Charles Marquardt, the former chief administrator of Evergreen Investment Management Co. LLC, settled with the SEC over charges that he sold shares in Evergreen's Ultra Short Opportunities Fund after obtaining insider information that a number of MBS holdings were going to fall in value. On June 11, 2008, he learned that Ultra, which deals mainly in mortgage-backed securities, was going to take a hit, and he sold all of his shares the next day, resulting in savings of about $5,000.

Igor Poteroba, a high-ranking investment banker in UBS Securities LLC's Global Healthcare Group, was charged by the SEC for allegedly tipping his friend Aleksey Koval with highly confidential information about impending transactions involving pharmaceutical companies, who later alerted their friend Alexander Vorobiev. They exchanged information through emails, using code words such as "frequent flyer miles" and "potatoes."

Insider Trading is a difficult charge to sort through in court because most cases involve snippets of phone conversations, text messages, and paper trails revolving around transactions that happened in the past. Federal prosecutors are now rethinking their tactics and may adopt a more aggressive tactic - much like they deal with drug dealers, agents may now start to go after potential inside traders through sting and "reverse-sting" operations. Not only does this increase the chances of catching potential cheaters, but it also sends a terrifying message to financial professionals as the individual they may be sharing information with could be an undercover agent.

The SEC created a stir in 2009 when it announced that, for the first time its history, it would attempt to use thousands of recorded conversations obtained by wiretaps of former disgraced hedge fund Galleon Group to convict its executives of insider trading. If prosecutors successfully argue their case for the use of wiretap evidence in the trial of Raj Rajartnam, it could translate to a lot more bugged phones on Wall Street.

• Decision in Galleon Group case could lead to more wiretapping of Wall Street officials.
• Founder Raj Rajartnam wins new hearing on claims that officials filed a misleading application to wiretap his conversations.

The S.E.C. can't seem to catch a break: The government watchdog recently suffered a setback in its attempts to crack down on insider trading after losing its case against Jon-Paul Rorech, a bond salesman at Deutsche Bank. The S.E.C. had accused Rorech of sharing nonpublic information with Renato Negrin, from the hedge fund Millennium Partners, about a bond offering to be made by VNU. The transaction in question was not the typical "inside-trading-case" security, but a credit default swap, a financial instrument not traded on an exchange and often dealt with behind closed doors. Because credit default swaps are dependent upon the exchange of information and highly sophisticated financial professionals, it remains to be seen how the S.E.C. can prosecute those deemed guilty of fraud.

On July 13, 2010, Brazilian police accused financial giant Goldman Sachs of alleged inside trading involving the takeover of pulp company Ripasa by rival Suzano Celulose in 2004. The police say Goldman traders sold Suzano shares between September and October of 2004 before information on the Ripasa deal was made public in November of that year. These dealings allegedly allowed Goldman to avoid approximately $141,000 in trading losses. Often, when a takeover is announced, the price of an acquiring company falls.

In 2001, Joseph Skowron faced what may have been more than just a career dilemma -- should he pursue a future in medicine? Or go for the money and head to Wall Street? Skowron, at the time in a residency program at Harvard no less, and ignoring the pleas of his advisor to continue on the path toward becoming an orthopedic surgeon, left it all behind and set his sights on New York City.

His story is a risible throwback to the yuppie '80s:

Dr. Skowron became a health-care analyst for the hedge fund SAC Capital Advisors LP before quickly moving on to another well-known hedge fund, Millennium Partners LLC. By 2003, he had joined FrontPoint Partners LLC, a hedge fund where he soon would co-manage more than $1 billion in health-care investments. With the big jobs came a 10,190-square-foot home in Greenwich, Conn., whose value was assessed in 2010 at slightly less than $6 million.

Dr. Skowron traveled in elite political and social circles, as a major donor to John McCain's 2008 presidential campaign, according to campaign finance records, and a member of the exclusive Monticello Motor Club, an automotive resort and track outside of New York City. The club's sign-up fees start at $25,000 and among the members are racer Jeff Gordon and comedian Jerry Seinfeld, the president of the club said.

Along the way, the 41-year-old husband and father amassed a collection of luxury cars that has included a blue Ferrari 458 and a black Porsche Cayenne, according to state records.

