Bear haunts insider case

October 23, 2009

The ghost of Bear Stearns is still haunting Wall Street.

Nineteen months after Bear Stearns collapsed, one of its former hedge funds, New Castle Funds, is at the center of a huge insider trading case that has ensnared Raj Rajaratnam and his onetime $5 billion Galleon Management fund.

Two New Castle executives, Mark Kurland and Danielle Chiesi, are charged with either trading on inside information about corporate earnings or sharing some of that top secret corporate intelligence with Rajaratnam.

The Bear connection to New Castle is a strong one. The fund’s managers took in most of their money from wealthy Bear customers and Bear executives like former chief executives James Cayne and Alan Schwartz, in addition to other small hedge funds.

Kurland, 60, was a longtime Bear executive who formerly ran Bear Stearns Asset Management, the division that nominally oversaw all of the firm’s hedge funds. Kurland liked to boast that he had a direct pipeline to Cayne and Alan “Ace” Greenberg, Bear’s legendary former chief executive, say people close to New Castle.

The criminal charges against Kurland and Chiesi are a fresh reminder of the cowboy culture that often ruled at Bear. Indeed, there were even discussions within Bear several years ago about spinning off New Castle, in part because of concerns that executives could not keep track of what the hedge fund’s small team was doing, the people close to New Castle say.

Those who worked with Kurland say he was combative — even for a rough and tumble place like Bear. And some thought it odd that Chiesi, although she had an office at Bear, almost never showed up — spending most of her time out in the field.

The arrests of Kurland and Chiesi came just days after two other Bear hedge fund managers – Ralph Cioffi and Matthew Tannin — went on trial in a Brooklyn federal courtroom on charges they lied to investors about the financial stability of their two funds, which once controlled some $30 billion in mortgage-related securities.

The two separate criminal cases make for a remarkable track record given that Bear, which had to be rescued by JPMorgan Chase in a Federal Reserve-engineered bailout, never had more than a dozen hedge funds under its command.

The two cases should serve as a warning to lawmakers that the longer they drag their feet on passing real financial regulatory reform, the harder it will be to keep the animal spirits that are always lurking in the shadows on Wall Street from running wild again.

Much of the attention in the insider trading case has focused on Rajaratnam — a Sri Lanka-born billionaire and one of the world’s highest-paid hedge fund managers. And that’s understandable, given that Rajaratnam is so rich he thinks nothing of taking part in an exclusive high-stakes fantasy football league where the winning teams can take home nearly $1 million in prize money.

Over the past 12 years, Rajaratnam built Galleon into one of the more successful tech-savvy hedge funds, employing 130 people in New York, London and Singapore.

When FBI agents swooped in and arrested him, the 52-year-old trader was planning a trip to London to discuss plans with several bankers for launching a new $200 million Sri Lanka-based infrastructure investment fund, says a person close to Galleon.

But the charges in this latest insider trading case show that when it comes to getting an edge, hedge funds both big and small will sometimes break the rules to get ahead.

Indeed, compared with Galleon, New Castle is a mere minnow — employing just 10 or so people. The 14-year-old fund is so nondescript, it sometimes gets confused with Newcastle Partners LP, a better-known activist investment hedge fund in Dallas. In fact, Newcastle put out a press release on October 19 noting it has nothing do with its namesake from New York.

Over the years, New Castle’s five mainly stock-focused funds put up decent, if not gangbuster returns. Last year was a flat one for New Castle, which isn’t bad given the average 20 percent decline for a broad swath of hedge funds in 2008.

Still, the insider trading charges against Kurland and Chiesi may prompt some New Castle investors to question the funds’ ability to fare so much better than the rest of the industry.

The 43-year-old Chiesi has received a fair amount of attention for her profanity-laced rants, which were captured on federal wiretaps and dutifully transcribed in a criminal complaint unsealed by prosecutors on October 16.

The Manhattan resident is facing a heap of trouble because she kept yakking and cussing away about her great connections to an executive at IBM, even as she admitted to being “paranoid” about the possibility someone was listening in on her phone calls.

Kurland, who lives in Mount Kisco, New York, was a loyal defender of Chiesi, say people who know them. He defended her against internal sniping at Bear about how much she was making and complaints about her outwardly flirtatious style of doing business. For some at Bear, the pair were a recipe for trouble. And now it appears those fears may have come true.

Of course, Kurland and Chiesi have only been charged. Like Cioffi and Tannin, they also will get their day in court.

Kurland’s lawyer Lawrence Iason says his client is innocent and Chiesi’s lawyer, Alan Kaufman, says the same of her. New Castle, which has put Kurland on leave and parted ways with Chiesi, says it “remains fully committed to serving the best interests of its clients.”

The lesson here is that internal hedge funds don’t only run the risk of creating huge losses for investment banks — they also pose immense reputational risk if there isn’t adequate oversight and compliance.

Wall Street would be better off if it simply got out of the business of running its own hedge funds. And if investment banks won’t do it voluntarily, maybe Congress should do it for them.

Comments

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Amen to Wall Street being better off without the hedge funds but don’t forget the rest of America! Seems like it takes about 70 years (or maybe 35 is closer) between meltdowns when regulation and enforcement get lax and the werewolves of Wall Street start howling at the moon while in search of blood meals.

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