Wall Street Needs Stronger Regulations

One of America's wealthiest men was among six hedge fund managers and corporate executives arrested in a hedge fund insider trading case that authorities say generated more than $25 million in illegal profits and was a wake-up call for Wall Street. Raj Rajaratnam, a portfolio manager for Galleon Group, a hedge fund with up to $7 billion in assets under management, was accused of conspiring with others to use insider information to trade securities in several publicly traded companies, including Google Inc. U.S. Magistrate Judge Douglas F. Eaton set bail at $100 million to be secured by $20 million in collateral despite a request by prosecutors to deny bail. He also ordered Rajaratnam, who has both U.S. and Sri Lankan citizenship, to stay within 110 miles of New York City.

U.S. Attorney Preet Bharara told a news conference it was the largest hedge fund case ever prosecuted and marked the first use of court-authorized wiretaps to capture conversations by suspects in an insider trading case. He said the case should cause financial professionals considering insider trades in the future to wonder whether law enforcement is listening. "Greed is not good," Bharara said. "This case should be a wake-up call for Wall Street." Joseph Demarest Jr., the head of the New York FBI office, said it was clear that "the $20 million in illicit profits come at the expense of the average public investor."

The Securities and Exchange Commission, which brought separate civil charges, said the scheme generated more than $25 million in illegal profits. Robert Khuzami, director of enforcement at the SEC, said the charges show Rajaratnam's "secret of success was not genius trading strategies." "He is not the master of the universe. He is a master of the Rolodex," Khuzami said. Galleon Group LLP said in a statement it was shocked to learn of Rajaratnam's arrest at his apartment. "We had no knowledge of the investigation before it was made public and we intend to cooperate fully with the relevant authorities," the statement said.

The firm added that Galleon "continues to operate and is highly liquid." Rajaratnam, 52, was ranked No. 559 by Forbes magazine this year among the world's wealthiest billionaires, with a $1.3 billion net worth. According to the Federal Election Commission, he is a generous contributor to Democratic candidates and causes. The FEC said he made over $87,000 in contributions to President Barack Obama's campaign, the Democratic National Committee and various campaigns on behalf of Hillary Rodham Clinton, U.S. Sen. Charles Schumer and New Jersey U.S. Sen. Robert Menendez in the past five years. The Center for Responsive Politics, a watchdog group, said he has given a total of $118,000 since 2004 -- all but one contribution, for $5,000, to Democrats.

The Associated Press has learned that even before his arrest, Rajaratnam was under scrutiny for helping bankroll Sri Lankan militants notorious for suicide bombings. Papers filed in U.S. District Court in Brooklyn allege that Rajaratnam worked closely with a phony charity that channeled funds to the Tamil Tiger terrorist organization. Those papers refer to him only as "Individual B." But U.S. law enforcement and government officials familiar with the case have confirmed that the individual is Rajaratnam. At an initial court appearance in U.S. District Court in Manhattan, Assistant U.S. Attorney Josh Klein sought detention for Rajaratnam, saying there was "a grave concern about flight risk" given Rajaratnam's wealth and his frequent travels around the world.

His lawyer, Jim Walden, called his client a "citizen of the world," who has made more than $20 million in charitable donations in the last five years and had risen from humble beginnings in the finance profession to oversee hedge funds responsible for nearly $8 billion. Walden promised "there's a lot more to this case" and his client was ready to prepare for it from home. Rajaratnam lives in a $10 million condominium with his wife of 20 years, their three children and two elderly parents. Walden noted that many of his employees were in court ready to sign a bail package on his behalf.

Rajaratnam -- born in Sri Lanka and a graduate of University of Pennsylvania's Wharton School of Business -- has been described as a savvy manager of billions of dollars in technology and health care hedge funds at Galleon, which he started in 1996. The firm is based in New York City with offices in California, China, Taiwan and India. He lives in New York. According to a criminal complaint filed in U.S. District Court in Manhattan, Rajaratnam obtained insider information and then caused the Galleon Technology Funds to execute trades that earned a profit of more than $12.7 million between January 2006 and July 2007. Other schemes garnered millions more and continued into this year, authorities said.

