The Demise of Galleon Group

Problem Statement

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)

Background

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.

Reactions

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)

Internal Response

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?

Potential Solutions

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.

To Wikinvest or not to Wikinvest?

This week I read Undisclosed paid content on Wikinvest. Dominic Jone’s article talks about how he found that several companies are paying a third party to write about them on Wikinvest.

Wikinvest is a site that provides financial data and backgrounds on most, if not all publicly traded companies. It can be edited by users, but content is monitored by Wikinvest to ensure there is no bias and that all information is neutral.

Jones feels that by paying the third party to write about the company automatically makes the information provided biased and it should not be posted on the site. Wikinvest states that “Upon review, though, the author had stayed within Wikinvest’s guidelines — unbiased, neutral content with little in the way of predictions or overly glowing descriptions. In fact, this author happened to be better than our average contributor at citing their references. As of now, these edits have been allowed to stand and we’ll continue to monitor issues like these as they arise to see if our standards should change.”

Jones ultimately felt that this wasn’t good enough and followed up with “I guess being paid (in stock or cash) to post content isn’t considered being biased at Wikinvest. So rather than waste my time counteracting paid content on the site, I’ll do one better and simply avoid using it.”

Personally, I really don’t see the issue with what these companies are doing. They are just using a third party to do the work that they would more than likely pay an internal employee to do anyways. Furthermore, if the information is unbiased and is merely stating facts then why does it make any difference who is posting it? It seems to me that this is a harmless issue. If any average person can make a comment on the site, then why not have someone who supposedly knows what they’re talking about make the comments? I feel much better knowing my information is coming from a professional than some guy off the street.

The only actual problem I have is with this mysterious Thomas McCarthy/Tom “the Dean” McCarthy. I do find it a bit weird that he has two profiles, but more importantly, he has two of the most unprofessional looking profiles. He could make it look like he was trying to run a legitimate business and market himself a bit better, but that is a whole other issue. Overall, I don’t see that harm in what these companies are doing as long as the content stays unbiased and factual.

Online Shareholder Meetings: The Good, the Bad, and the Hybrid

I read Dominic Jones' article More U.S. companies choosing virtual annual meetings for this week. The article goes on to discuss how some companies are moving to virtual or hybrid shareholder meetings. He talks mostly about how companies now have the ability to conduct their voting process online. Before this most companies that held online meetings had to have votes either mailed, phoned, or faxed in before the meeting started.

Now by allowing for shareholders to vote and pose questions online it makes to point that that the Notice & Access laws have some validity and if done the right way can be useful. Notice & Access allows for companies to send shareholders a slip of paper that has a URL address printed on it. The URL allows shareholders access to the company's shareholder materials rather than receiving a packet from the company. This saves the companies money and time in sending out their materials.

By having these online meetings it gives many shareholders the ability to attend and vote at these meetings without having to fly all over the country. This is particularly beneficial for shareholders who own shares of several companies. It saves everyone, the company and shareholder, time and money.

Jones also notes that "Most of the companies moving to [virtual meetings] are doing so because they don’t see value in having a shareowner meeting at all if only a few people show up." The hope is that more shareholders will attend the meetings if they are held online. However, for those who do disagree, companies like Intel are holding a hybrid meeting which means they will be holding both types of meetings. The hope is that this will allow for more shareholders to attend the meeting and vote, but it will also hold board members more accountable by forcing them to physically attend the meeting.

Personally, it seems as though the hybrid meeting seems to be the best move for all. It provides for the most people to attend while still upholding the integrity and accountability or the board and upper management. It won't allow anyone to hide behind a camera or the internet. It'll be interesting to see where companies take this in the upcoming years.

Insider Dreams

More insider trading problems arose this past wednesday. According to the Los Angeles Daily News and several other news services, two men were arrested due to their involvement in an insider trading scheme.

Two out of the five men are now being held for trial and the remaining three are expected to turn themselves in. The men worked for two separate Investor Relations firms and made upwards of $1 million in illegal profits.

