The Galleon defense

October 21, 2009

If the insider trading case against Galleon Management co-founder Raj Rajaratnam ever gets to trial, expect a vigorous defense strategy built around the difference between information that’s considered insightful “market color” versus top secret, market-moving trading tips.

The hedge fund manager’s lawyer will probably argue that the handful of trades that prosecutors say were the result of illegal tips were cherry-picked from the tens of thousands of clearly legitimate trades Galleon’s funds made over the last three years.

And the lawyers can note that the questionable transactions often were part of a complex trading strategy that can look more incriminating when taken in isolation.

Rajaratnam’s defense team may contend a tip about a company’s upcoming earnings report is nothing more than helpful insight, especially if the executive passing on the information fails to provide specific details like figures for revenues and net profits.

To buttress this point, the lawyers will no doubt point to things like today’s article in The New York Times, which notes that Galleon lost $30 million on the allegedly illegal trades.

But the problem for Rajaratnam is that by the time this case comes to trial a year or two from now, the charges against him could be even more serious. There’s a good chance that new allegations of insider trading could be lodged against Rajaratnam as other potential co-conspirators come forward in the coming weeks to cut deals with federal prosecutors.

The criminal complaint against Rajaratnam and his co-defendants is just the opening salvo — even though the investigation began two years ago.

One white-collar defense lawyer called the complaint a “warning shot” to other traders not yet identified who may have benefited from the same trading tips Galleon got.

Lawyers say a number of hedge fund traders not named in the criminal complaint are already “lawyering up,” largely out of fear they may be the next ones to fall within the gun-sights of federal prosecutors.

There’s an expectation among lawyers and those in hedge funds that prosecutors will quickly secure guilty pleas from several other traders who may have made similar bets with inside information.

None of this, of course, is good news for Rajaratnam and his co-defendants.

And some of the evidence the federal government has unearthed looks pretty damaging for Rajaratnam. It will be hard for Rajaratnam to explain away recorded conversations in which he is trying to give advice to others on how to trade on information without raising suspicions.

Especially troubling is the evidence Rajaratnam, who says he is innocent, directed his fund to make a big upside bet on Hilton Hotels in July 2007 after he is said to have received information from a Moody’s Investors Service analyst that Blackstone Group was on the verge of buying out the hotel chain.

Prosecutors say that the Moody’s analyst was paid $10,000 for his helpful tip. Now that’s not a lot of money for a trade that generated a $4 million profit for Galleon, according to prosecutors. But that speaks more to the poor negotiating skills of the former Moody’s analyst than anything else.

Any time someone is willing to pay cold cash for confidential market-moving information, it’s a safe bet the person buying the information knows it’s something they shouldn’t have in the first place.

So bring on the trial. If nothing else it will help shed light on the often shadowy ways in which hedge fund managers wheel and deal to get a trading edge.

One comment

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There needs to be more active oversight and registration of all funds, close the loopholes and hold them accountable and make them pay back TRIPLE any dealings based on fraud. Jailing a crook for a year is not enough – they need to pay back investors who lost money from their thievery.

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