On Nov. 2, life in the fast lane came to a halt. The U.S. Attorney's office in Manhattan and the Securities and Exchange Commission unveiled an insider-trading case, charging French doctor Yves M. Benhamou with sharing confidential drug-trial data with a hedge fund.

The fund in question? FrontPoint Partners. The amount they prevented in losses through the secret information? Allegedly $30 million.

Skowron was a man heavily involved in the philanthropy world, doing medical stints in Cuba, Kosovo and India. Since the announcement of the insider trading case, however, Skowron has also taken leave from his volunteer medical position with AmeriCares.

Insider trading cases are always difficult to anaylze and must be taken on a case-by-case basis before one can pass judgement. Yet, the same question is almost always asked -- why are those individuals who least need the money seem the most prone to engaging in these actions to get a larger cut of the pie?

Click here for update and profile of hedge fund star Todd Deutsch.

Federal authorities have launched one of the biggest crackdowns on insider trading in years. On Saturday, November 20, the Wall Street Journal reported that a huge insider trading investigation was under way. According to the paper's sources, a veritable hurricane of financial scandal was in the making:

Federal authorities, capping a three-year investigation, are preparing insider-trading charges that could ensnare consultants, investment bankers, hedge-fund and mutual-fund traders, and analysts across the nation, according to people familiar with the matter.

The criminal and civil probes, which authorities say could eclipse the impact on the financial industry of any previous such investigation, are examining whether multiple insider-trading rings reaped illegal profits totaling tens of millions of dollars, the people say. Some charges could be brought before year-end, they say.

The investigations, if they bear fruit, have the potential to expose a culture of pervasive insider trading in U.S. financial markets, including new ways non-public information is passed to traders through experts tied to specific industries or companies, federal authorities say.

Reading the article, it appeared as though it would be some time before the Feds took any concrete action. Yet perhaps fearing the destruction of evidence after the WSJ's story, investigators swung into action on Monday, with the FBI mounting raids of three hedge funds. The firms were Diamondback Capital Management and Level Global Investors in Connecticut and Loch Capital Management, based in Boston.

While none of these firms are well known, the WSJ story suggests that the insider trading firm could implicate some of the biggest players on Wall Street. The reporters write that "prosecutors and regulators are examining whether Goldman Sachs Group Inc. bankers leaked information about transactions, including health-care mergers, in ways that benefited certain investors, the people say. Goldman declined to comment." 

Also mentioned are SAC Capital Advisors LP and Citadel Asset Management, as well as as Janus Capital Group, Wellington Management Co. and MFS Investment Management. Collectively, these firms have tens of billions of dollars under management.

The most intriguing aspect of the emerging scandal is that insider information appears to have been systematically trafficked by "independent analysts and consultants who work for companies that provide "expert network" services to hedge funds and mutual funds." According to the story:

"Expert-network firms hire current or former company employees, as well as doctors and other specialists, to be consultants to funds making investment decisions. More than a third of institutional investment-management firms use expert networks, according to a late 2009 survey by Integrity Research Associates in New York. The consultants typically earn several hundred dollars an hour for their services, which can include meetings or phone calls with traders to discuss developments in their company or industry.

But the investigations also involve more familiar tip-offs of impending mergers and other deals:

"The SEC has been investigating potential leaks on takeover deals going back to at least 2007 amid an explosion of deals leading up to the financial crisis. The SEC sent subpoenas last autumn to more than 30 hedge funds and other investors.Some subpoenas were related to trading in Schering-Plough Corp. stock before its takeover by Merck & Co. in 2009, say people familiar with the matter. Schering-Plough stock rose 8% the trading day before the deal plan was announced and 14% the day of the announcement."

Not surprisingly, some of the investigations under way loop back to the Galleon Group case involving that firm's founder Raj Rajaratnam and 22 other defendants. Some 14 people have already pleaded guilty in that investigation and presumably some of them are providing insights about illegal doings elsewhere. 

Among hedge-fund managers whose trading in takeovers is a focus of the criminal probe is Todd Deutsch, a top Wall Street trader who left Galleon Group in 2008 to go out on his own, the people close to the situation say. A spokesman for Mr. Deutsch, who has specialized in health-care and technology stocks, declined to comment.

Click here for update and profile of hedge fund star Todd Deutsch.

It is never good to hear that large financial players may have broken the law, and the huge insider trading investigation unfolding on Wall Street is deeply troubling. But the upside to the probe is that it offers a chance to curb the outsized power of hedge funds.

