By Robert Falkner, Reed Smith LLP
The U.S. Securities and Exchange Commission (SEC) has so far secured no less than 14 high profile insider dealing convictions using wire tap evidence in connection with the trading of Raj Rajaratnam, the founder of the Galleon Group hedge fund.1 The Galleon convictions disclose widespread communication of inside information by many investment professionals and its repeated misuse in the general course of business. As such it goes to the core of business practice in the world's financial markets. What makes the Galleon insider dealing cases particularly noteworthy is that the convictions were secured with heavy reliance upon the extensive use of evidence obtained by wire taps – this is both unprecedented and controversial.
The EU/UK Regime
Section 53 CJA 1993 provides a defence where the defendant can show that he would have acted in the same way without the inside information or that the defendant reasonably believed the information had been disclosed to the extent those that may participate in relevant transactions would not have been prejudiced. Section 118(2) FSMA also expressly requires that a person deals "on the basis of" inside information. The Financial Services Authority's (FSA) Code of Market Conduct (MAR) at MAR 1.3.3 E lists some obvious factors to be taken into account when determining whether a deal is made on the basis of inside information. However, the listed factors are not helpful with reference to the issue concerning the circumstances in which it may be a legitimate defence to say that principal reliance was in fact placed on other market research or market "intelligence" and rumour.
The admission of wire tap evidence in U.S. insider dealing proceedings is not yet at least to be taken for granted. Strict procedures apply with respect to any wire tap interception and a serious case to answer must be established before such evidence is admitted in court proceedings. Further, the Galleon investigation was the first time wiretaps had been used to investigate and prosecute insider dealing offences.6 The statutory power exercised to use wiretaps does not identify insider dealing as an offence for which the wiretap powers can be used.7 In the Galleon cases the wiretap application referred to probable cause for wire fraud and money laundering and the Court concluded that the U.S. Government, in good faith, sought to investigate wire fraud through its wire taps and that the incidental crime of insider dealing could therefore be properly investigated and prosecuted using wire taps. Rajaratnam's counsel has announced an intention to appeal the convictions on the grounds that the wire tap evidence should not have been put before the jury – U.S. pundits do not rate the prospects of such an appeal highly.
In the UK, while telephone communications may be intercepted under a warrant issued by the Home Secretary only authorities such as the police and the intelligence services may obtain interception warrants,9 the FSA has no such power. Further, any material obtained under one of these warrants may only be used for background intelligence and is not admissible in court proceedings. There are FSA rules requiring taping by firms of all conversations concerning trade execution – these tapes may be admissible in court proceedings. However, this is not likely to catch the determined insider trader who will use other means to obtain or communicate inside information.10
Robert Falkner is a financial services litigation partner at Reed Smith LLP. Robert's practice covers domestic and international financial services. He specialises in litigation, regulatory enforcement defence work, general regulatory and compliance advice in the securities, derivatives, commodity, and foreign exchange markets. Telephone: +44 (0) 20 3116 2980; E-mail: email@example.com.
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