Why executives risk their jobs to tip a hedge fund
Filed under: Columns, Investing, AMD
A hedge fund manager worth $1.5 billion was arrested on Friday, along with five executives who allegedly helped that hedge fund make $20 million. This raises some interesting questions.Why would someone worth more than a billion risk it all for a little extra change? Why would executives who are probably worth millions risk their careers to help that hedge fund make a bit of extra money? Is the hedge fund in question alone in using inside information to profit?
The answer to the first question is simple to guess at but tough to prove. It is entirely possible that Galleon, the $3.7 billion hedge fund in question, did not make a mere $20 million of its roughly 20 percent annual returns from insider trading, it is possible that most of its profit came from such trading. The answer to the next: a belief that their involvement would help them catch up with hedge fund wealth.
As to the third, so-called expert networks -- which match hedge funds with industry insiders -- proliferate. And since the calls between the experts and the hedge funds are not recorded, there's no way to know what they discuss. But it's hard to see why the hedge funds would pay if they were not getting information that would help them trade.
Could much of Galleon's profit be a result of insider trading? As I posted, one example of Galleon's alleged profiting from inside information was a result of word from Danielle Chiesi, who worked for New Castle Funds, to Raj Rajaratnam, the head of Galleon Group, that her source at Akamai (AKAM) expected its earnings to be disappointing. So Rajaratnam allegedly shorted the stock and profited when the negative news broke.
It turns out that Rajaratnam, who was released late Friday on $100 million in bail, has gotten in trouble for short selling in the past. The Wall Street Journal reports that Galleon paid $2 million in 2005 after the SEC alleged it improperly sold short 17 stocks just before the companies sold additional shares. It is not hard to imagine that Galleon got information about those share issuance plans before it became public.
Meanwhile, it is not difficult to imagine why an executive would risk a career to offer inside information to Rajaratnam. After all, despite executives' millions, they may have felt as though they were as smart or smarter than Rajaratnam and therefore deserved to be making far more money. And these executives' efforts to keep up with that hedge fund compensation warped their judgment.
So how did Rajaratnam compensate those executives? It appears that some of them were trading tips with Rajaratnam, others were invested in hedge funds that benefited from the inside information. Consider the case of Anil Kumar, the McKinsey Director -- a position that pays millions a year -- who allegedly provided profitable information about a deal regarding a McKinsey client, Advanced Micro Devices (AMD).
Reuters reports that between August and October 2008, prosecutors allege that Kumar gave Rajaratnam information about a deal involving AMD -- telling him on September 11th, 2008 that the deal would close in early October which triggered Galleon to buy AMD stock ahead of the announcement. Since Kumar had money in Galleon funds, he stood to benefit, according to prosecutors.
Are such arrangements between hedge funds and executives common? Possibly. That's because there are expert networks which according to Business Week had $250 million in revenues in 2005 -- to which hedge funds pay $1 million a year, according to Ethisphere, so they can speak with people who have in-depth knowledge of companies and industries.
While those experts are supposed to get permission from their superiors and are officially prohibited from disclosing inside information, their calls to hedge funds are not recorded, according to Portfolio. But the New York Attorney General's office and the SEC began looking into them in January 2007 in connection with possible tips to hedge funds by employees at Circuit City and other public companies, according to the New York Times.
One such expert is John Parros, who according to his LinkedIn profile was formerly president of Bebe Stores (BEBE) and is also a member of two such expert networks. Could Parros be offering hedge funds information about Bebe's earnings reports using his contacts in the industry? There is no way to know.
As I posted, one "sure" way to make money in stocks is to bet on whether a company will beat and raise when it comes to quarterly earnings and future guidance -- or disappoint. A stock will surely rise if the former happens and it will tumble if it's the latter. The one problem with this approach is that the average investor has no way of knowing ahead of time what will happen.
And one theory is that hedge funds buy such information from experts. While Galleon had a different arrangement for its alleged $20 million in insider trading profits, how many of these expert network members are trading a maximum of $500 for a half hour call to a hedge fund for inside information that helps make billionaires out of the hedge funds while the experts struggle along with mere millions?
Peter Cohan is a management consultant, Babson professor and author of nine books, including Capital Rising (due in June 2010). Follow him on Twitter. He has no financial interest in the securities mentioned.
D-Day for Harry Reid: Can he wrangle 60 votes for Senate health bill?
Fed stalls on Chinese bank deal, costs taxpayers $1.7 billion
Dell in a handbasket: Should founder Michael Dell resign?
Reader Comments (Page 1 of 2)
10-17-2009 @ 4:51PM
Greg said...
