BUSINESS FINANCE - Research Paper Example

? BUSINESS FINANCE Introduction and Background of the Study The Galleon Group was the finest and most renowned hedge fund managing companies which managed over $6.9 billion of funds. The company was launched by Raj Rajaratnam in the year 1997 who was the president of Needham & Company and an equity analyst as well. The firm was headquartered in New York City and it became defunct on October 21, 2009. Rajaratnam is Sri Lankan who was born in Colombo, Ceylon. He earned an MBA degree from Wharton school (Pennsylvania University) and maintains residence in Connecticut, New York, Florida and George Town. Rajaratnam was entitled by the Forbes magazine as the self-made billionaire hedge fund manager and was also the 235th America’s richest men in the year 2009. As on 2009, the total net worth of Rajaratnam was over $1.88 billion. Thus, he was the richest Sri Lankan born entity in the world. He started his career business loan specialist to technology firms was working as the lending officer of Manhattan Bank. Then in the year 1985, Rajaratnam joined Needham & Co. as investment banker a focused on consumer electronics industry. It is extremely astonishing as well as praise worthy fact that from here Rajaratnam was promoted as the head of research at Needham & Co. in the year 1987 (just in a span of two years). He was then promoted to President of Needham & Co. in the year 1991, at the age of only 34 years. When he was at the pinnacle of the company, Rajaratnam seeded his own hedge fund company that he initially named as the Needham Emerging Growth Company and then later renamed it to Galleon. The hedge fund company Galleon was valued close to $4 billion in the year 2009, down from the peak value of $7 billion in the year 2008. According to the annual report of Galleon for the year 2009, the diversified hedge fund company had over 22% compounded annual returns since its inception. One of the reason for the company’s tremendous success and peak valuation for the year ending 2008 was the sudden collapse of Lehman Brothers and global financial crisis that encouraged firms to adapt aggressive hedging strategy. From the financial statements of the company from the year 2000 to 2008, it can be said that Rajaratnam invested primarily in pharmaceutical and technology sectors. The basic reasons behind such investment strategy could be: one, seeking growth of income as objective and two, both the sectors are defensive and export oriented. Rajaratnam was very knowledgeable to realize the importance of technology sector in future and so he knew that by investing in technology stocks at present would maximize shareholders’ wealth in future due to capital appreciation of the stocks. The demand for drugs and medicines on the other hand will always persist and probably increase in future with the rise in population. According to one of the face to face interviews by Rajaratnam, he said that the best ideas are outcomes of frequent visits to companies in which his company invested and also from regular conversations with the hedge fund managers. In the year 2009, Rajaratnam along with five others were charged and arrested for insider trading and multiple frauds conviction. The founder of Galleon fund, Rajaratnam pleaded that he was not guilty and paid $100 million bail to remain free (which was the largest bail amount in the history of United States). But in May 2011, a US district court found Rajaratnam guilty and then on October 2011 he was sentenced to 11 year imprisonment by the US district judge Richard Holwell. Other current and former traders of Galleon were charged and arrested with allegation of involvement in insider trading activity and alleged conspiracy. It is important to mention that several former employees of the organization cooperated in the investigation process. It was also reported in media that as of January 2012, over 50 people were either convicted or pleaded guilty from the Galleon hedge fund scandal (Hristova, 2012, pp.1-3). Overview of Insider Trading The Galleon insider trading case was one of the biggest hedge fund insiders trading case in decades. The case was highly publicized since October 2009 and finally in year 2011, the trial convicted Rajaratnam guilty of tapping wire in insider trading and he was prosecuted for 11 years of imprisonment. Similar to the Galleon hedge fund scandal and Rajaratnam trial, the government brought charges to a similar sort of case against Rajat Gupta, a high profile tipper of Rajaratnam, who was also the former chief executive officer of Goldman Sachs and McKinsey & Co. The term insider trading is used to define trading of confidential information to interested parties without the consent of the board of directors and the company. It is considered as an illegal activity since the impact of insider trading on minority shareholders is immense and uncontrollable. In legal terms the insider trading is said to occur when certain corporate individual who is a major stakeholder of a certain company sell or buy stocks of his or her company without disclosing transaction to Securities and Exchange Commission. However, if the event of buying and selling is informed to SEC before the actual transaction, then such trading will be considered as legal. Again, if someone overhears some confidential business critical information while travelling or outside board room and then takes buying or selling decision, such a trading is considered to be legal. Thus, the definition of insider trading is very vague and ambiguous. From the research it was found that the true definition of insider trading or illegal trading was not defined federal