Another Shocker on Wall Street

Copyright © 2009, Greenwich Financial Management Inc., a registered investment advisor.

After the Bernie Madoff revelations, one might have feared that we are hopelessly jaded by financial intrigue. Then along comes the Galleon insider trading story. It restores faith in Wall Street's continuing power to shock.

Federal prosecutors on October 16th filed criminal charges of conspiracy and securities fraud against Raj Rajeratnam, billionaire founder of Manhattan-based Galleon Group. Federal marshals arrested him under allegations of insider trading in the stocks of companies including Hilton Hotels, Google, Advanced Micro Devices and Akamai. Also arrested were five alleged co-conspirators: Mark Kurland, President of Newcastle Partners LP, based in White Plains, New York (formerly affiliated with Bear Stearns; no relationship to a similarly named merchant banking firm in Greenwich CT, called NewCastle Partners LLC); Danielle Chiesi, an employee of Newcastle; Rajiv Goel, of Intel, who was involved in their venture capital effort; Anil Kumar, an executive at consulting giant McKinsey & Company; and Robert Moffatt, an IBM executive working at its Armonk headquarters. Source: "Dealbook," NY Times, 10/16/2009 and Forbes.com.

The Galleon allegations differ fundamentally from those against Madoff. Madoff's operation siphoned huge amounts of money from investors under false pretenses. However, Madoff's firm carried out little or no actual trading, and it did not benefit from any privileged information about publicly listed companies. The federal allegations against Mr. Rajeratnam center on another fundamental purpose of federal securities laws (particularly the 1934 Securities Exchange Act, and regulations under it). That goal is to preserve fairness among competing investors as to the availability of highly relevant and timely information affecting publicly listed companies.

Others charged by prosecutors include Mark Kurland, the president of Newcastle Partners LP, a firm based in White Plains that formerly was associated with Bear Stearns (no relationship to NewCastle Partners LLC, of Greenwich, as incorrectly reported); Danielle Chiesi, an executive at Newcastle; Rajiv Goel, an executive at Intel’s treasury department who supported the company’s venture capital arm; Anil Kumar, an executive at McKinsey & Company; and Robert Moffatt, an executive at I.B.M..

A former Galleon employee, not yet named, cooperated with federal authorities in hopes of receiving a reduced sentence. Prosecutors say that they have wiretap evidence implicating the defendants. Although insider trading cases can be hard to prove, the wiretap evidence is potentially damning.

Of course, the SEC has made insider trading allegations quite frequently. What distinguishes this case is the scale of the trading and the scope of the alleged ring and the number of blue firms whose employees or principals allegedly participated in it. I can't remember anything of this magnitude since the Ivan Boesky trading ring of the 1980's. (The character of Gordon Gekko in the movie Wall Street was based in part on Boesky.)

We can expect more cases, both relating to the alleged Galleon trading ring and to unrelated matters, as part of a federal crackdown on insider trading networks. Targets will include hedge funds, Wall Street firms and law firms. The government has identified certain targets for investigation based on a "data mining" project, begun about two years ago, that looked for patterns of suspicious trading. "Once investigators find a cluster of correlated trades, they tap other sources of information to unravel how its members obtain and share tips…. For example, if a group profits on trades before a series of corporate takeovers, the SEC may check...which investment banks or law firms advised the deals. If one firm was involved in all of them, an employee there may be the source of the leak." Source: Joshua Gallu and David Scheer, "U.S. Said to Target Wave of Insider-Trading Cases After Galleon," Bloomberg News Service, 10/19/2009.

The Galleon news suggests that the Securities Exchange Commission and federal authorities, shamed and embarrassed by the Enron, Madoff and other debacles, are increasing the scope effectiveness of their enforcement activities.

Andrew Szabo CFA is managing director of Greenwich Financial Management Inc., a registered investment advisor. Questions call 917-796-8500 or e-mail Szabo@GreenwichFinancial.com). For more information, please visit http://greenwichfinancial.com/.

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