On October 16, 2009, Raj Rajaratnam was arrested by the FBI under the charge of insider trading. Rajaratnam, the founder and Managing Director of the hedge fund Galleon Group, was charged along with five others for their involvement in an insider trading scheme that reportedly earned the Galleon Group over $20 million.
The Galleon Group, now being essentially headless, has been left in a predicament, what to do when the face and head of your organization is arrested?
Evolution of Key People and Company
Raj Rajaratnam graduated from the University of Pennsylvania in 1983 with a Master’s in Business Administration. From here, he went on to work at Chase Manhattan Bank as a lending officer, dealing specifically in the technology field. Following a short stint there, he moved on to Needham & Co. as an analyst in the electronics field. Needham & Co. “is a nationally recognized investment banking and asset management firm focused solely on growth companies and their investors.” (needhamco.com) Here at Needham is where Rajaratnam began his climb to the title of “a billionaire hedge fund guru.” (Martinez, 2009) Rajaratnam quickly rose from an analyst, to head of research, to president by 1991. While at Needham, he started the Needham Emerging Growth Partnership hedge fund. The fund, which began in March of 1992, was later purchased by Rajaratnam and renamed to Galleon in 1997. Rajaratnam became known as one of the foremost hedge fund managers, with Galleon reaching close to $7 billion at it’s highest valuation. At the time of his arrest, Galleon was listed at just over $3 billion, more than likely due to the struggling economy.
Aside from the insider trading arrest, Rajaratnam has also been in the midst of scandal before. Reportedly he had given $3.5 million to a Sri Lankan organization known as the Tamils Rehabilitation Organization (TRO). The TRO is said to have been supporting the Tamil Tigers (LTTE), a terrorist organization that is based in Sri Lanka. Sri Lanka attributed Rajaratnam to supporting the Sri Lankan Civil War by continuing to contribute money. No charges were filed against Rajaratnam and the LTTE has since been defeated by the Sri Lankan Military.
The Galleon Group “is a privately owned hedge fund sponsor. The firm primarily provides its services to pooled investment vehicles. It invests in the public equity markets across the globe. The firm makes its alternative investments in private equity. It primarily invests in the growth stocks. The firm employs a fundamental analysis with a long/short equity strategy to make its investments. It conducts in-house research to make its investments. The firm invests in the companies operating in information technology and communication industries.” (linkedin)
The start of the insider trading, according to the SEC, dates back to July 1, 2007. Around this point in time, the Blackstone Group was in the midst of acquiring Hilton Hotels. This was not yet public knowledge, but there were some who knew the deal was going to take place and cause Hilton’s stock to shoot up. According to the Wall Street Journal’s interactive timeline, on July 2, Moody’s analyst Deep Shah provided information about the deal to an unknown source. The following day, this unknown source alerts Rajaratnam to the Hilton deal. Rajaratnam then quickly proceeds to purchase 400,000 shares for the Galleon Group and an additional 7,500 shares for his friend Rajiv Goel. Goel, a managing director for Intel was also charged in conjunction with Rajaratnam. After the announcement of the acquisition, Hilton’s stock goes up, as promised, and Galleon sells the shares it now owns for a reported profit of over $4 million. The following day, Goel’s shares are sold for a $78,000 profit.
The next bit of illegal trading involves short selling Google. On July 10, two of the unnamed sources converse regarding Google. The one source from Google shares that Google’s price will fall with their next earnings report. The other source tells Rajaratnam to short sell Google. Galleon makes moves to short sell and on July 19, Google announces that it was down from the last quarter and its price falls $28 a share. Galleon makes roughly $9.1 million by the end of July 20.
The final major piece to this puzzle deals with 3Com. 3Com were the makers of IT and network solutions. They have been recently acquired by Hewlett-Packard. On July 28, 2007, 3Com received a letter of acquisition interest from Bain Capital through the law firm Ropes & Gray. By August 6, news of the acquisition had been spread throughout Galleon and Craig Drimel, who was working in Galleon’s office at the time, purchased shares of 3Com. After the official announcement, the plan to acquire was quashed by the government. However, even though the deal did not go through, those involved in the 3Com insider trading scheme made any where from $200,000 to $5 million, according to the SEC. Two years later, after a series of wiretaps and investigations by the SEC and FBI, Rajaratnam and five others were arrested on securities fraud and conspiracy.
After Rajaratnam’s arrest, Galleon began taking a turn for the worse. Even as Rajaratnam proclaimed his innocence, millions were leaving the company as investors started to back out of the hedge fund. One of the more vocal pull-outs was Rochdale Investment Management in New York. Chief Executive Garrett D'Alessandro said “‘We don't conduct business with anyone who in fact violates the law’ though he added that he doesn't know whether Mr. Rajaratnam is guilty. Mr. D'Alessandro said the investment represents a ‘very small’ percentage of the Galleon fund and of Rochdale's investments.” (Pulliam & Zuckerman 2009) By October 21, just six days after his arrest, investors were withdrawing $1.3 billion of the $3.7 billion Galleon was holding in assets. Even in the midst of this Rajaratnam sent a letter to employees (see appendix) further proclaiming his innocence and that the company will keep functioning and serving the cliental.
The only other reaction that seemed to have come from the Galleon camp was from an anonymous Galleon trader regarding the Chief Operating Officer, Rick Schutte. Schutte reportedly told traders to “shed some positions in a ‘coordinated, orderly fashion,’… The trader said he wasn't told to sell everything but to begin raising some cash.” (Pulliam & Zuckerman 2009)
On October 22, 2009, one day after Rajaratnam’s employee letter was published in the Wall Street Journal, he sent out another letter. This time to employees and investors, to announce that “firm, bombarded with withdrawal requests from investors, will ‘conduct an orderly wind down’ of its funds as it explores ‘various alternatives for our business’ that could allow parts of Galleon to survive.” (Pulliam 2009)
Questions to Consider
1. What should Galleon have done immediately after the news of Rajaratnam’s arrest?
2. How should they have handled the media? Investors? The SEC? Employees?
3. What moves could have been made by the rest of Galleon’s management team to keep the company alive?
The problem that Galleon faced as a company is that no one was willing to release a statement on behalf of the company. This entire case became a problem with Galleon, when in reality, it was only a problem with Rajaratnam. The group should have released a statement explaining that they have no partaken in any fraud and will continue operating as usual.
It also appears as though Galleon has no board of directors to oversee the company. This is primarily the reason why no one was able to salvage the company. The sole leadership came from the man who has just been arrested and no one inside the company wanted to say and or do anything for fear of being caught up in the accusations. This is a perfect example as to why companies need a board of directors to audit the actions of management. There always needs to be checks and balances, and within Galleon there were none.