NEW YORK _ The federal prosecutors who sent Wall Streeters to prison for trading on insider information are taking on Washington's culture of leaks in a first-of-its-kind trial next week.
For the first time, the capital's "political intelligence" industry is in their crosshairs. Hedge funds and other businesses pay consultants, often recent government employees, expecting them to leverage relationships with colleagues still in public service to get a heads-up on government actions that could move markets.
David Blaszczak, who consulted for hedge funds after leaving the Centers for Medicare and Medicaid Services, is charged in Manhattan with passing details of government plans to cut reimbursement rates for a certain kind of cancer treatment and to increase payments for kidney dialysis. Prosecutors claim Blaszczak tipped partners at Deerfield Management, a New York fund that allegedly used the information to make more than $3.5 million in trading profits. Deerfield paid $832,000 in consulting fees to the firms where Blaszczak worked, they say.
Blaszczak got secrets from sources inside the government, including his friend and former CMS colleague Christopher Worrall, prosecutors say. Worrall _ along with Robert Olan and Theodore Huber, Deerfield partners who are now on leave from the fund _ are also on trial. All deny wrongdoing; their lawyers declined to comment or didn't respond to inquiries about the case.
The government's star witness is a former Deerfield partner, Jordan Fogel, who pleaded guilty and is cooperating in a bid for leniency. The firm agreed to pay $4.6 million in August to settle U.S. Securities and Exchange Commission allegations that it failed to properly supervise its employees. It didn't admit or deny the regulator's allegations. Deerfield declined to comment.
The trial is the first to focus on Washington intelligence firms, where the currency is government secrets, and not corporate ones. Beginning in 2009, the U.S. sent dozens of traders and executives to prison in a multiyear insider-trading crackdown that included the guilty plea of Steven A. Cohen's SAC Capital and the conviction of ex-Galleon Group co-founder Raj Rajaratnam.
The Blaszczak case may prove challenging.
"How do you regulate political intelligence?" asked Peter Henning, a professor at Wayne State University's law school in Detroit. "This is getting into a much grayer area than we've seen. This isn't Raj Rajaratnam getting a tip about an upcoming tender offer for Hilton."
That's because Washington's information ecosystem operates differently than Wall Street's. There's a revolving door between the places where policy gets made _ Congress and the administration _ and lobbying shops on K Street. Rumors flow freely and former staffers are hired for their connections and expertise.
But the porous nature of Washington has created a dilemma. A legitimate effort by a company to find out about a regulation or a law that will affect it can also be useful for an investor.
"This is not national security information. This is how the government is going to provide health care to millions of people," Henning said. "How secret is secret with this type of information versus confidential corporate information?"
In this case, the government plans to show how Blaszczak's cozy relationship with Worrall, which included lunch meetings, golf, baseball games and drinks, crossed the line into illegal sharing of insider tips after Blaszczak left his post as special assistant to the CMS administrator in 2005. Prosecutors claim he wooed Worrall by inviting him to join his firm in 2014, saying they'd probably make $2 million in revenue by year's end, according to court records.
"We'd kill it working together(r)," Blaszczak allegedly wrote in a text message to Worrall, who responded, "You're like a drunk whore to me. Hard to resist."
Ultimately Worrall didn't join Blaszczak's firm, but used such job offers to leverage a promotion at CMS, the SEC said in a related lawsuit.
Defense lawyers haven't detailed their case, but they argue in filings that the government must prove that Worrall leaked information that was illegal to disclose. A hurdle for prosecutors may be proving that the Deerfield partners knew Worrall was getting some sort of benefit from Blaszczak, as the law requires.
The outcome will matter in Washington. Firms including Marwood Group & Co. have sprung up to service investors while at the same time becoming targets for scrutiny. Marwood Group paid a $375,000 penalty in 2015, after the SEC accused it of getting inside tips from government workers and then sharing them with its investor clients.
Lawmakers have tried to regulate the political intelligence industry with little effect. Rep. Louise Slaughter, a New York Democrat who died this month, introduced the "Political Intelligence Transparency Act" last year, which would require firms to register and report their activities. The bill is stalled in Congress.
