Raj Rajaratnam: downfall of a hedge-fund billionaire

published 23 October 2009

When Raj Rajaratnam launched his hedge fund Galleon Technologies in 1997, he told a journalist "only the paranoid survive", says the FT. He should have watched his back more carefully. Last week the Sri Lanka-born hedgie was arrested at dawn at his Manhattan home and charged with running the biggest insider-trading scheme yet seen involving a hedge fund.

News of Rajaratnam's arrest "has shaken the secretive hedge-fund world", in which intelligence on companies is often shared among Wall Street analysts, traders and other investors, says The New York Times.

The investigation made extensive use of wire taps, tactics long used to tackle mobsters and drug gangs. The defendants, who include corporate insiders at Google, IBM and Intel (see below), operated in "a cosy world of you scratch my back, I'll scratch yours", claimed a prosecuting attorney. Rajaratnam built himself up as a market genius, impressing Wall Street for years with his talent for picking high-flying tech stocks. But it seems he is not so much a master of the universe as "a master of the Rolodex".

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Rajaratnam, 52, attributes his success to being hungrier than everyone else. "After a while, money is not my motivation... Taking calculated risks gets my adrenaline pumping," he told the author of a 2001 book The New Investment Superstars. His rise from humble technology analyst to hedge-fund billionaire (Forbes puts his net worth this year at $1.3bn and he is claimed to be the richest Sri Lankan in the world) was certainly impressive, says The Guardian. Until his arrest Rajaratnam was living in a $10m condo with his wife, three children and two elderly parents.

He had a pretty good start in life, says the Asian Tribune. Born into a wealthy Tamil family his father ran the Asian operations for sewing-machine-maker Singer Rajaratnam was sent to school in Britain and later studied engineering at the University of Sussex. After taking an MBA from Wharton in the US, he joined the investment boutique Needham & Co, rising to become president in 1991.

The internet boom hit full swing and he left the bank in 1997, taking its tech hedge fund renamed Galleon with him. Rajaratnam's returns were always enviable. In the years to 2008, Galleon boasted an annualised return of 23%, and he was credited with considerable nous when it came to market-timing. In 2000, when the average tech sector fund bombed 33%, his fund gained 16%.

Rajaratnam always remained close to his homeland too close some would say, according to The Wall Street Journal. In 2007, he was involved in a criminal complaint about fundraising for the Tamil Tigers, though he was never charged. A noted philanthropist (he gave millions when the 2004 tsunami struck), Rajaratnam has never denied funding his own people, says the Asian Tribune.

His arrest has "hit Sri Lanka like a thunderbolt", triggering panic among the many high-level politicians and business tycoons now "under a cloud of involvement with him", says Transcurrents.com. Rajaratnam's tentacles stretch everywhere: he is the single largest foreign investor in Sri Lanka's stockmarket, with stakes in all ten top-listed companies, and has links to several cabinet ministers. So the question on everyone's lips in Colombo this week was: who's next?

The fraud that led to his arrest

Rajaratnam is charged with 13 criminal counts of fraud and conspiracy. He is accused of making at least $20m via illegal tips from senior sources inside companies including Google, IBM, Intel and the Hilton hotel group. According to court documents, it was a suspicious trade involving Hilton shares that got the investigation going, reports the FT.

The US SEC was alerted when a single US trader netted $630,000 on Hilton options after Blackstone announced a takeover of the hotel group. Two weeks later, the same trader took home $500,000 when Google announced poor earnings. Within four months, the authorities were so hot on the trail that "the trader agreed to flip and tell all".

Privileged information obtained by Rajaratnam's "gang" which also included a McKinsey director and two executives from fund manager New Castle Funds typically related to forthcoming deals, says The Guardian.

A tip-off about an Intel investment in Clearwire, an internet service provider, allowed Galleon to make a quick $579,000 profit; the Hilton deal yielded some $4m. Overall, Rajaratnam's extensive network of cronies guaranteed him "a sneak preview of market-making events". He was careful to avoid leaving an email trail, little suspecting that the Feds were tapping his mobile phone.

Insider trading is said to be rampant among hedge funds, says the FT. This case, perhaps the first of many, represents "a significant ramping up" of the US commitment to tackle it. As New York federal prosecutor Preet Bharara sums it up: this case "should be a wake-up call for Wall Street".