Galleon’s reach

Raj can mean king or princely in Sanskrit and, until last week, Raj Rajaratnam lived up to his name on Wall Street.

Sent as a child from his native Sri Lanka to be educated in Britain and America, Mr Rajaratnam was among the most successful of a wave of US immigrants from the Indian subcontinent. At 52, the burly financier ran a hedge fund that had made him a billionaire and was admired for his intelligence and drive, in spite of a large ego.

But his reign ended abruptly last Friday when agents from the Federal Bureau of Investigation drove up to his apartment on Sutton Place, a street on New York’s affluent Upper East Side, at 6am and led him away in handcuffs. Later, he was charged with running an insider trading ring, the biggest since the arbitrageur Ivan Boesky was jailed in 1988.

Mr Rajaratnam, founder and chief executive of the Galleon group of funds, has denied the charges and told his 150 employees he would defend himself “with the same intensity and focus” that he brought to running his financial empire. But a man declared by Forbes magazine to be one of the richest 400 people in the US is in personal and financial turmoil.

He is winding up his US funds and returning $3.7bn (€2.5bn, £2.3bn) to investors – an action that has won praise on Wall Street, since other fund managers facing legal investigation have clung obstinately on to investors’ money – so he can concentrate on defending himself against the extraordinary charges.

The fact that Mr Rajaratnam, and not a junior banker or fund manager, has been bailed for $100m is striking enough. Even more shocking is the status of the five other defendants who are accused of being part of his insider trading ring. They include a partner of McKinsey, the blue-chip consulting firm, as well as a high-ranking IBM executive and an executive at Intel.

The FBI and officials of the Securities and Exchange Commission, who are basking in the arrests after their failure to catch Bernard Madoff, the fraudulent financier, tapped the mobile phones of Mr Rajaratnam and others for more than two years. They gained extensive evidence of alleged insider trading involving technology companies including Google and IBM.

Although the defendants assert their innocence, the charges have thrown a light on how hundreds of hedge funds in New York and London fight to get an edge over rivals – and gain millions of dollars for investors and themselves – by using private information to trade in shares.

Some of this information gathering – for which Mr Rajaratnam and Galleon were renowned – is legal and above board. Indeed, it is the mark of the best analysts that they penetrate the fronts companies put up.

But prosecutors allege that Mr Rajaratnam went beyond this, pressing his team of 45 analysts and others to produce tips from employees, consultants and the like – even one ratings analyst at Moody’s was allegedly involved – on how companies were faring financially. He would then trade in the shares to make money, or limit Galleon’s losses, before the companies made public announcements.

The scandal threatens further to tarnish the hedge fund industry, which is just starting to recover from the double blows inflicted by last year’s financial crisis and the Madoff affair. Stories of insider trading by hedge funds have circulated for years but these arrests are by far the biggest crackdown on suspected misbehaviour.

“We need a better definition of what insider trading means,” says one investor who places money from wealthy families and pension funds into hedge funds. “It is tough legally, because there are a lot of grey areas, and it is tough for the industry because it is one more cloud.”

US law says that not only company executives but also management consultants, stock analysts, public relations advisers, ratings analysts, lawyers, bankers and all others in possession of such data have a duty of confidentiality. If people who worked for such organisations were no longer trusted by companies with figures, it would be disastrous for how equity markets function. None of McKinsey’s 400 partners has faced such an accusation before – and when the California-based Anil Kumar was arrested in connection with the case, he fainted with shock.

Dominic Barton, McKinsey’s new managing director, has spent this week reassuring the firm’s corporate clients. Meanwhile, Google suspended its dealings with Market Street Partners, an investor relations firm, after an employee of the latter allegedly disclosed information about the group’s results in 2007. The employee no longer works for the company.

Mr Rajaratnam is a Tamil who attended school in the UK before studying engineering at the University of Sussex and then finance at Wharton business school in Philadelphia. He joined Needham & Co, a boutique Wall Street investment bank, as a semiconductor analyst, and was eventually appointed its president and chief operating officer.

He started a fund for Needham that invested in technology companies and, in 1997, spun off this fund as Galleon and left Needham in order to run it. From early on, Galleon’s style was heavily research-oriented and Mr Rajaratnam pushed his team of analysts to prepare long, detailed reports on companies and to hunt for information about their finances.

