July 31 (Bloomberg) -- Every dawn in the early spring of 2011, Matthew Kluger peered out his window, wondering when federal agents would knock at his door. Kluger, a mergers-and- acquisitions lawyer, says he worried that authorities were closing in on him as the source of illegal tips in a three-man insider-trading ring that had eluded detection for 17 years.
The knock came on April 6. U.S. agents handcuffed Kluger, hustled him into a Dodge Intrepid, drove to the Federal Bureau of Investigation office in Manassas, Virginia, and laid out the case against him. The evidence included tape recordings of Kluger telling the man he tipped to get rid of a cellular phone that could lead back to him -- and to do it carefully because the authorities had dogs that can sniff out mobiles.
"I really would like to see this phone go bye-bye ASAP," Kluger said, adding: "Do you want this to be our undoing?"
Kluger's account offers a unique view of insider trading by a mid-level lawyer who moved from one powerful firm to another, exploiting his access to partners and confidential documents. It shows how difficult it is to police such activity when conspirators take care to conceal their crimes and trade with discipline. The trio's downfall came only when one of them changed the routine after almost two decades.
Their stealth masked Kluger's ability to steal secrets from some of the most prominent U.S. law firms, including Wilson Sonsini Goodrich & Rosati PC and Skadden, Arps, Slate, Meagher & Flom LLP. The three men made $37 million in profit on deals involving some of the largest technology companies, including Oracle Corp., Adobe Systems Inc., Hewlett-Packard Co. and Intel Corp.
Kluger began confessing his crimes to federal authorities the day of his arrest. He first detailed them to Bloomberg News nine days later, after posting bail in Newark, New Jersey, when he needed a ride back to a jail to pick up his heart medicine. He offered additional details in interviews over the next year.
His biggest surprise, he said, was this: At the FBI, he discovered that one of his partners had kept more than 90 percent of the profit. He said he thought they were splitting the money equally.
"Maybe you want to laugh and say of course there's no honor among thieves," Kluger said. "But even when you're doing something you're not supposed to do, I trusted that they were honoring the commitments that they had made."
The plan was simple. Kluger, 51, gleaned details of mergers at four of the six law firms where he worked. He discussed the most promising deals with Kenneth Robinson, a mortgage broker and old friend. Robinson then alerted his friend Garrett Bauer, a day trader who bought shares of companies in play. After the deals went public, Bauer sold the stock at a profit. Then Bauer withdrew $50 bills at automated teller machines and paid Robinson, who split it with Kluger. The arrangement worked 30 times between 1994 and 2011.
In the most lucrative one, Bauer bought 4.5 million shares of Sun Microsystems Inc. based on Kluger's tip that the company would be bought by Oracle. Bauer sold shares for an $11.4 million profit after the deal's announcement in April 2009.
All three men pleaded guilty last year in federal court in Newark, where prosecutors built the case. The government said it was one of the longest-running insider trading schemes ever, with Bauer making $32 million in illicit profit. Kluger, who made less than $1 million, was sentenced last month to 12 years in prison, the longest insider-trading term in U.S. history. By contrast, Raj Rajaratnam, the Galleon Group LLC co-founder convicted of masterminding a much bigger, more profitable insider-trading ring last year, received an 11-year sentence.
Bauer got nine years. He began serving his term this month at the Federal Prison Camp in Montgomery, Alabama. Robinson will serve 27 months, a reward for cooperating with authorities. Both Kluger and Bauer are appealing their sentences.
In the interviews, Kluger recounted why he broke the law and what steps the trio took to conceal the scheme. He discussed two earlier investigations by the U.S. Securities and Exchange Commission, and how he was prepared to give up Robinson in 1997. The scheme was addictive, Kluger said.
"There was an excitement on finding a deal that looked promising," Kluger said. "It was excitement and relief to get in on the stock and know the train wasn't leaving without you. There was an excitement on reading what the profits were. The final excitement was picking up a bag of cash."
Kluger stares intently with brown eyes and speaks in torrents of expressive words. He is 5-feet, 7-inches tall and has been bald since he was 20. His rise as a lawyer and downward spiral followed a troubled adolescence, an Ivy League education and nearly a decade in restaurant management and car sales before law school.
As an infant he lived for several months in a foster home in the Bronx, New York. He was adopted by Phyllis and Richard Kluger, a Pulitzer Prize-winning social historian. He attended ninth grade at the Kent School in Connecticut until being treated for a year in a psychiatric facility affiliated with Yale University. He said he received therapy for "adolescent adjustment issues" stemming from his adoption and homosexuality.
