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Comment: Hedge funds in the firing line as insider trading storm grows

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Charges are stacking up against Raj Rajaratnam, founder of the Galleon hedge fund group who is accused of making at least USD36m in profits through deals that depended upon inside information.

US prosecutors appear to be expanding the scope of the investigation and looking to find more participants in insider trading willing to cut deals that involve naming names in exchange for immunity or more lenient sentences.

 
Some commentators are not hesitating to compare the Rajaratnam scandal with that in the late 1980s, immortalised in the film Wall Street, which ensnared arbitrage trader Ivan Boesky and junk bond king Michael Milken and resulted in the destruction of the investment bank where Milken popularised the concept of junk bonds, Drexel Burnham Lambert.
 
The Drexel case was one of the key steps in a process that ended the perception of insider trading as an essentially victimless activity and that made its eradication a priority for regulators and law enforcement agencies around the world. There is no mistaking the gravity of the charges for individuals and organisations caught up in the allegations surrounding Rajaratnam.
 
“This shows the seriousness with which law enforcement agencies treat insider dealing,” says Neill Blundell, a partner and head of the fraud group at law firm Eversheds. “Both in the US and now in the UK, the preferred route for dealing with this type of market abuse is criminal prosecution rather than regulatory action.
 
“Businesses and individuals need to be aware that insider dealing leads in one direction and that is jail. Clearly, the allegations in the case of Rajaratnam at Galleon allege substantial payment being made for inside information and as a result alleged multi-million-dollar profits. If convicted, he will be looking at a substantial sentence of imprisonment.”
 
Rajaratnam will not be the only one to suffer. Already the case is being conflated with the Bernie Madoff scandal as a stick with which to beat the hedge fund industry and press the case for more intrusive supervision and restrictive regulation.
 
In an environment where even honestly-earned high salaries, bonuses and profits in the financial industry arouse public anger and are the target of scorn and suspicion among politicians and in the media, where the rapid-fire automated trading techniques used by some funds are under fire for leaving other investors at a disadvantage, and where legislators are preparing to act on a range of new regulatory proposals affecting alternative funds in the coming months, the hedge fund industry needs an association with insider trading like a hole in the head.
 
With the – admittedly much more complex and nuanced – insider trading case involving former GLG star trader Philippe Jabre still relatively fresh in the memory, it seems probable that in the future managers will have to be more conservative than before in assessing the usability of information that may not be widely disseminated in the market, if only to demonstrate that they are whiter than white.

 

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