On Friday the SEC arrested and charged a billionaire hedge-fund manager and five others - including high ranking executives from IBM, Intel Capital, and Mckinsey & Co. - with insider trading resulting in $25 million in illicit gains.
While it's tempting to write this off as the work of a few greedy individuals, I don't believe that's the case. If the allegations are true, it would appear that the rampant conflicts of interest and insider trading of the tech bubble is still alive and well. The only difference is that, instead of investment banks, the instigators are now hedge funds.
Just look at the breadth and depth of the allegations that the feds used wiretaps and informants to uncover; this was no Mickey Mouse operation:
- It involves Robert Moffat - a senior VP and prime candidate to succeed IBM CEO Sam Palmisano, Rajiv Goel, a managing director at Intel Capital, and Anil Kumar, a director at McKinsey & Co.
- It involves confidential, inside information about earnings and acquisitions involving Google, Intel, Hilton, Clearwire, Sun, and Polycom.
- The linchpin is Raj Rajaratnam - a billionaire hedge-fund manager and former president of investment bank Needham & Co.
During the tech boom of the 90s, analysts from investment banks were routinely briefed by corporations prior to earnings announcements. The analysts would write reports that went out to clients of the banking firms. Big clients would also get personal "heads up" calls. Of course, trading on confidential "inside information" was still illegal, but the line had become muddled.
When the bubble burst on the tech sector and this widespread practice came to light c. 2000, the SEC came up with Reg FD or Regulation Fair Disclosure that prevents public companies from disclosing "material" information to individuals or companies prior to announcing to the general public.
A few years later federal and state prosecutors negotiated a record $1.4B settlement among the nation's top ten investment banks for conflicts of interest between their research analysts and investment banking operations - also related to insider trading.
Unfortunately, all that fanfare seems to have pushed insider trading further underground - to some hedge funds. Perhaps seeing the writing on the wall, as well as big dollar signs, Rajaratnam left Needham in 1997 to found Galleon Management LP, a multibillion dollar hedge fund firm where, according to SEC enforcement director Robert Khuzami, "He cultivated a network of high-ranking corporate executives and insiders, and then tapped into this ring to obtain confidential details about quarterly earnings and takeover activity."
My take on all this? As long as there's a stock market where people trade on information, there will be investment professionals looking for a competitive edge and a percentage of those willing to "cross the line." That's the way it's always been and I'm afraid that's the way it always will be. You can legislate and regulate, but fraud will always be there.
Full disclosure: I know more about this sort of thing than I'd like to. As an officer of a public company in the mid-90s, it was business as usual to brief Wall Street analysts, including Rajaratnam. I also presented at and attended several of Needham's investment conferences and recall Raj telling me he was leaving to start a hedge fund.