A WALL STREET WITCH HUNT / THE NEW YORK TIMES OPINIONATOR ( RECOMMENDED READING )

March 4, 2010, 7:45 pm

A Wall Street Witch Hunt

By WILLIAM D. COHAN

One of the darkest days in the illustrious 141-year history of Goldman Sachs was September 19, 2008, when investor confidence in Wall Street was at its nadir and Lloyd Blankfein, Goldman’s chief executive, called John Mack, then the top man at Morgan Stanley. Mack was struggling to keep Morgan Stanley afloat in the wake of the collapse of Bear Stearns, Lehman Brothers, Merrill Lynch and American International Group. Goldman could have been the next to fail if Morgan Stanley did not pull through. “You have to hang on, because I’m 30 seconds behind you,” Blankfein told Mack. Two days later, the Federal Reserve allowed both Goldman and Morgan Stanley to become bank holding companies, ending an era on Wall Street but likely saving our banking system.

A story of insider trading, prosecutorial excess and one banker’s ruined life.
As scary as those moments must have been for Blankfein and Goldman, they don’t hold a candle to the abject fear that raced through the firm some 21 years earlier when, on the morning of Feb. 12, 1987, a United States marshal, Thomas Doonan, entered the Goldman building at 85 Broad Street in search of a senior partner, Robert Freeman. Freeman, then 44 years old, was the head of Goldman’s hugely important risk arbitrage department on the 29th floor. On that cold February day, Freeman’s assistant told her boss that Doonan was waiting for him in his small office, just off the trading floor. When Freeman walked in, Doonan closed the door and pulled down the shades. Doonan, who at first mispronounced Freeman’s name, told him he was under arrest for insider trading and a breach of federal securities laws.

Goldman’s risk arbitrage department — where the firm placed bets with its own capital on whether and when announced merger deals would actually happen — had become the firm’s nerve center and one of its greatest source of profits. Over time, it would evolve into Goldman’s hugely successful proprietary trading effort. The department had also produced several of Goldman’s senior partners, including the legendary Gus Levy, who started it, and Robert Rubin, who ran it before eventually becoming Goldman’s co-senior partner (and then secretary of the Treasury). Rubin had been Freeman’s boss and mentor. The arrest could very well have spelled big trouble for Rubin and Goldman as a whole, given the central role the arbitrage department played at the firm and the fact that Goldman was still a partnership where every partner’s net worth was on the line on a daily basis. A federal indictment of the firm — were it to happen — would have likely led quickly to its demise.

In shock and disbelief after hearing Doonan’s words, Freeman opened the door to his office slightly and asked his secretary to call Larry Pedowitz, a lawyer at Wachtell Lipton whom Goldman had hired the previous November when Freeman’s name first surfaced as someone the government was tracking. (He had been mentioned in newspaper reports of the insider-trading arrests of the arbitrageur Ivan Boesky and two Drexel Burnham Lambert executives, Dennis Levine and Martin Siegel.) Pedowitz, who had been a criminal prosecutor in the United States Attorney’s Office in the Southern District of New York before joining Wachtell, asked Freeman to put Doonan on the phone. “Look, Bob Freeman’s a very good guy,” Pedowitz told Doonan. “Please don’t handcuff him in the office.”

Doonan obliged, and a humiliated — but uncuffed — Freeman was led across the trading floor to the elevators and then was taken down to Broad Street. Once outside, he was handcuffed, put in a van, and taken to the federal courthouse in Foley Square to be arraigned. When he got out of the van, Goldman’s head of security, Jim Flick — a neighbor of Freeman’s from Rye, N.Y. — threw a raincoat over Freeman’s wrists and the assembled press snapped pictures of the Goldman partner heading into the courthouse. He was photographed and fingerprinted. His passport — which had to be retrieved from his home — was confiscated. So frazzled was Freeman that when asked his social security number, he could not remember it. His bail was set at $250,000, and he was released to a life that would never be the same.

He went back to Goldman after his arraignment, this time to the 30th floor to meet with the management committee. Freeman saw Rubin and told him, “It’s not true, Bob. It’s just not true. I didn’t do this. I’m innocent of it.” All these years later, Freeman still remembers the moment as “surreal” and “unbelievable” but happening nonetheless. “One minute I am a person with an impeccable reputation and then I become something that was a complete lie,” he told me recently. “All of a sudden, I’m in this — I’ve often made the analogy to Dorothy — tornado flying in the wind to the yellow brick road. That’s what it felt like. It was so out of control. Something was happening to me and I was sort of outside of myself observing.”

The United States Attorney for the Southern District was a prosecutor with a flair for the limelight and political ambitions: Rudolph Giuliani. On the basis of undocumented allegations from Martin Siegel (who also fingered Richard Wigton and Timothy Tabor, two associates from his previous employer, Kidder Peabody). Giuliani went after Freeman hard, first in a nasty, factually inaccurate complaint and then by coaxing an indictment out of a federal grand jury. (Giuliani has since said that bringing the charges against the men so quickly and publicly was his biggest mistake as a prosecutor; The Times later editorialized that his actions were “an excess that haunted his 1989 mayoral campaign.”)

