The Galleon hedge fund, and trading on inside information

Galleon surprises

Newspapers have been full of stories about the rise and fall of the Galleon hedge fund run by Raj Rajaratnam, former research head at Needham.  Among the more striking revelations, to me at any rate, are:

1.  the level of annual brokerage commissions the group generated.  The $250 million figure mentioned by reporters would be 3.6% of the group’s peak assets of $7 billion.  That’s easily 10x the fees paid by a traditional fund management group dealing in equities.

2.  the speed with which the group’s assets have been unwound–implying that Galleon dealt primarily in plain-vanilla stocks and bonds.

3.  the fact that indicators of potential ethical or legal problems had been around for years, but not picked up on by the regulators.  The papers have cited a JP Morgan memo from 2001, as well as previous prosecution of the woman who is now the government’s chief witness against Galleon, in a case where Galleon was reportedly involved but not investigated.

4.  the list of senior executives, from Intel, IBM and McKinsey, among others, who the government asserts had been supplying Galleon with inside information for years.

5.  the–to me, anyway–curious lack of motivation cited so far for these executives to risk the loss of their careers and the chance of jail by providing Galleon with information they were obligated to keep secret.

Where’s the motive?

The only hint of possible motivation I’ve sen so far for prominent tech firm executives to have given company secrets to Galleon from an article in the Financial Times. It says that a number of the executives in question had personal investment accounts with Galleon.  The article questions whether having a Galleon account constituted a conflict of interest.  It also points out that there are no real standards governing executives’ private investing activity and that what rules corporations may have are often only laxly enforced.

What the article seems to imply is that the executives figured that the inside information would improve Galleon’s results, and thereby increase the value of their Galleon investments.  That’s kind of a stretch, though.

I suspect the Galleon affair may develop along the same lines as the investigation of former junk bond king, Michael Milken.  In fact, the story of a disgraced Fidelity junk bond portfolio manager from that time, Patricia Ostrander, appears strangely similar to what we’ve heard so far about the Galleon providers of inside information.

When the authorities were closing in on Milken, one of his associates told them about the “MacPherson partnership,”  an investment vehicle Milken set up and supposedly used as a reward to junk bond portfolio managers whose funds participated in worthless IPOs.  Portfolio managers would “invest” $5000-$10,000 in MacPherson and in short order cash out for $750,000 or so.

There’s also a simpler possibility.  So far there’s no information about the performance of the accused tippers’ Galleon accounts.  They may all turn out to be mini-MacPhersons.  If so, let’s hope the SEC is looking.

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