UPDATE 2-Rajaratnam manager testifies he gave his boss tips

Tue Mar 29, 2011 6:35pm EDT

* Money manager Adam Smith testifies against former boss

* Tipped by Morgan Stanley banker -trial testimony

* Pressure to get "edge" in trades at Galleon, Smith says (Updates with Smith testimony on "two torpedoes" strategy)

By Basil Katz

NEW YORK, March 29 (Reuters) - A former portfolio manager at Raj Rajaratnam's Galleon Group described pressure at the hedge fund to get "an edge" in trading and said he gave inside tips from a Morgan Stanley (MS.N) investment banker to his boss.

The testimony on Tuesday of Adam Smith, the first former Galleon employee to testify at the trial, provided a glimpse into the inner workings of Rajaratnam's hedge fund.

Smith said he passed on confidential information to the one-time billionaire, including periodic email updates written in code on a pending merger he learned of from the banker.

Smith, 39, said he referred to the two companies, Integrated Circuit Systems and Integrated Devices Technology, in code as the "two eyes" to Rajaratnam. The deal was announced in June 2005 and was valued at $1.7 billion at the time.

"I remember after the announcement having a sinking feeling in my stomach that this may be a problem," he said on the witness stand in Manhattan federal court in the biggest Wall Street insider trading scandal trial in decades.

Sri Lankan-born Rajaratnam, 53, is accused of making $45 million in illicit profit between 2003 and 2009 on stock tips from high-placed corporate insiders. He has vowed to clear his name at his criminal trial, arguing his trades were based on research or publicly available information.

Smith pleaded guilty in January and said he leaked details about merger activity and earnings reports to Rajaratnam and others at Galleon.

Smith was calm on the witness stand, leaning on an elbow and chewing gum as he answered questions. He described everyday operations at Galleon, including intense 8:30 a.m. meetings with analysts.

He said combining a tidbit of confidential information on a company with solid research on its sector was often called "having two torpedoes in the water."

"If one of them misses, the other is likely to hit."

LEAKED DETAILS

He said Kamal Ahmed, a Morgan Stanley banker in California, tipped him about the pending merger of Integrated Circuit and Integrated Devices in 2005.

About a year later, Smith had lunch with Ahmed at a Chinese restaurant in Stanford, California, where the Morgan Stanley banker leaked details of Advanced Micro Devices Inc's (AMD.N) interest in buying ATI Technologies Inc. Immediately after the lunch in May 2006, Smith said he passed the news of the pending takeover to Rajaratnam.

No charges have been announced against Ahmed. Morgan Stanley said in January that the banker had been put on leave.

Ahmed's lawyer, Douglas Tween, was not immediately available for comment on Tuesday. Tween has said previously that Ahmed was cooperating with Morgan Stanley in its investigation and that he did nothing wrong.

Smith testified there was pressure at Galleon for "getting an edge" -- extra pieces of information where a company's results might differ from Wall Street expectations.

"Research is sort of doing your homework ahead of time," Smith said. "Getting the number is more like cheating on a test ... I knew the answer ahead of time."

MCKINSEY CONNECTION

Rajaratnam is accused of assembling a web of high-placed contacts who provided him illicit stock tips. Prosecutors contend that former Goldman Sachs Group Inc (GS.N) board member Rajat Gupta, who has not been criminally charged, leaked details about the bank to Rajaratnam.

Also on Tuesday, prosecutors introduced McKinsey & Co consultancy phone records to show that Gupta, a former global head of the elite management firm, called Rajaratnam seconds after Goldman board meetings in 2008.

A McKinsey manager responsible for IT security testified that Gupta dialed into Goldman Sachs board meetings on Sept. 23, 2008, and Oct. 23, 2008, from a conference room phone in the consultancy's New York office. Gupta maintained an office, email and phone at McKinsey after he retired in 2007.

"Our firm no longer has a professional relationship with Rajat Gupta," a McKinsey spokesman said in a statement.

The case is USA v Raj Rajaratnam et al, U.S. District Court for the Southern District of New York, No. 09-01184. (Additional reporting by Grant McCool; writing by Martha Graybow, editing by Matthew Lewis, Gerald E. McCormick, Gary Hill)

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