“Isn’t This Illegal?”

In To Catch a Trader, FRONTLINE correspondent Martin Smith goes inside the government’s ongoing, seven-year crackdown on insider trading. The film premieres tomorrow night on most PBS stations (check local listings).

It’s phone calls like the one that Turney Duff took early in his career at the Galleon Group that authorities point to as what’s wrong with the hedge fund industry.

The voice on the other end of the line asked for Raj Rajaratnam, the CEO of the hedge fund. Duff explained that Rajaratnam was unavailable.

Then suddenly without warning, the voice whispered that investment analysts at the Jeffries Group were going to upgrade Amazon in six minutes.

In the below scene from tomorrow night’s FRONTLINE investigation, To Catch a Trader, Duff explained the choice he faced.

“If I don’t buy Amazon and the stock’s upgraded and the stock goes up, they’re going to find out,” he said. “But if I do it, isn’t this illegal?”

As Duff would learn, the call was just a hint of what was really going on at Galleon. In 2009, FBI agents raided Rajaratnam’s home and arrested him for insider trading. Two years later, a jury found him guilty on all 14 counts.

The arrest was part of a vast crackdown on insider trading that authorities have come to call “Operation Perfect Hedge.” The results have been sweeping. Since first setting its sights on the hedge fund industry, officials have brought charges against a total of 83 people and four entities, winning at least 78 of those cases through either a guilty plea or conviction at trial.

“We likened it to the first Jaws movie,” an FBI agent involved in the probe told FRONTLINE, “that we’re going to need a bigger boat.”

While it can be hard to gauge just how much the operation has done to level the playing field, at least one recent study suggests progress has been made. In the study, researchers at Florida Atlantic University examined merger deals over a nine-year period and found that abnormal jumps in the stock price of target firms — typically a sign of informed trading — fell 45 percent in the wake of the Galleon case.

A second major target of the federal dragnet has been SAC Capital. Since opening its doors in 1992, the hedge fund has consistently delivered sky-high returns for its investors. In some years, gains topped 70 percent.

According to the government, many of those gains were the product of illegal, inside trades. Since the start of Operation Perfect Hedge, six SAC employees have pleaded guilty to insider trading charges. In December, a federal jury in New York found a seventh employee, Michael Steinberg, guilty on five counts of securities fraud and conspiracy. Jury selection in the trial of an eighth SAC employee, Mathew Martoma, begins tomorrow.

SAC Capital’s founder and CEO Steven Cohen has not been criminally charged, but the firm that bears his initials has pleaded guilty to insider trading violations and agreed to pay a record $1.8 billion in penalties. As part of the settlement, SAC was forced to stop managing money for outside investors.

In To Catch a Trader, which premieres tomorrow, FRONTLINE goes inside the government’s unprecedented crackdown on insider trading. Drawing on exclusively obtained video of Cohen, FBI wiretaps, and interviews with Justice Department insiders, the film traces how an insatiable search for trading “edge” ultimately doomed some of the most successful names on Wall Street.

To Catch a Trader airs tomorrow on most PBS stations (check local listings here), or you can watch the film online, starting at 10 pm EST.