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CASE 132

Insider Trading at the Galleon Group

CASE NOTES FOR INSTRUCTORS

The federal investigation and prosecution of members of the Galleon Group is the largest insider trading

case in U.S. history. Over two dozen people were implicated, and Raj Rajaratnam, an eccentric

millionaire and head of Galleon, was convicted of 14 counts of securities fraud and conspiracy. The

investigation ushered in a new era in white-collar crime prosecution because wire taps and other

techniques were used to secure a conviction.

Students may be particularly interested in this case because of its lasting impact on the financial industry.

Insider trading cases are incredibly difficult to prove because prosecutors must demonstrate that the

defendant not only acquired insider information but also that he or she used that information to trade

stock in a way that damaged a company. While regulators have passed more legislation (such as the

Dodd-Frank Wall Street Reform and Consumer Protection Act) that seeks to discourage insider trading,

prosecutors are becoming more aggressive and are using strategies previously only seen against drug and

organized crime rings. Although it was successful in convicting several members of the Galleon network,

it has yet to be seen if the technique will work on other insider traders.

Since the Galleon case also covers an example of rampant criminally unethical activity, it is a natural to

be paired with the Ponzi and pyramidEnron, Wells Fargo, and/or Volkswagen schemes cases in this book.

Students can examine and compare the types of misconduct, the punishments, and the influence of those

involved on their personal and professional networks.

To understand this case, students need to understand some key terms. A hedge fund is a combination of

assets bundled together with various strategies that minimize risk. It is created as an unregistered

investment management company and is supposed to maximize returns while minimizing risk or

exposure. Hedge funds invest in a broad range of assets, including equities, bonds, and commodities.

Only investors who meet criteria set by regulators can participate in hedge funds. At its peak, the Galleon

Group invested $7 billion.

Hedge fund managers typically invest their own money in the funds they manage. Investors typically pay

management fees that go toward the operational costs of the fund. The management fee usually ranges

from 1 to 2 percent of an investor’s assets in the fund. Investors also pay performance fees when the

fund’s net asset value is higher than that of the previous year. The performance fee typically is 20 percent

of the fund’s gains in a given year. For example, if a client invested $100,000 and the fund earned 40

percent in one year, the additional fee would be $8,000, or 20 percent of the investor’s $40,000 gain. The

performance fee was Galleon’s main source of revenue. The fees associated with hedge funds can

generate massive wealth for hedge fund managers, as is shown in Table 1 (on the next page).

Because hedge funds are not sold to the general public, hedge fund managers have not been subject to the

same restrictions as other investment fund advisers. After the 2008 financial crisis, new regulations were

passed to increase government oversight and eliminate regulatory gaps between different kinds of

investment funds. The Dodd-Frank Wall Street Reform and Consumer Protection Act of July 2010

accessible website, in whole or in part.

Table 1. 2009 Top Fund Manger’s Earnings

1. David Tepper, Appaloosa Management, $4 billion

2. George Soros, Soros Fund Management, $3.3 billion

3. James Simons, Renaissance Technologies, $2.5 billion

4: John Paulson, Paulson & Company, $2.3 billion

5: Steve Cohen, SAC Capital Advisors, $1.4 billion

6. Carl Icahn, Icahn Capital, $1.3 billion

6. Edward Lampert, ESL Investments, $1.3 billion

8. Kenneth Griffin, Citadel Investment Group, $900 million

8. John Arnold, Centaurus Advisors, $900 million

10. Philip Falcone, Harbinger Capital Partners, $825 million

Source: Nelson D. Schwartz and Louse Story, “Pay of Hedge Fund Managers Roared Back Last Year,” New York

Times, March 31, 2010, http://www.nytimes.com/2010/04/01/business/01hedge.html (accessed January 14,

2016).August 4, 2017).

required hedge fund managers holding more than $150 million to register with the SEC as investment

advisers. Hedge fund managers with less than $100 million in assets are subject to state regulations.

Dodd-Frank requires hedge funds to provide information about trades and portfolios so that the Financial

Stability Oversight Council can monitor and regulate systemic risk.

Securities fraud occurs when a person or company misrepresents or misuses information that investors

utilize to make their financial decisions. The types of misrepresentation involved in securities fraud

include providing false information, withholding key information, offering bad advice, and offering or

acting on inside information. In Galleon’s case, it was found to be engaging in insider trading.

Finally, students should know about some of the other common unethical practices in which Rajaratnam

and his colleagues engaged. A tax shelter is a kind of investment that allows investors to reduce their

taxable income, such as pension plans and real estate. Not all tax shelters are legal. In the Galleon case,

Rajaratnam was accused of having a fraudulent tax shelter, because he hid taxable money in foreign bank

accounts. A shell corporation is a company that has legal status but provides no service or products and

has few, if any, assets. Shell companies are illegal if they are used for income tax evasion or are formed to

attract funding.

QUESTIONS AND DISCUSSION

1. Are information gathering techniques like Rajaratnam’s common on Wall Street? If so, what could

regulators, investors, and executives do to reduce the practice?

The simple answer is yes, these practices are common. To help students understand the complexities of

Information gatherers and their companies acquire what is called competitive intelligence (CI). Their

purpose is to monitor competitors and, if possible, determine what business rivals will do before they do

Few clear cut guidelines and laws exist for the acquisition of CI. Hedge funds, because they had not been

as heavily regulated, often engaged in unethical CI practices. Examples of common unethical behaviors

accessible website, in whole or in part.

The Galleon Group was operating in this unethical environment. In the case of the Galleon Group,

Rajaratnam’s informant list included former business school classmates, fellow hedge fund traders, and

technology industry executives. Some students may argue that Rajaratnam was simply following common

When discussing the second portion of the question, some students may introduce the passage of the

Dodd-Frank Act as a sign that the financial services industry now has more regulation. Students should

2. What are the implications of sharing confidential material information? Is it something that would

affect your decision about how to trade a stock if you knew about it?

According to the Sarbanes-Oxley Act, there are many severe legal consequences for trading confidential

A lively discussion can center on what the government says regarding punishments for white-collar

crimes, and what actually happens to offenders. The most recent sentencing data from the Sentencing

Commission reveal a trend of longer prison terms for white-collar offenders. However, the reality is that

the average sentence imposed for an economic crime conviction is 26.2 months while the average

3. Do you think the secret investigation and conviction of Rajaratnam and other people in the Galleon

network will deter other fund managers and investors from sharing nonpublic information?

The answer is probably yes, but much will depend on the outcome of similar cases. Insider trading cases

can be complex and difficult to unravel. They can also be hard to prosecute because insider trading is

Instructors may wish to use the CNBC video listed under “Additional Resources” as a supplement to this

case. It discusses the impact of the Rajaratnam case. Instructors may like to encourage a discussion

ADDITIONAL RESOURCES

Rajaratnam verdict: https://www.youtube.com/watch?v=0si-5tOczco/

accessible website, in whole or in part.

Limits on insider trading prosecutions:

http://www.wsj.com/articles/supreme-court-denies-doj-appeal-on-insider–trading-prosecutions-14440

53439.

Rajat Gupta still tries to clear his name:

https://blogs.wsj.com/law/2016/05/06/rajat-guptas-quest-to-clear-his-name-returns-to-second-circuit/

accessible website, in whole or in part.