Kluger finished high school at the Hammonasset School in Connecticut and graduated in 1984 from Cornell University, where he studied hotel administration. After working in restaurants in Texas, he sold Toyotas in California, then moved to New York to work in residential real estate. For a few weeks in 1991, his co-worker was Robinson. The two remained friends.
While selling cars in Roslyn, New York, Kluger decided to pursue a career as a lawyer. He started at Brooklyn Law School, then transferred to New York University. After his second year, he became a summer associate at Cravath, Swaine & Moore LLP, a prominent New York firm, assigned to mergers and acquisitions.
"It was exciting," Kluger said. "There was a sense of urgency, of fast work, of making the front page of the newspaper."
During that summer, he talked on the phone to Robinson, Kluger said. Robinson was intrigued by the material, non-public information on public companies that Kluger saw daily.
"He said, 'So what you're telling me is you get to know what's going to happen before the rest of the world does,'" Kluger said. "I said, 'Yeah, I guess.' He said, 'You could make a lot of money with that information.' I remember saying, 'Yeah, but it's really risky. You could end up going to jail.'"
Robinson, who will report to prison after the Sept. 3 Labor Day holiday, declined to comment last week at his home.
After working with Kluger, Robinson took a job at Weiss, Peck & Greer, a New York venture capital firm where he met Bauer. Robinson and Bauer, a native of Melville, New York, became fast friends. Robinson told Kluger he should meet Bauer, who bought and sold so many shares that any tainted trades would not arouse suspicion by the SEC.
"That was the moment when I should have said, 'Just kidding, let me go on with my life,'" Kluger said. "That was when I made the stupidest decision of my entire life."
Both Bauer and Kluger lived on East 87th Street in Manhattan. Robinson arranged for them to meet in June 1994 on the street outside of Bauer's apartment building. Kluger leaned against a pay-phone enclosure, smoking cigarettes and sizing up Bauer.
"He was trying to demonstrate to me that he was a big stock trader," Kluger said. "His attitude was arrogant and know-it-all. He was trying to make it seem that I needed him more than he needed me."
Still, the men agreed to try trading on inside information and split the money three ways, Kluger said.
Kluger's first tip involved the proposed merger of QVC Inc. and CBS Corp., a Cravath client. The deal never happened. Kluger then passed information about the acquisition of Neutrogena by Johnson & Johnson, another Cravath client. Each man made about $8,000, Kluger said.
"I had no idea that we were launching a scheme that was going to go on and on and on," Kluger said. "All that I was doing at that point was a very small insider-trading deal."
The men made about $16,000 each from J&J's acquisition of Mitek Surgical Products Inc., he said. Kluger stayed at Cravath after graduating cum laude from NYU. By 1995, the trio had their first big score when International Business Machines Corp. bought Lotus Development Corp. They split profits of about $213,000.
Kluger said that greed motivated his actions. He justified them to himself by saying that corporate executives "feathered their own nests" through insider trading and other methods, he said.
Rampant Insider Trading
"I knew insider trading was rampant," he said. "None of that makes it OK. You're asking how an otherwise honest and law- abiding person did something that was really, really bad. I'm greedy. I deluded myself into believing that what I was doing wasn't all that bad. I wasn't stealing from anybody, lots of people were doing it, and I was doing it on such a small scale as to not have a material impact on any markets or people."
Kluger said he met Bauer or spoke on the phone with him several times, even as each man took pains to avoid association with the other.
Bauer's profits began to grow, while Kluger said he personally never made more than $50,000 or $60,000 on any deal in those years. In court documents, prosecutors said the illicit profits were about $423,000 when J&J bought Cordis Corp. in November 1995. In 1997, the profits were $490,000 when NationsBank bought Barnett Banks Inc. in the largest banking acquisition ever at the time. Most of the money went to Bauer, Kluger said he learned later.
Kluger left Cravath and worked for a few weeks at Milbank, Tweed, Hadley & McCloy LLP, another New York firm. The men later had their first run-in with investigators. An SEC lawyer called Kluger, asking about three transactions on which he had leaked inside information.
Regulators subpoenaed bank and phone records. Kluger hired a lawyer.
"I was ready to sell Robinson up the river, like he ultimately did to me," Kluger said.
The probe fizzled without the SEC suing anyone or prosecutors filing charges. Kluger and Robinson agreed to be more careful by speaking only on pay phones.
"They had us in the crosshairs and backed off," Kluger said. "They were incompetent all the way through. We were emboldened, somewhat."
They were unable to outsmart the SEC a decade later.
