New York: Raj Rajaratnam, the authorities say, masterminded one of the biggest insider-trading schemes in a generation.
But if Rajaratnam was trading on insider information, apparently he was not very good at it.
A close examination of the trades that led to his arrest last week reveals a startling fact: In all, Rajaratnam lost millions from what prosecutors characterize as illegal trading.
One bad trade, in the shares of the chip maker Advanced Micro Devices, cost his hedge fund, the Galleon Group, $30 million. That loss more than wiped out the profits that prosecutors claim Rajaratnam and his accomplices reaped with their scheme.
Prosecutors highlighted the winning trades in a case that they say stretched from the secretive world of hedge funds to some of the country's biggest technology companies. They did not mention the losers.
Profitable or not, insider trading is insider trading. And Rajaratnam, who maintains he is innocent, might have broken the law even if he lost money on his trades.
But the fact that some of the investments soured, and that, in all, Rajaratnam lost money, could be powerful evidence for defendants. Inside information is, by definition, information that is material to investors, and thus could cause a company's stock to move in a direction that will be obvious in advance.
For example, if a company's stock is trading at $75 and someone learns that the company will be taken over for $100 a share, that information would be material. But routine corporate news — a retailer announcing new store openings, for instance — is generally not considered material.
"The violation is trading on material non-public information," said Robert A. Mintz, a former federal prosecutor who now heads the white-collar defense practice at the law firm McCarter and English. "There's no requirement that that trade results in a gain to the defendant. But if it turns out to have been a money-loser, it obviously gives the defense some fodder to argue that the information was not material."
Utpal Bhattacharya, a professor at the Indiana University Kelley School of Business and the co-author of a study on insider trading convictions from 1995 to 2004, said that convicted defendants had profited in every one of the cases he examined.
"A loss is likely to weaken the prosecution's case," Bhattacharya said. But he added that prosecutors had wiretaps in which defendants expressed concerns about their actions, which could strengthen the case.
A spokesman for the US attorney's office in Manhattan said the office could not comment beyond the criminal complaint or press statement from last week.
That statement refers in its headline to a "$20 million insider trading case" and explains that Rajaratnam and other defendants "are charged in insider trading schemes that together netted more than $20 million in illegal profits."
A one-page graphic released by prosecutors mentions six trades made by Rajaratnam that netted Galleon, his hedge fund, total profits of $20.6 million.
Missing from that handout is a 2008 trade that moved badly against Rajaratnam and Danielle Chiesi, who also is charged in the fraud case. Chiesi worked at New Castle Funds, another hedge fund, and is accused of supplying insider information to both Rajaratnam and New Castle.
From August 2008 to October 2008, Rajaratnam ordered Galleon to buy at least 16 million shares of AMD, a computer chip maker, according to the federal criminal complaint against him and a related complaint by the Securities and Exchange Commission.
During the same period, New Castle bought about 2.5 million AMD shares, according to another criminal complaint that focuses on Chiesi.
Galleon and New Castle bought the shares because Rajaratnam and Chiesi received information from an IBM executive in August that the government of Abu Dhabi would invest billions of dollars in AMD as part of a deal for to spin off its manufacturing facilities, according to the complaints.
But the possibility of a deal between AMD and Abu Dhabi had been rumored before Galleon and New Castle began buying.
"Some analysts speculate that the spinoff will require a substantial investment from the government of Abu Dhabi," The Austin American-Statesman reported on 18 July.
Galleon spent $85 million to $90 million on the 16 million share purchases that are disclosed in the two complaints, an average of about $5.50 a share. But as global stock markets plunged in September and October, AMD shares sank too. By 6 October, Galleon's shares in AMD were worth only about $68 million, a loss of roughly 25%. On 7 October, AMD announced its deal with Abu Dhabi. Its stock closed about 8% higher that day, but was still significantly lower than Galleon's purchase price.
Galleon then held on to nearly all its AMD stock after the deal was announced, and AMD stock resumed its plunge during the rest of October.
The criminal complaint acknowledges that "most of the shares, however, were held until at least later in October 2008," at which point AMD stock was trading between $3 and $4 a share and Galleon had lost about $30 million. A person close to Galleon confirmed the figure.
The fact that Rajaratnam lost money on the trades could mean he and other defendants will receive a short sentence even if they are convicted, said Steven D. Feldman, partner in the white-collar criminal litigation practice at Herrick, Feinstein.
"The higher the gain, the higher the recommended sentence," he said.
Feldman added that prosecutors might choose to remove the AMD transactions if and when they formally indict the defendants.
Rajaratnam and the other defendants were arrested last week on a complaint from prosecutors. They have not been formally indicted, a procedure that requires a grand jury's vote.
Feldman, who once worked as an assistant federal prosecutor in the securities fraud department in Manhattan, said the lack of an indictment, as well as the fact that there were two separate complaints, indicated that the investigation might have been chaotic at the end.
“Traditionally, you're going to want to bring these cases by indictment,” Feldman said. “The fact that they didn't is evidence they were rushed.”
©2009/THE NEW YORK TIMES