(Bloomberg News) Trader Garrett Bauer had good reason to be nervous. Federal agents had just searched the home of his friend, a go-between in an alleged insider-trading scheme based on secret tips passed from a well-placed lawyer. The scam earned $32 million in profits for the three men, prosecutors said.

Bauer, 43, believed he had hidden their crimes by talking on disposable cell phones and using cash to reward the attorney and the middleman for the tips, prosecutors charged. What Bauer didn't know was the go-between had secretly recorded their conversations for the government, according to court papers.

"There is no way they could ever be recorded," Bauer said to the middleman about the telephone calls, according to a criminal complaint filed yesterday in federal court in Newark, New Jersey.

Bauer, arrested in New York, is accused of trading on tips from attorney Matthew Kluger, 50, who was picked up in Virginia. The case is the latest in a nationwide crackdown on insider trading that began with Galleon Group LLC co-founder Raj Rajaratnam, a billionaire hedge fund manager now on trial in New York. U.S. prosecutors rested their case against Rajaratnam yesterday, and a jury may begin deliberations by next week.

Like Bauer, Rajaratnam was secretly recorded by U.S. agents. Since 2009, probes of insider trading by U.S. Attorney Preet Bharara in Manhattan have led to about four dozen arrests and focused on hedge funds, corporate executives and so-called expert networking firms.

'Massive' Scheme

In announcing the case yesterday in Newark, U.S. Attorney Paul Fishman said Bauer and Kluger were charged for a "massive insider-trading scheme involving leading law firms, major corporate transactions, and millions of dollars in cash."

The scheme, he said, began with Kluger passing tips about deals he worked on as an associate at Cravath Swaine & Moore LLP from 1994 to 1997 and at Skadden Arps Slate Meagher & Flom LLP from 1998 to 2001.

After a five-year hiatus, the scheme resumed in December 2005 and continued until March 2011, when Kluger worked in the Washington office of Wilson Sonsini Goodrich & Rosati PC, authorities said. Kluger passed on tips about deals he culled from the law firm's computer system, according to a Federal Bureau of Investigation arrest complaint filed in court.

Government agents began working the case last year, Fishman said. The U.S. Securities and Exchange Commission's market surveillance helped uncover the pattern of insider trading, said Daniel M. Hawke, chief of the SEC's market abuse unit, at a news conference yesterday. The SEC filed a civil lawsuit against Bauer and Kluger.

Increased Scrutiny

Hawke's group, founded in January 2010, seeks patterns, connections and relationships among traders and institutions. As a result of those efforts, law firms, consulting companies and other insiders have come under increased scrutiny.

The probe of Bauer and Kluger accelerated after FBI and Internal Revenue Service agents searched the middleman's home in Long Beach, N.Y., on March 8. Kluger and the unidentified middleman had known each other since at least 1987, and they worked together from that year until 1991, a year before Kluger enrolled at New York University School of Law, according to the SEC.

The middleman worked in 1991 with Kluger at a real estate company, and then with Bauer at Weiss, Peck & Greer, a venture capital firm. The middleman was once a registered trader and later worked in the mortgage loan business, according to the FBI.

Conspiracy, Fraud

The middleman wasn't charged, while Bauer and Kluger were accused of conspiracy to commit securities fraud, securities fraud, obstructing justice and conspiracy to commit money laundering. Both were ordered detained after court hearings.

Kluger furnished tips about deals and transactions, and Bauer "made substantial trades based on that information and then divided the profits with Kluger and the middleman," Fishman said yesterday. He said Bauer made more than $30 million, the middleman more than $875,000, and Kluger more than $500,000.

With his profits, Bauer bought a $6.65 million condominium in Manhattan, where he conducted his trading, and an $875,000 home in Boca Raton, Florida, the FBI said.

Assistant U.S. Attorney Matthew Beck said a fourth law firm also was involved. He cited the recordings in telling a judge that the government's evidence was "overwhelming."

U.S. agents seized a $20.5 million account controlled by Bauer, who told court officials that he had $70 million in assets, according to Beck.

'Presumption of Innocence'

After the hearing, Bauer attorney Donald Derfner said, "There is still a presumption of innocence."

Kluger appeared without a lawyer yesterday in federal court in Alexandria, Virginia, where a magistrate judge ordered him held without bail. The judge set a preliminary hearing for April 8. Kluger asked the judge to appoint a lawyer for him.

Five calls from March 17 to March 28 are detailed in 12 pages of the FBI complaint. The calls show that Bauer believed his reliance on disposable cell phones would help them escape detection.

"It could get ugly," Kluger is quoted as saying on March 17 in a conversation recorded by the middleman for the FBI. If the FBI looks into his bank accounts and links him to the trades, he said, "I would have not only the financial ruin, but I'd have to-I would have to do time."

