The execution of search warrants at 3 hedge funds marks a significant escalation of the government inquiry into insider trading, writes Peter J. Henning in his White Collar Watch on the NYT Dealbook site.  By using a search warrant rather than a grand jury subpoena, prosecutors have signaled there's a good chance that securities laws were violated, and they want evidence gathered quickly and in a way that avoids the possibility that some material might be destroyed.

Under the 4th Amendment, which governs the issuance of search warrants, the government must provide sufficient detail to a federal magistrate or judge regarding the location to be searched and the items to be seized, along with a description of the criminal activity that establishes the need for the search.  Prosecutors do not ask for a warrant based on a hunch or suspicion, especially in an insider trading case, and it is executed out in the open, so everyone knows who is linked to the possible criminal activity.

By comparison, In white collar crime cases, the description of what comes within the scope of the warrant is usually quite broad, covering numerous records, along with the computers and servers where they're stored, that may contain evidence helpful in a prosecution.  It's not uncommon for agents to cart away stacks of boxes and computers to be reviewed later.

    Targeted Funds.   (i) Level Global Investors, (ii) Diamondback Capital, (iii) Loch Capital Management were searched, indicating that prosecutors believe there was evidence in their offices that can show the flow of insider information that can help prove insider trading.  It remains to be seen whether the firms and/or any of their employees are targets of the probe - but the search would appear to indicate that prosecutors believe they had some involvement in the possible insider trading.

• Level Global and Diamondback have ties to the hedge fund giant
• Founders of Loch Capital have connections to a cooperating defendant, Steven Fortuna, in the Galleon Group insider trading prosecution. 
  

Click to Access the Source:  [NYT Dealbook's White Collar Watch, 11/23]   Otherwise, continue reading the story, which follows in reduced font.

The search warrants came only a couple days after the Wall Street Journal published a story about the head of a technology research firm, John Kinnucan, sending an e-mail to various hedge funds, including SAC Capital, about being visited by “fresh faced eager beavers from the FBI” who wanted him to record conversations with his clients to help gather information about insider trading, a task he declined to accept. The F.B.I. usually asks someone to provide this type of assistance only when it already has information to show the person engaged in illegal conduct — the carrot of cooperation is offered to mitigate any future punishment.

Any undercover operation, such as wearing a wire or recording telephone conversations, relies on those under investigation being unaware of the government’s interest. Once Mr. Kinnucan’s e-mail came to light, the cat was out of the bag about the investigation and it was time to execute the search warrants if prosecutors hoped to obtain incriminating information from the three hedge funds.
The more common type of insider trading involves information about a major corporate transaction or event such as an offer to acquire a company or the disclosure of news that will have a significant impact on the stock price in the short term. Another way, which seems to be the focus of the search warrants, involves firms like the three hedge funds that use a network of contacts to gather tidbits of information, some of which may be confidential, to put together a profile of where a company is headed and then trade on that analysis.

What types of information are prosecutors looking for to establish this type of case? The hedge funds’ trading records are likely to be available from the brokerage firms they used to execute their trades, so the more likely object of the search warrants are communications, such as e-mail and text messages, that may include references to inside information along with internal memoranda or other documents showing the basis for trading decisions. While it is unlikely prosecutors expect to find the proverbial “smoking gun” in a firm’s files, getting the records that show what the firm knew about a company, and when it knew it, can be helpful to building a case showing that trades were made on the basis of inside information and not fundamental research.

Each of the hedge funds stated that it was cooperating with the government in the investigation, but there is not much they can do when Federal Bureau of Investigation agents arrive with a search warrant giving them the authority to enter the premises and seize any items designated in it. Their time at the firms’ offices gives agents a chance to learn about the operations and, perhaps, discover additional evidence that might be in “plain view,” i.e. immediately apparent as involving criminal conduct. In addition, agents often try to speak with workers during the execution of the warrant, voluntarily of course, in the hope of gathering additional information and perhaps even an incriminating statement or two that can be used in a subsequent criminal prosecution.

In white collar crime investigations, the typical tool for gathering evidence is a grand jury subpoena, which requires the recipient to turn over the identified items within a specified period. A subpoena does not require prior judicial approval, and in the early stages of an investigation, prosecutors often use one to obtain a wide range of documents that may turn out to be irrelevant.
While a subpoena is easy to issue, simply requiring a prosecutor’s approval before being served, a disadvantage to using one is that it puts the onus of compliance on the recipient, who may be tempted not to produce all the records, perhaps by withholding some or worse getting rid of those that are incriminating. With a search warrant, government agents get to decide initially what items to seize, have immediate access to the records, and largely avoid the risk that records or other evidence will be destroyed before agents arrive because there is no prior warning of the issuance of a warrant. The decision to use a search warrant rather than a subpoena may indicate the Justice Department does not necessarily trust that a subpoena will be fully complied with.
The search of the three hedge funds also sends a powerful message that the government believes there is evidence of criminal conduct at the locations searched. The warrants were executed by Federal Bureau of Investigation agents who were armed, which can be quite intimidating. Using a search warrant rather than a subpoena ratchets up the pressure on those involved because prosecutors are not looking for their cooperation at this point, instead sending the message that this is going to be a fight.
Those who believe they may be targets of the investigation are on notice that prosecutors are serious, which means that if they want to cooperate in the case, the time to come forward is now, before prosecutors gather sufficient information to proceed without them. A search warrant is a warning shot across the bow of the hedge funds and those who were in their network that the Justice Department is getting closer to making a decision about whom to prosecute.