Hedge funds are major players in the so-called "shadow banking system" and had a key role in the financial shenanigans that brought down the economy in 2008. Some large funds gorged on high-risk investments tied to mortgage-backed securities and made hugely leveraged bets. The failure of two hedge funds at Bear Sterns in July 2007, both of which had loaded up on collateralized debt obligations bought with borrowed money, helped start Wall Street on the road to crisis. And hedge funds may have accelerated the fall of Lehman Brothers by short-selling that firm's stock. A decade earlier, of course, Long Term Capital Management almost precipitated a financial disaster by over-leveraged speculation on foreign currency. 

High-flying hedge fund managers also fueled Wall Street's culture of greed during the go-go years. The huge sums made by these traders created envy among investments bankers who took home mere eight-figure bonuses and pushed more of them to raise their sights -- which meant more leverage and risk. 

Reformers in Washington hoped to quell the casino-like dynamics in America's financial sector and regulate the shadow banking system. But they didn't go far enough and it's not clear whether the new law will do anything to rein in hedge funds. The law, which will include regulations not yet written, does require that hedge funds register with the SEC and reveal certain information about their activities. So far, though, there are no rules to prevent hedge funds from making large-scale risky bets that could destabilize the financial system if they go wrong. The huge lobbying muscle of hedge funds in Washington is a big reason why they have escaped greater oversight. Another Long Term Capital Management could easily crash and burn in the wake of financial reform, perhaps with devastating consequences for the economy and investors. 

The insider trading probe of hedge funds thus offers a welcome chance to make another run at curbing the power of these financial players. Beyond fueling the culture of greed in finance, hedge funds have pushed this sector's ethics in the wrong direction, with evidence growing that some funds used illegal or unethical tactics to make their billions.

Two big examples have already emerged of hedge funds operating on the dark side. The first was last year's insider trading case implicating Raj Rajaratnam and his Galleon Group, with involved the large-scale trafficking of nonpublic information. Fourteen people have pleaded guilty in that investigation.

Then there are the allegations involving Goldman Sachs and John Paulson's hedge fund. The story there, according to the SEC's complaint against Goldman, is that Paulson put together a special fund at Goldman to bet against mortgage-backed securities and the firm sold this junk to unwitting investors while Paulson made north of $1 billion.

The insider trading probe now under way -- which reportedly includes famous funds like Citadel and SAC -- offers an opportunity to uncover other shady doings of hedge funds over recent years. The intense new scrutiny of the sector will hopefully bring hedge fund managers down a few notches and federal authorities should take an expansive view of their goals here.

Meanwhile, let's hope that the emerging scandal will influence the policy debate in Washington. Regulators are still writing the rules that will implement financial reform and there are ways that the law can be interpreted to more strictly regulate hedge funds. The tarnishing of the industry should make it harder for them to resist such rules and raise the chances that the public interest will prevail over private power.

Here is a name that may -- or may not -- become much better known as federal authorities move forward in their vast investigation of insider trading: Todd Deutsch. 

Now, before saying another word, let me just make something clear: Todd Deutsch, who is a super successful hedge fund trader, has not been accused of any wrongdoing. He was simply mentioned in the Wall Street Journal article on November 20 that revealed the insider trading investigation. Specifically, the article stated:

Among hedge-fund managers whose trading in takeovers is a focus of the criminal probe is Todd Deutsch, a top Wall Street trader who left Galleon Group in 2008 to go out on his own, the people close to the situation say. A spokesman for Mr. Deutsch, who has specialized in health-care and technology stocks, declined to comment.

No doubt, that one sentence has turned Todd Deutsch's life upside down and he is probably now hunkered down with lawyers preparing to fight charges that may -- or may not -- materialize and which may -- or may not -- be true. It can't be easy being near the center of what the Journal said is a probe so big that it could "eclipse the impact on the financial industry of any previous such investigation." 

My purpose here is not to traffic in innuendo or imply that Deustch is guilty of anything. Nor do I want to invade his privacy at what must be a very difficult time. On the other hand, if Todd Deutsch is being investigated for good reason, he could well become the Dennis Levine of our time. And so people may rightly be wondering right now: Who is Todd Deutsch?

Here's what we know.

