Galleon heads for collapse after Rajaratnam arrest

The Galleon Group, the Wall Street hedge fund at the centre of one of the biggest insider trading cases in years, could be heading for collapse as investors rush to withdraw funds under management.

Despite assurances from Raj Rajaratnam, Galleon's billionaire co-founder indicted on fraud charges last week, investors have sought to withdraw about $1.3bn of the $3.7bn in assets Galleon manages.

Two of the brokerage firms Galleon normally deals with, Bank of America and Barclays, have told Galleon they will no longer trade Galleon's securities positions. The beleaguered hedge fund, meanwhile, is unloading technology stocks and other holdings to raise cash to meet the redemptions.

"Once a few big investors head for the exits, it doesn't take long for the floodgates to open,” noted one lawyer representing investors.

In a Galleon meeting yesterday Rajaratnam - released on a record $100m bail following his arrest last week - told more than 100 employees at the firm's Manhattan offices he will be "busy" defending himself. "I'm counting on you to take care of our investors," he told staff.

Traders at the firm say they believe competitors are looking to profit from Galleon's troubles by selling stocks in companies it also holds, hoping they will fall further when Galleon sells.

Meanwhile a picture is emerging of a firm where inconsistencies and red flags over the "source of alpha" - industry parlance for market-beating profits - were recognised by investors. They say they grew concerned over Galleon's habit of making large directional bets on single stocks.

"Crudely, there are three ways to make money as a hedge fund manager," one multi-billion dollar asset manager told the Financial Times.

"You can take advantage of trading technology, but few do. You can be more intelligent than others, but few are. Or you can have some specialised source of sustainable information.

"Unless that information is from fundamental analysis - and in Galleon’s case it did not all seem to be - then that's a red flag for us."

Rajaratnam's arrest is certain to increase pressure on regulators to reform the hedge fund industry. Prosecutors claim he was running a ring of informants across corporate America. The extent of the network allegedly uncovered, riddled with unnamed co-conspirators and tipsters, suggests authorities spent time and resources building the case using wiretaps.

"If you're going to shoot the king, you better shoot to kill," former SEC investigator Bradley Bennett told the New York Times. "If they're going to take on a billionaire, they need to have the strongest possible case. The defendant's own words are the strongest possible evidence."

A more complete picture of Rajaratnam has begun to emerge. Nassim Nicholas Taleb, author of The Black Swan, says he was surprised to see his Wharton business school colleague under arrest. "He was an extremely likeable fellow, chubby, a warm personality. If I had to give my keys to someone in case of getting locked out of the house, he’d be the kind of guy I’d go to."

Rajaratnam credited his success to being hungrier than everyone else. “It is pride, and I want to win,” he said in 2001. “After a while, money is not the motivation. I want to win every time. Taking calculated risks gets my adrenaline pumping."

Yet he was also known as a boss who demanded that his traders and analysts cultivate superior knowledge. "Get an edge or you're gone," Was Rajaratnam’s credo, according to one former Galleon trader . "Galleon is looking for that little bit of extra edge. That's what the firm is about."

Galleon's extra edge may now have contributed to its impending implosion. A study by the Stern School of Business recently concluded that rule-bending by fund managers is a leading indicator of fund collapses. “People mistake wealth for intelligence," explained an investor yesterday. "No one pretended Raj was a brilliant stock analyst - he was just extremely well connected. And he always made that known..."

EDITOR'S NOTE: Since this item was posted, Raj Rajaratnam was reported on October 21 to have written to employees and investors informing them that all Galleon's hedge funds are to be wound down. Deadline for redemption requests in most funds is November 15.