Hedge fund cases point to a maze of alleged insider trading

Joseph Contorinis was in a mood to celebrate his big score, so he made reservations for dinner at one of Manhattan’s most expensive restaurants.

The tab for sushi and sake at Masa came to $1,150, but Contorinis could afford it. The hedge fund manager had just turned a $7-million stock-trading profit, court filings show, thanks to inside information about secret plans for a multibillion-dollar takeover of grocery giant Albertson’s.

His guest at dinner: Nicos Stephanou, the investment banker who illegally leaked the information.


The mood was less festive two years later, in January 2009, when FBI agents stopped Contorinis at Miami International Airport on his way back from vacation in South America to question him about those trades.

The case, which resulted in criminal convictions of both Contorinis and Stephanou, drew little notice at the time. But it marked the public debut of what has turned into a full-scale offensive by the government against one of the most elite bastions on Wall Street: hedge funds.

Since then, dozens of people employed by or connected with hedge funds have been charged with insider trading in a spate of interlocking cases.

On Thursday, four more people were arrested on charges tied to alleged insider trading. The government said all four, as well as a fifth person whose guilty plea was disclosed Thursday, had passed along confidential information about tech companies to hedge funds and other investors.

The charges brought so far suggest that prosecutors see a web of interconnected human networks set up to enable the illegal trading of stocks based on privileged information.

That’s in sharp contrast to the conventional insider-trading story line of, say, a low-level corporate executive sharing a hot tip with a golfing buddy.

“What makes these cases so unique is that these are insider-trading cases on a systemic level,” said David Segal, a former federal prosecutor now in private practice in New York.

The probes grew out of a 25-person hedge-fund task force created by the Securities and Exchange Commission in 2007, which developed a computer program to analyze stock market movements and identify not only suspicious trading but also suspicious relationships between traders, according to people close to the investigations who were not authorized to speak on the record.

The arrests of Contorinis and Stephanou were the first fruits of that technology, those people said. A statement issued by the SEC after Contorinis’ arrest alluded to the new software, saying the case was the “direct result of innovative investigative techniques that the SEC is using.”

With those techniques, the SEC “does not have to rely on traditional methods of looking for a low-level informant to get to a bigger fish,” said Arthur Laby, a professor at Rutgers University’s law school who worked at the SEC until 2006.

More recently, the government also has used wiretaps to try to follow the trail of illegally shared information.

It can be hard to tell where one trading network ends and another begins.

In the highest-profile investigation to date, the head of New York hedge-fund firm Galleon Group, Raj Rajaratnam, is awaiting trial on charges that he made millions from inside information given to him by employees or people close to Google Inc., IBM Corp. and other tech companies.

Some defendants in that case led the government to an alleged trading ring led by New York investor Zvi Goffer, court filings show. Rajaratnam and Goffer, dubbed “Octopussy” by prosecutors because of his extensive network, have pleaded not guilty.

There’s no indication that investigators believe that all or even most hedge funds engage in illegal trading, but the industry is clearly a target.

When FBI agents stopped Contorinis at the Miami airport, they immediately asked him about other hedge funds, including some high-profile names, he testified at his trial.

Hedge funds — private investment pools open only to investors with a net worth of at least $1 million — have been around for decades. The industry has exploded in recent years as financial markets have grown more complex, creating more distortions that smart traders can capitalize on. But exploiting market inefficiencies has generated huge profits, making hedge funds a natural target.

Some in the industry fear that if big players are taken down for insider trading, investors may respond by pulling money out of hedge funds.

“There’s a lot of concern about how far this will go,” said Washington lawyer Paul Huey-Burns, an expert on insider-trading law.

The Albertson’s case began in 2005, when Stephanou was a young banker in New York at UBS, which was advising a private investment firm looking at acquiring Albertson’s.

After attending meetings at Albertson’s Idaho headquarters, Stephanou fed information to his father, Achilleas Stephanou, in Cyprus, who subsequently made about $300,000 trading in Albertson’s shares, according to court filings.

Stephanou then began giving updates to Contorinis, a friend he met in Los Angeles and partied with in New York’s high-flying social scene. Contorinis was working in Connecticut, managing a hedge fund for a unit of Jefferies Group Inc.

A few weeks before Albertson’s announced it was being acquired for about $10 billion in cash and stock by a consortium including grocer SuperValu and drugstore giant CVS, Stephanou learned the deal was going through and phoned Contorinis. During their four-minute call, Contorinis bought 219,200 shares of Albertson’s stock for his fund.

Contorinis ultimately bought 2.5 million Albertson’s shares, all of which he sold almost as soon as the takeover plan became public Jan. 23, 2006. He made reservations for the extravagant dinner at Masa the same day.

A federal jury in Manhattan convicted Contorinis on seven counts of securities fraud and one of conspiracy. He is to be sentenced Friday. Stephanou pleaded guilty to seven felony counts and is to be sentenced this month.

The Albertson’s case gave prosecutors one of their first scalps in the hedge-fund industry and one of their first looks at SAC Capital Advisors, a Stamford, Conn., fund operator that boasts some of the highest returns in the industry.

Prosecutors have said in court filings that Stephanou, who is awaiting sentencing, gave information on deals he was working on to Jonathan Hollander, the manager of an SAC fund. Hollander, who has not been charged, gave a statement to prosecutors describing what he knew, according to filings in the case.

SAC Capital, which is run by billionaire art collector Steven Cohen, subsequently received a subpoena from prosecutors. Two other hedge-fund firms founded by SAC alumni were raided by FBI agents who left with boxes of materials.

But if SAC is coming into the government’s sights, so are many others.

“Here you clearly have a decision that was made not just to take on one case, but to pursue the whole pattern,” said Jacob Frenkel, a securities lawyer and former federal prosecutor. “It’s fair to say this is an unprecedented initiative.”