Taiwan Offers Trove of Insider Data for Hedge Funds
For technology companies, Taiwan is home to the biggest custom producers of chips used in products like Apple’s iPhone and Dell computers. For hedge funds, it’s a cornucopia of confidential data, leaked from chipmakers and parlayed into an edge in trading stocks of their U.S. customers.
The U.S. insider-trading investigation that began last year with the arrest of the head of Galleon Group LLC is shedding new light on this nexus of underground research and offshore manufacturing. Last week, a U.S.-based employee of Taiwan’s biggest chipmaker, moonlighting as a consultant for Primary Global Research LLC, was charged with providing material, nonpublic information to investors. Last month, a Primary Global employee with ties to Taiwan was arrested in the probe.
While the Taiwan connection is just emerging in complaints filed by the U.S. Attorney in Manhattan, the nation’s black market for business intelligence and its appeal to hedge funds looking for an advantage are well-established. Since at least 2004, incidents of analysts dealing in confidential chip- production data have occurred at the Taipei offices of banks including JPMorgan Chase & Co. and Lehman Brothers Holdings Inc., said six people in the finance industry with knowledge of the events, who asked not to be identified to protect their business relationships.
“Taiwan has been the wild, wild East,” said Peter Douglas, a principal of Singapore-based hedge-fund consultant GFIA Pte. “If you want to understand the global tech value chain, you’re going to need to know what’s going on in the Taiwan slice of it.”
SEC ‘Too Strong’
Don Ching Trang Chu, the Primary Global employee arrested on Nov. 24, had a cadre of Asia-based employees of North American technology companies signed up to feed information to clients, prosecutors said in the criminal complaint against him. The firm, based in Mountain View, California, is among about 40 “expert networks” that provide investors with access to research and experts in a range of sectors, countries and thousands of individual companies.
Chu offered to set up meetings with some of his experts for hedge-fund manager Richard Choo-Beng Lee when he traveled to Taiwan, according to the complaint. The U.S. Securities and Exchange Commission is “too strong,” Chu, a Taiwan native who became a U.S. citizen in 1987, told Lee, according to the complaint. “In Asia, there, nobody cares.”
Lee, co-founder of Spherix Capital LLC in San Jose, California, was secretly cooperating with the government after being ensnared in the Galleon case. Chu’s lawyer, James DeVita, declined to comment. Chu, 56, was fired by Primary Global, which hasn’t been charged with wrongdoing.
The country’s semiconductor foundries count most major chip designers as customers, including Texas Instruments Inc. and Qualcomm Inc., which in turn supply companies such as Apple Inc. and Dell Inc. Taiwan Semiconductor Manufacturing Co., based in Hsinchu, is the world’s largest contract chip manufacturer, followed by cross-town rival United Microelectronics Corp. Neither TSMC nor UMC has been accused of wrongdoing in the U.S. investigation.
The foundries’ role in the global supply chain means that gleaning information on their orders can provide insight for investors into the sales expectations of their customers, said John Crossman, a partner at Taipei-based Independent Research Partners Co. who has worked in Taiwan’s securities industry for 20 years.
“Taiwan operated this way in part because it’s a pretty small community and everyone knows someone personally in the sales department of these tech companies,” with the result being a lot of friendly information-swapping, Crossman said. “It is tolerated because it’s assumed that everyone does it, so the information doesn’t have explosive value.”
TSMC fell 2.3 percent, the most in three months, to NT$71.20 in Taipei, while UMC declined 1.5 percent to NT$16.45. The benchmark Taiex index dropped 49.18, or 0.56 percent, to 8768.72, ending a five-day rally.
In early 2007, Lehman Brothers’ compliance team received reports that a Taiwan technology analyst was getting TSMC production data and passing it on to selective clients.
Two compliance officers flew in to investigate and concluded there was no breach of policy, according to three people familiar with the matter, who declined to be identified because the probe was confidential. The investigators found such activity so common in Taiwan that no clear distinction could be made between legitimate research and insider trading, these people said. The analyst was disqualified from getting a promotion, however.