Todd Deutsch is in his late 30s. He was born in 1972, grew up on Long Island, and graduated from the University of Wisconsin in Madison in 1994. For years, he has been seen as a rising star in the hedge fund industry. He worked for Goldman Sachs and then a hedge fund named JLF Asset Management before moving to the Galleon Group, a hugely successful hedge fun run by Raj Raj Rajaratnam known for its investments in technology stocks. In August 2005, the Boring-est Blog mentioned Todd Deutsch, then 32, as real comer in the hedge fund world, quoting a colleague at Galleon as saying that Deutsch was "One of the three best traders in the industry." The article also said that "He's known for his tech and health-care stock-trading prowess" and estimated his annual income in 2005 at "$25 – $30 million."

The website aTrade characterized Raj Rajaratnam's Galleon Group this way at one point:

His firm has a slew of health-care and tech long/short funds that combine fundamental research and savvy trading to capture both long-term and short-term gains. Rajaratnam personally manages close to $2 billion, and those funds collectively returned 15.6 percent last year. Finally, add in a taste of the Galleon Group's overall action (the firm has $4.2 billion in assets), and Raj is rocking -- as are his main traders."

Todd Deutsch became better known in early 2006 when Trader Monthly magazine ranked him 51st on their list of top 100 traders for 2005 and estimated his income at $40 to $50 million that year. Deutsch got more attention in September 2006, when The Wall Street Journal reported that the $800 million Captain’s Offshore Fund, which he ran for the Galleon Group, was up more than 30 percent with investments in drug stocks and the retailer Best Buy. Ultimately, Todd Deutsch's Captain's Offshore Fund ended 2006 with returns of 44 percent. His earnings that year were estimated at $75 to $100 million.

In other years the fund earned returns of over 50 percent and his overall annualized returns during his eight years of leading Captain's Offshore Fund was reportedly 20 percent. He was said to have done even better when he was at JLF Asset Management, with returns of over 60 percent in some years. 

So it was not surprising that Todd Deutsch got high praise in 2007 in the blog 1440 Wall Street: "Todd Deutsch of the Galleon Group is one of the biggest rockstars on Wall Street. Born and bred to be in the business, he is the Tiger Woods of equities, racking up huge gains over the past few years."

The subject of that article, however, was Deutsch's difficulties at the Galleon Group during a period when the Captain's Offshore Fund suffered significant losses -- ending the year ultimately down 25 percent. The article was titled: "Todd Deutsch finally hits an air bubble."

Todd Deutsch left Galleon Group in June 2008, before that firm crashed and burned in an insider trading scandal. His stated reason was to take some time off. The Captain's Offshore Fund was closed after Deutsch left Galleon. Not long after, Todd Deutch began working to start his own hedge fund and reportedly approached some former colleagues at Goldman Sachs about the venture. 

Todd Deutsch's new hedge fund, launched in the first half of 2009 with some $210 million in start-up investments, was called Bascom Hill Partners -- named after a large hill that lies at the center of the University of Wisconsin-Madison. Gregg Moskowitz, another trader from Galleon, joined Todd Deutsch in this new hedge fund. It started trading in August and was based in offices on East 55th Street in Manhattan -- walking distance from Todd Deutsch's $2.5 million apartment on the 33rd floor of a tower located near the East River. 

The Galleon Group became embroiled in scandal in 2009 and closed its doors in October of that year. Todd Deutsch was not implicated in any wrongdoing at the firm. 

While all eyes are fixated on the federal investigation of possible insider trading by top hedge funds, the SEC is also moving forward with other insider trading cases, as it reported today.

The Securities and Exchange Commission today charged a former Deloitte Tax LLP partner and his wife with repeatedly leaking confidential merger and acquisition information to family members overseas in a multi-million dollar insider trading scheme.

The SEC alleges that Arnold McClellan and his wife Annabel, who live in San Francisco, provided advance notice of at least seven confidential acquisitions planned by Deloitte's clients to Annabel's sister and brother-in-law in London. After receiving the illegal tips, the brother-in-law took financial positions in U.S. companies that were targets of acquisitions by Arnold McClellan's clients. His subsequent trades were closely timed with telephone calls between Annabel McClellan and her sister, and with in-person visits with the McClellans. Their insider trading reaped illegal profits of approximately $3 million in U.S. dollars, half of which was to be funneled back to Annabel McClellan.

This is yet another striking case of smart and well-educated people trying to make money in a way that isn't just unethical, but amazingly stupid.