securities law. According to a much generalized version of the definition of insider trading, it is said to occur when an individual sell or buy security while possessing private or non-public information which if leaked would lead to breach of trust. Under the current law of insider trading, it imposes the liability of illegal trading on the individual who accesses confidential non-public information through fraudulent activities and then by leveraging such information he or she trades shares of respective company. The one who accesses private information illegally is called the “tippee” where as the person with whom the information is shared is known as the “tipper”. The definition will hold true as long as the tippee is aware that such leak of information would be breach of trust. In most of the insider trading cases the central issue of the matter was concerned with sale of equity instruments including put and call options. But the insider trading cases may also be involved in debt instruments such as bonds. Thus, the criminal charges on insider trading may apply to any underlying security and the thing which is important is the manner in which transaction was made by leaking non-private information to the tipper. From the Rajaratnam hedge fund scandal it is evident that consequences of the individual found guilty of insider trading can be severe. If the individuals alleged to have been involved in insider trading found guilty then they may face imprisonment up to 20 years depending on the magnitude of fraud and losses. They will also have paid a hefty fine up to maximum of $5,000,000 or twice the gains from offense, whichever is greater. In addition to this, the convicted individual will also be barred from serving as the director or officer of public company. Such individual will also not be allowed to become an investment advisor or act as broker, accountant, attorney general or any professional capacity before Securities and Exchange Commission. Critical Analysis of the Galleon Scandal According to an article in the Wall Street journal, the Galleon hedge fund scandal involving Rajaratnam, the founder of Galleon, was at the center of play. Rajaratnam was the co-founder and the owner of $3.7 billion entity Galleon Group whose fortunes and personal assets was estimated to be over $1.5 billion. He was native of Sri Lanka but the Galleon was headquartered in New York. At a sudden raid by the US Federal Bureau of Investigation on October 16, 2009, Raj Rajaratnam was arrested from his personal apartment in New York. The FBI accused him of conspiring with others to engage in illegal trading or insider trading activity with stocks of publicly traded companies. According to the press release by the US attorney general, the total gains from such insider trading activity was estimated to be over $60 million and hence it was publicly circulated in media that the magnitude of scandal was the largest hedge fund insider trading case in the history of United States. However, at that point of time the attorney and defender of Rajaratnam, Jim Walden claimed that his client was innocent and that Rajaratnam would defend insider trading charges against himself. From the details of the press release it was found that Rajaratnam gained from the non-public information leak by five major entities namely Anil Kumar (Sr. executive of McKinsey & Co.), Robert Moffat (Sr. executive and in-line CEO of IBM), and Roomy Khan (Sr. executive of Intel Corp., who was also convicted of wire fraud and insider trading information by her previous employer), Rajiv Goel (Mid level executive at Intel Corp.). Later during investigation it was also found that Goel, Rajaratnam, and Kumar were all from Wharton Business School (Wharton Executive Education, 2010, pp.6-13). According to the Wall Street, Rajaratnam was able to create an average annual return over 21% that beats the earlier estimates of S&P 500 index. It was alleged by the district court that Rajaratnam and his Galleon group members mostly relied on phone wiretaps to swap non-public business information (during the period 2006 to 2008) that had the potential to influence stock market movements (Kumar, p.6). Mr. Rajaratnam along with Ms. Chiesi created an insider link with various networks of contracts. The excerpts of the taped conversation between Rajaratnam and Galleon fund with various companies that was presented in court filings proved that there was information exchange illegally related to strategic steps regarding how to trade shares. The wire taps also formed high anxiety in hedge fund trading regarding strategies of how such insider information would influence the stock prices in future. Transcripts released in press note revealed that the conversation between Mr. Kurland (Sr. Executive of New Castle Partners LLC) and Ms. Chiesi (Portfolio Manager at New Castle) were involved in leaking private information to Mr. Rajaratnam. The phone wiretaps also proved Ms. Chiesi restraining Mr. Kurland not to communicate with Raj via email. It was evident from their communication that both Ms. Chiesi and Rajaratnam treated their informants in various companies as outsourcing analysts. These so called outsourced analysts used to illegally leak private information of the company (such as earnings projection, investment strategies, M&A plans, news related to launch of new products, deal negotiation progress, etc.) about which the market was completely unaware. (Source: The Wall Street Journal, 2009) For instance, the Blackstone Group planned to acquire ownership stake in Hilton hotel chain in July 2007. This was supposed to push up the market price of the company after the new