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The Hedge Fund Trader Who Beat the Feds

After Todd Newman’s insider-trading conviction was overturned, his case became a landmark.

The Hedge Fund Trader Who Beat the Feds

Hedge fund manager Todd Newman’s successful career was upended when he was prosecuted for insider trading. After his conviction was thrown out on appeal, the case became a landmark in Wall Street regulation. An inside look at what it’s like to be stalked by the feds—and not back down.

The phone call that changed Todd Newman’s life came without warning. It was 8:45 on a Monday morning in November 2010. Newman was at his desk at Diamondback Capital Management, a hedge fund based in Stamford, Conn. He had arrived 15 minutes earlier at the firm’s office in One Landmark Square—coincidentally, a building Newman’s grandfather had developed years earlier—after commuting that morning from his home outside Boston, where he lived with his wife and daughter. Newman was a portfolio manager at Diamondback. He ran a long/short book of about $150 million, trading mostly in the stocks of technology companies.

No name showed up on the caller ID, but Newman answered anyway. On the other end was David Makol, a 39-year-old FBI agent who, Newman would come to learn, specialized in the “art of the flip”—or getting hedge fund employees to squeal on their colleagues about alleged criminal activity. “We have some stuff going on later today that’s going to affect your job, your family,” Makol told him. “We’ve got to get stuff done. This is urgent.”

Newman found the call unsettling, if not particularly alarming. He couldn’t imagine that the FBI had any reason to come after him.

He might not have considered himself a target, but Newman was well aware that the feds were in the midst of a major crackdown on insider trading. Eleven months earlier the FBI had arrested Raj Rajaratnam, the billionaire founder of the Galleon Group hedge fund, on charges of insider trading. When he was arrested, Preet Bharara, the U.S. Attorney in the Southern District of New York, said Rajaratnam’s scheme was the largest of its kind in U.S. history. Reports soon surfaced that Bharara was also eyeing another hedge fund billionaire, Steven A. Cohen, the founder of SAC Capital. Bharara made Cohen—and anyone in his circle—a primary target of his investigations.

That meant Diamondback was an obvious candidate for the prosecutor’s scrutiny. The fund had been started a year earlier by two traders, Richard Schimel and Larry Sapanski, who had branched off from SAC Capital. What’s more, Schimel was married to Cohen’s sister. Although Diamondback hadn’t taken seed money from SAC, the connections between the two firms were obvious. (SAC would eventually, in 2013, agree to plead guilty to insider trading and to pay a massive $1.8 billion settlement, but Cohen himself was not prosecuted.)

Moreover, there were signs that something big was about to go down. Just two days before Newman received the call from Makol, the Wall Street Journal had published a long article, under the headline “U.S. in Vast Insider Trading Probe,” that detailed a three-year, Bharara-led investigation that was about to “ensnare consultants, investment bankers, hedge-fund and mutual-fund traders, and analysts across the nation.” One focus was so-called expert networks, and specifically a company, Primary Global Research, which reportedly connected experts in a variety of industries—particularly health care and technology—with investors looking for information. The Journal story had put Wall Street on edge.

Preet Bharara, US Attorney for the South Prosecutor Preet Bharara, Wall Street’s top cop, explaining the charges against Newman and others on Jan. 18, 2012.Photograph by Timothy A. Clary—AFP/Getty Images

Now, on the phone with Makol, Newman asked the FBI agent what he wanted him to do. “We’re at the McDonald’s around the corner,” Makol said. “We want to talk to you.”

“What do you want to talk about?” Newman says he asked Makol.

“If you come down, we’ll talk about it,” Makol replied.

Newman tried to buy some time. He asked Makol how long he would be at the McDonald’s. “We’re acting on stuff pretty quickly,” Makol said.

“Okay,” Newman replied. “If I see you, I see you. If not, whatever.”

After hanging up, Newman went to see Diamondback’s general counsel, and together they spoke to the chief operating officer, as well as with the firm’s outside counsel at WilmerHale. Although Newman says he would have been happy to meet with Makol, they agreed that the better course of action for Newman would be to go see Alfred Pavlis, an attorney in Stamford, at Finn Dixon & Herling. The thinking was that in case their interests diverged, Pavlis could represent Newman, while WilmerHale could represent Diamondback.