Freeman’s saga comes to mind in the wake of the very public arrests last October of the hedge fund manager Raj Rajaratnam and his alleged co-conspirators on similar charges of insider trading. While the six people arrested that October day — and another 15 who have been charged criminally or civilly since then — were innocent until proven guilty even a cursory reading of the supposed transcripts of the conversations that took place among them, leaves one breathless with their alleged audacity. (Ten of the 21 have now pleaded guilty.)

In one alleged recording, Danielle Chiesi, a hedge-fund manager at Bear Stearns (and then at JPMorganChase), was having a conversation with an unnamed co-conspirator about a pending restructuring of Advanced Micro Devices, a publicly-traded chip manufacturer. After some supposed non-public information passed between them, Chiesi allegedly said: “I swear to you in front of God. You put me in jail if you talk … I’m dead if this leaks. I really am…and my career is over” Innocent people rarely talk this way, although at her arraignment last December she and Rajaratnam pleaded not guilty. Their trial is set to begin sometime this year.
At first blush, the contrast between the Rajaratnam case and Freeman’s could not be starker. This time around, the F.B.I. used informants and legal wiretapping to get what seems to be irrefutable evidence of wrongdoing before moving in for the arrests. Only time will tell, of course, what happens to the other 14 defendants but seven guilty pleas is a good indication of where these cases might be heading.

But in 1986, Rudy Giuliani had no such concrete evidence in hand when he went after Freeman, Wigton and Tabor. They were arrested based solely on Siegel’s representations, and before any documentary evidence had been examined. Their actual trading records, subpoenaed after the arrests, in many cases showed trading precisely the opposite of what Siegel alleged.

After the initial drama — replete with television cameras staked out in front of Freeman’s home — the case languished, leaving Freeman in judicial hell. One by one, Siegel’s specious charges against Freeman for trading on inside information were refuted as Pedowitz and Goldman’s other lawyers scoured the firm’s meticulous trading records for signs of wrongdoing. Freeman voluntarily submitted to five lie-detector tests over two days and passed them all. The original indictment against the three men was eventually dropped. Yet Giuliani said a new indictment would be forthcoming in “record time” and that the original charges were just “the tip of an iceberg.” Then the government vacated all charges against Wigton and Tabor, but not those against Freeman, even though they were similar to those Siegel had lodged against his former Kidder colleagues. Giuliani’s office kept peppering Freeman and Goldman with Siegel’s new allegations, and each time the charges were refuted by Goldman’s lawyers.

By this time, Siegel, who had only met Freeman once — in 1972 — had pleaded guilty to his own insider-trading charges and turned government informant. (Siegel served two months in prison and was fined $10 million.) While it was true that in the years before his arrest Freeman talked occasionally with Siegel other big-time dealmakers like Bruce Wasserstein about the announced deals they were working on, in this regard Freeman was no different than the scores of other arbitrageurs whose job it was to scrounge around in the market for scraps of information about deals that had been publicly announced. The key to success was a willingness to make the calls in order to glean “market color” about previously announced mergers and acquisitions.

In those days, before the law required any material non-public information to be released to the market all at the same time, there was really no other way for “arbs” to do their jobs, which was to provide cash to selling shareholders — both large and small — who didn’t want to wait around to see if a deal would close. The arbs’ risk was in figuring out if a deal would really close, and when, and hence the value of any crumbs of information. Freeman and Rubin could have just placed their bets and sat back and waited without making the calls. But, like it or not, that was considered too passive, and not the Goldman way.

The old Will Rogers adage, “It takes a lifetime to build a good reputation, but you can lose it in a minute” has never been truer than in the case of Bob Freeman.

To be sure, trolling for information other investors did not have on announced deals by calling the bankers working on those deals was a funny business with few redeeming aspects, but it was also the state of the art at the time and was not against the law. (As opposed to Siegel’s admitted crime of taking money from Boesky in exchange for non-public information.) Not surprisingly, Giuliani and his staff were heavily invested in Siegel’s story, especially after so publicly arresting three men based upon Siegel’s accusations. The dropping of the charges against Wigton and Tabor surely ratcheted up the pressure on prosecutors to salvage the investment in Siegel by pinning something on Freeman.

And this is where one of the most the infamous lines in Wall Street history — “Your bunny has a good nose” — comes in. During the three months after Freeman was first mentioned as a person of interest and before he was arrested, Pedowitz investigated every nook and cranny of Goldman’s arbitrage business, including interviewing Freeman and his fellow Goldman arbitrageur, Frank Brosens, about conversations they may have had with Siegel about pending deals.