hits the market. It was later found that Rajaratnam was already informed about the deal and Galleon Technology Funds used this information to buy and sell about 400,000 shares of Hilton and made a profit close to $4 million. It was also alleged that Moody Investor Services, who was not named in the filings received consideration in exchange of this information. When the phone wiretaps were presented in front of the court and jury, the lawyer and defendant of both Mr. Kurland and Ms. Chiesi declined to comment (Strasburg and Bray, 2009, pp.1-4). As soon as the arrest of Rajaratnam was reported publicly by the media, the Sri Lankan stock markets crashed sharply. The market quickly factored in the importance of the charges of insider trading on Rajaratnam. The SEC also reviewed and scrutinized active stock trading with a view of identifying any insider trading activities. It was also alleged that the main mastermind of the hedge fund scandal, Rajaratnam also conspired to get non-public and confidential information related to a $5 billion deal. It was a very sensitive issue and so the deal was encapsulated from public. It was speculated that billionaire investor Warren Buffett’s Berkshire Hathaway would purchase the preferred stocks of Goldman Sachs before official announcement. It was first reported by the Wall Street that former Director and chief Executive of Goldman and McKinsey and Co., Mr. Rajat Gupta was the person who leaked this sensitive information to Rajaratnam in April 2009, prior to actual public announcement by the company for personal benefit. With the leak of this information it was evident that both the chairman of Galleon as well as Gupta would benefit from prior transactions. Gupta however maintained that he was innocent but was arrested and countersued by administrative charges in March 2011 (Overton, 2013, pp.1969-1972). Conclusion The Galleon Group and billionaire hedge fund king Rajaratnam was charged with one of the biggest insider trading scandal that compelled the company to liquidate its funds. The founder of Galleon Hedge fund, Rajaratnam along with others including Mark Kurland, Robert Moffat, Danielle Chiesi, and Rajiv Goel were actively involved in the insider trading network that netted over $20 million. All the person that were allegedly involved in the insider trading hedge fund scandal could face up to 20 years of imprisonment if the federal prosecutors win the conviction. The company’s board of directors and the management has also decided to approach potential buyers of the company with the option to keep the management team of the firm intact. The fund managers of Galleon used both active trading strategies and fundamental investment strategies (using outside research and proprietary research) to maintain consensus with the thinking of Wall Street. The funds that were handled by Rajaratnam experienced close to 18% drop in portfolio value. According to Reuters, the diversified hedge fund never had actual loss since inception. Also under the guidance of Rajaratnam the total the total returns generated by the company was over 2800% since its launch in the year 1992. The conviction of Raj Rajaratnam was the main highlight of the government and finally after 8 weeks trial, on May 11, 2011, the federal jury of New York found and declared Rajaratnam guilty of security fraud and insider trading. The trial of Galleon Hedge fund’s owner Rajaratnam was one of the biggest hedge fund frauds in the history of insider trading. The trial showed glimpse about how the operations of high profile hedge fund companies used to make illegal profits with the assistance from corporate insiders that used to provide sensitive non-public information. Rajaratnam and others used to trade securities on the basis of the private information that had the potential to influence the stock market movements. Galleon traded shares of blue-chip companies such as McKinsey, IBM, and Goldman Sachs and the profitability of Rajaratnam was mainly driven by the industry insiders’ information sharing. There were over 18,000 calls between Rajaratnam and his accomplices and the government secretly taped about 45 phone conversations which proved that Rajaratnam was guilty. Rajaratnam was ordered to pay fine of $54 million and was also sentenced to imprisonment for 11 years (Daniels Fund Ethics Initiative, 2012, p.6). References Daniels Funds Ethics Initiative. (2012). Martha Stewart’s Insider Trading Scandal. Retrieved from http://danielsethics.mgt.unm.edu/pdf/Martha%20Stewart%20Case.pdf. Hristova, M. V. (2012). The Case for Insider Trading Criminalization and Sentencing Reform. Retrieved from http://trace.tennessee.edu/cgi/viewcontent.cgi?article=1244&context=transactions. Kumar, A. (No date). Deemed to be Insiders: Major Players of Insider Trading. Retrieved from http://nmims.edu/wp-content/uploads/2012/p3/MPSTME/Insider%20%20Trading-Abhay%20Kumar.pdf. Overton, W. (2013). Wall Street Scandals. Retrieved from http://books.google.co.in/books?id=kENcP8Q_aXwC&pg=PA1971&lpg=PA1971&dq=Raj+Rajaratnam+and+his+Galleon+hedge+funds+scandal+pdf&source=bl&ots=yyfN-QpA-D&sig=-qDm0Kfwk0SswKUjy3pX0mdpgj8&hl=en&sa=X&ei=Z2bFUf_6OcTrrQe1k4HoBA&sqi=2&ved=0CGEQ6AEwCQ#v=onepage&q=Raj%20Rajaratnam%20and%20his%20Galleon%20hedge%20funds%20scandal%20pdf&f=false. Strasburg, J. and Bray, C. (2009). Six Charged in Vast Insider-Trading Ring. Retrieved from http://eso4600.ru/blog/wp-content/uploads/2009/10/Six-Charged-in-Vast-Insider-Trading-Ring-WSJ.pdf. Wharton Executive Education. (2010). Wharton on Corporate Ethics. Retrieved from http://executiveeducation.wharton.upenn.edu/resources/upload/wharton-on-corporate-ethics.pdf. Read More