Rajaratnam arrest spurred hedge funds to clean up

Thu Mar 10, 2011 3:06pm EST

* Insider trading probe scares hedge funds into changes

* Compliance is new watchword as Rajaratnam trial begins

By Svea Herbst-Bayliss and Grant McCool

BOSTON/NEW YORK, March 10 (Reuters) - Between warnings on what to say in emails, sweeps for listening devices and lessons on securing laptops, life has become more constrained at hedge funds since Raj Rajaratnam was arrested for insider trading.

In the 17 months between the arrest of the Galleon Group co-founder and the start of his trial this week, the $1.9 trillion hedge fund industry has scrambled to change its image from a band of freewheeling traders to compliance-conscious businesses by putting new rules and practices into place.

Fund firms like Paulson & Co and Millennium Management have spent millions to hire former regulators as advisers. Others have restricted employees' personal trading and warned about the use of personal cell phones on the job. Still others have brought in lawyers and consultants to host seminars on how to keep data safe -- that includes always keeping a hand on company laptops loaded with client information and trading strategies while in airports.

And some are even shunning so-called expert networks as the government's probe intensifies into whether these middlemen might be passing along nonpublic information, hedge fund managers, investors, industry lawyers and consultants said.

"For some time, hedge funds have clamped down, tightening compliance procedures, and making sure that they've got their staff trained on them," said Peter Turecek, senior managing director at risk consulting group Kroll Inc.

While compliance lacks the sexy ring long associated with millionaire hedge fund managers making big and noisy bets, it is now the key to survival in an age where the tiniest whiff of scandal sends investors running for the exits.

For example, three of the four hedge funds raided late last year as part of the ongoing insider trading probe that began with Rajaratnam have shut down. They were leveled, in part, by heavy investor redemptions even though no one at any of the firms was accused of wrongdoing.

POWERFUL WARNINGS

The fourth raided firm, Diamondback Capital Management, is still in business after taking investor friendly steps including frequent email updates and phone calls to -- for now, at least -- keep on board big-name clients like New Mexico's and New York's pension funds.

While the bulk of hedge fund managers are probably not relying on insider information to make trades, industry experts are busy warning people to beware of what they write and say.

"Employers have the right to look at emails," said Kroll's Turecek, whose company has been hired to help many hedge funds with assessing risks. "Even after you hit the delete button, the email can still be found. People write the most inappropriate things, whether it is about inter-office love affairs or ethical issues," he said.

But the government's revelation that it intercepted more than 2,400 of Rajaratnam's and at least 130 other individuals' private telephone conversations might have had the biggest effect on the industry, hedge fund managers and lawyers said. Rajaratnam lost his bid to suppress the evidence from trial.

"For those in the hedge fund world who are used to speaking without concern that anyone is overhearing them, there has been a bit of chill that's run through that community," said Richard Strassberg, a partner at law firm Goodwin Procter.

Indeed some hedge funds are worried enough about the prospect of someone listening in that they have hired security firms to search for listening devices when moving into a new office or expanding an old one.

One executive at such a firm, who asked not to be identified to keep the business confidential, said that clients are generally more worried about rivals stealing their ideas instead of the government listening in when they pay firms to sweep for bugs.

While compliance lacks the sexy ring long associated with millionaire hedge fund managers making big and noisy bets, it is now the key to survival in an age where the tiniest whiff of scandal sends investors running for the exits.

For example, three of the four hedge funds raided late last year as part of the ongoing insider trading probe that began with Rajaratnam have shut down. They were leveled, in part, by heavy investor redemptions even though no one at any of the firms was accused of wrongdoing.

POWERFUL WARNINGS

The fourth raided firm, Diamondback Capital Management, is still in business after taking investor friendly steps including frequent email updates and phone calls to -- for now, at least -- keep on board big-name clients like New Mexico and New York's pension funds.

While the bulk of hedge fund managers are probably not relying on insider information to make trades, industry experts are busy warning people to beware of what they write and say.

"We warn people that employers have the right to look at emails," said Kroll's Turecek, whose company has been hired to help many hedge funds with assessing risks. "Even after you hit the delete button, it is still there and people write the most inappropriate things whether it is about inter-office love affairs or ethical issues," he said.

But the government's revelation that it intercepted more than 2,400 of Rajaratnam's and at least 130 other individuals' private telephone conversations, might have had the biggest effect on the industry, hedge fund managers and lawyers said. Rajaratnam lost his bid to suppress the evidence from trial.

"For those in the hedge fund world who are used to speaking without concern that anyone is overhearing them, there has been a bit of chill that's run through that community, said Richard Strassberg, a partner at law firm Goodwin Procter.

Some hedge funds feel so worried enough about the prospect of someone listening in that they hire Kroll or other security firms to search for listening devices when moving into a new office or expanding an old one.

"We've swept for bugs," Kroll's Turecek said adding "We've got a handful of clients who come to us for that service but mostly they are worried about their rivals possibly listening and getting an advantage, not the government listening." (Editing by Steve Orlofsky)

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