Kluger began work in 1998 at another prominent firm in New York, Skadden Arps. Based on his tips, the illicit profits were more than $1 million on inside information that Intel would buy DSP Communications Inc., according to prosecutors. Kluger said he made about $50,000 on that deal, and Robinson told him the three made a total of $150,000 after Bauer paid taxes. In any deal, Bauer would take out about 45 percent for taxes and fees, Kluger said.
Kluger left Skadden Arps in 2001, and the scheme continued while he worked at Fried Frank Harris Shriver & Jacobson LLP in New York. After a year, he was fired. In 2002, Kluger filed a sex-discrimination lawsuit against the firm, claiming he was harassed and fired because he was gay. The case was settled confidentially in 2004 in state court in New York.
The scheme took a hiatus when Kluger left Fried Frank. From 2002 until early 2004, he worked at Sills Cummis & Gross PC, a firm in Newark. He then joined Asbury Automotive Group as the associate general counsel. After conflict with his boss, he went to Tampa to run a Pontiac-GMC dealership.
Kluger got his final shot at the action of big mergers when Wilson Sonsini hired him at its office in Reston, Virginia, in December 2005. The firm later moved to a Washington office, and his salary eventually rose to $300,000 a year. In April 2006, Bauer bought 477,600 shares of Advanced Digital Information Corp. before its acquisition by Quantum Corp. The illicit profit was $1.7 million.
Ten more insider trades followed during Kluger's time at Wilson Sonsini, including the Sun Microsystems deal that made $11.4 million in illicit profit.
In the scheme's early years, when Kluger lived in New York, Robinson met him at his office or a street corner to hand him cash. When Kluger was at Wilson Sonsini, he drove from Washington to New York several times to get the cash in small, cheap gym bags.
The men employed several techniques to avoid detection, such as disposable cellular phones. Kluger was adept at searching the titles of documents in Wilson Sonsini's computer system to determine how far a merger had progressed. He didn't want to open documents and leave an electronic fingerprint. He listened closely to what his colleagues said around the office. Sometimes he overheard conversations about deals and confirmed them in the documents.
"People at law firms yap about things they're not supposed to yap about," he said. "Ninety percent of what I learned about the Sun Microsystems deal came from my hearing about it from an antitrust partner who had a big mouth."
Alicia Towler White, a spokeswoman for Wilson Sonsini, declined to comment.
After picking up merger intelligence, Kluger would discuss it with Robinson to decide if they should present it to Bauer. While they successfully executed 30 insider trades, they talked about another 120 possible deals over the 17 years, he said.
"It was pretty clear these had to be big-name companies that were trading at 1 million shares a day to even discuss it with Bauer," he said. "I would call Robinson on every deal I got my hands on, even on deals that didn't make sense."
The men tried to time Bauer's buying to avoid the eve of merger announcements.
"It was like a board meeting," he said.
Kluger said the cash payments helped him to build a house in Easthampton, New York, eat at better restaurants and pay for the surrogate mother for his three adopted children.
"I was living a somewhat more lavish lifestyle than my salary alone would have allowed," he said. "This was not a constant thing, with money flowing in every 10 seconds. This was twice a year where I would take in 50 or 60 grand."
Bauer was becoming increasingly aggressive in the stock market. He moved $8.4 billion through his account in 2010, prosecutors said. Bauer made $32 million on the nine Wilson Sonsini deals, prosecutors and the SEC said.
Bauer weathered a 2007 SEC investigation into his activities, Kluger said. He said he oversaw an SEC document requesting information from a Wilson Sonsini partner regarding possible insider trading involving Bauer.
Wilson Sonsini told Kluger in the fall of 2010 to get a new job. It was the sixth law firm since 1994 at which he didn't become a partner. He did no work at the firm for the last few months as he looked for other employment.
"It's hard enough to be a 49-year-old guy and a bit of a job hopper," he said. "Obviously, nobody knew that I was a bit of a crook."
Kluger was relieved to leave the scheme at last, he said.
"I wasn't going to be subject to Ken saying, 'Oh please, please, please,'" he said. "I had the sense that we had pushed our luck beyond where we should have pushed it. It was never intended to be this ongoing, forever thing. It needed to have an end."
Kluger and Robinson had talked about one last score, for $1 million or $2 million, that would have allowed them to walk away, Kluger said.
"I would have happily called it quits," Kluger said.
In March 2011, Kluger started a new job as president of a transportation company. He lived with his children and a partner in Oakton, Virginia, 24 miles west of Washington. Still, he needed to collect his final cut of $88,000 from Robinson.
