Right about earnings? Win a wiretap!

By Felix Salmon
December 30, 2009
Susan Pulliam's account of how the Galleon case was put together, I'm struck by how unprepossessing some of the most crucial dots were.

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Prosecutors of white-collar crime are a bit like investigative journalists, trying to connect dots. But reading Susan Pulliam’s account of how the Galleon case was put together, I’m struck by how unprepossessing some of the most crucial dots were.

Andrew Michaelson was buried in paper, millions of pages of it…

When Mr. Michaelson’s team found the needle in this haystack of documents — a single text message — it pointed them toward Raj Rajaratnam himself. The writer urged him not to buy video-conferencing firm Polycom Inc.’s stock “till I get guidance; want to make sure guidance OK.”

The cryptic note was sent by Roomy Khan, a former Intel Corp. employee whom authorities had suspected in the past of sending inside information to Mr. Rajaratnam. People familiar with the matter say those few words hidden among millions of others proved a turning point in what would become the biggest insider-trading case in two decades.

By November 2007, Ms. Khan, confronted with the text message, agreed to cooperate and record her phone calls with the hedge-fund tycoon…

Ms. Khan — who has since pleaded guilty to conspiracy, insider trading and obstruction of justice in connection the Polycom, Hilton and Google trades — agreed to record phone calls between her and Mr. Rajaratnam. Before Ms. Khan dialed him on Jan. 14, 2008, FBI agent B.J. Kang walked her through how she should quiz her old friend.

“What’s going on with earnings this season? Are you getting anything on Intel?” she asked, according to a person familiar with the situation. Mr. Rajaratnam answered that Intel’s revenue would be up 9% to 10% and that profit margins would be “good,” according to the person.

Mr. Rajaratnam was right: The next day, Intel reported revenue up 10.5% for the period and profit margins above the company’s earlier prediction.

That was enough for prosecutors. Using evidence from the Intel call and other recordings Ms. Khan made, they asked a Manhattan federal judge in March for permission to eavesdrop on Mr. Rajaratnam’s phone calls.

We have two seemingly smoking guns here. The first is a text message from a hedge fund consultant saying that she was looking to get guidance on Polycom earnings; the second is a phone call with Raj Rajaratnam himself in which he was reasonably good at guessing what Intel’s earnings were going to look like.

Isn’t this what stock-picking hedge funds like Galleon do? They try to anticipate corporate earnings — that’s their job. And while it’s always possible that people who are right about earnings are right because they have inside information, there are lots of other possibilities too. After all, people who are right about earnings often don’t have inside information, and people who are wrong about earnings sometimes do.

But in both key cases here — the text message and the phone call — talk of upcoming earnings was taken as prima facie evidence of some kind of crime. In the first case, it sufficed to turn Roomy Khan into a government informant.

I feel there must be something I’m missing here — or is this really all that’s needed to persuade a judge to approve a wiretap?

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