Insider trading sting reverberates throughout the tech industry

With some of the charges reading more like an organized crime sting than the pursuit of white-collar crime, observers say these initial allegations against several tech industry insiders could be just the beginning of a broad government investigation.

By Tam Harbert, Contributing editor -- EDN, April 5, 2011

The investigation and trial of Raj Rajaratnam of Galleon Group - the largest hedge-fund insider trading case in history - has already ruined the careers of several top high-tech executives. Robert W Moffat Jr, former senior vice president and group executive for IBM's Systems and Technology Group, pleaded guilty and got six months in jail. Ali Hariri, former vice president of broadband carrier networking at Atheros Communications Inc pleaded guilty and got 18 months. Although he was not charged with any wrongdoing, former AMD CEO Hector Ruiz was questioned during the investigation.

But the Galleon case is just one part of a broad push by the government to crack down on insider trading. Another component  - one in which the US Department of Justice and the US Securities and Exchange Commission (SEC) are investigating possible insider trading based on information from expert networks - may ultimately prove more damaging to many mid-level technology professionals. This probe has exposed a lucrative sideline that is likely very attractive to many technology employees - although it's hard to know how many actually participated - and yet seems to have remained under the radar of corporate compliance officers. At the least, the government's investigation is raising important questions about this practice. At most, more technology professionals could be going to jail.

In the last four months, the government has arrested and filed both criminal fraud and civil insider trading charges against mid-level executives at AMD, Dell, Flextronics, and TSMC that had been moonlighting as consultants for expert network firm Primary Global Research LLC. (See  "The charges," right) The detailed evidence spelled out in the charges demonstrates just how aggressively the government is pursuing insider trading. The FBI wiretapped cell-phone calls, e-mails and text messages, used undercover informants, and successfully "flipped" suspects, enticing them to cooperate in the investigation by promising possible leniency. Parts of the charges read more like an organized crime sting than the pursuit of white-collar crime.  It's clear that "the DOJ and especially the US attorney in the southern district of New York have instituted a campaign against insider trading [in which they are using] what I would call blue-collar tactics in order to ferret out the criminal activity," said Frank C Razzano, a partner in the Washington, DC, office of Pepper Hamilton LLP. Razzano's experience includes a stint as an assistant US attorney for the District of New Jersey as well as an assistant chief trial attorney at the SEC.

This could be just the tip of the iceberg. "Today's charges allege that a corrupt network of insiders at some of the world's leading technology companies served as so-called 'consultants' who sold out their employers by stealing and then peddling their valuable inside information," said Manhattan US Attorney Preet Bharara when he announced the charges. "Over the next many months and beyond, we will continue to enforce the law, police the market, and protect honest businesses and their shareholders by working methodically with the FBI and SEC to root out corporate corruption and insider trading."

The charges include transcripts of wiretapped conversations and messages going back to at least 2008. The Wall Street Journal reported that one of the key cooperating witnesses in the investigation made more than 60 calls to corporate managers at technology companies, seeking to gather evidence for the government. The list of companies mentioned in the DOJ and SEC filings is long and covers a broad swath of the electronics industry. (See "A broad swath" list below.)

"The US attorney's office made it really clear when it announced the last round of charges that they were only at the beginning," said Thomas Gorman, a former staff member of the SEC's Enforcement Division and now a partner at Dorsey & Whitney LLP specializing in civil and criminal securities and business litigation. While the Galleon investigation is probably winding down, he said, "the expert network side really just started last fall, and they are just starting to trace that out."

A new spin on social networking

The investigation shines a spotlight on the business of expert network firms, which maintain a pool of industry experts as part-time consultants and match them with clients who want to learn quickly about specific industries, companies, and technologies. The business has been around for at least a decade, but the number of firms has increased substantially in the last several years, from four companies in 1998 to 25 in 2008 to 38 by the end of 2009, according to Integrity Research Associates LLC, which tracks expert network firms. A report published by Integrity Research in 2009 listed some of the major companies:  CognoLink, Coleman Research, DeMatteo Monness, Gerson Lehrman Group, Guidepoint Global Advisors, Primary Global Research, and Primary Insight.

Expert network firms' clients include investors, hedge funds, traders, private equity firms, venture capital firms, professional service firms, strategic consulting firms, and corporations. The clients often pay the firms annual retainers of tens of thousands of dollars for access to their experts, according to the government's charges.

The firms' "experts" are usually independent consultants or retired executives, but the investigation has highlighted the fact that these firms also use employees of public companies.  The pay is lucrative, averaging hundreds of dollars per hour. The prospect of making such money just for participating in a phone call can be tempting, particularly after the 2008 market crash and subsequent recession. "A lot of people saw their retirements go south," suggested Rob Enderle, a technology analyst and president of the Enderle Group who has worked for expert network firms. "A lot of people were trying to rebuild their nest egg."