About an hour after Makol’s call to Newman, Reed Brodsky, an assistant U.S. Attorney working for Bharara who had been the lead prosecutor on the Rajaratnam case, spoke to Pavlis. Newman recalls that Brodsky told Pavlis he would like to speak with Newman because “we have him” on tape hearing “possible gray stuff” about corporate earnings and that he was trading on inside information about possible mergers and acquisitions. Newman says Brodsky also told Pavlis that Newman had used “expert networks” to get corporate information. Newman says he told Pavlis he would be happy to speak with Brodsky because he was certain he did not trade on any “gray stuff,” that he hadn’t traded on an M&A deal in years, and that he had never called a consultant at an expert network. “He’s lying!” Newman remembers telling his lawyer.

Newman and Pavlis were discussing the merits of meeting with Brodsky when Newman got an emergency text from his office: The FBI was raiding Diamondback! Newman was shocked at how fast things seemed to be moving.

In retrospect, his world had already changed irrevocably. That Monday, Nov. 22, 2010, serves as the dividing line between Newman’s old life and a darker new one. Over the next few years the hedge fund manager’s successful career was destroyed and his marriage ended. After enduring months of uncertainty, he would be charged officially with insider trading and, in December 2012, convicted of the crime. Then, two years later, his conviction would be overturned by an appeals court. When the Supreme Court declined to hear the government’s appeal last fall, Newman was a free man—but one with a very different perspective on the authorities who regulate his industry.

For more on insider trading, watch this Fortune video:

The reversal of Newman’s conviction was a major setback for Bharara, Wall Street’s top cop, who had successfully prosecuted more than 80 insider-­trading cases since 2009. Newman was his first loss on appeal and another half-dozen guilty pleas were vacated in the wake of the appeals court ruling.

But even more than that, the Newman case has touched off a new debate in the legal community and on Wall Street about what precisely constitutes insider trading. (For more on the case’s implications, see “Why Insider Trading May Be Tougher Than Ever to Prosecute.”) Along the way Newman has become an unlikely hero to those on Wall Street who believe Bharara has been overzealous and overreached.

Here, for the first time, Newman shares with Fortune exclusively his story about what it was like to be the target of a driven federal prosecutor determined to add another insider-trading conviction to his growing pile of Wall Street pelts. Through it all, Newman never backed down from his belief that he did nothing wrong. (Bharara still maintains that Newman was rightfully convicted, but he did not respond to Fortune’s requests to comment for this article.)

As he reflects on the events that reshaped his life, Newman, 51, shows traces of bitterness but mostly exudes calm and a degree of satisfaction. That perspective has come only with time, though. The day the feds came calling, his feelings ran more toward fear, panic, and confusion.

Newman was no neophyte by the time he answered the call from Makol. He had already been working in finance for more than two decades. An accounting major at Skidmore College, he decided early on that a career as an accountant was not for him. He’d gotten an MBA from Babson College, passed his chartered financial analyst exam, and landed a job, in Boston, at a division of John Hancock’s asset management business. Newman next spent a few years as a tech analyst at Merrill Lynch in New York and another seven years running money at a couple of hedge funds in Boston. In March 2006 he was recruited to Diamondback as a portfolio manager. Over his nearly three years there actively managing money, Newman made investors over $75 million in profit. In return, Diamondback paid him more than $9 million.

Bharara and his team treated Newman like a high-value target from the beginning. In fact, they broke new ground in building the case against him. The day before Makol placed his call, a Sunday, the FBI had obtained a search warrant from a federal judge in Bridgeport, Conn., authorizing the raid on Diamondback. This was a new twist in the investigation of insider trading, just as the authorized use of wiretaps had been in the Rajaratnam case. The FBI had never before raided a hedge fund’s office looking for evidence of insider trading. Instead, agents had previously gathered information they wanted through subpoenas.

The warrant authorized the FBI to search Newman’s office, his files, and his computer, among other things, to look for evidence related to alleged insider trading by him in the stock of Dell Computer, based on information he supposedly received from Primary Global Research. The FBI was also looking for any email correspondence between Newman and his former research analyst, Jesse Tortora, as well as with Sam Adondakis, an analyst who worked for Anthony Chiasson, a portfolio manager at hedge fund Level Global Investors. (The FBI also raided the offices of Level Global and another hedge fund, Loch Capital.)

To establish probable cause for the warrant, an FBI agent named Michael Howard swore out an affidavit, in which he described how the FBI had approached an independent consultant—later revealed to be Karl Motey—who admitted to obtaining information from insiders at public companies and then providing it to clients at hedge funds in exchange for fees. Motey became a cooperating witness for the government. (Motey later pleaded guilty to providing nonpublic information to hedge funds.) Howard asserted in his affidavit that Diamondback, and specifically Newman, was one of Motey’s clients between 2007 and March 2009 and had paid for “inside information” from him about two semiconductor companies: Marvell Technology Group and UMC. (Newman says he never traded on any information Motey provided to him about Marvell or UMC. Reached by email, Motey declined to comment for this article.)

