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The Rajaratnam Conviction: How Big a Victory?
Raj Rajaratnam's conviction is the biggest blow against insider trading in a generation. Unfortunately, the Galleon case shows the problem is worse than ever

By Paul M. Barrett, Katherine Burton and Saijel Kishan

Congratulations to the prosecutors and FBI agents responsible for the sweeping insider-trading conviction on May 11 of Raj Rajaratnam. The good guys won a round. Do not, however, take the wrong lesson from the government's triumph. The nailing of the Galleon Group hedge fund tycoon doesn't mean the end of insider trading any more than a roundup at Rick's Cafe meant the end of gambling in Casablanca. What the seven-week trial revealed is that insider trading is even more pervasive than previously thought.

Even as the Feds use wiretaps and other sophisticated methods to police the financial industry, the schemers and schemes are proliferating. Wall Street, the Galleon case shows, is all about insider trading.

To his credit, the Street's main beat cop, Manhattan U.S. Attorney Preet Bharara, has conceded lately that illegal trading is "rampant." More prosecutions are on the docket, but: "Insider trading can't be stopped by a case or two," says Bruce A. Baird, a partner with law firm Covington & Burling in Washington. As a young prosecutor, Baird worked on the Ivan Boesky-era illegal-trading cases in the 1980s. If anything, opportunities to profit on secret information have mushroomed since Boesky's day, as have the cast of characters with access to valuable tidbits. Greed and the will to best competitors, he says, "are powerful instinctive human drives."

The Galleon trial involved an enormous and varied troupe of players. At the end, a federal jury found Rajaratnam, 53, guilty of engaging in a seven-year conspiracy to trade on illegal tips from corporate executives, bankers, consultants, traders, and directors of public companies, including Goldman Sachs (GS). It was the largest and most important insider-trading case in a generation. Rajaratnam, a U.S. citizen born in Sri Lanka, gained $64 million, prosecutors said, and at a sentencing hearing scheduled for July 29, faces 19½ years in prison. All told, more than 40 people have pleaded guilty or face criminal charges or civil lawsuits stemming from a nationwide investigation that has roots going back to 1998.

The most striking aspect of the case was the sheer volume of obscure financial-world figures with access to potentially lucrative tips—and an inclination to sell them. "The government's recent insider-trading prosecutions have shined a light on both the recent democratization and globalization of what is allegedly inside information," says Adam J. Wasserman, a white-collar criminal attorney at the Dechert law firm in New York. "It's not just in the hands of CEOs and CFOs anymore."

The FBI's investigation started with Roomy Khan, a former Intel (INTC) engineer who gave semiconductor pricing and sales data to Galleon, according to the government. She later worked at the New York-based hedge fund and eventually cooperated with the government as part of a plea bargain. Among those charged is Zvi Goffer, a 34-year-old day trader known among colleagues as "Octopussy." The James Bond-themed nickname alluded to his many sources of tech industry gossip. He has pleaded not guilty and awaits trial later in May.

The Galleon investigation took jurors into the murky world of expert-network firms, a new breed of middlemen that market nonpublic corporate information. For a fee, the firms connect hedge fund traders with talkative corporate workers. (If this sounds like an invitation to monkey business, it is.) Evidence in the Galleon case showed that one such network, Primary Global Research, paid Manosha Karunatilaka, a former U.S. account manager at Taiwan Semiconductor Manufacturing (TSM), $200 per phone call to reveal production reports on the chipmaker's largest customers. The information went to hedge fund traders. Karunatilaka, 37, pleaded guilty the day of the Rajaratnam conviction. Eight Primary Global employees or consultants crossed the line by divulging confidential information, according to the government.

In the Boesky days, insider trading cases were primarily a domestic affair. No more. "For any analyst or portfolio manager, information is more readily available now that the supply chain is predominantly global in nature," says Peter Rup, chief investment officer of Artemis Wealth Advisors, which allocates client money to hedge funds. "The dissemination of material information is beyond the reach and control of U.S. regulators."

Consider Don Ching Trang Chu, a Primary Global employee arrested at his home in Franklin Township, N.J., in November. He had a cadre of Asia-based employees of North American tech companies signed up to feed information to clients, prosecutors say. Chu arranged investor meetings in Asia because regulators aren't aggressive there. The U.S. Securities and Exchange Commission, by contrast, is "too strong," he said in a conversation recorded by the FBI in August 2009. In Asia, he added, "nobody cares."

Hedge funds, a fledgling industry in the mid-1980s, have taken center stage as major moneymakers. In 1990 there were 70 of them managing $39 billion. At the end of 2010 there were 2,600 managing $1.7 trillion, according to data compiled by Bloomberg. Some fund managers, including Rajaratnam, have made fortunes betting on short-term stock moves triggered by such events as surprises in quarterly earnings. "There are a lot more tradable events today than before—it's not just mergers," says Daniel Celeghin, a partner at Casey, Quirk & Associates, a financial-consulting firm in Darien, Conn. "There's so much more valuable information out there, and the odds of inside information leaking have risen exponentially."

Combine that shift with a profit-by-any-means-necessary ethos, and you get Galleon. "It's a more cutthroat business," says Celeghin.

Before Rajaratnam co-founded Galleon, he was president at Needham & Co., an investment bank. A former colleague remembers him walking into the trading room before Intel reported earnings and telling the employees assembled there exactly what the company's numbers would be. Rajaratnam told potential clients that if his analysts needed to date someone's secretary to get advance information, he'd foot the bill, according to people who met with him.

It would be easier to contain hedge fund pirates if there were a federal statute clearly defining insider trading. Amazingly, there isn't one. Prosecutors have to strain for convictions under other fraud theories. Unfortunately, Wall Street's fear of empowering investigators will preclude Congress from remedying that gap.

Their belts decorated with notches from the Galleon shootout, investigators and prosecutors will mosey along, doing the best they can. The candid among them will view the Rajaratnam verdict with sober eyes. "I wish I could say that we were just about finished investigating pervasive insider trading," Bharara, the U.S. Attorney, said during a press conference last month. "Sadly, we are not."

With David Glovin, Patricia Hurtado, and Bob Van Voris. Barrett is an assistant managing editor at Bloomberg Businessweek. Burton and Kishan are reporters for Bloomberg News.
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