasn’t a whole lot of computer assistance when it came to matching up names or matching up employers,” said Bruce Carton, a former SEC senior counsel and now editor of Securities Docket, an online securities law blog. “That’s extremely helpful.”

 

PHILADELPHIA STORY

This newly elevated status for Hawke’s crew may come as a surprise to some on Wall Street, where the SEC’s Philadelphia office is often seen as playing second fiddle in regulatory matters to New York and Washington, D.C.

After all, the Galleon case has been almost entirely a New York and Washington operation. And while Hawke’s office has jurisdiction over firms operating in five mid Atlantic states and the nation’s capital, no one could confuse Philadelphia’s Market Street district with Wall Street.

Four years ago, security was so lax at the building where Hawke works that a group of self-styled anarchists stormed the entryway of the SEC’s offices and staged a protest.

But tapping Hawke to oversee the SEC’s new market abuse task force is a way for the agency’s bosses to acknowledge that the Philadelphia office has come up with innovative ways to investigate insider trading.

The agency is giving Hawke the authority to pull in SEC lawyers across the nation. Indeed, his deputy in the market abuse unit is Sanjay Wadhaw, who is currently the assistant regional director of the SEC’s New York office.

Hawke began briefing the agency’s top brass about his computer-assisted forensic work in late 2007. During a meeting with then SEC Enforcement Chief Linda Thomsen and others, he explained how his team had begun compiling trading records kept by Wall Street market makers on dozens of stocks that were buyout targets. He told his superiors they were looking for common trading patterns to begin an initial inquiry.

A year ago, Hawke’s strategy of combing through these so-called “blue sheet” trading records scored its first big success. The Philadelphia office, in tandem with federal prosecutors in New York, filed civil and criminal charges against seven people in conjunction with an insider trading scheme that reaped more than $11 million in profits. The case arose from an analysis of trading patterns in stocks of several companies involved in buyouts in which UBS kept coming-up as one of the deal advisors.

Federal prosecutors got a big break in that investigation when one of the defendants, former UBS investment banker Nicos Stephanou, pleaded guilty and agreed to testify against his alleged co-conspirators. Stephanou is charged with providing some of the defendants with confidential information about the impending buyouts of supermarket chain Albertsons and construction materials manufacturer ElkCorp.

In his cooperation agreement, Stephanou also admitted providing some of his co-conspirators with confidential deal information as far back as 1997. Before the arrests in Galleon, the Stephanou case was one of the bigger insider trading busts by prosecutors and securities regulators in recent memory.

 

LONG ARM OF THE SEC

Over the years, Hawke, a Washington native, whose father John was a former U.S. Comptroller of the Currency, has earned a reputation for taking on complex cases. He joined the SEC in 1999, after walking away from a lucrative job as a partner with a Washington law firm.

One of his first assignments was a case that led to the SEC filing administrative charges in the summer of 2001 against the now defunct accounting firm Arthur Andersen, which the agency accused of producing faulty audits of trash hauling giant Waste Management Inc. A few months later, Arthur Anderson would again be in the news for its improper audits of Enron.

But it is in insider trading cases where Hawke has shined. And he’s not shied away from taking on cases where defendants accused of wrongful trading live in far flung places.

In the Stephanou case, for instance, some of the defendants come from Cyprus and Greece. In 2005, he uncovered a scheme by traders in Estonia to get illegal access to corporate press releases distributed by Business Wire before the potential market-moving information was released to the public.

“Dan has a long history pursuing investigations that have a market abuse angle,” said Scott Friestad, an associate director in the SEC’s Washington, D.C. office, who supervised Hawke before he moved to the Philadelphia office. “He has been involved in bringing a number of cases that are ground-breaking in some fashion.”

Hawke has also had his share of setbacks. For example, in 2008, a federal judge tossed out a case Hawke’s office had filed against a hedge fund manager it had accused of insider trading.

Right now, the Philadelphia office is embroiled in a pitched legal battle with suspended Blackstone Group <BX.N> investment banker Ramesh Chakrapani, one of the defendants in the Stephanou case. In an unusual procedural move, Hawke’s office wants to dismiss its insider trading case against Chakrapani but retain the right to refile the case at a later date. But a lawyer for Chakrapani, in a bid to clear his client’s name, has asked a federal judge to dismiss the SEC action with prejudice — meaning the agency can’t come back and charge the banker again.

A ruling in the matter is pending.

And some, even inside the SEC, question whether Hawke’s approach is of much use for developing investigative leads beyond cases in which traders are getting access to confidential buyout-related information.

Hawke is cognizant of those criticisms. He said his proactive approach doesn’t necessarily trump tips or informants. The Estonian case, he pointed out, began with a tip from Seattle-area trader and well-known regulatory gadfly Yolanda Holtzee about an unusual spike in trading in a stock.

Rather, he said, computer-assisted probes are intended as a “starting point” for investigations. They help regulators get a better view of what traders are doing in the markets, he said.

Hawke, whose office overlooks the historic building where Thomas Jefferson penned the Declaration of Independence, also said he hopes to send a stern warning to would-be scofflaws that the SEC is on the watch and won’t be waiting for informants to come forward to expose wrongdoing.

(Editing by Jim Impoco and Claudia Parsons) ((matthew.goldstein@thomsonreuters.com; 1-646-223-5773))

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