The scariest thing is that these men worked for investor relations firms. It's not unheard of for there to be insider trading, but to have it be men who are supposed to be the gate keepers of this information is just disturbing. "'Everyone involved in the financial industry has fiduciary and ethical duties, but in this case those responsibilities were ignored in favor of profits derived from illegal stock trading,' said U.S. Attorney Andre Birotte Jr."

It's unsettling to see this happen and for this to be a continuing problem. It seems that everything the government and the industry is working towards is supposed to eliminate insider trading by providing more information and more transparency. At this point it seems the only way to truly eliminate insider trading is to take out the monetary worth of securities. Which we all know will never happen outside of a dream world.

Smarter Investors

Thomson Reuters announced this morning that they will be releasing their new software, Smart Targets. The software is "a first of its kind tool to assess investor interest and risk." The hope with the release of this software is to help IROs to better target Investors that would be truly interested in their company. It will help IROs to analyze their existing shareholders and better assess which institutional investors are right for their company.

The article also states that "Smart Targets provides full transparency into factors driving buying and selling behavior." I feel that this brings up an interesting point, if more and more companies are making it easier and easier to asses stockholders, institutional investors and analyze market trends, then why can't a "normal investor"? It seems that the investment world could be moving toward investors making their own decisions and less of a need for analysts. I think with Reuters new software it will open the door for more independent investors and could effectively change how the investment world operates.

Please Don't Read Our Report

I read Dominic Jones’ piece on Moody’s Corporation today and it really struck a cord with me regarding my last piece. His piece Dear Moody’s Corp: Type this fast 3 times discusses how some companies send out annual shareholder materials.

The point Jones is trying to make is that the system is severely flawed. Jones paraphrases the SEC who notes that the “process for the delivery of annual meeting materials, companies can mail their shareholders a slip of paper containing a URL where recipients can access their proxy materials online.” The piece went on to explain that Moody’s Corporation was doing just that and sending their shareholders a piece of paper with an unnecessarily long and complicated URL and very bland instructions. Additionally, once a shareholder actually made it to the site, the document and site are set up very poorly and offer practically no navigation through the tedious 214 pages.

Jones also makes good points when he brings up that Moody’s should at the very least be shortening the URL and taking steps to ensure its shareholders reach the site. He also says that the SEC is not doing it’s job and is allowing theses “materials [to be] in half-baked, barely usable formats” and are “akin to a root canal.”

I think Jones brings up very good points and I agree with him completely. I just would take it a step further to imply some other things. By sending out your annual shareholder materials in the way that Moody’s has, they are basically telling shareholders, please don’t look at our report. We are going to make it as difficult as humanly possible to find, read, and understand the material. It almost makes one wonder if there is something in there they do not want shareholders to read or if they just simply do not want any shareholder input and this is their way of trying to keep some quiet.

Perhaps I am wrong and this is simply a case of ignorance and a company that does not fully understand the capability of the technology available today. This may be an actual possibility, especially after seeing how poorly laid out and navigable Moody’s website is.

The problem becomes a lack of transparency, which I feel is essential for all companies especially those that frequently deal with their investors. What Moody's has done is about as legally close to being opaque as a company can be.

Ending Insider Trading Through Transparency

One of the never ending problems in the financial world is that of poor ethics and specifically insider trading/transparency of companies. This problem not only stretches throughout the financial world but also affects all those that work in and around the field. Many of those most affected call themselves Investor Relations Officers. IROs frequently are caught in difficult positions of finding the balance of their company’s interests, the public’s interests, and abiding by the laws of the SEC. Many times IROs find themselves in such a predicament that they can bend or break laws and shatter morals. At the heart of this problem is insider trading and how transparent companies are/want to be.

Insider trading is a practice in which there is “generally buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Insider trading violations may also include "tipping" such information, securities trading by the person "tipped," and securities trading by those who misappropriate such information.” There are “good” and legal sides to insider trading, but these obviously are not problems. The issue of transparency though is one that can cause insider trading. Transparency simply refers to how much information the company makes public. This information can then be acted upon by the general public to buy and or sell securities.

