White-Collar Wiretaps

Last month, we noted how the conviction of Galleon Group's co-founder Raj Rajaratnam, with the help of evidence gathered through government wiretaps, had shaken up the corporate world. Officers and directors of public companies, as well as their lawyers and other consultants, are on notice that the government just may be “listening in.” How justified is their newfound concern, and what can be done to limit exposure to criminal liability? We continue the discussion herein.

Limitations

The legal limitations on the use of wiretaps in white-collar criminal investigations stem primarily from the language of the statute itself. Title III of the Omnibus Crime Control and Safe Streets Act of 1968 (codified in 18 U.S.C. ' 2510, et seq.) specifies certain predicate offenses that the federal government must be investigating in order to apply for an electronic surveillance order. 18 U.S.C. ' 2516. Notably, neither securities fraud nor insider trading is one of those predicate offenses. Id. While the proverbial “catch-all” offenses of wire fraud and mail fraud can provide a basis for obtaining warrants to wiretap suspects being investigated for a variety of different activities, the decisions by Southern District of New York Judges Richard Holwell and Richard Sullivan in the Galleon-related cases remain the only legal precedent for allowing the use of wiretaps in an insider trading case, and those decisions will undoubtedly be appealed. See United States v. Rajaratnam, No. 09 Cr. 1184 (RJH), 2010 WL 4867402 at *1 (S.D.N.Y. Nov. 24, 2010) (Holwell, J.); United States v. Goffer, 756 F.Supp.2d 588 (S.D.N.Y. 2011) (Sullivan, J.).

If, as some have predicted, the government tries to capitalize on the Rajaratnam victory by applying more frequently for wiretaps to investigate financial crimes, it remains to be seen whether courts will follow the lead of these decisions, or if they will begin to recognize limits. The government can only seek a wiretap if there is probable cause to believe that a predicate offense is being committed, and a court may suppress a wiretap if the application fails to meet this standard or for government misconduct.

Securities Fraud

The number of crimes that may be investigated using wiretaps has expanded over time, but still does not include securities fraud. Since 1986, Congress has repeatedly added to the list of predicate offenses to include access device fraud, bank fraud, computer fraud and criminal violations of the Sherman Act. Rajaratnam, 2010 WL 4867402 at *6, n.8. Similarly, in March 2011, the Obama administration proposed legislation granting law enforcement the authority to seek wiretaps in investigations of criminal copyright and trademark offenses. Exec. Office of the President, Administration's White Paper on Intellectual Property Enforcement Legislative Recommendations (2011), available at www.whitehouse.gov/sites/default/files/ip_white_paper.pdf. Thus, the government recognizes that prosecutors may not always be able to bootstrap non-predicate white-collar offenses to wire fraud and mail fraud in order to get around the limitations of the statute.

Notably, the proposed legislation was received with some skepticism. David Makarewicz, Do Obama's Proposed New Copyright Laws Go Too Far?, Sites and Blogs (March 16, 2011), www.sitesandblogs.com/2011/03/do-obamas-proposed-new-copyright-laws.html; David Makarewicz, New Proposal to Wiretap Suspected Infringers Raises Privacy Concerns, Infowars.com (Mar. 17 2011), www.infowars.com/new-proposal-to-wiretap-suspected-infringers-raises-privacy-concerns/. And privacy advocates have raised concerns about attempts by the government to further monitor people's communications. Debra Cassens Weiss, Privacy Advocates Decry Anti-Crime Proposals for Internet Wiretaps, Bank Disclosures, ABA Journal, (Sept. 27, 2010, 8:03 AM), www.abajournal.com/news/article/privacy_advocates_decry_anticrime_proposals_for_internet_wiretaps_bank_dis/. It, therefore, seems unlikely that the government will be given carte blanche to expand the reach of the wiretap statute.

'Necessity'

The second legal hurdle the government faces in obtaining wiretap authorization in white-collar criminal cases is the requirement to show “necessity”: The government must set forth facts to support a finding that “other investigative procedures have been tried and failed” or that “they reasonably appear to be unlikely to succeed if tried” or are “too dangerous.” 18 U.S.C. ' 2518(1)(c). Additionally, a wiretap application has to be renewed after 30 days, and the government is required to justify the continued necessity of the wiretaps. Most financial crimes can be detected using conventional investigative techniques, making it difficult for the government to be able to routinely show necessity when applying for electronic surveillance. While the government is not required to exhaust all other techniques before turning to wiretaps, electronic surveillance is not intended to be “a routine initial step” in an investigation. United States v. Lilla, 699 F.2d 99, 104 (2d Cir. 1983) (internal quotations and citations omitted).