Jim Handy, an analyst at Objective Analysis, which conducts market research on the semiconductor industry, has been a consultant for Gerson Lehrman Group since 2003. He explained how the process, much of which is done online, works. "You sign up, you tell them what you're good at, and how much per hour you want for a consultation, and they set you up with an account," he said. When Gerson Lehrman has a client that needs that expertise, it goes through a process of finding the best matches, presents them for the client to choose from and then sets up the call.  After the call "the expert logs into Gerson Lehrman's Web site and records how many minutes he spent talking to this client. Then Gerson Lehrman cuts a check for the expert."  Handy emphasized that Gerson Lehrman is very careful about conflicts of interest. "They are constantly putting the terms [and conditions] in front of you," he said. Experts are required to complete online compliance training, and before each call the expert is required to review and reaffirm the terms and conditions by clicking a box on the Web site, he noted.

Checking the box on compliance

On its Web site, Gerson Lehrman stresses its "compliance framework," a set of rules and procedures designed to "reduce clients' exposure to conflicts." Its terms and conditions contract, which experts must renew every year, spells out the do's and don'ts specifically. In addition, Gerson Lehrman explicitly precludes employees from participating in projects about their employer. The company also maintains a database on the policies of thousands of public companies, including which ones prohibit outside consulting by employees. Based on that database, it will block employees from those companies from participating, Gerson Lehrman claims.

Gerson Lehrman is not the only expert network firm that touts its strict compliance systems. The real question is whether policies are followed and systems are effective. In fact, in 2009 Integrity Research had reviewed many firms' compliance policies and procedures and found Primary Global's to be good. In a recent blog post, Integrity Research Chairman and Founder Michael Mayhew said the recent scandal has prompted the firm to reconsider how it evaluates firms' compliance policies. "Based purely on [the] firm's written policies, Primary Global Research looked to have a relatively robust compliance system in place," Mayhew wrote. "Apparently, PGR's actual compliance practices and culture were not consistent with the firm's written policies. In other words, this research firm probably did not do what it said it would do."

But what about compliance procedures at public companies? The extent to which corporate compliance officers at high-tech companies were aware of expert networks, what policies they may have had in place, and how or whether they were educating their employees about those policies is hard to determine because technology companies aren't talking.  Three different semiconductor companies declined our requests for an interview on the topic.

 "Until recently, [expert network activity] has been relatively under the radar," said Gorman. "These are the first cases to really highlight this, and I think it is something that compliance officers have struggled with."

In its charges, the SEC notes that the consultants had signed non-disclosure agreements with their employers and were aware that they should not share certain information. It also points out that Primary Global Research specifically stated that its consultants were not to share proprietary information.

But apparently such contracts and agreements are sometimes ignored. "I think there are [employees of public companies] who sidestep that," said Handy. The safeguards "are not rock solid. There is an awful lot of honor system stuff."

Can you hear me now?

In particular, there seem to be no safeguards during the actual call. In the case of Global Research, it appears that the only other party listening to the calls was the FBI. Two other expert network companies confirmed that they do not monitor calls to make sure no lines were crossed.

That's a problem, said Gorman.  It's easy for an employee to become entangled during one of these calls and find himself giving information he shouldn't, especially when the client is skilled at asking questions. Gorman suggested that a better approach would be for the expert to provide information that then passes through the firm to the client. "The closer you get to talking to the traders ... the easier it is to step over the line," he said.

In fact, Handy once heard a consultant describe an incident that sounds like a good example. "He said that a client said to him, 'I don't want to hear what everybody else knows. I want to hear stuff that only you know,'" said Handy. "That sounded to him like, you know, 'I want to hear material non-public information.'"

After all, if an employee is making $350 an hour to talk on the phone, there is a lot of pressure to provide valuable information. Unless an employee is well-versed in the intricacies of insider-trading laws, these calls are dangerous at best. "It takes me about three hours to explain to students what insider trading is," said Razzano, who also teaches law. "At the end of those three hours, some of them still don't understand it."

"My advice to any employee at a company is: don't discuss company business with anyone, except for people within the company and for a legitimate purpose," he said. That's especially true if compensation is offered in exchange for information.

"If you get money for passing along information about your employer, you may not know the intricacies of insider trading laws, but you know that's wrong," he said.


A broad swath

The investigation has touched many companies in the technology industry. Here is a list of some of the companies mentioned in the government's filings. The fact that a company is mentioned in a filing does not mean that the company broke any law or is being accused of any wrongdoing. Indeed, many of these companies cooperated fully with the government. However, the long list illustrates the extent of the investigation.

Actel
Akamai Technologies
AMD
Apple
Atheros Communications
ATI Technologies
Broadcom
Clearwire
Cypress Semiconductor
Dell
Ebay
Fairchild Semiconductor
Flextronics
Google
IBM
Intel
Marvell
Nvidia
Polycom
Research In Motion
Seagate
Sierra Wireless
Sun Microsystems
TSMC
Western Digital