THE CRIMINAL insider trading case against billionaire investor Raj Rajaratnam and his Galleon hedge funds represents a significant ramping up of the US commitment to tackle market abuse. Court documents in the case claim to reveal extensive use of confidential witnesses and the first wiretaps in an insider dealing case. Such tactics are reminiscent of the approach the US has long used to tackle mobsters and drug gangs but their use is novel in this kind of white-collar crime.

The allegations open a window into a kind of information trading that authorities say is illegal and New York and London insiders say powers high returns at many hedge funds and proprietary trading firms. Studies suggest suspicious trading precedes more than one out of every four takeover announcements.

"After years of brimming rumours that hedge funds were getting these tips, it is heartening to see the government go after it," said Daniel Richman, a Columbia University law professor. "This is really different in terms of what the government is willing to do to get information."

Robert Khuzami, enforcement director of the US Securities and Exchange Commission, said the case was part of his agency's redoubled effort to prevent market abuse.

According to court documents, the investigation got going after a single US trader netted $630,000 on Hilton options after Blackstone announced a takeover of the hotel company. The same trader took home $500,000 two weeks later when Google announced disappointing earnings.

Within four months, the SEC was so hot on the trail that the trader agreed to flip and tell all. The resulting information helped lift the lid on what prosecutors alleged is the biggest insider trading scheme involving hedge funds. Rajaratnam and executives at Intel, IBM, Bear Stearns and McKinsey have all been charged with criminal conspiracy and insider trading. Traditionally market abuse by hedge funds is all but impossible to spot and punish, because they place so many punts at a time that they can always argue they got lucky. But in this case, the informant and the wiretaps enabled prosecutors to home in on what they say is insider dealing.

According to complaints filed by the SEC and prosecutors, corporate insiders at Google, IBM and Intel all allegedly passed on tips about earnings and merger announcements to traders for Rajaratnam's Galleon hedge funds and Bear Stearns' New Castle hedge fund. They in turn stand accused of sharing it among themselves and trading for either their own or their funds' accounts. "The defendants operated in a world of, you scratch my back, I'll scratch your back," said Preet Bhara, the US attorney whose office brought the case. Jim Walden, a lawyer for Rajaratnam, said: "My client is innocent and we are going to fight the charges."

The court documents paint a picture of the original tipster, called Tipper A in the SEC complaint, as a former Galleon employee who ran into financial trouble. The tipster approached Galleon in 2005 about a job and proffered inside information from an executive of Polycom, the US technology company, about forthcoming earnings to Rajaratnam, the complaint says.

Tipper A allegedly provided inside information about Polycom's earnings in both January and April of 2006 and then also allegedly passed on the tips about Hilton and Google to Rajaratnam in July of that year. The SEC claims that the Galleon funds made upwards of $14 million on those tips alone.

Once the FBI won permission to tap Rajaratnam's mobile, it claimed to have captured him and other defendants allegedly sharing information. At one point, Danielle Chiesi, a New Castle portfolio manager, allegedly asked Rajaratnam whether he would be be buying stock in AMD "if the two of us weren't close to the company". "I wouldn't," Rajaratnam allegedly replied. Ms Chiesi added she "would not have touched it with a . . . 10ft pole."

"We are going to see a surprising number of classic fraud-style cases," predicted Jacob Frenkel, a former SEC enforcement lawyer. "This really is the tip of the iceberg." - (Copyright The Financial Times Limited 2009)

(c) 2009 Irish Times. Provided by ProQuest LLC. All rights Reserved.

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