Kluger had no way of knowing that the SEC never ended its 2007 investigation. The agency was using new technology to confirm its suspicions that Bauer had an inside source on Wilson Sonsini merger deals. The Philadelphia office covertly monitored Bauer's trades for three years to find the source, according to a person familiar with the matter.
In 2009, an investigator noticed that Robinson and Bauer often traded in the same stocks, although Robinson avoided the Wilson Sonsini deals. Then the SEC got a break. Robinson himself bought shares of 3Com Inc. before its acquisition by Hewlett- Packard, a deal handled by Wilson Sonsini. Investigators concluded that Robinson and Bauer had a common source, the person said, asking not to be identified because the investigation was confidential.
"The SEC's use of automated trading and relationship analysis in this case was critical to establishing that Robinson and Bauer were part of the same trading scheme and had a common source -- Kluger," said Daniel M. Hawke, chief of the SEC's market-abuse unit and director of the Philadelphia Regional Office.
In the summer of 2010, the SEC went to the U.S. Attorney's Office in New Jersey with its evidence. Prosecutors took up the case, working with federal agents who approached Robinson in March 2011. Within days, Robinson agreed to cooperate.
He told prosecutors how the scheme worked, identified Kluger as the source and gave them a gym bag with $175,000 in Bauer's cash he was supposed to split with Kluger, who never got the money. Most important, Robinson agreed to secretly record his friends making incriminating statements.
When Kluger called Robinson on March 13, Robinson dropped a bomb: The FBI and Internal Revenue Service had searched his house in Long Beach, New York, six days earlier.
Robinson said agents knew he traded on information from Wilson Sonsini and could link him to Bauer. He said his wife wanted him to cooperate with authorities. Robinson didn't say he had already chosen to betray Kluger and Bauer.
Kluger and Bauer, known to his partners as Mr. G, fell into the trap. In calls over the next three weeks, Kluger said he destroyed a computer and iPhone used in the scheme. Kluger counseled silence.
"As long as Mr. G keeps his mouth shut and I keep mine and you keep yours, I don't think they're gonna find enough of anything," he said.
By April 6, agents found enough evidence. They showed up at Kluger's Colonial home at 6:50 a.m. to arrest him. At the same time, other agents handcuffed Bauer in his $6.7 million condominium in New York's Upper East Side.
Prosecutors charged Kluger and Bauer with securities fraud, conspiracy to commit securities fraud, conspiracy to commit money laundering and obstruction of justice. Robinson pleaded guilty a few days later.
Both Bauer and Kluger pleaded guilty last December. Kluger has also settled an SEC lawsuit, agreeing to pay $516,510 for his illicit profit while he worked at Wilson Sonsini.
Before his sentencing, Bauer hit the lecture circuit with a talk sometimes titled "Confessions of an Inside Trader."
He occasionally discussed the recorded conversations with Robinson, including one in which he discussed laundering the $175,000 in cash -- literally. He laundered it in a washing machine, to remove fingerprints.
Bauer gave the talk 147 times at universities all over the U.S., including the NYU law school Kluger had attended.
"I feel remorse," he told the NYU students. "That's why I'm here."
In a bid for leniency, Bauer's lawyers presented 200 letters on his behalf at his sentencing.
"No 'Scared Straight' program could hope to be as effective as the one Garrett provided my two classes," wrote Mark Brennan, an adjunct professor at NYU's business school.
Kluger and Bauer were sentenced by U.S. District Judge Katharine Hayden on June 4. Assistant U.S. Attorney Judith Germano, who oversaw the prosecution, argued that Kluger was liable for the $37 million in illicit profit as the "mastermind." Under federal sentencing guidelines, she said, he deserved 11 to 14 years in prison.
At the hearing, Kluger's attorney Alan Zegas argued that he shouldn't be judged on the basis of $37 million in profits because he saw so little of it.
"I was not the mastermind," Kluger said later in an interview. "I'm not saying I was a good guy. I was definitely a very bad guy. These two guys were definitely manipulating me to keep me alive as a source."
Judge Hayden was not persuaded. She said Kluger engaged in "thuggish" behavior that helped undermine investor confidence in the market.
The scheme succeeded for so long, she said, because of its simplicity, the discipline of its limited number of people and its "essential amoral nature, where anything and everything involving trust and honor was thrown out of the window because of that blissful access to information that Mr. Kluger enjoyed."
She also said his actions were particularly egregious because he was a lawyer who had taken oaths of integrity. Kluger fully deserved 12 years in prison, she said.
"People stay out of the market in part because they think it's skewed toward the insiders," she said. "These people may be right."
She recommended that Kluger report to the federal prison in Butner, North Carolina, where Bernard Madoff is serving 150 years. The date hasn't been set.