If, as Cohna reports, there are avenues of information exchange that can allow hedge funds to beat the market, a situation that is properly frowned upon and forbidden by regulators, yet cannot be tracked adequately to control the situation, what can be done to reachieve balance? Make the penalty so incredibly onerous--say, thirty in federal penitentiary--that violations won't occur? (No, of course not: capital crimes still happen). Perhaps, outlawing the type of investment known as hedge funds is the only solution? Or is it not a zero sum game; illegally operated hedge funds profits seep into the ordinary world of ordinary investors, much as a pig farm's odor seeps into the locat environment, in such quality and quantity that the benefit is worth the stench? In such case, leave the hedge funds alone, let them do their excesses, dissolve the ones that start causing noticibel damage, and tax them heavily--very heavily--for the opportunity to make of mere humans, with few ethics and an adrenaline addiction, multi-billionaires.
Reply
10-17-2009 @ 5:53PM
Charlie said...
I have a link to the criminal complaint and other official documents from the US Attorneys against Raj Rajaratnam and a very brief write up on the technical charges against him on my blog here if anyone is interested:
http://www.modernbandit.com/2009/10/billionare-founder-of-galleon-group.html
Or click here to go directly to it.
Reply
10-17-2009 @ 7:38PM
h zehner said...
Peter, You do a great job reporting on important subjects that are not normally found ( at least in such detail ) in the news media. I recently discovered your articles, with the previous expose (sic) " Five hosipal secrets you should
know " being my first encounter. You must have good
sources and do much detailed investigations to give such
outstanding reports. Thank you very much. Howard.
Reply
10-17-2009 @ 7:43PM
RJ said...
Please Chase after the bad guys for the average U.S. taxpayers and consumers.....
Reply
10-17-2009 @ 8:46PM
joey bagodonuts said...
Here's an insider tip, there will be massive layoffs for the pump and dumps, come December. Many are already relocating, bailing on their big monthy nut, due to the writing on the wall. Pumping commodities all year, making payroll, bottom is about to drop out.
Reply
10-17-2009 @ 8:47PM
TAN said...
More Greed $1.5 billion isn't enough for 1 person. Way to go Bob Moffat (millionaire) - you were a creep when I worked for IBM - Go to Jail - straight to Jail - I'll live comfortbly on my $25K IBM Pension - Creeps
Reply
10-17-2009 @ 11:41PM
tom said...
wow you say 1.5 billion,then call him a million aire,hope it was a typo.if not he is a billion aire?
10-17-2009 @ 9:38PM
Steve said...
There is an erosion of trust that cannot be measured when "experts" cheat. It is likely that the SEC has been so weakened by the last administration in the name of deregulation, that this is just a small fraction of the corruption. Make a billion and get slapped on the wrist for a mere 20 million? This behavior is un-American and treasonous in my opinion, because it undermines one of the foundations of our country. You can gussy it up with nice terms, like "insider trading" and "expert network" but it is cheating. If you did this stuff in Vegas, you would be disposed of in the desert after a severe beating.
Reply
10-18-2009 @ 11:01AM
Fair minded said...
Well said Steve. It reminds me of Charlie Rangel, a 40 yr antique, who now Chairs the Ways & Means Committee. That is of course, the Tax Code folks of our government.
This is somebody who you can apparently trust, right? NOT!!
Opps!! I "forgot" I was collecting $ 600,000 in rent!!
Every game in town is rigged. Only a sucker would trust anybody now a days. Rangel, and all the scum that he represents, have got to be sent packing.
A million dollar a year salary is a $ 20,000 per WEEK paycheck. Yet, people still feel the urge to cheat? How much do you really need?
There is no change. Yeah, a few tokens may be sacrificed, to keep the mob quite, but the wheeling and dealing, lying and stealing, just goes on. It's every man for himself from here on out.
10-18-2009 @ 8:15AM
Jaycee Catull said...
Thank you, a very good article. Let the truth about these "people" shine out!
Reply
10-17-2009 @ 10:49PM
STARR said...
The wisdom in your future is to force savings into one account, save taxes in a second account to avoid emotions upon April 15th, then you can focus on your lifestyle. Increase your savings every quarter. Pay yourself first and invest over bundles of securities vs one stock to be wisest. Make your future have more money at the end of your life than more life at the end of your money :) www.WorldStarr.com
$xo$
Blessings.
Reply
10-17-2009 @ 10:56PM
Edward said...
Gordon Gecko in Wall Street stated, ( Money is not lost or made it is simply transferred, I create nothing I own everything ). What we have here is a transfer of wealth from the middle class to the Big Corporations and Wall Street. It is inconceivable that the American taxpayer is being punished for the excesses of others. Folks there is something very wrong with this picture. Washington represents special interest and a foreign government and not the American people. Our system is broke. It is corrupt and needs to be changed. It is too cumbersome and unresponsive to the American people, and nobody in Washington is ever held accountable.
