Feb. 17 (Bloomberg) -- The insider-trading trial of Galleon Group LLC co-founder Raj Rajaratnam next month is the culmination of U.S. investigations dating back 12 years that involved blind alleys, anonymous tips, wiretaps and a trip into the Tamil Tiger underworld before prosecutors got their man.
Rajaratnam, 53, stands accused by Manhattan U.S. Attorney Preet Bharara of leading an insider-trading conspiracy that earned his fund about $45 million. He has pleaded not guilty.
Testimony at a four-day hearing in October to consider the admissibility of wiretaps showed what evidence the U.S. is likely to rely on at trial, set for March 8, as well as much of the inside story of how investigators cracked the case.
The government began pursuing the Sri Lankan-born Rajaratnam as long ago as 1999. Federal prosecutors in California and New York, as well the Securities and Exchange Commission, would eventually carry out what became the largest insider-trading probe of hedge funds. To date, at least 26 people have been charged; 19 have pleaded guilty.
The Federal Bureau of Investigation said it considered placing an undercover agent inside the New York-based Galleon firm, before opting instead to tap his phones because it had no viable candidate. The case was woven from other threads, including a former Intel Corp. employee’s confessions; a 2006 regulatory probe of his brother Rengan, instant messages from Rajaratnam; and a March 2007 anonymous letter to the SEC.
“To Whom it May Concern: it is hedge funds like Galleon Group that create wealth for their shareholders and themselves at the expense of innocent investors,” according to letter, which was read during the October hearing in New York. “‘Insider trading’ word in this fund should be changed to ‘insider partnership and prostitution.’”
The case was the first to make significant use of phone taps to gather evidence of trading on inside information, a technique more commonly used against organized crime figures. During a three-year probe, the FBI secretly recorded more than 2,400 conversations. U.S. District Judge Richard Holwell, who is presiding over the case, ruled those recordings admissible at trial.
Prosecutors said Rajaratnam used tips from hedge fund executives, corporate officials and other insiders to conduct illegal trades involving 12 companies, including Intel, International Business Machines Corp., Akamai Technologies Inc., Google Inc., Advanced Micro Devices Inc., EBay Inc., Polycom Inc. and Hilton Hotels Corp.
Jim McCarthy, a spokesman for Rajaratnam, declined to comment.
‘A Great Resource’
Rajaratnam founded Galleon in 1997 with three other colleagues from Needham & Co. as a hedge fund firm focusing on technology and health-care stocks. Galleon had as much as $7 billion in assets under management and was once among the 10 largest hedge funds in the world.
Rajaratnam attributed his success to demands he placed on his analysts and a network of 60 to 70 technology executives who were investors in his fund.
“They are a great resource to bounce ideas off,” he said in an April 1997 HedgeFundNews.com interview that was submitted at the hearing. “If we ask any of them which of their customers or suppliers are doing well or badly we get four stock ideas.”
“At some point, you stop working for money, you work for pride,” he said. “We want to win; we want to be the best.”
‘Super Bowl Parties’
The SEC’s anonymous tipster told a different story, saying Galleon’s limited partners held positions such as chairman, chief financial officer and director at large public companies. These insiders faxed privileged, nonpublic financial and product data to Galleon managers before public release.
“In return, the fund provides greater returns on their money,” the tipster said. “This is a great formula, totally at the expense of poor, common weakly behaving investors.”
Special FBI Agent B.J. Kang, lead investigator in the government’s insider-trading case, said agents also pursued reports of other benefits, such as “treating these company executives to Super Bowl parties as a way to thank them for the inside information.”
In 1998, Kang said the FBI and prosecutors in Northern California began investigating Intel employee Roomy Khan, after receiving a complaint from the company. The world’s largest chipmaker had conducted an internal probe and fired Khan in May 1998, Kang said. Intel suspected her of passing information to Rajaratnam, then a lead semiconductor analyst at Needham, Kang said. A video camera installed by Intel over a fax machine captured images of her as well as the number she dialed, which the FBI identified as Rajaratnam’s.