Practical Limitations

There are also practical limitations to the routine use of wiretaps in insider trading cases. Wiretaps are an invaluable tool for investigating ongoing crimes involving large groups of individuals where the government is able to build a foundation over an extended period of time. White-collar cases do not often follow this model. Investigations of financial crimes are typically historical in nature, and often start after the fraudulent act or insider trading has already taken place.

Unlike the Rajaratnam investigation, which spanned nearly a decade and involved a large network of individuals that included hedge fund managers, consultants, corporate insiders and even attorneys, the garden-variety insider trading cases ordinarily involve a handful of suspects accused of making a discreet number of illicit trades. In such instances involving few individuals and relatively small losses, the considerable time and expense required to conduct electronic surveillance makes its routine use impractical. (According to the Report of the Director of the Administrative Office of the United States Courts, the average cost for federal wiretaps in 2009 was $62,552.)

Implications

Although electronic surveillance of the financial sector may not become routine, its dramatic use in the Galleon and expert networking investigations has highlighted the need for effective and comprehensive compliance programs to identify and address questionable practices before they become widespread. With the government having publicly declared its policy of aggressively pursuing cases of financial fraud, companies are well-advised to take this opportunity to review and update their internal policies and procedures currently in place, to retrain their employees on best practices, and establish a culture in which employees seek advice on actions that may be close to the line.

Similarly, the recordings played at the recent insider trading trials highlight the challenges that public companies and their investment relations officers (IROs) face in managing disclosure risks. Some commentators have called it “an opportunity for IROs to reinforce their disclosure policies internally to insiders who might be tempted to provide sensitive information either via expert networks or directly to analysts.” Brad Allen, Galleon Verdict Bolsters Role of IR, Business Insider (May 12, 2011), www.businessinsider.com/galleon-verdict-bolsters-role-of-ir-2011-5. Compliance officers and IROs who seize this opportunity stand a greater chance of preventing or detecting early even an inadvertent improper disclosure of material nonpublic information, which not only protects the company and its insiders from criminal prosecution, but also benefits the investing public.

Jonathan B. New, a member of this newsletter's Board of Editors, is a partner in Baker Hostetler's white collar defense and corporate investigations practice in the New York office and a former assistant U.S. attorney. Sammi Malek is a litigation associate at the firm's New York office. This article also appeared in the New York Law Journal, an ALM sibling publication of this newsletter.

Last month, we noted how the conviction of Galleon Group's co-founder Raj Rajaratnam, with the help of evidence gathered through government wiretaps, had shaken up the corporate world. Officers and directors of public companies, as well as their lawyers and other consultants, are on notice that the government just may be “listening in.” How justified is their newfound concern, and what can be done to limit exposure to criminal liability? We continue the discussion herein.

Limitations

The legal limitations on the use of wiretaps in white-collar criminal investigations stem primarily from the language of the statute itself. Title III of the Omnibus Crime Control and Safe Streets Act of 1968 (codified in 18 U.S.C. ' 2510, et seq.) specifies certain predicate offenses that the federal government must be investigating in order to apply for an electronic surveillance order. 18 U.S.C. ' 2516. Notably, neither securities fraud nor insider trading is one of those predicate offenses. Id. While the proverbial “catch-all” offenses of wire fraud and mail fraud can provide a basis for obtaining warrants to wiretap suspects being investigated for a variety of different activities, the decisions by Southern District of New York Judges Richard Holwell and Richard Sullivan in the Galleon-related cases remain the only legal precedent for allowing the use of wiretaps in an insider trading case, and those decisions will undoubtedly be appealed. See United States v. Rajaratnam, No. 09 Cr. 1184 (RJH), 2010 WL 4867402 at *1 (S.D.N.Y. Nov. 24, 2010) (Holwell, J.); United States v. Goffer , 756 F.Supp.2d 588 (S.D.N.Y. 2011) (Sullivan, J.).

If, as some have predicted, the government tries to capitalize on the Rajaratnam victory by applying more frequently for wiretaps to investigate financial crimes, it remains to be seen whether courts will follow the lead of these decisions, or if they will begin to recognize limits. The government can only seek a wiretap if there is probable cause to believe that a predicate offense is being committed, and a court may suppress a wiretap if the application fails to meet this standard or for government misconduct.