"The McClellans might have thought that they could conceal their illegal scheme by having close relatives make illegal trades offshore. They were wrong," said Robert Khuzami, Director of the SEC's Division of Enforcement. "In this day and age, whether it's across oceans or across markets, the SEC and its domestic and foreign law enforcement partners are committed to identifying and prosecuting illegal insider trading."

Marc J. Fagel, Director of the SEC's San Francisco Regional Office, added, "Deloitte and its clients entrusted Arnold McClellan with highly confidential information. Along with his wife, he abused that trust and used high-placed access to corporate secrets for the couple's own benefit and their family's enrichment."

According to the SEC's complaint, Arnold McClellan had access to highly confidential information while serving as the head of one of Deloitte's regional mergers and acquisitions teams. He provided tax and other advice to Deloitte's clients that were considering corporate acquisitions.

The SEC alleges that between 2006 and 2008, James Sanders used the non-public information obtained from the McClellans to purchase derivative financial instruments known as "spread bets" that are pegged to the price of the underlying U.S. stock. The trading started modestly, with James Sanders buying the equivalent of 1,000 shares of stock in a company that Arnold McClellan's client was attempting to acquire. Subsequent deals netted significant trading profits, and eventually James Sanders was taking large positions and passing along information about Arnold McClellan's deals to colleagues and clients at his trading firm as well as to his father.

Of course, given how often insider trading and other financial crimes go unpunished, maybe it's no surprise that this crew thought that they could beat the odds.

If there is anything we've learned from the new insider trading probe, as well as the Galleon Group case, it is that the law in this area is very complex. In fact, there is no clear-cut definition of insider trading that is easy to find and understand. As an important recent memo by the law firm Fried Frank points out,

Despite a half century of insider trading enforcement, the U.S. remains a relatively rare jurisdiction in that it has no statutory definition of the violation. Instead, this body of law has been developed through court decisions and SEC proceedings generally applying the antifraud prescription in Section 10(b) of the Securities Exchange Act

That can make for considerable murkiness when a key strategy of investors and researchers is "mosaic theory." This involves collecting a lot of different pieces of information about a company from many sources, public and private, and then piecing it together into a broader picture to inform an investment decision. (See Andrew Ross Sorkin's cogent explanation of mosaic theory and insider trading.)

A researcher or investor might well talk to a company's executives as part of their effort. But the key is to do this without getting "material" information that is given to you inappropriately. And what is material information, exactly? Well, according to the Fried Frank memo, it is  “information that a reasonable investor would consider significant in deciding whether to purchase or sell a company’s securities.” The memo also says:

The great majority of investment analysts and portfolio managers are not trading tips on disposable cellular telephones, nor are they providing envelopes of cash for market information. Almost every buy-side investor evaluates information with the goal of reaching a conclusion that the rest of the market does not yet appreciate. The research process involves a myriad of methods and sources – meetings with public company management, models of forecasted income, assessment of macroeconomic trends and walks through the aisles of retail stores to assess shopping trends. This work exposes investors to nonpublic information, and some of that information will be significant to the analyst involved.

Got all that?

In fact, there is no sharply delineated definition of "material" information. Rather, the SEC and courts interpret what such information is on a case-by-case basis.

The Fried Frank memo is so important because it provides a concise guide to this complicated area. By all accounts it is being read with close interest across the investment world.

If you want to see how the federal government is thinking about insider trading, and why it has mounted a huge probe, check out the speech that U.S. Attorney Preet Bharara gave to the New York City Bar Association on October 20, 2010. Bharara is the point guy in the latest crackdown on Wall Street. Born in India in 1968 and raised in New Jersey, he is a graduate of Harvard and Columbia Law School. (Check out the New York Times profile of Bharara that ran last year.)

His speech has gotten attention for the memorable phrase that "inside information is a form of financial steroid."

Now I am told there are some people who don’t see what all the fuss is about. Insider trading, they suggest, is not a particular scourge and is a poor pick as a priority for law enforcement. I know that no one in this room thinks that. (Perhaps that’s because you all have bills to pay.)

It will come as no surprise to anyone here that I believe illegal insider trading is
extremely significant and should be to everyone who cares about the protection of
confidential information and the integrity of the markets.

