Galleon founder's fate may help sink the group

BOSTON Tue Oct 20, 2009 4:28am EDT

Galleon hedge fund partner Raj Rajaratnam is escorted by FBI agents after being taken into custody in New York October 16, 2009. Rajaratnam and five others were charged with crimes including securities fraud and conspiracy involving insider trading that generated more than $20 million in profits, U.S. prosecutors and the FBI said. REUTERS/Brendan McDermid

Galleon hedge fund partner Raj Rajaratnam is escorted by FBI agents after being taken into custody in New York October 16, 2009. Rajaratnam and five others were charged with crimes including securities fraud and conspiracy involving insider trading that generated more than $20 million in profits, U.S. prosecutors and the FBI said.

Credit: Reuters/Brendan McDermid

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BOSTON (Reuters) - Raj Rajaratnam attracted some of Wall Street's savviest investors to his hedge funds. Now his arrest could put his Galleon Group out of business and spark fresh calls in Washington for tighter industry regulation.

A number of pension funds and endowments put money with Rajaratnam, helping the 52-year old billionaire build Galleon Group into one of the world's biggest hedge funds with $7 billion (4 billion pounds) in assets at its peak last year. U.S. financial regulators said the fund had $2.6 billion in assets as of March.

Rajaratnam's degree from the University of Pennsylvania's prestigious Wharton School, his long history at Needham & Co -- a New York-based investment bank that specializes in technology and health-care companies -- and the way he set up Galleon with a number of partners -- Krishen Sud, Gary Rosenbach and Ari Arjavalingam -- appealed to many investors.

"How he set up the firm was exactly what you wanted to see," said Michael Hennessy, managing director at Morgan Creek Capital Management, which invests $9 billion with hedge funds. Hennessy said he met Rajaratnam many times but never invested with him.

Now investors who once counted themselves lucky for getting access to one of the industry's finest technology hedge funds may be running for the exits, frightened by news that Rajaratnam was arrested and charged with running the biggest-ever insider trading scheme involving a hedge fund, industry analysts and lawyers said.

Rajaratnam was charged, along with others, with making up to $20 million in illegal profits through a network of secret informants over several years.

Rajaratnam's lawyer, Jim Walden, did not have any comment.

"This may shutter Galleon," said Ron Geffner, a partner at law firm Sadis & Goldberg LLP, who works with hedge funds and their investors. "But there is not yet enough information to determine that," he cautioned.

Many industry analysts feel the fund group, once ranked among the three top technology hedge funds, is doomed.

Pequot Capital, which shut down earlier this year as the government revived an insider trading investigation, and Bowman Capital, which shut down in 2002 amid losses, were considered the other top technology hedge funds, industry analysts said.

Rajaratnam built his empire by hiring top talent, driving his analysts hard and allowing portfolio managers to set up many funds. Besides the Galleon Diversified Fund, the group also ran portfolios with names like Captain's, Admirals and Buccaneer's funds, all playing on the maritime motif Rajaratnam chose for himself in 1997.

Geffner said some wealthy individuals may, however, remain loyal to other fund managers at the group who have not been accused of wrongdoing.

Institutional investors, however, including pension funds, likely have to quit any and all Galleon portfolios immediately, given their requirements to exit a management company if something happens to a key individual at the firm.

Usually these clauses refer to managers leaving the firm, but having the founder accused of insider trading and led away in handcuffs would also qualify, several lawyers said.

With investors still shellshocked from the Bernard Madoff and Allen Stanford Ponzi schemes, hedge fund investors said many are likely to want to get out as fast you can.

"I don't think any big investor would hang around and wait for the verdict when they see headlines in the newspaper every day," said one person who invests with hedge funds but asked not be named since he cannot discuss his investments publicly.

The headlines are bound to add fresh fuel to calls on Main Street and in corners of Congress to demand new information from hedge fund managers who zealously guard strategies, often telling no one exactly how they make money.

"That fire has already exploded into an atomic bomb," Sadis & Goldberg's Geffner said, referring to Congress' efforts to create new laws for the $1.4 trillion business that has until now not had to report its performance numbers or other information the way mutual funds are required to.

Indeed the SEC's move against Galleon may also help secure new resources at an agency that has been harshly criticized for having ignored tips to huge financial scams.

But hedge fund industry insiders also warned against tarnishing the entire industry with one person's actions. "This is not necessarily a reflection of what happens at a typical hedge fund," said Stewart Massey, founding partner of Massey, Quick & Co, which invests in hedge funds. "Insider trading is a reflection of a character flaw with an individual and not an industry. It is about personal greed."

(Reporting by Svea Herbst-Bayliss; Editing by Phil Berlowitz)

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