Involving a number of investment houses, the charges cast a wider net than anyone had anticipated. Plus, a piggyback cover-up scheme is revealed
Even John Grisham would have a tough time topping the latest Wall Street insider-trading saga, outlined on Mar. 1 by federal authorities against a group of current and former employees of four big investment houses: UBS (UBS) Morgan Stanley (MS), Bank of America (BAC) and Bear Stearns (BSC).
The case involves allegations that hedge funds bought information about impending rating changes on stocks from an executive at UBS, got tips about upcoming corporate mergers from a former Morgan Stanley compliance officer, and paid a Bank of America broker for the right to get shares in hot initial public offerings. There's even a charge that some day traders, who had gotten wind of the alleged activities, were shaking down other traders for money to keep secret their role in the purported insider-trading scheme.
The Plot Thickens
News of the investigation and the possibility of federal authorities filing charges against a UBS employee were first reported this week by BusinessWeek.com. But the extent of the alleged wrongdoing is far greater and more complex than anyone imagined.
In all, nine people, including Mitchel Guttenberg, 41, a UBS executive director, and Randi Collotta, a former Morgan Stanley compliance officer, are facing an array of criminal or civil securities fraud charges. Four other people have already pleaded guilty to federal criminal charges including securities fraud, conspiracy, and bribery.
The Securities & Exchange Commission estimates the various insider-trading schemes netted more than $15 million for all of the participants. The SEC says the maneuver in which Guttenberg tipped off two traders to impending changes in stock ratings accounted for the lion's share of the illicit trading gains, netting $14 million in "illegal profits." Michael Garcia, the U.S. Attorney for the Southern District of New York, put the defendants' total haul from the various schemes at $8 million. Authorities say the discrepancy in the figures is due to the fact that civil charges filed by the SEC are slightly different from those in the criminal case brought by prosecutors.
Largest Case in 20 Years
Whatever the precise figure, the case is a big black eye for Wall Street. Indeed, federal authorities are calling the arrests, which took place following a six-month investigation, one of the more significant insider-trading cases ever filed. Scott Friestad, an SEC associate director, says the "action is one of the largest SEC insider-trading cases" in nearly two decades.
The investigation moved so swiftly because prosecutors and regulators got help from a number of cooperating witnesses, some of whom even secretly recorded conversations with some of the defendants, say people familiar with the case. Some of the defendants learned only recently that they were under investigation.
Up until Feb. 28, the day before the charges were announced, Guttenberg had continued to show up for work at UBS. Doug Morris, a spokesman in New York for the Swiss-based bank, says Guttenberg is now on an unpaid leave of absence. "UBS is assisting the authorities to the fullest extent possible in their investigation into the alleged actions of a single UBS employee. The U.S. Attorney has described UBS as a victim of this alleged scheme," says Morris. Lawyers for Guttenberg and many of the other defendants could not be reached for comment.
Selling Tips for Four Years
What's most astonishing may be the brazenness of the activities alleged to have taken place. In the case of Guttenberg, for instance, federal prosecutors say he was selling advance notice of ratings changes on stock by UBS analysts to two traders for nearly four years. Guttenberg, a member of UBS's investment review committee, stopped selling the information only when he stepped down from the committee in December. Prosecutors say one of the jobs of the investment review committee is to review "changes in analysts' securities recommendations—before being released to the public."
Authorities charge that Guttenberg sold information about upcoming rating changes on hundreds of stocks to David Tavdy and Erik Franklin for "hundreds of thousands of dollars." Tavdy and Franklin profited from that information by making trades in those stocks in advance of the rating changes being made public. For instance, prosecutors say that on May 25, 2006, Guttenberg told Tavdy that UBS was going to upgrade its rating on shares of Goldman Sachs (GS). After receiving the tip, Tavdy allegedly bought 7,300 shares of Goldman Sachs. He then sold the stock for a $20,000 profit the following day, after the upgrade was publicly announced. Authorities say that while the profits on each trade were small, they quickly added up, given the number of tips passed on by Guttenberg.
Franklin used the information provided by Guttenberg to make profitable trades for three hedge funds he had been associated with: Lyford Cay Capital, Chelsey Capital, and Q Capital Investment Partners. Tavdy did his trading at day-trading shops Andover Brokerage, Assent, and Jasper Capital. Authorities say Guttenberg "used coded text messages on disposable cell phones to communicate the tips." In some instances, Guttenberg allegedly shared in the trading profits.
A Pivotal Player
Tavdy was set to be arraigned on Mar. 1 along with Guttenberg on criminal charges arising from the scheme. Franklin pleaded guilty on Feb. 27 to four counts of conspiracy, securities fraud, and commercial bribery. His lawyer, Michael Bachner, declined to comment.
Franklin appears to have played a pivotal role in the insider-trading investigation because he benefited from all three illicit trading schemes. He also was on the receiving end of tips about corporate mergers that Collotta, a former Morgan Stanley compliance officer, was selling. Additionally, Franklin allegedly paid $9,500 to former Banc of America Securities broker Paul Risoli for shares in several IPOs. Prosecutors alleged Franklin struck the deal with Risoli for the benefit of Q Capital, one of the hedge funds he worked for.
Collotta, who is an attorney but didn't practice law at Morgan Stanley, left the Wall Street firm in 2005. Her husband, Christopher Collotta (also an attorney), was charged along with his wife with conspiracy to commit securities fraud. A Morgan Stanley spokeswoman says: "We have cooperated and are continuing to cooperate fully with authorities regarding a former employee who allegedly stole information from Morgan Stanley."
Others also charged by prosecutors and regulators include Risoli and two former Bear Stearns brokers, Robert Babcock and Ken Okada. Authorities allege that Babcock and Okada profited by trading on the Morgan Stanley merger tips and information about the UBS analyst rating changes. Prosecutors contend that the duo shared information with Franklin and served as a nexus between the two big insider-trading schemes. A Bear Stearns spokesman did not return a phone call.
One of the more intriguing activities uncovered by prosecutors was an alleged scheme by two day traders, Samuel Childs Jr. and Laurence McKeever, to shake down Tavdy and another trader, David Glass. Prosecutors charged that Childs and McKeever learned what Tavdy and Glass were doing with the UBS stock tips and promised not to tell anyone if they were paid money. Glass allegedly paid a total of $150,000 to the pair.
Besides Franklin, the other defendants pleading guilty in recent days include Glass, Babcock, and Marc Jurman, a Florida broker.