Galleon’s edge

October 17, 2009

The arrest of hedge fund millionaire Raj Rajaratnam on charges that he and his $7 billion Galleon Group hedge fund profited from illegal insider trading will no doubt feed suspicion in some corners about the way hedge funds generate fat profits.

But for anyone to assume that all hedge fund managers owe their success to getting information on the sly is unfair and wrong. The overwhelming majority of hedge funds are only as good as the quality of the research performed by their analysts and traders.

And the truth is the vast majority of hedge funds are rather ordinary. If the majority of hedge funds managers were so crafty, not so many funds would have gone bust last year–or lost bundles of money for their wealthy investors.

The true standouts in the industry are a real minority. Anyone can put together an offering statement, call themselves a hedge fund manager and go out and raise money. That’s one reason why wealthy people and pension funds who throw money blindly at hedge funds without doing adequate due diligence are being plain foolish.

Still, the charges against Rajaratnam and five co-defendants are disturbing. Hubris and greed are powerful motivators. And some hedge funds will stretch, even break the rules to get an edge–even if it’s to book just another $20 million for a fund with nearly $7 billion in assets.

Indeed, it’s worth noting that this isn’t the first time Galleon has been accused of skirting the rules to get an edge.

In 2005, Galleon paid an $800,000 fine to the SEC to settle a civil investigation into allegations it improperly profited from shorting 17 stocks. The SEC alleged the hedge fund violated securities rules by using shares obtained in a secondary offering to cover, or close out, a pre-existing short position on a stock. Regulators claimed that impermissible strategy called “collapsing the box” essentially was a risk-less one and generated $1 million in trading profits for Galleon.

Maybe the 2005 settlement put Galleon on a watch-list for prosecutors. It appears from the criminal complaint prosecutors began focusing on Galleon and its co-founder in 2006. Dealbreaker’s crack investigative reporter Teri Buhl has a good speculative piece on whom at Galleon might have been cooperating with investigators.

Also, Galleon always has had something of a cowboy culture. Years ago, the fund recruited a former Bank of America technology analyst who was fined and suspended by securities regulators because he allegedly issued misleading bullish research reports on stocks he was simultaneously advising hedge funds to sell short. I broke the scandal when I was still at TheStreet.com.

However, what may be most troubling about this latest case brought by federal authorities in New York is that one of the people allegedly providing illegal tips on leveraged buyouts and other deals was an analyst with Moody’s Investors Services, the credit rating agency. The alleged tipster got $10,000 for his work.

The allegation about the Moody’s analyst raises serious questions about safeguarding the flow of information from credit rating agencies to traders on Wall Street. We’ve already seen evidence in a civil lawsuit against UBS that suggests some at Moody’s may have discussed potential rating changes on CDOs with some Wall Street banks.

Insider trading is a problem that has been around as long as people have traded stocks. And it’s almost impossible to stamp-out insider trading, given the premium someone will put on getting inside information.

But aggressive law enforcement like the kind done in this case should serve as a deterrent–hopefully.

14 comments

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“for anyone to assume that all hedge fund managers owe their success to getting information on the sly is unfair and wrong”

Does this mean you knew about Galleon’s (alleged) insider trading? In order to make the quoted statement one would assume that you know which Hedgies are breaking the law and which ones aren’t. Or are you the one making assumptions…

You also write, “If the majority of hedge funds managers were so crafty, not so many funds would have gone bust last year–or lost bundles of money for their wealthy investors.” I won’t even begin to explain why this statement doesn’t make any sense. Are you saying that hedge funds that engage in insider trading can’t loose money?

Posted by HedgeSwede | Report as abusive

Great Summary of the Issues at play in this case. You would hope the Moodys leak hits home with clients and they take action by pulling business from the company. Let’s also not forget how distribing it is that a top guy at McKinsey is equally involved in leaking corporate client information. Their crimes are much worse then Raj’s $20m trading gain. Galleon has a team of partners running their own funds that likely earned their gains through skillful research.

Posted by Pete | Report as abusive

Your comparison is quite misplaced. Its like saying just because this guy in the corner of the street is a thief doesn’t mean every one in the neighborhood is also one. Of course not all hedge fund managers are unscrupulous. And what about your comment regarding only $20 million out of $7 billion? Are you saying that these people only use land line phones to pass insider tips even if they meet for dinner? Do they not meet face to face or use any other way to share information? And your statement “if all those fund managers were that crafty…” also doesn’t make any sense. You are saying as if somehow some but not all hedge fund manager could get an insider tip on the coming financial meltdown and save themselves.

