What Raj Knew

Integrity is telling myself the trust. And honesty is telling the truth to other people.

Here at Honestly Lay Bare Central we love nothing better than a story about an executive that has got to big for their boots ... thought that they were above it all and that laws and rules only applied to other people.

So when a Honestly Lay Bare subscriber and friend (to date not a mutually exclusive categorisation!) brought our attention to a meeting that they had a couple of years ago with a person with an 'entitlement complex' ... someone that thought that they were above it all ... we couldnt resist digging further.

Then we found out that 'entitlement complex' fellow was associated with the Galleon Group ... a now notorious company which was until this month one of the largest hedge funds in the world.

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A galleon was a large, multi-decked sailing ship used primarily by the nations of Europe from the 16th to 18th centuries. Whether used for war or commerce, they were generally armed with the demi-culverin type of cannon.

They were used in both military and trade applications, most famously in the Spanish treasure fleet, and the Manila Galleons. In fact, galleons were so versatile that a single vessel may have been refitted for wartime and peacetime roles several times during its lifespan.

It was after these magestic ships that the Galleon Group was named.

Now before we go on ... what follows is being contested by the named persons at Galleon Group (Our lawyers told us to say that!).

Galleon Group founder Raj Rajaratnam; Danielle Chiesi and Mark Kurland of hedge-fund firm New Castle Partners; and executives at IBM, Intel Corp. and McKinsey & Co. were arrested earlier this month on charges they were part of a network that trafficked in private, market-moving information about upcoming earnings reports and acquisitions.

Rajaratnam is alleged to have made roughly $20 million in profit from trading on insider information about companies including Akamai Technologies Inc., Google Inc., Hilton Hotels and Polycom Inc.

Federal prosecutors used wiretaps over a period of roughly two years to track the activities and conversations of Rajaratnam, Chiesi, Kurland and others. The official techniques employed in this case have been used successfully against the Mafia and drug cartels, but prosecutors plan to rely on them more to track down insider trading and other white-collar crime.

Chiesi spent a lot of time wooing company executives to get information, which she shared with Rajaratnam and Kurland, according to federal charges filed against her earlier this month.

On July 24, 2008, Chiesi called Rajaratnam and told him she was talking to an unidentified Akamai executive "about the family" and how "you're the only person in the family that helps me," the charges allege.

Chiesi then told Rajaratnam the Akamai executive had told her the company was going to "guide down a lot" when it reported quarterly results the following Wednesday. The executive also told her that the company's stock could fall as low as $25.

Rajaratnam said he would be "radio silent" and told Chiesi to keep shorting Akamai shares, which she allegedly did on behalf of New Castle.

After the stock market closed on July 30, Akamai released results and said it expected earnings per share for the following quarter to be below analysts' expectations. The stock opened the next day down roughly 20% at $25.06.

Rajaratnam called Chiesi to thank her for the information. New Castle unwound its negative bets on Akamai the next day, making a $2.4 million profit, according to federal prosecutors.

In September, Kurland told Chiesi to contact the Akamai executive again. She said it was a "scary thing to do."

"Call him ... let him talk," Kurland replied, according to federal prosecutors.

A week later, the Akamai executive called Chiesi and suggested that Akamai didn't drop its earnings guidance far enough when it reported quarterly results in July. Chiesi then advised the executive to buy shares of chip maker Advance Micro Devices Inc. (AMD), based on insider information prosecutors say she got from Robert Moffat, a senior executive at IBM.

Chiesi and Rajaratnam also talked about the value of her contact at IBM. They discussed the possibility of him moving to another company.

"Put him in some company where we can trade well," Rajaratnam allegedly said.

Chiesi also suggested Moffat would be more valuable if he stayed at IBM. "This guy is giving me more information. ... I'd like to keep him at IBM right now because that's a very powerful place for him. For us, too."

"Only if he becomes CEO," Rajaratnam replied.

Moffat ended up proving his worth in early 2009, prosecutors claim.

In January, Moffat was among nine IBM executives doing due diligence on Sun Microsystems Inc. because IBM was considering buying the company. Prosecutors say Moffat told Chiesi that Sun would beat quarterly expectations before the company's results came out.

"The only way ... he would know is because I know they were doing due diligence," Chiesi told a cooperating witness in the government's case. "The only reason my guy would know that is because it's his deal. Like, he's in bed with them."

A day later, on Jan. 27, Sun reported quarterly revenue that topped analysts' forecasts. New Castle made a profit of more than $900,000 as Sun's shares rallied after the report, prosecutors say.

Chiesi also asked Rajaratnam for advice on making sure her trading didn't catch the attention of regulators. She was worried that if AMD shares rose a lot, her large purchases of stock might attract attention.

"I think you should buy and sell, buy and sell," Rajaratnam said, according to federal prosecutors.

Rajaratnam emphasized the importance of being quiet and boasted about his access to information on other companies. "On Akamai or IBM, anything, be radio silent," he said. "Like, you know, I get shit on lots of companies."

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Putting aside the joys of listening in on someone else's phone conversations ... we bring this case to your attention because it is 100 years since the concept of insider trading was formalised in the United States judicial system.

In 1909, the Supreme Court in Strong v. Repide gave impetus to the trend allowing recovery by plaintiffs where inside information was abused.

Strong v. Repide was an insider trading case arising from the sale of stock in the Philippine Sugar Estates Development Company to one of the directors of the company. The defendant, while negotiating the purchase of the plaintiff's stock, was simultaneously negotiating the sale of the corporate land assets to the Philippine government.

The defendant took extraordinary efforts to conceal the information about the negotiations. As a result, the purchaser was able to obtain the stock from the stockholder for about one-tenth of its actual value.

In a decision written by Justice Peckham, the Supreme Court held that under the particular facts of the case, "the law would indeed be impotent if the sale could not be set aside or the defendant case in damages for his fraud.

This "special facts or special circumstances" rule meant that although directors generally had no duty to disclose material facts when trading with shareholders a duty might arise where there were special circumstances, such as concealment of the defendant-purchaser's identity (the corporate officer had used an agent go-between to avoid detection of his actions by the seller here) and a failure to disclose significant facts that materially affected the price of the stock.

100 years on there is still insider trading.

For as long as there is profit to be made by knowing information that others dont know, Honestly Lay Bare is confident that it will always be there!