Galleon Wiretaps Rattle Hedge Funds as Insider Trading Targeted

by Katherine Burton and Richard Glovin

Oct. 26 (Bloomberg) – First came the biggest bear market since the 1930s, then Bernard Madoff’s $65 billion Ponzi scheme and the threat of increased regulation. Now hedge funds have a new concern: getting caught on tape as the government expands its use of wiretaps to ferret out insider trading.

Prosecutors, using secretly recorded phone conversations for the first time against hedge funds, alleged Oct. 16 that billionaire Raj Rajaratnam and five others made $20 million by swapping material inside information on companies such as Hilton Hotels Corp. and Google Inc. They may charge at least 10 more people soon, people familiar with the matter said last week.

Rajaratnam, founder of New York-based Galleon Group LLC, regularly talked to hundreds of contacts, including other traders, according to people who know him. His arrest rattled hedge-fund managers, who are questioning whether legitimate discussions caught on the tapped lines will draw scrutiny, say lawyers who’ve fielded such queries. A broader worry: whose phones are being monitored as prosecutors and U.S. Securities and Exchange Commission continue their probes?

“The word wiretap strikes fear in the hearts of everyone, even the innocent,” said Brad Balter, who runs Balter Capital Management LLC, a Boston-based firm that allocates clients’ money to hedge funds.

Ross Intelisano, an attorney with Rich & Intelisano LLP in New York, said he received a call from an executive at a $1 billion hedge fund who was considering hiring a company to test his firm’s phones for listening devices. The client asked what to do if the firm found any. “Do we go to the police?” the executive asked, according to Intelisano.

The executive instructed his colleagues to be extra careful about what they say on the phone, not because they are breaking the law, but because they are fearful that any conversation about stocks could be misconstrued, Intelisano said.

Calls Aren’t Safe

“After the Bear Stearns case, e-mails aren’t safe, and now phone calls aren’t safe,” Intelisano said. “From now on, people are going to be meeting for lunch.”

Prosecutors used e-mails to build their case against former Bear Stearns Cos. hedge-fund mangers Ralph Cioffi and Matthew Tannin, who are currently on trial in Brooklyn for misleading investors about the health of two funds that collapsed in 2007. It’s the biggest trial stemming from a U.S. probe of banks and mortgage firms whose losses in subprime loans and related securities total at least $396 billion.

For hedge-fund managers whose knowledge of wiretaps may have been limited to “The Wire,” the HBO drama in which Baltimore police eavesdrop on drug dealers, electronic bugging is a new reality of their industry as U.S. Attorney Preet Bharara’s new Complex Frauds Unit targets white-collar crime.

Covering Tracks

Prosecutors said they turned to wiretaps because of the ease with which hedge funds can hide when trades were based on illegal tips. At a bail hearing on Oct. 16, Assistant U.S. Attorney Josh Klein told a judge that Rajaratnam instructed others to fabricate “e-mail trails” that would explain why they executed corrupt trades.                 CONTINUED HERE.