Cornering Rajaratnam Rekindles Dennis Levine Taking Down Drexel

By David Scheer and Joshua Gallu
January 4, 2010

Days after he was arrested in an insider-trading probe in 1986, investment banker Dennis Levine sequestered himself at his lawyer’s New York office to read the government’s evidence. As he finished, he gazed out a window some 30 floors up, silently urging himself to open it and jump. He didn’t.

Instead, as recounted in his 1991 memoir, Levine came clean. He turned on his co-conspirators and cooperated with prosecutors, helping them build their case against arbitrager Ivan Boesky, who in turn led them to junk bond pioneer Michael Milken.

The episode brought down Levine’s former employer, Drexel Burnham Lambert, and spawned new rules that changed the entire investment-banking industry.

This time, the insider-trading allegations involve hedge funds, Bloomberg Markets reports in its February 2010 issue. Since federal agents in October arrested billionaire Raj Rajaratnam, co-founder of Galleon Group LLC, they’ve swept up about 20 alleged co-conspirators. And they’ve set in motion a chain of events like those Levine was a part of, securities lawyers say. Some of the people involved so far will give up more traders and tipsters to help prosecutors expand their case -- and help themselves avoid harsh punishments.

“Your ticket to freedom is as much information and as many people as you can turn over,” says Seth Taube, a former Securities and Exchange Commission attorney and federal prosecutor who’s now at Baker Botts LLP in New York.

Warning to Insiders

The officials in charge of the Galleon investigation have signaled that the case will grow. U.S. Attorney Preet Bharara at a Nov. 5 press conference, turned to a phalanx of television cameras and warned: “If you or someone you know has been involved in insider-trading activity, or traded on inside information, you should contact us. I urge you to knock on our door before we come knocking on yours.”

Each person caught up in the Galleon case can potentially lead to several more, says James Cox, a securities law professor at Duke University in Durham, North Carolina. “Everyone targeted in the investigation is going to be squeezed to the limit to implicate people,” he says.

People who see acquaintances caught up in the scandal may conclude that they’re next, says Bill Mateja, a former Justice Department lawyer now at Fish & Richardson PC in Dallas. “This will go down as a seminal insider-trading case,” he says, and prosecutors are broadening their reach. “I can guarantee their tentacles go well beyond what you see on paper.”

Biggest Since Boesky

The arrest of Rajaratnam heralds the biggest insider case since Boesky’s, which ended in 1990 with Milken pleading guilty to six felonies for securities rule violations (although he wasn’t convicted for trading on nonpublic information).

The defendants form alleged networks of fund employees, financial professionals and former executives at companies such as Intel Corp. and International Business Machines Corp. Investigators, basing their cases in part on wiretaps, say the participants relied on insider information for trades that yielded at least $53 million in illegal profits. Rajaratnam and Danielle Chiesi, who prosecutors say conspired with him, pleaded not guilty on Dec. 21. The technology company executives have said they did nothing illegal, and their employers have not been accused of wrongdoing.

The Galleon charges may spur lawmakers to push for insider- trading rules aimed specifically at hedge funds, Cox says. When the government went after Boesky, Milken and Drexel, legislation followed. A 1988 measure forced securities firms to enact policies for protecting secrets and subjected them to stiffer penalties if their employees were caught in wrongdoing.

Subpoenas Sent

In the end, the ability of regulators and law enforcement officials to show that the misdeeds were widespread may determine what changes result from the Galleon prosecution. Since Rajaratnam’s arrest, the SEC has sent more than three dozen subpoenas to brokerages, hedge funds and other investors about well-timed bets linked to corporate takeovers in the health-care and retail industries, two people familiar with the matter say.

Investigators are examining how groups of investors appeared to reap profits on similar deals, according to the people, who asked to remain anonymous because the probe isn’t public. While this type of examination can arise from monitoring stock- and derivatives-trading patterns, the cooperation of people who were involved can make or break a case. The subpoenas don’t stem from the Galleon case, although there may be ties to it, one of the people says.

Whatever laws or regulations may come, the Galleon case is already changing behavior. Attorneys who provide advice to hedge fund firms on complying with securities rules say managers are reviewing practices and updating their training.

Fine Line

Hedge fund managers and analysts walk a fine line, says Tom Hanusik, a former Justice Department and SEC lawyer who’s now at Crowell & Moring LLP in Washington. They want good contacts among investment bankers and corporate executives. “Analysts use all sorts of sources,” Hanusik says. They have to be careful not to cross the line and use intelligence in a way that constitutes insider trading, he says. The Galleon case is likely to help shift the line, Hanusik says. “The landscape is certainly going to change as to what the elements of an insider-trading offense are.”

Investors, meanwhile, know that a hedge fund can be crippled once prosecutors target the managers, says Nicola Ralston, co-founder of London-based PiRho Investment Consulting Ltd., which advises clients on investing in hedge funds. With the Galleon case pending, and perhaps growing, investors are demanding to know about funds’ safeguards, she says: “No investors can detect insider trading, no matter how hard they try, but they are asking more questions now and seeking more comfort on where managers are getting their information from and how they get their edge.”

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