Wednesday, 28 October 2009
Galleon wiretap rattles hedge fund industry
First came the biggest bear market since the 1930s, then Bernard Madoff’s US$65 billion Ponzi scheme and the threat of increased regulation. Now hedge funds have a new concern: getting caught on tape as the government expands its use of wiretaps to ferret out insider trading.
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Galleon wiretap rattles hedge fund industry
Managers question whether legitimate talks on tapped lines will draw scrutiny
Bloomberg
28 October 2009
(NEW YORK) First came the biggest bear market since the 1930s, then Bernard Madoff’s US$65 billion Ponzi scheme and the threat of increased regulation. Now hedge funds have a new concern: getting caught on tape as the government expands its use of wiretaps to ferret out insider trading.
Prosecutors, using secretly recorded phone conversations for the first time against hedge funds, alleged on Oct 16 that billionaire Raj Rajaratnam and five others made US$20 million by swapping material inside information on companies such as Hilton Hotels Corp and Google Inc.
They may charge at least 10 more people soon, people familiar with the matter said last week.
Rajaratnam, founder of New York-based Galleon Group LLC, regularly talked to hundreds of contacts, including other traders, according to people who know him. His arrest rattled hedge-fund managers, who are questioning whether legitimate discussions caught on the tapped lines will draw scrutiny, say lawyers who’ve fielded such queries.
A broader worry: whose phones are being monitored as prosecutors and US Securities and Exchange Commission continue their probes?
‘The word wiretap strikes fear in the hearts of everyone, even the innocent,’ said Brad Balter, who runs Balter Capital Management LLC, a Boston-based firm that allocates clients’ money to hedge funds.
Ross Intelisano, an attorney with Rich & Intelisano LLP in New York, said he received a call from an executive at a US$1 billion hedge fund who was considering hiring a company to test his firm’s phones for listening devices. The client asked what to do if the firm found any. ‘Do we go to the police?’ the executive asked, according to Mr. Intelisano.
The executive instructed his colleagues to be extra careful about what they say on the phone, not because they are breaking the law, but because they are fearful that any conversation about stocks could be misconstrued, Mr. Intelisano said.
‘After the Bear Stearns case, e-mails aren’t safe, and now phone calls aren’t safe,’ Mr. Intelisano said. ‘From now on, people are going to be meeting for lunch.’
Prosecutors used e-mails to build their case against former Bear Stearns hedge-fund managers Ralph Cioffi and Matthew Tannin, who are currently on trial in Brooklyn for misleading investors about the health of two funds that collapsed in 2007.
It’s the biggest trial stemming from a US probe of banks and mortgage firms whose losses in sub-prime loans and related securities total at least US$396 billion.
For hedge-fund managers whose knowledge of wiretaps may have been limited to The Wire, the HBO drama in which Baltimore police eavesdrop on drug dealers, electronic bugging is a new reality of their industry as US attorney Preet Bharara’s new Complex Frauds Unit targets white-collar crime.
Prosecutors said they turned to wiretaps because of the ease with which hedge funds can hide when trades were based on illegal tips. At a bail hearing on Oct 16, Assistant US Attorney Josh Klein told a judge that Rajaratnam instructed others to fabricate ‘e-mail trails’ that would explain why they executed corrupt trades.
‘There were consistent endeavours to mask’ the trades, Mr. Klein said in court.
The case against Rajaratnam, 52, who said last week he is innocent, is the largest since takeover investor Ivan Boesky and investment banker Dennis Levine were convicted in a crackdown two decades ago.
Thirteen people were criminally charged in a series of schemes that investigators said stretched over five years, yielded US$15 million in illegal profits and also involved employees at UBS AG and Bank of America Corp.
The US$1.4 trillion hedge-fund industry is recovering after posting a record loss averaging 19 per cent in 2008, according to data compiled by Hedge Fund Research Inc. Funds have returned 17 per cent this year, the Chicago-based firm’s data show.
Confidence in the industry was shaken by the December arrest and subsequent conviction of Madoff, who victimised hedge funds and individual investors and whose fraud triggered renewed efforts by Congress and the SEC to regulate the private investment partnerships.
Former federal prosecutor Steven Peikin, who headed the securities fraud unit in the US Attorney’s Office in the Southern District of New York, said investigators have long relied on advanced techniques in battling white-collar crime.
What’s new is the focus on hedge funds and the use of labour-intensive phone taps, he said in an interview. Last year, 84 per cent of the 1,891 authorised taps were used in drug-related cases, according to a report by the Administrative Office of US Courts, which provides support to the federal judicial branch.
‘It’s a declaration that they want to submit substantial resources to this,’ Mr. Peikin, now an attorney at Sullivan & Cromwell LLP in New York, said of the use of wiretaps. ‘Preet is continuing a long and proud tradition.’ - Bloomberg
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