Insider trading involving a tipper and a tippee is both a theft and a fraud, and it is
intolerable. Your law-abiding institutional clients all believe and understand this also.
Your institutional clients are in business, after all, because they believe in the market.
Fair and efficient markets depend, ultimately, on public information and honest dealings
and enforced rules. And every cheater— whether he trades on inside information or
manipulates the market or makes misrepresentations—cheats every other participant
and offends the principles of the market that honest players live by and make their living
on.

Unlawful insider trading should therefore be offensive to everyone who believes in, and
relies upon, the market. And it is an affront not only to the fairness of the market but
also to the rule of law.

And it only further feeds the pervasive crisis of confidence in our financial system, what
some see as a lack of faith in the economic order and a lack of trust that the same rules
apply to everyone.

So, what is the scope of the insider trading problem at this moment? Unfortunately,
from what I can see from my vantage point as the U.S. Attorney here, illegal insider
trading is rampant and may even be on the rise. And the people who are cheating the
system include bad actors not only at Wall Street firms, but also at Main Street
companies.

Disturbingly, many of the people who are going to such lengths to obtain inside
information for a trading advantage are already among the most advantaged, privileged,
and wealthy insiders in modern finance.

But for them, material non-public information is akin to a performance-enhancing drug
that provides the illegal “edge” to outpace their rivals and make even more money.
In some respects, inside information is a form of financial steroid. It is unfair; it is
offensive; it is unlawful; and it puts a black mark on the entire enterprise.

At the same time and for a host of reasons, the detection, investigation, and criminal
prosecution of illegal insider trading has become increasingly difficult. It has perhaps
never been more difficult to attack through traditional investigative means.

This is so for a number of reasons. Among other things, the sheer volume and
complexity of modern stock trading heightens the difficulty of pinpointing specific illicit
trades that were based on illegally acquired inside information.

When an institution or a trader can jump in and out of positions at the speed of light and
in enormous volumes, illicit trades become easier to mask, harder to find, and subject to
plausible deniability.

In this context, moreover, pre-textual trading designed to stymie enforcement becomes
that much easier to pull off.

Moreover, in the modern information age, there has been a veritable explosion of
newsletters, websites, blogs, tweets, and feeds publishing every last rumor and report
of potential mergers and acquisitions and earnings reports.

That of course makes it easier for an accused insider trader to argue – in the absence
of incriminating recorded evidence to the contrary – that any trades were based on
some report somewhere, which may never have in fact been believed or even read.

A persistent puzzle about financial crimes is that they often involve fabulously rich executives or traders who risk everything to do even better. The rest of us can only wonder: Just what, exactly, are these people thinking? 

That question came up often during the insider trading scandals of the 1980s, which brought down two insanely rich Wall Street superstars, Ivan Boesky and Michael Milken. It arose when bllionaire Martha Stewart faced charges -- and eventually served prison time -- for acting on inside information to avoid losses of a few hundred thousand dollars. And the question is sure to be asked often in the months ahead as federal authorities round up more well-heeled suspects on insider trading charges.

This latest government crackdown on insider trading has already ensnared a number of very wealthy individuals. Most notable among them is the billionaire Raj Rajaratnam and the top IBM executive Robert Moffat. Joseph Skowron, the hedge fund executive involved in the FrontPoint case -- but not charged with any crime -- lived in 10,000-square-foot mansion in Greenwich, Connecticut and, according to news reports, "amassed a collection of luxury cars that has included a blue Ferrari 458 and a black Porsche Cayenne."

And just the other day, authorities arrested wealthy San Francisco tax attorney Arnold McClellan, a partner at Deloitte Tax LLP, on charges of insider trading. His wife Annabel was also arrested. The McClellans lived the good life in San Francisco, with a 6,000-square-foot home in Pacific Heights. 

What's up with these people, and so many others like them? Why would they risk so much when they already have everything?

Well, as I argued in my book The Cheating Culture, a number of converging factors are usually at work when otherwise law-abiding people with lots of money turn into criminals. 

One is a persistent focus among those who are wealthy and competitive on their relative, rather than their absolute, well-being. A 6,000-square-foot house may sound pretty big to most of us, but it may not feel that way if those in your peer group own 10,000-square-foot homes and vacation places in Hawaii to boot. Likewise, a hedge fund guy who makes $10 million a year would seem to be doing amazingly well -- except when he compares himself to the trader down the street in Greenwich who is making $100 million. Raj Rajaratnam was worth $1.5 billion in 2009 -- big money, but not compared to George Soros who was worth $13 billion.