Kimberly Macleod, a spokeswoman for Lehman in New York, declined to comment.
In 2004, a Taipei-based member of JPMorgan Chase’s research team seeking a position at Merrill Lynch & Co. produced during an interview a TSMC spreadsheet, which the candidate said showed monthly customer shipments, according to a person with knowledge of the meeting, who declined to be identified because the details were confidential. The candidate didn’t get the job.
The principal players in Taiwan’s intelligence black market have evolved, according to the people with knowledge of the matter. From about 2004 to 2007, they were semiconductor analysts at sell-side firms, exploiting their contacts at TSMC and UMC to get confidential data. The analysts have been mostly supplanted since the 2008 financial crisis by expert networks like Primary Global.
The most important customers have remained the same: hedge funds.
“There were a number of hedge funds that realized getting data points was the way to invest, and Taiwan was one of the first places where this caught on,” said Crossman of Independent Research.
No Taiwan Cases
No hedge funds have been accused of insider-trading in Taiwan. Stocks not listed in the country don’t come under the jurisdiction of the island’s regulators, according to Lin Tung- liang, chief secretary at the Taipei-based Financial Supervisory Commission. The U.S. probe has focused on domestic stocks.
Galleon registered its Galleon Asia-Pacific (HK) Ltd. in Taiwan in January 2008, according to records at the country’s economy ministry. The office closed and New York-based Galleon liquidated after co-founder Raj Rajaratnam was arrested in October 2009 for allegedly being at the center of two insider- trading rings.
Rajaratnam has said he is innocent, and no one at the Taiwan office has been accused of wrongdoing. Jim McCarthy, a spokesman for Rajaratnam, declined to comment.
Another firm with a Taiwan presence was Loch Capital Management LLC. Loch’s Boston headquarters were searched last month as part of the federal insider-trading investigation. The Taiwan office voluntarily deregistered in November 2009.
Loch said in a Dec. 3 letter to investors that it received a subpoena and that it isn’t the target of a government probe. Mark O’Toole, a spokesman for the firm, declined to comment. Loch hasn’t been accused of wrongdoing in the U.S. or Taiwan.
Incentive for Analysts
Funds still operating in Taipei include Clairvoyance Capital Management Inc., Cavalry Management Group LLC and Empire Capital Management LLC, according to registration details from Taiwan’s economy ministry. The firms declined to comment or didn’t respond to telephone calls or e-mails seeking comment on the Taiwan hedge-fund industry.
For analysts, providing clients with tips is a way to boost their reputations and win votes in investor rankings, according to Vincent Chen, head of Greater China technology research at Yuanta Securities Co. in Taipei. A top spot in Institutional Investor’s annual All-Asia Research Team can lead to a pay raise and more clients for their firms.
“An analyst’s main purpose is to get votes for themselves and brokerage business for their firm,” Chen said in a telephone interview.
One example of a data sheet, obtained by Bloomberg News, shows a rolling update in expected demand for TSMC’s factories in a specific quarter, broken down by customer. The information shows that some customers increased their forecast for production demand while others left their expectations unchanged, according to a person familiar with the data who declined to be identified because it’s confidential.
Elizabeth Sun, a TSMC spokeswoman, said that while the format looked familiar, she couldn’t verify if the document was genuine.
Manufacturers and customers have said they were frustrated by the dissemination of inside information. In a June 30, 2006, e-mail, TSMC’s North America operations chief, Rick Cassidy, related to Taiwan colleagues a formal complaint filed by Atheros Communications Inc., which said its foundry production data was being leaked to hedge funds.
The document was introduced as evidence in a lawsuit filed by TSMC against Shanghai-based Semiconductor Manufacturing International Corp. and settled in November 2009. The litigation was unrelated to insider trading and dealt with a patent and breach of contract dispute between the two Asian companies.
Cassidy said in the e-mail that he’d discussed the Atheros complaint with Paul Franklin, vice president operations of the Santa Clara, California-based company, and Jack Lazar, chief financial officer, whom, wrote Cassidy, “has recently been talking to a number of hedge funds that know specific information about Atheros (and other TSMC customers, Broadcom, Marvell, etc.) that is not public information.”
