• By
  • Ashby Jones

Earlier Tuesday, we had lengthy, wide-ranging conversations with two former federal prosecutors, Duke Law School’s Sam Buell and Cozen O’Connor’s Stephen Miller, about insider trading.

We asked them: Why are insider-trading prosecutions so hard to win? Are inside traders harder or easier to go after today than they used to be? Do the SDNY’s Galleon case and the current hedge-fund investigation signal that something new is afoot in insider-trading prosecutions? How prevalent is insider trading anyway? Below are edited excerpts.

Insider trading cases are traditionally known as being hard to win. How true is this? Why?

Both Miller and Buell agreed that insider-trading cases can be hard for the government to win. For starters, it’s often not easy to prove all the elements required, because typically there just isn’t slam-dunk, smoking-gun evidence.

Miller said that in the past, the government has largely had to make due with circumstantial evidence, like a suspicious trade. From there, the government, has typically looked for a cooperating witness who can validate the suspicion.

“That’s often all you have to go on — something that looks funny and a cooperator,” said Miller, who mentioned the Martha Stewart prosecution as an example. However, ”If the defense does a good job attacking the cooperating witness, a case suddenly can become extremely hard to win,” he said.

Both Buell and Miller said the government has had a decent track record on the prosecutions it has brought. “Sometimes you’ll get a circumstantial story that’s so overwhelmingly obvious that there’s just no room to argue that the trade wasn’t based on insider information,” said Buell.

Buell pointed to the former CEO of Imclone, Sam Waksal, who pleaded guilty to insider-trading charges for selling ImClone shares knowing the FDA was going to issue a negative report on the drug before the agency’s eventual approval of it. “This was low hanging fruit,” he said.

The government seems to be adapting its approach, though. It’s using wiretaps in the case centered on the Galleon Group hedge fund and is using mass FBI raids in the latest investigation. Do you think this signals a shift in the way these cases are going to be investigated and prosecuted?

In Miller’s mind, the use of wiretaps “revolutionizes” the prosecution of these cases by providing more concrete evidence, potentially removing the need to speculate as to what was going on.

“It’s extremely powerful evidence and makes me wonder why it hasn’t been widely used in the past,” he added. “It’s why the Galleon [defendants] are trying so hard to keep the evidence out.”

Buell added that both cases seemed to develop the way organized crime or drug investigations unfold.”The government starts in on a nucleus of activity, and it starts branching off and unfolding organically in unexpected ways,” he said.

For that reason, he didn’t see either case as being the product of a new overarching top-down strategy. “You can’t design this from on high,” he said. “Even if you were sitting there wondering about hedge funds and insider trading, how would you go about getting into it? You’d only get there if you first got something to work with.”

These prosecutions seem different than, say, the Martha Stewart prosecution in so many ways. They’re big, sprawling, involve new technologies. In what ways will they be easier for the government to win, and in what ways will they be more difficult?

In Miller’s opinion, improvements in technology — and the advent of email, Twitter, Facebook, etc., — are a double-edged sword for the government.

The evidence these technologies create — permanent, time-stamped data — can be extremely useful to a government’s case. “In the old Ivan Boesky days, at best you had a record that a three-minute phone call took place — or maybe that someone witnessed a meeting,” said Miller.

But Buell predicts that the complexity of the trading and hedge-fund worlds makes it more likely we’ll see more novel and creative defenses brought forward.

“You have all these types of trading and different kinds of derivative products, it’s bound to make more complicated the calculus of what constitutes insider trading,” he said. He predicted we’ll see more situations in which someone says “I didn’t execute this trade” or “Yes I executed this trade, but this wasn’t insider information,” or “This was information that wasn’t known around the world, but was certainly well-known within the industry.”

Indeed, the government could have trouble proving criminal intent related to behavior that’s become fairly common, Miller said. The government would also have to explain increasingly complex sets of facts to a jury. ”Too much complexity typically favors the defense,” he said.

How widespread is insider trading?

“We can pretty safely say that the incidence of the offense is significantly larger than the number of prosecutions,” said Buell. “But we really have no idea. There’s an extremely limited amount of empirical information on this.”

Buell questions whether it’s smart for the government to talk about just how rampant insider trading is. “People who are on the fence may be led to believe they may get caught or that what they’re doing will fly under the radar. It’s very hard to know.”