As the economist Robert Frank points out in his book, Luxury Fever, the push to improve one's relative position is actually quite rational and may be hardwired in us. If you're the person with the smallest house in the neighborhood, even though you live in a big house, you may look less like you're going places and get fewer opportunities thrown your way. If you're the person wearing the $500 suit, you may lose out to the guy wearing the $1,000 suit, all other things being equal. 

Of course, various Wall Steeters have put the point about relative position in simpler terms over the decades: Money is how people keep score on Wall Street. If you want to be a winner, you need to make more than the next person -- regardless of how much you make already. That imperative can lead people to do some pretty stupid, and illegal, things. Even small amounts of money, such as in Martha Stewart's case, can seem significant because highly successful people often believe that they are winners because they fight relentlessly to score each and every point. 

Second, criminal behavior can be rooted in the ever rising bar of material expectations and the financial pressures that result. If you travel in circles where it is normal to have a spacious apartment on the Upper East Side and a place in the Hamptons, you're facing a heavy lift to achieve and sustain that standard of living yourself. In this situation, it does make a difference whether you make $5 million a year or $15 million. Throw in a private jet and a place in Aspen as part of the norm, as well as philanthropic commitments, and you're not going to be in the game without an income that is reliably in the mid-eight figures. 

It is easy for anyone to get financially over-extended, and this happens to the rich all the time. There is a long history of wealthy people who have crashed and burned in scandal because they turned to criminal actions to sustain an unaffordable lifestyle. For a particularly egregious case, recall the suicide a few years back of Jeffrey Silverman, the Upper East Side financier -- with homes in Bridgehampton and Palm Beach -- who stole from his own company to make ends meet. He killed himself as the net began to close. New York magazine called him "The Man Who Had Everything." Unfortunately, he couldn't afford everything. 

Finally, there is a more pedestrian reason why the rich cheat and break the law. Because they can -- or think they can. When you're part of a winning class which basically owns our political system, it can be easy to think that you're above the rules. Or that you can avoid punishment when you break the rules by pushing the right buttons. 

Of course, this belief in impunity is largely correct. Most financial crimes do not result in punishment. The rich know the odds favor them when they cheat and the rewards can be vast. Until that calculus changes, big financial crimes will keep on coming. 

Preet Bharara, the U.S. Attorney leading the vast hedge fund probe, is moving systematically to tighten the net around top hedge fund managers and analysts. Today he announced the arrest of four individuals charged with providing information to hedge funds. What's interesting about the criminal complaint filed by Bhara's office is not who is named. But who is not yet named.

The four people charged are Walter Shimoon, a senior director of business development at Flextronics International; Mark Longoria, a supply chain manager for Advanced Micro Devices; Manosha Karunatilaka, of the Taiwan Semiconductor Manufacturing Company; and James Fleishman, a sales manger for an expert-network firm, Primary Global Research.

Ever heard of any of these guys? I didn't think so. in fact, with the exception of Advanced Micro Devices, you've probably never heard of any of their companies. Three of the defendants -- Longoria, Karunatilaka, and Shimoon -- were charged with revealing material nonpublic information. Fleischman was charged with being a middle man who finds employees willing to provide confidential information, helps them find the best information, and pays them huge rewards. Or as the government's complaint states: Fleischman "facilitated the theft of Insider Information." And then he turned around and sold it to hedge funds. As the F.B.I.’s assistant director-in-charge, Janice K. Fedarcyk, said James Fleischman "was directly involved in the transfer of inside information from the consultants to hedge funds and other end users.”

The government's case is now really coming into focus, As Preet Bahara explained: “Today’s charges allege that a corrupt network of insiders at some of the world’s leading technology companies served as so-called ‘consultants’ who sold out their employers by stealing and then peddling their valuable inside information.”

In effect, Bahara is alleging that a whole cottage industry has grown up around the hedge fund world to steal and sell company secrets that ordinary investors would never have access to.It's pretty mind-blowing and another example of how greed driven cheating in the financial world gets ever more sophisticated as time passes. Dennis Levine and the inside traders of the 1980s look like amateurs compared to this new cast of cheaters, who figured out to systematize the collection and monetization of insider information. Those skeptics who have been saying that the probe is insignificant and is criminalizing trivial gray zone activities will be proven wrong as things goes forward.

