Galleon Group founder Raj Rajaratnam’s arrest on insider trading charges last month is likely to further damage the reputation of hedge funds at a time when the industry is just starting to come back from the Madoff scandal and investors’ ire over last year’s performance.
“It gets at the core of what the industry is,” says one prominent hedge fund executive, explaining that “hedge funds are built on the idea of better information and better analysis—information arbitrage. As an investor, how do you know whether others are doing what Raj is alleged to have done?”
This executive says he is “sure others are engaged in insider trading” and welcomes more investigations by the government. “People need to have confidence that others are behaving properly.”
Could an investor have had reason to suspect Rajaratnam? One who looked at Galleon several times but declined to invest points to two issues that kept him from signing on: An ugly lawsuit from former partner Krishen Sud and sexual harassment litigation with a female employee.
Ever since Rajaratnam started his hedge fund at Needham & Co., where he was running the broker/dealer, there were potential conflicts, says one person who met Rajaratnam then and later invested. “The selling point of the fund was that 85 of the 99 investors were CEOs or CFOs of major tech companies, and through talking to them, Rajaratnam said he got incredible information,” he recalls. “But nobody interpreted that as saying ‘ These guys are just breaking the law and feeding him insider information.’ ”
When Rajaratnam left Needham in 1997, he took his fund and renamed it Galleon Technology, the firm’s flagship until 2005. But as Galleon tried to attract more institutional money, it created a number of additional funds as well as a feeder; none of their returns matched that of the initial technology fund.
Rajaratnam has denied the insider trading charges. Facing massive redemption notices, Galleon is closing and returning funds to investors, but it’s unclear if those funds will be used to pay Rajaratnam’s legal defense or if investors will have to disgorge profits, if obtained illegally.