Precautions

While speaking on the phone, the trio took precautions, according to the complaint.

At Wilson Sonsini, Kluger didn't pass along information from mergers he was working on personally; he culled information from his firm's computer system on other people's deals, according to authorities. And for those, he was careful not to open computer files so as not to leave an electronic trail, he said in one recorded conversation.

To avoid detection, Bauer paid the middleman and Kluger in cash. Bauer used ATM withdrawals from multiple accounts at Citigroup Inc., sometimes reaching the daily $5,000 withdrawal limit.

Kluger and the middleman structured their cash deposits to be less than $10,000 so they wouldn't trigger reporting requirements, the FBI said. The middleman also stowed cash in safety deposit boxes.

After the raid on the middleman's home, Bauer and Kluger feared they were under suspicion and began to destroy evidence, including computers and phones, authorities said.

'Burn It'

Bauer said he broke one telephone in half and threw the pieces into two separate trash cans at a McDonald's restaurant in Manhattan. Bauer became worried his fingerprints would show up on $175,000 in cash the friend had hidden and told him to burn it.

"Burn it?" the middleman asked.

"I would burn it in a fire," Bauer is quoted as saying. Earlier he had told the middleman he had $20 million in the bank and would give him whatever was needed for attorneys' fees and support for his family if he wound up in jail.

The complaint charges 11 illegal trades over Kluger's five years at Wilson Sonsini, when the men invested more than $109 million in the scheme, according to the authorities.

"Wilson Sonsini needs to explain why they could never have seen this coming," said Bruce MacEwen, a law-firm consultant at New York-based Adam Smith Esq. LLC.

"The reputational damage that Wilson Sonsini does have to worry about is for companies planning a major acquisition or IPO if they want to use the firm, how can they be sure that next week word won't leak out," MacEwen said.

Quantum, 3Com

The FBI said Kluger funneled tips before the announcements in May 2006 that Quantum Corp. would buy Advanced Digital Information Corp.; in May 2006 that Silver Lake Partners and Value Act Partners would buy Acxiom Corp.; in June 2007 that Elevation Partners would invest $325 million in Palm Inc.; and in September 2007 that affiliates of Bain Capital Partners LLC would acquire 3Com.

Kluger also supplied tips before announcements in September 2007 that Omniture Inc. would acquire Visual Sciences Inc.; in March 2008 that Ansys Inc. would acquire Ansoft Corp.; in April 2009 that Oracle Corp. would buy Sun; in September 2009 that Adobe Systems Inc. would acquire Omniture Inc.; in November 2009 that Hewlett-Packard Co. would buy 3Com; in August 2009 that Intel Corp. would acquire McAfee Inc.; and in February 2011 that CSR Plc would merge with Zoran Corp., according to the FBI.

The illicit profits in those 11 transactions ranged from $199,248 in the Hewlett-Packard-3Com deal to $11.4 million in the Oracle-Sun deal, according to the FBI complaint.

IBM, AOL

The FBI also charges Kluger gave inside tips on Johnson & Johnson's 1994 acquisition of Neutrogena Corp.; International Business Machine Corp.'s acquisition in 1995 of Lotus Development Corp.; IBM's purchase in 1996 of Tivoli Systems Inc.; Unilever's 1996 acquisition of Helene Curtis Industries Inc.; and America Online Inc.'s acquisition in 1999 of MovieFone Inc.

"We were shocked to learn of the conduct the government has alleged a former employee committed against us and two other prominent law firms," said Courtney Chiang Dorman, a senior vice president at Wilson Sonsini. "We have provided our full support to the federal investigation and will continue to do so. In light of the pending actions by the U.S. Attorney's Office and the SEC, we are not in a position to comment further."

Cravath spokeswoman Robin Shanzer didn't return a phone and e-mail messages seeking comment yesterday.

'Strict Policies'

"We have strict policies that protect our clients' confidential information, which we monitor closely," Skadden spokesman Brendan Intindola said in a statement. "It would be deeply disappointing if these policies were not followed in this instance. We are cooperating fully with the government in this matter."

By March 18, Bauer was worried.

"I can't sleep," Bauer said during a call that day. "I am waiting for the FBI to ride into my apartment. And I am on edge all night thinking that they're coming."

On March 21, Bauer was recorded saying: "I mean the fact is we did something wrong. So it is not like we are being convicted of doing nothing. We did something wrong here."

The criminal case is U.S. v. Garrett Bauer, 11-mj-3536, U.S. District Court, District of New Jersey (Newark). The SEC case is Securities and Exchange Commission v. Matthew H. Kluger and Garrett D. Bauer, U.S. District Court, District of New Jersey (Newark).