Bharara said the defendants benefited from tips about the earnings, earnings guidance and acquisition plans of various companies. Sometimes, those who provided tips received financial benefits and sometimes they just traded tips for more inside information, he added. The timing of the arrests might be explained by a footnote in the complaint against Rajaratnam. In it, an FBI agent said he had learned that Rajaratnam had been warned to be careful and that Rajaratnam, in response, had said that a former employee of the Galleon Group was likely to be wearing a "wire." The agent said he learned from federal authorities that Rajaratnam had a ticket to fly from Kennedy International Airport to London on Friday and to return to New York from Geneva, Switzerland next Thursday.

Also charged in the scheme are Rajiv Goel, 51, of Los Altos, Calif., a director of strategic investments at Intel Capital, the investment arm of Intel Corp., Anil Kumar, 51, of Santa Clara, Calif., a director at McKinsey & Co. Inc., a global management consulting firm, and Robert Moffat, 53, of Ridgefield, Conn., senior vice president and group executive at International Business Machines Corp.'s Systems and Technology Group. The others charged in the case were identified as Danielle Chiesi, 43, of New York City, and Mark Kurland, 60, also of New York City. According to court papers, Chiesi worked for New Castle, the equity hedge fund group of Bear Stearns Asset Management Inc. that had assets worth about $1 billion under management. Kurland is a top executive at New Castle.

Kumar's lawyer, Isabelle Kirshner, said of her client: "He's distraught." He was freed on $5 million bail, secured in part by his $2.5 million California home. Kerry Lawrence, an attorney representing Moffat, said: "He's shocked by the charges." Bail for Kurland was set at $3 million while bail for Moffat and Chiesi was set at $2 million each. Lawyers for Moffat and Chiesi said their clients will plead not guilty. The law firm representing Kurland did not immediately return a phone call for comment. A message left at Goel's residence was not immediately returned. He was released on bail after an appearance in California.

A criminal complaint filed in the case shows that an unidentified person involved in the insider trading scheme began cooperating and authorities obtained wiretaps of conversations between the defendants. In one conversation about a pending deal that was described in a criminal complaint, Chiesi is quoted as saying: "I'm dead if this leaks. I really am. ... and my career is over. I'll be like Martha (expletive) Stewart." Stewart, the homemaking maven, was convicted in 2004 of lying to the government about the sale of her shares in a friend's company whose stock plummeted after a negative public announcement. She served five months in prison and five months of home confinement.

Prosecutors charged those arrested with conspiracy and securities fraud. A separate criminal complaint in the case said Chiesi and Moffat conspired to engage in insider trading in the securities of International Business Machines Corp. According to another criminal complaint in the case, Chiesi and Rajaratnam were heard on a government wiretap of a Sept. 26, 2008, phone conversation discussing whether Chiesi's friend Moffat should move from IBM to a different technology company to aid the scheme. "Put him in some company where we can trade well," Rajaratnam was quoted in the court papers as saying.

The complaint said Chiesi replied: "I know, I know. I'm thinking that too. Or just keep him at IBM, you know, because this guy is giving me more information. ... I'd like to keep him at IBM right now because that's a very powerful place for him. For us, too." According to the court papers, Rajaratnam replied: "Only if he becomes CEO." And Chiesi was quoted as replying: "Well, not really. I mean, come on. ... you know, we nailed it." The criminal complaints in the case also captured what authorities said were efforts by the defendants to hide their conversations from authorities. In one conversation, Chiesi was heard telling Rajaratnam that she was "glad that we talk on a secure line, I appreciate that," to which Rajaratnam replied: "I never call you on my cell phone," the complaint said. It added that Chiesi said she was "nervous" about being investigated.

In the wake of this, this is why the Obama administration is pushing back at bank lobbying on regulations. White House officials say they are growing frustrated that the banking industry is fighting President Barack Obama’s plan to overhaul financial regulations after taxpayer bailouts helped firms restore profits and near- record compensation for executives. Their anger is directed even at firms such as New York’s JPMorgan Chase & Co. and Goldman Sachs Group Inc. that have paid back their government assistance and reported a surge in third- quarter earnings this week. The issue, according to administration officials, is the industry is generally on sound footing because of government help and lobbying against Obama’s regulatory plans goes against the nation’s long-term interest. “We are disappointed by the lobbying of anyone in the financial industry against regulatory reform, considering the obvious need for change on that front,” Valerie Jarrett, a senior adviser to Obama, said.

