UPDATE 2-Judge: US omitted key facts to tap Rajaratnam

Fri Aug 13, 2010 3:20pm EDT

* Judge questions whether government wiretap necessary

* Evidentiary hearing scheduled for Sept. 7

* Judge denies motions to strike out some charges (Adds judge's opinion, lawyer statement)

By Grant McCool

NEW YORK, Aug 13 (Reuters) - Galleon hedge fund founder Raj Rajaratnam made a "substantial preliminary showing" that U.S. investigators "knowingly or recklessly" omitted key facts in seeking permission to record his telephone conversations in an insider trading probe, a judge said.

The ruling means that the 53-year-old money manager will get another day in court to argue that wiretap evidence amassed by the government should be thrown out of his criminal trial scheduled for January. The case marks the first time wiretaps were used in a widespread probe of insider trading on Wall Street.

Manhattan federal Judge Richard Holwell granted the Sri Lankan-born U.S. citizen a relatively uncommon evidentiary hearing to consider more information over a March 2008 affidavit to another judge requesting wiretap permission.

Holwell, whose opinion was dated Aug. 12 and made public Friday, set the hearing for Sept. 7.

Separately, the judge dismissed motions by Rajaratnam and his principal co-defendant, former New Castle Funds LLC trader Danielle Chiesi, 44, to strike one count of the indictment against them and other charges they said the government added.

Rajaratnam and Chiesi deny fraud and conspiracy charges related to allegations of insider trading.

In a written statement, Rajaratnam's lead attorney, John Dowd, said the judge's order is "a vindication of the principle that the government must be candid with the court when seeking permission to eavesdrop on private conversations."

Chiesi's lawyer, Alan Kaufman, declined to comment.

Holwell's order said "several key facts" omitted from the affidavit included prior probes by the U.S. Securities and Exchange Commission and the FBI, 4 million documents in evidence and transcripts of investigators' interviews with Rajaratnam and Galleon employees.

The judge wrote that the omissions "are serious enough to constitute a substantial preliminary showing that the government acted knowingly or recklessly."

"Moreover, the omissions, at least as Rajaratnam has presented them at this time, appear material to Judge Lynch's (U.S. District Judge Gerard Lynch) determination that a wiretap was justified in this case."

He wrote that the existence and scope of the SEC investigation raised a substantial question over whether the affidavit showed conventional investigative techniques "had been tried and had failed, or that there would be little use in trying them because they would likely fail."

Yusill Scribner, a spokeswoman for Manhattan U.S. Attorney Preet Bharara, declined to comment on the order.

When authorities charged Rajaratnam, Chiesi and 19 others last October and November, U.S. prosecutors described the case as the biggest probe of insider trading at hedge funds in the United States.

The case is USA v Raj Rajaratnam and Danielle Chiesi, U.S. District Court for the Southern District of New York, No. 09-01184. (Reporting by Grant McCool. Editing by Robert MacMillan)