Posted by Ash | Report as abusive

“for anyone to assume that all hedge fund managers owe their success to getting information on the sly is unfair and wrong”

It would be more unfair and wrong to assume that Crooked Street (nee Wall Street) goes about their business in an honest fashion.

From the top of my head we have insider trading, naked shorting, IPO Laddering, flash quotes, high frequency trading, collapsing the box, PIPEs, late trading mutual fund NAVs and good old fashioned collusion . . . it’s not a pretty picture when we start counting the ways is it? Nice business model they have going. Real American heroes. Next thing we know, they will be making huge campaign contributions so that they can get key appointments within the government that will allow them to engineer the regulatory structure in a manner that will allow them to commit such massive fraud that it will threaten the global financial system . . . errr, wait a minute. Surely, if they did that, they would go to jail. I must be crazy for thinking they undertake such a thing, the consequences would be too great. Shame on them for doing it. Shame on us all – particularly you in the media – for letting them get away with it.

Posted by K | Report as abusive

Wall Street is bullsh!t. Good hedge fund bosses are those who do not get caught running their little schemes that includes trading with full knowledge of insider information. Bad hedge fund bosses get caught with their guard down. It is not whether hedgies are privy to insider info. The maturity of a hedgie lies in how well they guard their information source and themselves. Without a regulation of the hedge fund industry whatever you say is just opinion – one among many.

Posted by Jakcson | Report as abusive

“In 2005, Galleon paid an $800,000 fine to the SEC…Regulators claimed that impermissible strategy called “collapsing the box” essentially was a risk-less one and generated $1 million in trading profits for Galleon.”

A 25% return even after getting caught. IOW, they made $40,000 ($200K*0.2) for the hedge fund net of the fine.

And since 2005, every other hedge fund manager has known about that opportunity. If we assume hedge fund managers are rational, then a null hypothesis of “to assume that all hedge fund managers owe their success to getting information on the sly is unfair and wrong” would have to be rejected.

This is merely a dog & pony show for the public, the entire financial crisis was caused by insider trading, and the governments answer was to give the people that caused it billions of taxpayer dollars while America is bleeding jobs by the millions. What this country needs is a hard and deep enema of our congressional leaders to flush out all the garbage in Washington. Let’s face it the real criminals are above the law, and the people are helpless to do anything about the situation our elected leaders have put us in. History will remember us as there was once a great country called America.

Posted by Rob | Report as abusive

I have a link to the criminal complaint and other official documents from the US Attorneys against Raj Rajaratnam and a very brief write up on the technical charges against him on my blog here if anyone is interested:

http://www.modernbandit.com/2009/10/bill ionare-founder-of-galleon-group.html

Or click here to go directly to it.

Raj Rajaratnam, billionaire founder of the Galleon Group, a major hedge fund, is led in handcuffs from FBI headquarters in New York Friday, Oct.16, 2009. Rajaratnam was charged with insider trading in the stock of several companies including Hilton, Clearwire, and Google.