In verbal testimony given at the trial, Cassidy said other clients had also expressed their concerns to TSMC about data leaks from the foundry, according to a court transcript.
Molly Mulloy, a spokeswoman for Atheros, declined to comment. TSMC’s Sun declined to comment on specific cases or investigations it has conducted.
“Around 2004, there were more rumors floating around about our customers and wafer shipments, so we did step up our investigations further,” she said. The company put on a seminar about insider trading, at which it warned employees to be on the defensive with people trying to get access to sensitive information.
It was during that period that expert networks began stepping up their contacts with employees, according to Sun. She recalled representatives of Gerson Lehrman Group seeking to recruit TSMC employees as consultants in its expert network, the industry’s largest. Sun said the company’s general counsel wrote to Gerson Lehrman, asking that the firm stop contacting TSMC workers. The company doesn’t allow employees to engage in outside work, Sun said.
In January 2006, a Gerson Lehrman attorney, Michael O’Toole, sent an e-mail to Sun in which he said the firm had contacted some TSMC employees about being consultants and was unaware of company rules barring it.
“I wanted to reach out to you to discuss and better understand Taiwan Semiconductor’s policies on employee consulting,” O’Toole said in the e-mail, a copy of which was obtained by Bloomberg News.
Sun replied in an e-mail that TSMC’s general counsel and human resources head advised her that employees were prohibited from expert-network consulting. Gerson Lehrman said in an internal e-mail obtained by Bloomberg News that it would comply with TSMC’s prohibition. The New York-based firm has a marketing agreement with Bloomberg LP, the parent of Bloomberg News.
Still, Manosha Karunatilaka, an account manager at TSMC’s office in Burlington, Massachusetts, began talking to clients of Primary Global in September 2008, according to the complaint filed when he was arrested on Dec. 16. Karunatilaka provided inside information to a second cooperating witness in the U.S. investigation, prosecutors said.
Karunatilaka received production reports on the foundry’s top 10 customers, and was paid $200 per call to consult with Primary Global clients, prosecutors said in the complaint.
TSMC’s customers typically provide monthly forecasts and place orders based on those forecasts, Karunatilaka said to the witness, according to the complaint. “You can kind of estimate what will be the shippings, you know, based on that,” he said.
TSMC said in a statement that Karunatilaka, 37, has been fired.
Brad Bailey, an attorney for Karunatilaka, said in a telephone interview that he’s reviewing the case and declined to comment on any specifics alleged in the complaint. Two messages left at a Marlborough, Massachusetts, number listed under the name Karunatilaka weren’t returned.
Arrested on the same day as Karunatilaka were James Fleishman, a sales manager at Primary Global; Mark Anthony Longoria, a supply manager at Advanced Micro Devices Inc. who worked as a Primary Global expert; and Walter Shimoon, an employee of Flextronics International Ltd. who was also in the expert network.
A fifth man, Daniel DeVore, formerly a supply manager at Dell, pleaded guilty in federal court in New York on Dec. 10 to conspiracy to commit securities fraud and wire fraud as part of the probe. He is cooperating with the investigation.
UMC has also faced the problem of people seeking inside information for their clients, said Liu Chi-tung, its chief financial officer. Several years ago, the company discovered a secretary had made friends with analysts and regularly met them to discuss company information, he said.
‘Outside Official Windows’
The secretary was fired, said Liu, who declined to name the worker or the analysts. No secret information was released, according to Liu.
“Some try to make contact with UMC outside of the official windows, yet we have tight control and haven’t had any leaks that I’m aware of,” said Liu, who joined the company in 2001.
The arrests of Chu and Fleishman showed the government’s heightened interest in investors’ use of expert networks and whether they have crossed the line from legitimate research to insider information.
“Any fundamentally driven investment strategy is going to try to create an information edge,” said Douglas, the GFIA consultant. “The question is whether you’re doing that legally, morally and ethically, or not.”