Khan at Galleon
Khan worked briefly at Galleon’s California office as an analyst after leaving Intel, Rajaratnam said in court papers. She was fired in March 1999 “for trading in a personal brokerage account while working there,” John Dowd, Rajaratnam’s lawyer, said in court papers.
Years later, information Khan provided to the U.S. formed part of the basis for obtaining the court-authorized wiretaps that are the centerpiece of the case against Rajaratnam.
By April 1999, the California investigation broadened to include Rajaratnam, Kang said. Khan met repeatedly with the SEC, prosecutors and U.S. investigators over the next 17 months.
Khan pleaded guilty in April 2001 to wire fraud. As part of a cooperation agreement with the U.S., she was sentenced on July 1, 2002, to six months’ home detention, fined $30,000 and ordered to pay $120,000 in restitution, court records show.
“All I can say is I’m extremely sorry about this,” Khan told U.S. District Judge James Ware in federal court in San Jose, California. “I’ve never been involved in anything criminal, and I’m really sorry.”
No charges were filed against Rajaratnam in California. Prosecutors closed that case in August 2002, Kang said.
“Mr. Rajaratnam could not be tied to illegal insider trading,” the government’s sentencing memo for Khan stated. “He did not provide any monetary payment for the information Khan allegedly provided him,” prosecutors said.
Dowd, Rajaratnam’s lawyer, has argued no action was taken against his client because the U.S. was “unable to substantiate any of Khan’s allegations against Mr. Rajaratnam.”
Kang said the decision to close the California probe was made 11 months after the Sept. 11, 2001, terrorist attacks, when the FBI changed its focus to terrorism. FBI agents assigned to work on the Intel case had also moved or were reassigned, he said.
Rajaratnam had also come under the scrutiny of counter-terrorism investigators about that time, Kang said. The FBI’s Joint Terrorism Task Force, or JTTF, in New Jersey, New York and Connecticut had made inquiries about him as part of an investigation into the financing of the Sri Lankan terrorist group called the Liberation Tigers of Tamil Eelam, or LTTE.
U.S. prosecutors in Brooklyn, New York, who began a counter-terrorism investigation in 1998, investigated “possible ties” Rajaratnam had to the group’s financing, Kang testified.
“Newark JTTF was asking about Mr. Rajaratnam, so I think that was one of the reasons why they decided to refer the matter to JTTF,” Kang said of the government’s tabling of the white-collar crime probe against him.
Rajaratnam was never charged in a terror probe. Dowd said during the October hearing that his client had met with the FBI about their investigation. Dowd argued the U.S. had attempted to “smear” his client.
“He was giving money,” to a fund that helped victims of the tsunami in Sri Lanka, Dowd said, “a charity here in the United States, sanctioned by the Internal Revenue Service,” Dowd said. “President Bush and President Clinton did the same thing that Raj did to help his country.”
2003 SEC Subpoenas
The insider-trading case continued with an SEC formal order of investigation in November 2003 and subpoenas served on Galleon from 2003 to 2005.
The SEC would obtain more than 4 million pages of business records and depose more than 20 Galleon employees as part of the probe, Rajaratnam’s lawyers said. Rajaratnam gave a deposition to the SEC in 2007, and the agency conducted an on-site review of Galleon.
Dowd said in court papers that the U.S. pursued its probe of his client unabated during this period. Prosecutors said that the SEC subpoenas weren’t related to any regulatory insider-trading probe.
“None of these investigations was related to the instant SEC investigation and none resulted in insider trading charges,” prosecutors said in court papers.
Andrew Michaelson, one of the principal SEC lawyers investigating the case, testified that in September 2006 the agency launched an insider-trading probe of Sedna Capital Management LLC, a fund operated by Rengan Rajaratnam, a former Galleon employee.
Michaelson, now a member of the prosecution team, said the SEC deposed Sedna and Galleon employees, reviewed millions of pages of documents and reviewed every single e-mail and instant message of Raj Rajaratnam’s for 2006. Soon regulators had another target, he said.