The guy is “DARK SKIN” Obama is going to call the “FEDS” and make them and the “NEW YORK POLICE” to release this “guy?” and apologize for arresting him, because he is “DARK SKIN” be prepared working hard FEDERAL AGENTS, why bother doing the job when he could be out on the street, oh yeah he is out on 20 million bail that he stole.
AMERICA LAND OF OPPERTUNITY!
By the way Obama’s life history looks suspicious but what do you expect he works for the Mafia and he is only in office for a ploy to get other countries to like us on false basis, plan didn’t work every one seen right through him.
Now Obama will screw up trying to stick up for his own kind and go off the Mafias track and it will be blamed against some one else.
The Mafias of the White house is so discrete that no one has any idea they exist, a lot of planning, that is what comes with good “organized crime” maybe one day one if our good Fed agents will have enough guts and reveal the truth.
Back to Obama, same as Bush he was not elected by the people but by the mafia of the white house, sure we have votes they are true in America they do exist but they don’t matter, the next 25 Presidents are all ready chosen.
Obama’s role was to get other countries to believe that we have changed and we accept other migrants to lead our country.
None fell for it after seeing the continuance deception that our government plays with us, our health, our money our freedom, our everything.
Every one san see what it is but no one has done anything about it.
I prepare my kids to be the next real President, leader to lead this country and to clean up all the messes that all others had made and take out the Mafia that has been there and turn this country around into what it was set out to be and meant to be and should be.
Call me racism what is that? a word? What does it mean? Nothing, it is a figure of speech a personal belief a freedom of speech a right of ones own, for what the word is meant to be and how they mean it is up to that person only.
Everyone has their rights of views and beliefs.
With the topic of minority of Black, they all have dome nothing but complain about years ago slavery when they were not even a part of it.
Sure it was wrong to do to any human being but the majority of black people use it as a weapon and it has nothing o do with them.
The only factor is they were taken from their land forced to be slaves, they are free now they can return back to their countries no one is keeping them here,
They choose to stay here but their roots are from Africa, they choose to stay to complain to keep trying to get whets coming to them, what is that? What do they seek? Revenge? then that to me is a war and they all should be deported it is a security risk that all native Americans would be and are in danger, that is s something to think about and the last stunt that Obama pulled in Boston is a clear example and proof.
What needs to be done?
the people of America need to get this country back to some formality of principals, dignity and honor.
I will sign my name by “TRUTH” only because I choose from past experience not to get harassed for exercising my freedom of speech but when my sons are the next president I will reveal all, until then…..

Posted by TRUTH | Report as abusive

It’s nice to see the FBI making surprise inroads into the ongoing juggernaut of white-collar crime, in spite of GW Bush’s unanaesthetized emasculation of that agency’s investigatory budget and resources in the circus-like aftermath of 911.

Hedge funds have defiantly resisted legal pruning for the longest time. They go smugly about their dirty business as though actually contributing anything to society instead of deliberately wrecking it for fun and profit. That’s all they’re good at and it’s what they do.

Ever since the glib libertine travesty of Reaganomics, predatory financing practices have taken stranglehold on the economy; net result being, that so-called free market economics has become an utterly meaningless ghost-ship theory of zero account – every bit as meaningless as trite comparisons between the decadently moribund Soviet Union and theoretical socialism.

In the end, unregulated hedge funds were always destined to meet to a squalid fate. Hopefully, this is exactly what will happen next because all along, it was only ever going to be them – or us.

By doing that at which selected administrations fail, namely their job, it will be a major milestone in history when the FBI single-handedly revives whatever little remains by way of credibility in the capitalist system.

Paulson, Bernanke, Geithner et al are too busy doing this ailing economic system of ours not one damn bit of good. At this point in time the FBI may be the only ones really trying. To quote Shakespeare: for this relief, much thanks.

Posted by The Bell | Report as abusive

Why haven’t they arrested the executive from Akamai? They have the conversations recorded via wiretap of the executive saying “I’ve got a gift for you…information”. Yet the Akamai exec remains uncharged at this point. Can someone explain why that is?

Posted by Chase33 | Report as abusive

AKAM exec isnt charged yet because he is cooperating

Posted by jj | Report as abusive

[...] The golden age of insider trading yields a big fish.  (Deal Journal, Matthew Goldstein) [...]

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[...] The Galleon Insider Trading Scandal By aaronmiller5 So big news in my world with this Galleon mess. If you haven’t heard much about it here’s a few links or [...]

I had worked in Hongkong as saleman way back in 1968 for
hedge fund of VERY VERY HIGH REPUTE; I’m NOT alleging or
accusing anyone of anything but my advice to investing public is to STAY AWAY FROM HEDGE FUNDS, CONTROL YOUR OWN
DESTINY AND INVEST DIRECTLY IN EQUITIES/STOCKS; stocks:-

you can sell at click of button and buy/sell market exists before your eyes 24 hrs a day on computer screen,
your funds are 100% in your control;
in hedge funds the “manager” controls your destiny.

Posted by jjmk4546 | Report as abusive

I am not pointing any fingers until this plays out. I would say that a hedge fund manager/owner better have some honest people and better know that he is responsible for all his people. Also the officers and board at IBM is responsible for what occured and must be willing to take the responsibility for their employees action. We complain about high corporate salaries. Now it is time for the high salaried people to start earning their money and root out their dishonest employees.

Posted by f belz | Report as abusive

[...] Galleon’s Edge @ Matthew Goldstein [...]