• US Hedge fund charged with making illicit profits of $25 million, made $9 million profit from tip off on Google earnings announcement
  • SEC warns hedge fund that it is committed to "oulling back the curtain on hedge fund operations"
  • First time wire tap used successfully by US Authorities in insider trading case

A leading US hedge fund manager and six co-conspirators have been charged by the US Securities and Exchange Commission (SEC) with insider trading in what is believed to be biggest case ever brought for insider trading in the hedge fund industry. The SEC alleges that Raj Rajaratnam, the founder and managing partner of hedge fund Galleon, used a network of friends and business associates to gain insider tips and confidential information about corporate earnings and takeovers. Trading with this information generated more than $25 million in illegal gains for Galleon. The co-conspirators included executives at IBM, Intel and consulting firm McKinsey.

One example of insider trading cited in the SEC's complaint related to hotel chain Hilton. In July 2007, shortly before Hilton's acquisition by a private equity firm, one of Rajaratnam's contacts, known as "Tipper A," obtained information about the takeover from an analyst working at the rating agency Moody's. After receiving the tip about the impending takeover, Rajaratnam purchased 400,000 of shares in Hilton via his Galleon hedge funds. The hedge funds sold their shares after the announcement for a profit of $4 million. Tipper A also made illegal profits of $630,000.

In another example, Tipper A received information from a PR consultancy working for Google and passed a tip to Rajaratnam telling him that Google's earnings would be lower than Wall Street's expectations. Rajaratnam then began buying put options for the Galleon funds and also shorted Google stock. Following the drop in Google's share price after the earnings announcement, Galleon made profits of more than $9 million.

Speaking at the press conference, Robert Khuzami, Director of the SEC Enforcement Division, said Rajaratnam was not the "master of the universe" he claimed to be, but was instead a "master of the rolodex."

Khuzami also described the involvement of hedge funds in this scheme as a "particular concern" for the SEC, because they were responsible for massive trading volumes, including in derivatives "for which there was little transparency." He warned: "We at the SEC are committed to pulling back the curtain on hedge fund operations and taking a closer look at their activity. We are developing a variety of initiatives to do that involving greater specialisation and expertise, improved technological tools to track and analyse trading, better coordination among regulators and law enforcement, new legislative initiatives, and other means to address these areas."

Rajaratnam founded Galleon in 1997 and according to the SEC had more than $2.6 billion in assets under management. Before founding his hedge fund, Rajaratnam was a broker-dealer for 11 years and had previously studied at the Wharton Business School at the University of Pennsylvania, and Sussex University in the UK. In 2009, he was listed by Forbes magazine as the world's 559th richest man with a fortune of $1.3 billion.

The SEC investigation was also notable for being the first time the US authorities have successfully used wire taps to bring an insider dealing prosecution.

For a visual chart of the insider trading scheme, click here.

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