Page last updated at 12:50 GMT, Monday, 19 October 2009 13:50 UK

Hedge funds face insider trading scrutiny

Raj Rajaratnam arrested
The hedge fund world was shocked when Mr Rajaratnam was arrested

By Kabir Chibber
Business reporter, BBC News

When Raj Rajaratnam arrives on Monday morning to address the staff at his hedge fund's Madison Avenue offices in New York, the mood will probably be sombre.

On Friday, Mr Rajaratnam was charged with five others with carrying out $25m (£15.3m) in insider trading by the Securities and Exchange Commission (SEC).

It has been labelled the biggest hedge fund insider trading case in US history.

Despite efforts by the prosecutors, he is now free on $100m bail - the highest ever set by a US court.

Among the questions his staff ask, the first will probably be if it is true. The second might be: why?

Mr Rajaratnam is estimated to be worth about $1.3bn by Forbes magazine. Galleon, the hedge fund he founded, had managed up to $7bn in assets.

And the SEC has signalled that this is only the beginning, as authorities crack down on the secretive world of hedge funds.


"It would be wise for investment advisers and corporate executives to closely look at today's case, their own internal operations, and the increasing focus and scrutiny on hedge fund trading by the SEC and others," said Robert Khuzami, director of the SEC's enforcement division.

This case should be a wake-up call for Wall Street
US attorney Preet Bharara

Hedge funds are largely unregulated pools of money that try to make money regardless of whether markets go up or down.

Their activities include betting on downward movements - known as shorting - which was blamed for exacerbating the financial crisis last year and temporarily banned by financial authorities.

Their size and backing by many of the world's largest banks make them some of the largest players in the financial world.

The reputation of hedge funds took a beating earlier this year when Bernard Madoff was jailed for 150 years for running a $65bn Ponzi scheme.

Soon afterwards, Mr Khuzami told the US Congress that the SEC had failed in its mission to protect investors. "It is a sobering and humbling experience," he said.

"We deeply regret our failure to detect the Madoff fraud and pledge to continue to fix the problems that contributed to this failure," he and acting director of exams and compliance John Walsh added.

Mr Rajaratnam's arrest is probably the first step as the SEC attempts to restore investor confidence.

Sri Lanka impact

The charges are an interesting twist in the life story of the 52-year-old Mr Rajaratnam.

US authorities on Raj Rajaratnam arrest
US authorities have made big news of the six arrests

Born in Sri Lanka, he was educated at the prestigious Wharton business school in Pennsylvania and went to set up a hedge fund for boutique investment bank Needham.

The hedge fund was spun off with Mr Rajaratnam at its head in 1997.

Galleon was well known for its extensive research reports, according to the New York Times, and for having many senior technology executives as its investors.

Mr Rajaratnam was investigated by the Federal Bureau of Investigation in 2007 for allegedly funding the Tamil Tiger rebel movement in Sri Lanka, the Central Bank of Sri Lanka said on Monday.

He was among several wealthy Sri Lankans who donated to the US-based charity, the Tamil Rehabilitation Organisation, which may have been funnelled to the Tamil Tigers.

"At the time Mr Rajaratnam made the donations, the TRO was not banned by the Sri Lankan government, nor the US," said DK Wijesuriya, the central bank's investigations unit head. "It was a donation made in good faith."

The central bank added that investigations are still ongoing into the matter and he had not yet been cleared.

Sri Lankan shares tumbled 3.1% on fears about the case against Mr Rajaratnam, who has substantial investments in the country.

Wider net cast

The other people arrested along with Mr Rajaratnam also hint at the scope of the authorities' ambitions.

They include Anil Kumar, a director at prestigious consulting firm McKinsey and Robert Moffat, of computer group IBM's systems and technology division.

Among the other hedge fund insiders charged are Rajiv Goel, a director of strategic investments at Intel Capital, the investment arm of microchip giant Intel.

All investors in Galleon, they are alleged to have secured inside information regarding firms including Google, AMD, and Hilton Hotels.

Hedge funds commonly hire lobbyists and other insiders as they seek to eke out every shred of profitable information about companies.

The SEC seems able and willing to go after the rest of Wall Street as it cracks down on hedge funds.

"Greed is not good," US attorney Preet Bharara told a press conference on Friday. "This case should be a wake-up call for Wall Street."

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