What is fascinating at this point is how Bahara is advancing just half his case first: arresting the people who passed along or peddled the inside information. It's a classic investigation technique: nail the little guys and they help deliver the big game.

Much bigger headlines are still to come when Bahara starts arresting the hedge fund managers and analysts who bought the information. These customers are alluded to throughout this latest criminal complaint. But none are named. That is the bombshell coming next. Stay tuned.

U.S. Attorney's Office Statement in Insider Trading Case

The federal insider trading investigation keeps getting bigger, and it's finally starting to ensnare some actual hedge fund managers -- as opposed to those who feed them allegedly inside information.

Last week, the SEC charged two hedge fund guys with insider trading: Robert Feinblatt, co-founder of New York hedge fund Trivium Capital Management, and Jeffrey Yokuty, an analyst at Trivium analyst.

Can't say we know much about Feinblatt or Trivium. Both have been pretty invisible in recent years -- which may explain the temptation to take shortcuts. 

Also charged last week were Sunil Bhalla, a former senior executive at Polycom Inc., and and Shammara Hussain, a former employee of Market Street Partners.

The huge federal insider trading probe is said to be spreading terror in the investment world. But let's get some context here: insider traders rarely spend long stints in prison, even the most extreme offenders. While Michael Milken was indicted on 98 counts of racketeering and securities fraud in 1989, for instance, and was sentenced to 10 years after a pleading guilty to many fewer charges, he ultimately spent less than two years behind bars. Ivan Boesky, another storied figure in that scandal, also spent less two years in prison.

Not much has changed in twenty years. Prison sentences for inside trading tend to be light and many insider traders caught by the feds never go to prison at all. A recent analysis by Bloomberg Businessweek of cases in New York found that: "Almost half of the 43 defendants who were sentenced in Manhattan federal court in the past eight years for insider trading avoided a prison term, with many never seeing the inside of a jail cell because they cooperated with prosecutors."

The average defendent got a term of 18.4 months.

One reason for the light sentences is that many defendents cooperate with prosecutors the moment they are caught. This isn't the Mafia, after all. Educated and savvy criminals see the handwriting on the wall early on and get on board to help further investigations. That counts for a lot at sentencing time. Another factor is the amount of money involved. When inside traders make small profits, their sentences are shorter.

The 2007 case involving UBS banker Mitchel S. Guttenberg shows these patterns at work. The SEC charged 11 individuals in that case, which involved two separate insider trading schemes over a number of years. Besides Guttenberg, the defendents included: Erik Franklin, David Tavdy, Mark Lenowitz, Robert Babcock, Andrew Srebnik, Ken Okada, David Glass, Marc Jurman, Randi Collotta, and Christopher Collotta.

But only two people actually went to prison. Guttenberg, who pleaded guilty, was sentenced to 6.5 years, and David Tavdy -- who didn't cooperate with prosecutors -- got 63 months. 

Guttenberg's prison term was one of the longest in recent years, but Credit Suisse Group AG banker Hafiz Muhammad Zubair Naseem got a stiffer sentence: 10 years for leading a fraud that netted nearly $8 million. Joseph Contorinis, a former money manager at Jefferies Paragon Fund who also made big profits -- more than $7 million -- was sentenced last year to six years. 

These tough sentences are outliers. Many defendents get probation or home confinement. For instance, in the UBS case, Randi Collotta and Christopher Collotta (a former lawyer for Morgan Stanley and her husband), were both sentenced to home confinement for their role in an insider trading scheme. In that case, the government also went lightly because Mr. Collotta had health issues, a not uncommon occurrance. Prosecutors are allowed to take health isues into account in recommending sentences.

Home confinement sounds tough, doesn't it? Especially in cases involving wealthy defendents with palatial digs.

People on Wall Street like to complain that sentences for insider trading are too high -- that this is an insignificant crime and that the shame of arrest and loss of livelihood is enough of a deterrent. Well, the facts suggest otherwise. Not only are punishments quite light, but there is clearly not enough deterrence judging by how much insider trading goes on. Not only have prosecutors nailed dozens on insider traders in recent years, but experts agree that much insider trading never results in arrests.

Obviously the risk-and-benefit analysis remains favorable enough to draw many people to insider trading. And we're not talking about just anyone. We're talking about individuals who analyze risk for a living.