The culture at Galleon was intense and hard-driving. The fund even had a rap track commissioned – “It’s the good ship Galleon, when Wall Street has a rally on” runs one line. Another passage speaks to its prescience: “When the market flopped, they knew it would dip, that’s why they call it the good ship.”

Analysts who failed to generate information to use in trading were squeezed out, say people who worked there. A presentation to investors last year described the team as its “eyes and ears on portfolio companies”.

Mr Rajaratnam dominated. He ran the morning meeting of its traders and analysts, and alienated some Galleon portfolio managers by countermanding them. He was known as a relentless networker and, as his firm grew, struck some other hedge fund managers as bombastic and self-satisfied. “Investors can confuse wealth with intelligence,” says one.

As he became richer, he took more interest in Sri Lanka, contributing $5m to rebuilding homes after the 2004 tsunami. The Sri Lankan government regarded him with suspicion and accused him of providing cash to the rebel Tamil Tigers through front organisations, which he denied, saying he had merely funded legitimate charities.

No one, however, contested his expertise on the technology companies of Silicon Valley, in which he invested for Galleon’s $350m technology fund. In late 2005, according to prosecutors, Roomy Khan, a former Galleon analyst who lives in California, called to ask for a job. He allegedly responded by asking her in what companies she had an “edge”.

Prosecutors allege that Ms Khan, who later co-operated with the inquiry and is identified in the SEC complaint only as “Tipper A”, went on to supply inside information about Polycom, Hilton and Google, which Mr Rajaratnam used to make trades. But after suspicious trading was picked up by the New York Stock Exchange in 2007, she let her conversations with him be recorded.

That led investigators to other people with whom he allegedly shared inside information, including Danielle Chiesi, a former analyst for a hedge fund called New Castle Partners. Ms Chiesi and Mark Kurland, who ran New Castle, were among those arrested and charged last week. Both deny wrongdoing. The complaint did not allege Ms Chiesi gave anything of value, her attorney has pointed out.

She allegedly gleaned information from technology executives including Robert Moffat, a senior IBM official who is a confidant of Sam Palmisano, its chief executive. Mr Moffat, a friend of Ms Chiesi, is accused of giving her inside information about Sun Microsystems and AMD. He and Intel’s Rajiv Goel also deny the charges.

Ms Chiesi provided some of the most colourful quotes in the tapped phone conversations that are cited in the court documents filed by the SEC. During one, she is quoted as saying to a “co-conspirator” that “I’m dead if this leaks. I really am and my career is over. I’ll be like Martha [expletive] Stewart.”

The case is unusual not only for the seniority of the people involved but for the sheer amount of evidence gathered through tapping phone conversations over two years. The SEC and prosecutors hope this will be enough to obtain convictions and to deter others on Wall Street.

But winning such cases, even when the alleged perpetrators are identified, is not easy. Mark Cuban, a billionaire technology entrepreneur, was recently cleared of insider trading despite having sold his stake in a company after being told by its chief executive of a planned share offering. Mr Cuban had argued he had no agreement with the company or fiduciary duty not to sell the stock.

“Tracking down insider trading is tricky and then you must prove intent, that someone knew they had illegal inside information and went ahead and traded with it,” says Utpal Bhattacharya, professor of finance at the Kelley School of business at Indiana University.

Even by getting this far, the SEC has impressed many people who believed that bringing charges for insider dealing at the highest levels was too hard. After two years of monitoring, the authorities swung into action when they found Mr Rajaratnam planned to leave the country.

He had booked tickets to fly to London and then Switzerland rather than home to Sri Lanka, where he feared kidnap or assassination, according to a friend there. “He loved this place but he realised it was becoming too dangerous for him – he was dead scared they were going to kill him.”

Mr Rajaratnam is safely out on bail in New York and visited his office this week to reassure his employees and to reiterate his innocence. But whatever happens now, his Wall Street reign is over.

Additional reporting by Henny Sender, Sam Jones and Joanna Chung in New York, Brooke Masters in London and James Fontanella-Khan in Colombo