“This civil investigation began to focus on possible insider trading by Rajaratnam at Galleon because Rajaratnam and Rengan Rajaratnam appeared to be exchanging non-public information,” prosecutors said.
Rengan Rajaratnam has never been criminally charged. John Nester, a spokesman for the SEC, didn’t immediately return a voice-mail message seeking comment. Ellen Davis, a spokeswoman for Bharara’s office, declined to comment.
Rengan Rajaratnam couldn’t be reached for comment. A call to a number listed in that name in Manhattan was answered by a man who said: “No he is not here, and this is not his number.”
‘Seen Press Release’
The SEC found instant electronic messages between Raj Rajaratnam and Khan, showing that the two communicated about Polycom, Intel, Broadcom Corp. and other companies, Michaelson said. The agency also found discussions, such as an April 21, 2006, exchange between Rajaratnam and Quint Slattery, who managed a hedge fund in which Rajaratnam had invested, prosecutors said. The two discussed CA Inc., the second-largest maker of software for mainframe computers.
“What about our CA, you staying short?” Slattery asked Rajaratnam, according to the message the FBI said it obtained.
“My guy has seen press release, yes,” Rajaratnam answered.
‘Careful on IM’
“Obviously I know you are kidding about that,” Slattery replied, adding, “I am careful on IM,” a reference to instant messages.
“Oh, s--t,” Rajaratnam wrote, then added, “Press release about the Yankees releasing Derek Jeter.”
While they determined Galleon traded in CA during this time period, Kang said neither agents nor the SEC had been able to pinpoint who Rajaratnam’s CA source was.
Slattery, who isn’t accused of wrongdoing, didn’t immediately return voice-mail and e-mail messages seeking comment after regular business hours yesterday.
While the SEC was investigating possible insider trading by Rajaratnam on 28 different stocks, there wasn’t enough either to make a civil fraud case or to bring criminal charges, regulators testified. “Our testimony hadn’t gotten anywhere,” Michaelson said. “We kept pushing, trying to get these boulders to the top of the hill.”
Manhattan federal prosecutors and the New York FBI launched a criminal probe in March 2007. Kang said he approached Khan in late 2007, and she agreed to become a U.S. cooperator.
Lauren Goldberg, a former assistant Manhattan U.S. attorney, said her office conducted a “classic insider-trading probe,” for more than a year, and then the investigation stalled. An exhaustive review of phone and trading records failed to capture explicit evidence that would sustain a criminal case, she said.
“We realized we had hit a bit of a wall,” said Goldberg, who is now an attorney with McAndrews & Forbes Holdings Inc.
The evidence showed that Rajaratnam exchanged instant messages regarding a stock and then would request a follow-up phone call, Kang said.
“What did that suggest to you about what you were going to need to do in order to find out the content of material nonpublic information that was being passed?” Assistant Manhattan U.S. Attorney Jonathan Streeter asked.
“You needed the wiretap,” Kang said.
On March 7, 2008, prosecutors asked a federal judge to approve their application for a wiretap on Rajaratnam’s phones. Once the wiretap was approved, the U.S. began building a criminal case against him. His lawyers said in court papers that the U.S. made “18,000 audio recordings” as part of the insider-trading investigations. Prosecutors said they might play more than 170 conversations at trial.
The U.S. even considered sending an undercover FBI agent into Galleon’s offices, Kang said. Investigators feared that if they approached a co-conspirator, that person might inform others. He said the bureau learned the hedge fund world was also an insular place.
Galleon employees “have MBAs from Harvard, with extensive background in finance and business,” Kang said. “So you have to have a very good pedigree, background, similar to the analysts and people that Galleon hired.”
Asked if the FBI had such a candidate for the undercover job, Kang replied, “No.”
The case is U.S. v. Rajaratnam, 1:09-cr-1184, U.S. District Court, Southern District of New York (Manhattan).
To contact the editor responsible for this story: John Pickering at email@example.com.