Wall Street regulation is scheduled to be among the topics when Jarrett, Obama adviser David Axelrod and White House Chief of Staff Rahm Emanuel appear on Sunday news talk shows Oct. 18. The administration is mounting a counteroffensive by pointing to a disconnect between Wall Street and the rest of the country: while some big banks report compensation plans and profits at pre-crisis levels, the unemployment rate rose to 9.8 percent last month and home foreclosures jumped 29.2 percent from a year earlier. The tougher message is being repeated from the president on down. Now is the time for “firm rules of the road so that banks can’t game the system and the financial crisis on Wall Street doesn’t end up hurting folks on Main Street,” Obama said last night at a Democratic Party fundraiser in San Francisco.

Lawrence Summers, director of Obama’s National Economic Council, was giving voice to it today in New York. “There is no financial institution that exists today that is not the direct or indirect beneficiary of massive taxpayer support for the financial system,” Summers said in remarks to a conference sponsored by the Economist newspaper. Obama is renewing his push to redo financial industry regulations by the end of the year, and many of his proposals, including a Consumer Financial Protection Agency, are facing stiff industry opposition. Groups led by the Financial Services Roundtable and American Bankers Association, both based in Washington, urged Congress in July to scrap the consumer agency, saying creation of a new regulator would cut consumer access to credit.

Goldman Sachs CEO Lloyd Blankfein said he didn’t expect a “backlash” when he accepted the government funds. “Had I know it was as pregnant with this kind of potential for backlash then of course I would not have liked it,” Blankfein said today at a Fortune magazine breakfast in New York. “We are firm believers in effective regulation and believe that it is systemically important to have a regulatory framework which ensures stability of the financial system,” Goldman Sachs spokesman Lucas van Praag said. Joseph Evangelisti, spokesman for JPMorgan, referred to comments Chief Executive Officer Jamie Dimon made in his letter to shareholders in which he said that the extent of the problems made it clear that “rules and regulations must be completely overhauled.” Dimon also said that new policies should be “grounded in a thorough analysis of what happened” and that “political agendas or simplistic views will not serve us well.”

Citigroup didn’t immediately respond for comment. The mounting frustration about pushback from the industry comes the same week that the Dow Jones Industrial Average climbed above 10,000 for the first time in a year and firms including JPMorgan and New York-based Citigroup Inc. reported third-quarter earnings that beat analyst estimates. Administration officials say they recognize a healthy banking sector is critical to the economic recovery and that they’re limited in their ability to penalize the firms, particularly those that no longer owe the government money. The most politically volatile issue is executive compensation. Obama has said he believes some of the resistance to his agenda stems from resentment about expanding government involvement in the private sector, including bank bailouts. Reports about rising profits, executive salaries and bonuses following on the government rescue, may add to voter dissatisfaction.

Earlier last week, Citigroup reported a $101 million third-quarter profit as it slowed the pace of building reserves for future loan defaults. On a per-share basis, the bank had a loss of 27 cents because of a charge related to the exchange of preferred shares into common stock. Citigroup, JPMorgan Chase and San Francisco-based Wells Fargo & Co. also asked regulators for a reprieve from meeting higher capital requirements taking effect next year, arguing that lending and the economic recovery would be harmed. Goldman Sachs, which repaid $10 billion it received from the U.S. Treasury last year, also reported a surge in third- quarter profit. The company has set aside $16.7 billion to pay employees so far this year, enough to pay each worker $527,192 for the period. JPMorgan, which repaid $25 billion of U.S. rescue funds in June, said this week that its profit surged sevenfold in the quarter, to $3.59 billion, on higher investment-banking revenue. The company, which is the second biggest bank by assets, set aside $8.79 billion for compensation and benefits for its investment-bank employees in the first nine months of 2009, enough to pay $353,834 to each.

Administration officials have pointed to the appointment of Kenneth Feinberg to oversee compensation plans at the top firms that haven’t repaid assistance funds. They also cite Obama’s support for giving shareholders a non-binding say on compensation. Feinberg’s compensation reviews for companies including Charlotte, North Carolina-based Bank of America Corp. and Citigroup, each of which got $45 billion in government aid, are expected as early as next week. He’s already advised Bank of America Chief Executive Officer Kenneth Lewis to forego his 2009 salary and bonus. Bank of America, the biggest U.S. lender, posted a $1 billion third- quarter loss. Citigroup announced last week that it would sell its Phibro LLC energy-trading unit, a decision made to avoid a potential showdown with Feinberg over the unit’s CEO, Andrew Hall’s $100 million pay package.