Reply
10-17-2009 @ 10:58PM
Edward said...
Take the greed out of wall street and all you have left is paper. The stock market is just one big ponzi scam.
Reply
10-17-2009 @ 11:43PM
rann948 said...
OMG Is that a BROWN face I see? Bilking the groveling masses?
Reply
10-18-2009 @ 8:23AM
Rock Fossil said...
There is a latin idiom, "Divide et Impera", literally translated means Divide and Rule, the tool of wealthy corporatists and elitist politicians.There is a weapon however; "Vox Populi, Vox Dei", translation: The Voice of the People is the Voice of God coupled with "E Pluribus Unum"...out of Many come One. This is the true strength of "We the People" to stay focused for our own self interests and know the truth. I will begin by presenting the basis of all truths and how it relates to the abysmal situation we find our country, our economy and our world in today. I promise you, you will not find this information anywhere in today's diluted, scripted Media outlets be it on TV, Radio or in newspaper print
G. Edward Griffin is a sheer genius! Why pay $100 for a financial seminar to tell you a lie. Wall street is a casino, Banks are the cash cages and you and I are the dummies pulling the handles.....take 42minutes and 15 seconds to educate yourself in a way that even bankers aren't schooled in. Take this viral folks.....send it to 10 people you love enough to wake them up to the truth of how we have been taken in a very large way! It won't cost you dime and if you think this is part of a conspiracy, just look around you and see how what you will watch is exactly what you are seeing taking place in real time.
Click on the link or copy and paste:
http://video.google.com/videoplay?docid=6507136891691870450#
Reply
10-18-2009 @ 8:26AM
john said...
This is not capitalism; it is corportatism where the government and the politicians join forces for their mutual benefit. Long before the bailouts the government made laws that provided Wall Street with massive amounts of money from pension funds and 401k's so that these manipulators could gamble with it. People could either pay taxes to the government on their full salary, or put it into a 401k for the crooks on Wall Street to use. The government could have easily exempted twenty percent of wages from taxation and allowed the workers to make their own decisons as to what they would invest their money in. Many would have just purchase CDs or tangible commodities. And while the wealthy keep the money they set the middle and lower classes against each other by fostering racial and economic animosity between group, while they walk away with the wealth. If the middle and lower classses would forget their differences, and realize the wealthy are their real enemy, the guillotine would come back ito vogue.
Reply
10-18-2009 @ 8:48AM
Vincent Benfante said...
THIS s.e.c. IS A BIG JOKE, BY LETTING ARE THESE SCAM ARTISTS GET AWAY WITH THESE SCAMS.
THE CORRUPTION IN OUR COUNTRY INCLUDING OUR GOVERNMENT IS KILLING OUR COUNTRY EVERY SINGLE DAY, IF NOTHING IS DONE TO CURB THIS CORRUPTION SOON,WE ARE HEADED TO DEFEAT.
IT ALL STEMS TO THAT /////////// case closed //////////////////
Reply
10-18-2009 @ 9:40AM
Average White Boy said...
This is how Apple always gets screwed upon earnings calls. Even though the company blows out earnings there is never really a way to tell which way shares are going after the call. There are analysts that suddenly change their predictions days before the earnings call. They'll pump the stock up raising expectations and then suddenly start casting doubt that the company can beat expectations. Many of us smaller investors think there is some manipulation of the stock going on due to the inconsistency of their predictions.
I just wish they'd catch some of these fund managers and throw them all in jail. They get too damn fat from screwing the smaller investors and in some ways shake small investors belief in the company.
Reply
10-18-2009 @ 9:45AM
jake said...
The money changers are not going to stop ORG CRIME activity until law enforcement begins using VERY long PRISON sentences and MASSIVE FINES .. use the RICO LAWS for a start .. they may have caught BERNIE MADOFF sooner if NYS SEC and NYS attorney general was not cozy with MADOFF FINANCIAL MOBSTER.
Reply
10-18-2009 @ 10:12AM
Meanstr said...
There was a time you brought stock and held that stock and got dividens from the company they made money you got some because in away you owned a piece of the Company ,The Stock Market was good.But now it has become nothing but brokers selling useless stock with inflated prices allowing the price of the stock to continue to climb so the market once again begins it's climb ,Once again some day they will pull the pug and the last one to bye the stock will find the stock useless are only worth the original price.This is what the market has become Hedge funds and Ponzi systems .Stock that is only worth something if someone else wants it.With no dividens are no real value.Close the market down the only thing that keeps it going is greed.
Reply