Juicy Details on Getting Rid of Insider Trading Evidence

The latest round of insider trading arrests on Wall Street sound like they are out of a gangster move, with juicy details of destroying hard drives and hiding them in Manhattan garbage trucks.

Clearly, the federal prosecutors have turned the heat up on hedge funds that used the tips from expert research networks.

On Tuesday, federal prosecutors unveiled charges against three hedge fund managers, including two, Noah Freeman and Donald Longueuil, who previously worked at SAC Capital Advisors, who allegedly shared tipsters and pooled confidential information about publicly traded technology companies, according to today's New York Times.

What I found most interesting are the lengths to which sophisticated hedge fund managers will resort to destroying evidence. One portfolio manager, Longueuil, used pliers to rip open his flash drive, stuff the fragments into his North Face jacket, and then dump the scraps into random Manhattan garbage trucks at night.

How would the federal prosecutors know about this? Prosecutors have been wiretapping conversations between the consultants or company insiders hired by expert research networks and hedge fund managers that paid them to pass on confidential information about technology companies. After reading a news article about a grand jury investigation of insider trading, Longueuil decided to destroy the computer drive.

According to the Times article, "Longueuil destroyed his flash drive on which he had logged his conversations with company insiders, as well as two external hard drives bearing incriminating evidence, the company says." But then it gets worse. Longueuil "recounted his actions in a taped telephone conversation with Mr. Freeman," another portfolio manager who was accused of insider trading on Tuesday.

At the news conference on Tuesday, Preet Bharara, the United States Attorney in Manhattan, called the cover-up something "out of a bad movie and said this was probably the first time that Wall Street portfolio manager used pliers as 'a tool of the trade,'" noted the Times.

Clearly, these hedge fund managers didn't confer with their compliance officers before they destroyed the hard drives nor did they think about discussing the process on a phone call that was being taped. Then again, they probably didn't tell compliance that they relied on insider tips, either.

Now that Bharara has charged 46 people with insider trading, with 29 having pleaded guilty, these arrests no longer look like isolated incidents. They create the impression that Wall Street must be saturated with insider tipsters, which really undermines the reputation of the hedge fund industry. Many, if not most funds, work extremely hard to research investments, developing quant or fundamental models and spreadsheets, burning the midnight oil to analyze massive amounts of data.

In the Times article, the zealous prosecutor, said, "We are not talking about the occasional corrupt individual; we are talking about something verging on a corrupt business model; for the defendants seem to have taken the concept of social networking and turned it into a criminal enterprise."

Social networking, cell phones and flash drives have become the tools of insider trading. If hedge funds are going to trade on inside information, they should at least be smarter about recording it. And the rest of the street conducting legitimate research, should also be careful.