After the raid, Newman was put on paid leave until the end of 2010. That was the end of his career at Diamondback. In January 2011, according to Newman, Diamondback’s attorney informed Pavlis that there was nothing Newman could do to get his job back, so he decided to resign.

Meanwhile, Brodsky kept calling Pavlis to try to get his client to speak with him. “If Newman doesn’t want to come in and talk to us, we have other guys wearing wires at Diamondback,” Brodsky told Pavlis, says Newman. But after the raid on Diamondback Newman decided that he was not going to cooperate with the prosecutors. The raid offended Newman, he says, because it was needlessly disruptive to people’s lives. And besides, he believed he had done nothing wrong.

After resigning from Diamondback, Newman moved back to the house in Needham, Mass., that he shared with his wife, Jill, and their daughter, who was 9 at the time. By then he says his marriage was on the rocks—over, really—and had been for some time, though he remained a devoted father. Before the raid, Newman’s routine had been to stay with his mother in Wilton, Conn., during the week and return home on the weekends. Now he wanted as much time as possible with his daughter.

Newman spent months in judicial purgatory. Every day, he woke up in abject fear that he might be arrested. Once, after a news story about insider trading appeared, a group of reporters from ­Reuters came to his house. (He wasn’t there.) Another time he got a call from a Bloomberg reporter wanting to talk to him. He didn’t answer the phone and then had his landline disconnected. He couldn’t sleep well because he was worried that his daughter would wake up and see him being arrested. He couldn’t work. He couldn’t trade. “All you do is spend your days kind of in panic mode, like, What’s going to come?” he recalls.

In September 2011, Pavlis heard from Diamondback’s lawyers that Diamondback was pushing hard to negotiate a settlement with the government in an attempt to stem a flood of investor redemptions. (On Jan. 23, 2012, the Justice Department entered into a deferred prosecution agreement with the firm in exchange for a total of $9 million in fines paid to the Securities and Exchange Commission and the DOJ. The firm announced it would close in December 2012 as a result of the redemptions. After Newman’s conviction was overturned, the government repaid the $9 million.)

Every day, Newman woke up in abject fear that he might be arrested. “All you do is spend your days kind of in panic mode, like, what’s going to come?” he recalls.

A month later, on a Friday afternoon, a furious Brodsky called Pavlis again. “It’s 10 months since the raid, and your client has to come tell us what the hell happened!” Brodsky screamed over the phone, according to Newman. “He’s got to tell us what went on there. This is a high-profile case!” (Brodsky did not respond to requests to comment for this article.)

Brodsky told Pavlis that Newman had two weeks to meet with him. “If you’re going to give him two weeks, if you’re going to arrest him in two weeks, why don’t you tell us what you have?” Pavlis replied.

“I never said I was going to arrest him,” Brodsky said. “What are you talking about?” When Pavlis relayed the conversation with Brodsky to Newman, Newman says he was both happy and nervous. Something didn’t feel right.

The following Monday, Newman met with Pavlis and they resolved that Newman would not go see Brodsky. “They have nothing,” Newman told Pavlis. Still, the more he thought about what Brodsky said, the more concerned the trader became. He thought, “They’re going to make something up, and I’m going to get arrested at some point.”

That point finally came at around 6 a.m. on Jan. 8, 2012, some 14 months after the FBI had first called him. Newman was at home in Needham. Just as he always imagined, he heard a knock at his door. He looked out the window and saw eight FBI agents. The local Needham police were there too. There were about 12 cars total in and around his driveway. But no sirens. “They wanted to surprise me,” he says. “They take great joy in that.” Newman was relieved that his daughter was still asleep.

Newman put on a T-shirt and pants and opened the door. “What’s up?” he said nonchalantly. He was surprised, he recalls, when the agents hesitated for a moment. “We’re arresting you for insider trading,” they finally told him, “and you’ve got to come with us.” He told them he needed to get his glasses. They said no. “You can’t leave our sight,” they told him. They searched him and handcuffed him. Newman claims that he was not read his Miranda rights.

He stayed cool as the agents put him in the backseat of a small Chevy. “You can’t let them see you panic because you can tell this is their sole desire,” he says. Needham is 20 miles from Boston, and at that time of day it should have been a quick trip to the courthouse. But the “two meathead FBI guys,” he says, decided to take him a very long, slow way through small towns and back roads. What should have been a 20-minute trip took 90 minutes.

