Empty Pockets

Galleon Insider Trading Review

Empty Pockets

The hedge-fund industry, $1.2 trillion strong, has been lobbying for years to avoid heavy regulation. That fight has stepped up recently in the wake of the financial crisis, but they have been dealt a serious blow by Galleon Group and their founder Raj Rajaratnam.

A little history lesson seems in order. Galleons were the principal warships used by the opposing fleets of the English and Spanish in the 1588 confrontation of the Spanish Armada.
 
It seems as though Mr. Rajaratnam and Galleon have inadvertently turned their guns on themselves and potentially the rest of the hedge-fund industry. According to The Wall Street Journal, “the U.S. attorney’s office in Manhattan on Friday alleged that Mr. Rajaratnam—along with two former Bear Stearns Cos. hedge-fund traders, several technology executives, a consultant and a ratings-firm analyst—illegally trafficked in nonpublic information of high-profile tech companies, generating a profit of $20 million.” This has put Galleon “…at the center of the biggest insider-trading case in decades…” It is not the first time Galleon has seen trouble from regulators. In 2005, they were charged by the SEC with improper trading and creating “sham transactions” for which they paid a fine of nearly $2 million without admitting or denying the charges.
 
Galleon became prominent in the tech bubble of the 1990s, an era when analysts and favored clients were previewed to analyst reports, tips about corporate earnings and hot IPOs prior to the general public. After the collapse in 2000, new regulations barred companies from disclosing information selectively. However, The Wall Street Journal reports that, “getting exclusive information remained a crucial part of Galleon’s investment strategy, and the firm aggressively pursued rumors and used sources to gain it.” 
 
“Aggressively pursued” may not give Galleon their proper due. The Wall Street Journal also mentions an incident in 2008 when an analyst from Galleon “was repeatedly urged to press a company representative for information [on] a potential acquisition…” The analyst, nervous about the situation, consulted an attorney and was told, “…he would be ‘bending the ethics bar.’” Several current and former Galleon employees told The Wall Street Journal that senior trader Leon Shaulov “…sometimes berated traders or analysts who couldn’t uncover enough information that could move stocks...”
 
In the current SEC civil complaint, it alleges,
 
“…that a person the agency identified as Tipper A received information in 2007 about an impending earnings shortfall [at Google] from an unnamed employee of Market Street Partners, a San Francisco investor-relations firm. The SEC complaint said that Tipper A provided the information to Mr. Rajaratnam and that Galleon executed trades designed to profit on a decline in Google stock, netting $9 million.”
 
In the federal criminal complaint, Mr. Rajaratnam is alleged to have boasted about having a source at Intel Corp. Indeed, says the article, “one of those facing conspiracy and securities-fraud criminal charges, as well as civil insider-trading charges, is Intel executive Rajiv Goel…”
 
Also included in the government’s case is ex-Bear Stearns trader Danielle Chiesi. As one article reports, in recorded phone calls, “…Ms. Chiesi is alleged to have talked about her efforts to get information about International Business Machines Corp. earnings for the second half of 2008 and the first quarter of 2009 from Robert Moffat, an IBM executive then in charge of the company’s supply chain.” Then on April 20, 2009, “Ms. Chiesi told a cooperating witness that she had asked Mr. Moffat what IBM’s first quarter ‘looked like.’ ‘You flat out asked him?’ the cooperating witness said, according to the complaint. ‘Yeah, so here’s what I think,’ Ms. Chiesi said. ‘They’ll miss the revs (referring to revenues) by 7 percent’ and that IBM would ‘miss the short term but that the ‘bottom line’ referring to earnings ‘looks good,’ she said…” The article continues, “When IBM announced results after the stock market closed that day, its earnings missed analysts’ expectations, but its long-term contracts posted an increase.”
 
Since the news broke early Friday, investors have been seeking to withdraw funds in droves. In the latest article on October 20, 2009, it is reported that investors have sought nearly $1.7 billion of the $3.7 billion in assets Galleon manages. Unfortunately, the investors are required to give 45 days notice of any withdrawals so any money will not need to be returned until January 1. Furthermore, Bank of America, Merrill Lynch and Barclays PLC, two of Galleon’s brokers, have refused to trade securities positions with the fund firm.
 
We all hope the hedge-fund industry will learn its lesson that investors and regulators will not tolerate unethical, sleazy behavior. Have others in the industry, worried by scandal, begun a process to self-regulate and stop unethical wrongdoing? The quick answer is no! As reported in Forbes Magazine, one hedge-fund has already sent out feelers to experts that may help them investigate whether their employees are wearing wires. So the lesson learned is Don’t Get Caught!