There are some varying opinions on the matter. They are both positive and negative and touch on all parts of the spectrum in between. Some comments have been made to limit employee discussions as “experts” and that insider trading is a huge problem. Another comment stated that companies needed to become more transparent to avoid insider trading. Some have made comments regarding transparency and how to go about it, citing that many are fearful of branching out and using new ways to file reports. While many others are pushing for more and more electronic influence on reporting in hopes that this will help the situation.

Many industry professionals have made specific comments regarding the issue of insider trading including: Jim Allen (CFA Centre for Financial Market Integrity) who says that “‘The best defense [to insider trading] is greater transparency,’ companies make themselves vulnerable to leaks ‘when they start warehousing information. If the information is in the market, you don’t have to worry about it leaking illegally.’” Additionally, Peter Carter, a Securities litigation attorney and Dorsey & Whitney partner, says that “companies [should] prohibit employees from ‘consulting’ for expert networks” and that “It’s a huge problem.” Both of theses men feel that the right way to combat insider trading and poor morals is to be more transparent and to try to cover any leaks that could cause a major issue.

This idea of more transparency, however, brings up differing opinions. Though Allen has made the comment that we should be more transparent, others question how companies can go about that. One of the most suggested routes is to use new social media. Brian Solis, a writer for Techcrunch.com, says that “While PR, marketing, advertising, branding, HR, and customer service are rapidly adopting participatory communication channels such as Twitter and Facebook, IR has (wisely) observed the landscape to ascertain the risks and opportunities present within the new SEC guidelines.” Solis goes on to further say that the IR community still needs to get a feel for how the SEC will react fully, even as EDGAR reports become more and more user friendly.

Dominic Jones, a blogger for IRWebReport.com, has made comments regarding IR moving to accept new forms of technology as well. He makes note that companies should be looking into these new forms of social media even though the industry is moving slowly to fully adopt them. He also points out that there is much fear in using these new forms of media because organizations like FINRA (Financial Industry Regulatory Authority) have only very recently started a task force to see if using new media can really work with Reg. FD. Jones in another post discusses how employees should be able to discuss anything about a company, because executives should be doing the same, publicly. He feels that by using full disclosure, that it will eliminate all problems and help the industry as a whole.

Personally, I feel that Jim Allen hit the nail on the head when he said that the industry needs more transparency. Most of the problems seem to arise when employees are not allowed to discuss much of what they do. It is beyond difficult to be a social human being with those restrictions on your conversation. Also, insider trading comes about due to yes, greed and poor morals, but if the world knew what was going on in your company, then there would be no need to illegal trade, because the world has nothing to illegally trade on. Enron is probably the best example of this. Enron was known as the “black box”. People didn’t understand (and didn’t want to) how Enron made money which then provided the opportunity for certain individuals to profit off of this lack of knowledge. To prevent this from happening again we know have Reg. FD. But with Reg. FD has also know come the XBRL. The XBRL is a new reporting system that uses a spreadsheet to allow for manipulation and better use of the numbers reported. This ultimately will help bring better transparency, as there will be fewer places for companies to hide information, they certainly cannot do it anymore with a small font.

In the future I believe that companies will become more transparent, especially if they adopt using forms of new social media and are willing to be open and honest with the public. I am sure that people will still try and find ways to trade illegally, but it will only occur with those companies that have stayed towards the back of the pack and have not made the moves to update their practices and truly give full disclosure to the general public at all times.

By embracing new media and the XBRL, it will allow for the general public to follow companies and make decisions themselves, without the need of an intermediary analyst. This will give the general public greater power and should force companies that are not adapting, to make that push to become updated with the times. All of these moves to allow for more transparency will ultimately allow for fewer and fewer illegal activities and should (in theory) one day lead to a morally sound market.