Finally, Newman was checked in at the courthouse at around 8 a.m. and deposited in a jail cell. In the cell with Newman was a guy accused of robbing banks. He asked Newman what he was in for. Newman replied that he was being charged with insider trading. “Oh, the same thing as me,” the guy said. Newman fell asleep with his head on a roll of toilet paper. After a couple of hours a federal marshal took Newman to be fingerprinted and have his mug shot taken. There were about seven other marshals in the room watching The Departed, the Martin Scorsese film about Boston cops. Newman couldn’t believe it. “They’re saying to each other, ‘Oh, this part is awesome,’ and they’re all sitting there entranced,” he recalls. He says the marshal initially messed up the fingerprinting because he was distracted by the movie. Newman was released later in the day after posting bail of $1 million.

Back at home, Newman went through the indictment against him carefully. He was charged along with Anthony Chiasson of Level Global, even though the two hedgies barely knew each other, according to Newman. The gist of the government’s case against them was that a ring composed of their research ­analysts—Tortora for Newman, and Adondakis for Chiasson, both of whom had pleaded guilty and were cooperating with prosecutors—and others had exchanged with each other “material nonpublic information obtained directly and indirectly from employees of certain publicly traded technology companies.” The “fight club,” as Tortora often referred to the circle of analysts, then allegedly gave this inside information to Newman and Chiasson, who traded on it.

Specifically, the government alleged, Tortora had obtained “inside information” about Dell from Sandy Goyal, an unindicted “co-conspirator” who obtained the information about Dell from a company insider who worked in the investor relations department. In other words, whatever inside information that Newman allegedly received and traded on came to him fourth-hand. For instance, before Dell’s May 29, 2008, earnings call, the Dell ­insider—later identified as Rob Ray, a Dell investor relations employee who was never charged with wrongdoing by prosecutors—allegedly shared with Goyal the information that Dell’s gross margins would be higher than expected. The government alleged that Goyal passed the information to Tortora, who passed it to Newman, who allegedly traded on the information and made about a $1 million profit for Diamondback’s investors. (The same information went to Adondakis, who supposedly passed it on to Chiasson, who allegedly traded on it and made a profit of $4 million.)

The same information flow allegedly occurred before Dell’s August 2008 earnings call. And the indictment also alleged that Newman and Chiasson had traded on inside information about Nvidia’s earnings in 2009. Newman and Chiasson were each accused of multiple counts of securities fraud and of one count of conspiracy to commit securities fraud. The government alleged that Newman had made a total of $4 million in illegal gains.

Right away, Newman knew something was amiss. He looked back at Dell’s quarterly earnings for May 2008 and discovered that the gross margins had been lower than anticipated, not higher. The Wall Street estimate for Dell’s margin that quarter had been 18.5%, but the actual gross margin for the quarter was 18.1%. “They’re charging me for something that didn’t even happen!” he thought. He called Pavlis. “Not only do I not remember getting any information,” Newman told his lawyer, “but the information they put in is wrong.” Pavlis said it was something to examine.

“They’re ­charging me for ­something that didn’t even happen!” thought Newman as he read the details of the indictment.

Newman, though, decided it was time to hire new, high-powered lawyers. (Diamondback’s insurance paid about 95% of Newman’s $10.2 million in legal fees; he paid the rest.) He hired Stephen Fishbein and John Nathanson, at Shearman & Sterling, in New York City. They immediately reached the same conclusion as Newman about the Dell gross margins. “They charged you for something you shouldn’t have been charged for,” he says his new lawyers told him.

However, the government’s factual snafu didn’t seem to help Newman in the trial, presided over by federal judge Richard Sullivan. Antonia Apps, who prosecuted the case for the government, argued that it didn’t matter whether the Dell information was right or wrong. All that mattered was that the information should not have been shared in the first place. Once it was, regardless of whether Newman knew where it had come from or whether it was material and nonpublic, he should not have traded on it.

For Newman, one of the more disturbing aspects of the trial, which occurred over six weeks in late 2012 at the federal courthouse in Manhattan, was learning what Tortora, his former analyst, said about him. By that time the two men did not get along. “He didn’t like me,” Newman says. “We didn’t leave on good terms.” At the end of 2009, after a little more than two years of working together, says Newman, he fired Tortora for poor performance. Newman says he still paid him $700,000 for the year. The year before Tortora had made more than $2 million. “He flipped out,” Newman says. Newman gave him a few months to look for a new job, then cut him loose. Tortora was furious.

Tortora pleaded guilty and agreed to help the prosecution make its case against Newman. Newman says Tortora “burned through all his money, and he didn’t have a choice” but to cooperate with the government. At trial, Tortora testified that he had lost hundreds of thousands of dollars day-trading and gambling. When asked during the trial about his relationship with Newman, Tortora said, “I hate him. I hate him to this day.” (Tortora did not respond to requests for comment made through his lawyer.)