One such pending deal, it turned out, was the acquisition of Beatrice Foods in 1986 by the Kohlberg, Kravis, Roberts, at the time the largest leveraged buyout ever. At one point after K.K.R.’s acquisition of Beatrice was announced — but before it had closed — Freeman became concerned that the deal would be delayed, which would have cost Goldman millions of dollars (and also would have cost Freeman personally too, since — with Goldman’s permission — he had bet some of his own money that the deal would close.) Freeman had bought for Goldman 1.4 million Beatrice shares plus call options — for a total investment of the then sizable sum of $66 million (and above his $50 million limit). For his own account, Freeman had bought 25,600 shares, worth $1.5 million.

Increasingly worried about the fate of the deal, Freeman called Henry Kravis at K.K.R. to see if he could get some insight into what was happening. Kravis declined to share anything, and his abrupt tone worried Freeman even more. The next morning, Freeman had one of his Goldman traders start selling the Beatrice stock. The indefatigable Freeman then had a conversation with Bernie "Bunny” Lasker, known by all as Bunny, a former chairman of the New York Stock Exchange and a well-known Wall Street insider and arbitrageur. Lasker told Freeman he had heard the deal might be in trouble, too.

Then, Freeman recalls, he called Siegel, who was advising K.K.R. on the Beatrice deal. Freeman asked Siegel about any potential hiccups with it. Siegel asked Freeman the source of his information about the deal possibly being in trouble, and Freeman told him about his brief conversation with Bunny Lasker. That’s when Siegel uttered: “Your Bunny has a good nose.”

Freeman then sold more of the Beatrice stock before trading in it was halted because K.K.R. announced it was lowering the cash portion of its bid for Beatrice, driving the stock price down. Trading on these innuendoes and hunches, Freeman saved Goldman from losing $548,000 it otherwise would have lost. (And saved himself from losing $93,000.)

Siegel had never testified about the the phone call to Freeman, never reported it Giuliani and his team, and still says he has no recollection of the “bunny” line. (While not proving anything illegal, the call was stronger evidence against Freeman than anything Siegel had told the prosecutors.) Since Freeman had told Brosens about it, though, Brosens reported the conversation to the grand jury. And that is how Giuliani became aware of this scrap of financial folklore. For better or for worse, Brosens’ grand jury testimony did in Freeman, his own colleague. (Brosens, who gave that testimony under a grant of immunity, now runs Taconic Capital Partners, a multibillion-dollar hedge fund, and was Treasury Secretary Timothy Geithner’s first choice to run the Treasury’s Troubled Asset Relief Program.)

Even though the Beatrice deal was never part of the original indictment against Freeman, and even though there was no second indictment brought against him, on Aug. 18, 1989, he agreed to plead guilty to one count of mail fraud to make the matter go away. In a letter to John Weinberg, then Goldman’s senior partner, Freeman wrote that he decided to plead because the threat of a conviction by a jury and the potential huge financial penalties — there had been rumors he might face racketeering charges, with triple damages — and the ongoing strain on his wife and three children were “too much to bear.” He added, “I recognize that I should not have initiated any trading after Siegel confirmed the rumor that there was a problem with the Beatrice deal, and I am prepared to take full responsibility for what I did.”

Pierre Laval, the federal judge in charge of Freeman’s sentencing, received no shortage of missives pleading leniency. Bob Rubin wrote that he believed Freeman “conducted his business activities honestly and honorably” and that he “would unhesitatingly trust Bob’s integrity in any future business or other activity that he undertook.” Rubin explained how he had spent much time with Freeman and his family during the ordeal. “I can tell you first hand what an extraordinarily traumatic time this has been for Bob and his family,” Rubin wrote. “Bob’s reputation was terribly damaged by the publicity that followed his arrest, and his family’s sense of security and well-being was directly affected by the vast media attention that followed on the heals of the arrest. The damage to Bob’s reputation also effectively stopped him from practicing his profession.”

In the end, Laval sentenced Freeman to a year in prison, with eight months suspended, and levied a $1 million fine, which Freeman paid with a check. He served his four months in 1990, at Saufley Federal Prison Camp, outside of Pensacola, Florida. He was prisoner number 13691-054. The old Will Rogers adage, “It takes a lifetime to build a good reputation, but you can lose it in a minute” has never been truer than in the case of Bob Freeman.

Now 67, Bob Freeman still lives in the same house in Rye with his wife, Margo, as he did on the day he was arrested. His children have grown. He plays golf when he can. He is recovering from cancer. He thinks a lot about what happened to him. He has never really worked again. He missed out on his chance for an even more senior position at Goldman Sachs and a windfall of hundreds of millions of dollars that other Goldman senior partners received when Goldman went public a decade ago.
But mostly he worries about the inexorable march of time, and whether he can ever get back what he lost so suddenly the moment Tom Doonan showed up in his office more than 23 years ago. Whether Barack Obama is a one-term president — as Dick Cheney would have it — or gets a second term, the moment to consider pardons in this administration for those wronged by the judicial system is a ways off. For Bob Freeman that moment cannot come soon enough.

Copyright 2010 The New York Times Company