Securities Fraud

The number of crimes that may be investigated using wiretaps has expanded over time, but still does not include securities fraud. Since 1986, Congress has repeatedly added to the list of predicate offenses to include access device fraud, bank fraud, computer fraud and criminal violations of the Sherman Act. Rajaratnam, 2010 WL 4867402 at *6, n.8. Similarly, in March 2011, the Obama administration proposed legislation granting law enforcement the authority to seek wiretaps in investigations of criminal copyright and trademark offenses. Exec. Office of the President, Administration's White Paper on Intellectual Property Enforcement Legislative Recommendations (2011), available at www.whitehouse.gov/sites/default/files/ip_white_paper.pdf. Thus, the government recognizes that prosecutors may not always be able to bootstrap non-predicate white-collar offenses to wire fraud and mail fraud in order to get around the limitations of the statute.

Notably, the proposed legislation was received with some skepticism. David Makarewicz, Do Obama's Proposed New Copyright Laws Go Too Far?, Sites and Blogs (March 16, 2011), www.sitesandblogs.com/2011/03/do-obamas-proposed-new-copyright-laws.html; David Makarewicz, New Proposal to Wiretap Suspected Infringers Raises Privacy Concerns, Infowars.com (Mar. 17 2011), www.infowars.com/new-proposal-to-wiretap-suspected-infringers-raises-privacy-concerns/. And privacy advocates have raised concerns about attempts by the government to further monitor people's communications. Debra Cassens Weiss, Privacy Advocates Decry Anti-Crime Proposals for Internet Wiretaps, Bank Disclosures, ABA Journal, (Sept. 27, 2010, 8:03 AM), www.abajournal.com/news/article/privacy_advocates_decry_anticrime_proposals_for_internet_wiretaps_bank_dis/. It, therefore, seems unlikely that the government will be given carte blanche to expand the reach of the wiretap statute.

'Necessity'

The second legal hurdle the government faces in obtaining wiretap authorization in white-collar criminal cases is the requirement to show “necessity”: The government must set forth facts to support a finding that “other investigative procedures have been tried and failed” or that “they reasonably appear to be unlikely to succeed if tried” or are “too dangerous.” 18 U.S.C. ' 2518(1)(c). Additionally, a wiretap application has to be renewed after 30 days, and the government is required to justify the continued necessity of the wiretaps. Most financial crimes can be detected using conventional investigative techniques, making it difficult for the government to be able to routinely show necessity when applying for electronic surveillance. While the government is not required to exhaust all other techniques before turning to wiretaps, electronic surveillance is not intended to be “a routine initial step” in an investigation. United States v. Lilla , 699 F.2d 99, 104 (2d Cir. 1983) (internal quotations and citations omitted).

Practical Limitations

There are also practical limitations to the routine use of wiretaps in insider trading cases. Wiretaps are an invaluable tool for investigating ongoing crimes involving large groups of individuals where the government is able to build a foundation over an extended period of time. White-collar cases do not often follow this model. Investigations of financial crimes are typically historical in nature, and often start after the fraudulent act or insider trading has already taken place.

Unlike the Rajaratnam investigation, which spanned nearly a decade and involved a large network of individuals that included hedge fund managers, consultants, corporate insiders and even attorneys, the garden-variety insider trading cases ordinarily involve a handful of suspects accused of making a discreet number of illicit trades. In such instances involving few individuals and relatively small losses, the considerable time and expense required to conduct electronic surveillance makes its routine use impractical. (According to the Report of the Director of the Administrative Office of the United States Courts, the average cost for federal wiretaps in 2009 was $62,552.)

Implications

Although electronic surveillance of the financial sector may not become routine, its dramatic use in the Galleon and expert networking investigations has highlighted the need for effective and comprehensive compliance programs to identify and address questionable practices before they become widespread. With the government having publicly declared its policy of aggressively pursuing cases of financial fraud, companies are well-advised to take this opportunity to review and update their internal policies and procedures currently in place, to retrain their employees on best practices, and establish a culture in which employees seek advice on actions that may be close to the line.

Similarly, the recordings played at the recent insider trading trials highlight the challenges that public companies and their investment relations officers (IROs) face in managing disclosure risks. Some commentators have called it “an opportunity for IROs to reinforce their disclosure policies internally to insiders who might be tempted to provide sensitive information either via expert networks or directly to analysts.” Brad Allen, Galleon Verdict Bolsters Role of IR, Business Insider (May 12, 2011), www.businessinsider.com/galleon-verdict-bolsters-role-of-ir-2011-5. Compliance officers and IROs who seize this opportunity stand a greater chance of preventing or detecting early even an inadvertent improper disclosure of material nonpublic information, which not only protects the company and its insiders from criminal prosecution, but also benefits the investing public.

Jonathan B. New, a member of this newsletter's Board of Editors, is a partner in Baker Hostetler's white collar defense and corporate investigations practice in the New York office and a former assistant U.S. attorney. Sammi Malek is a litigation associate at the firm's New York office. This article also appeared in the New York Law Journal, an ALM sibling publication of this newsletter.