After two days of deliberation, on Dec. 17, 2012, the jury convicted Newman and Chiasson of four counts of securities fraud and one count of conspiracy to commit securities fraud. Newman had steeled himself against the verdict, and he intentionally showed no emotion as the verdict was being read.

The jury agreed with the prosecution’s argument that confidential information should not be traded on regardless of where it came from, even if the trader did not know it had been obtained illegally. Newman’s lawyers argued that this was new law, though: Prior to Newman’s conviction, it was illegal to trade on inside information only if the insider sharing the confidential, nonpublic information breached a fiduciary duty to shareholders and if the person who received the information, and then traded on it, knew that the information was obtained improperly.

Newman says there’s “close to no chance” that he could land another hedge fund job. Today he’s focused on rebuilding his life.Photograph by Spencer Heyfron

Apps argued that Newman should have known that the information he had received about Dell and Nvidia was “bad information.” But, Newman says, “there was no tipper ever charged. The Dell and Nvidia guys were never charged criminally or civilly. You can’t have insider trading if you don’t charge the tipper.”

On May 2, 2013, Judge Sullivan sentenced Newman to 54 months in federal prison. “Fifty-four months for something I didn’t do,” Newman says now. “Nuts.” He was also ordered to pay a $1 million fine and forfeit $737,724 in ill-gotten compensation, or about half of Newman’s liquid assets at the time.

Bharara piled on in a public statement. “With today’s sentence, Todd Newman becomes the first member of this corrupt circle of friends to be punished for his conduct,” he said after the sentencing. “Efforts to cheat the market by gaining an illegal edge ultimately lead to a loss of one’s liberty, as it did for Todd Newman today.”

Three months later Newman appealed his conviction to the Second Circuit Court of Appeals. The gist of his appeal was that what the jury convicted Newman of was not a crime—at least based on the insider-trading laws as they have been applied for decades. Newman’s lawyers faulted the judge for failing to properly instruct the jury about the law. “When all was said and done, Mr. Newman was not convicted of trading on information he knew to be obtained improperly,” the Shearman & Sterling lawyers wrote. “The jury was not instructed that such knowledge needed to be proved and the government offered no evidence to prove it. Instead, Mr. Newman was convicted simply of profiting from information that ordinary investors did not have. That is not a crime.”

On Dec. 10, 2014, a three-judge panel on the Second Circuit agreed with Newman and threw out his conviction as well as that of Chiasson. The panel ruled that the prosecution’s argument was flawed and that Sullivan had erred in advising the jury. The appeals court ruled, importantly, that the prosecutors presented “no evidence” at trial that Newman and Chiasson “knew that they were trading on information obtained from insiders in violation of those insiders’ fiduciary duties.”

Bharara didn’t give up right away. First, he asked for an “en banc” ruling from the Second Circuit—one in which all the judges on the court, not just a three-judge subset, reconsider the decision. In April 2015 the Second Circuit denied Bharara’s request. Then, last October, the Supreme Court declined to review the Second Circuit’s ruling, freeing Newman once and for all. On Oct. 22, Bharara dropped the charges against the six “cooperating witnesses” in Newman’s case, all of whom had pleaded guilty, including Tortora. Maintaining their guilty pleas, he said, would not be “in the interests of justice.” Tortora’s attorney issued a statement: “After five long years, my client is thrilled to be vindicated. Justice was served in the end.”

Needless to say, Newman believes that Bharara came after him wrongly and recklessly. “He blames everybody else on Wall Street for stepping over the line, and he’s the one that stepped over the line in my case,” Newman says.

He was offended at first to read that Bharara had cooperated with the producers of Showtime’s hit show Billions, about a ruthless federal prosecutor in New York who’s determined to take down a billionaire hedge fund manager for insider trading. He didn’t like the idea of a show making light of such situations. But after seeing the show, he’s amused by it. “They’ve actually made the hedge fund guy look better than the U.S. Attorney in the Southern District,” says Newman with a smile.

These days, Newman is mostly focused on putting his life back together. He does some trading. But he says there’s no chance “or close to no chance” of getting hired at a hedge fund again, so he hasn’t bothered trying. He plans to start a business to help others make it through experiences similar to his own.

He has plenty of hard-won lessons to share. The trial itself was especially painful. “You sit there for five weeks being ripped apart,” he says. For Newman it was humiliating, and he started losing hope that he would prevail. But then he picked himself up and continued the fight. In the process, he may have helped change the way we regulate Wall Street forever.

A version of this article appears in the September 1, 2016 issue of Fortune.