New York, NY – Last week, Rajat Gupta’s lead attorney in his insider trading investigation said federal prosecutors informed him they were investigating an unnamed Goldman employee in California for passing inside information about two public companies to Raj Rajaratnam. Including Mr. Gupta, this would make the fourth Goldman Sachs employee who is being investigated for insider trading.
Another Insider Trading Source for Raj
The new investigation of another Goldman Sachs employee was made known to Gary Naftalis, Gupta’s lawyer, during a hearing last week involving the insider trading case against former Goldman board member Rajat Gupta. Gupta, a former director of Goldman Sachs, has been charged with illegally tipping his former friend Raj Rajaratnam. Naftalis, acknowledged that Assistant US Attorney Reed Brodsky asked him not divulge the details of the newly disclosed investigation.
This new information could prove important to Mr. Gupta’s case as this would be a fourth Goldman Sachs source who is being investigated for allegedly providing inside information to Mr. Rajaratnam. This could create doubt about the ultimate source of the inside information that Rajaratnam traded on. Gupta has denied any wrongdoing in the case. Gupta’s trial is scheduled to begin on May 21.
In March, newspapers published that prosecutors were investigating a Goldman Sachs Managing Director named David Loeb. Loeb is an institutional salesperson who works with technology hedge-funds. Loeb also introduced Goldman Sachs technology analyst based in Asia, Henry King, to a number of hedge funds, including to Galleon. King is also under investigation for providing insider information. Neither Loeb nor King has been accused of any wrongdoing in this matter.
According to people familiar with the matter, the new Goldman Sachs source is different from Loeb or King whose names became publicly associated with the investigation last month.
Unintended Consequences of Investigation
Since Rajaratnam’s arrest, federal authorities have charged 64 people with crimes related to insider trading, of which 59 have pleaded guilty or been convicted. The FBI says that it currently has enough informants to keep prosecutions going for another five years.
Despite the obvious success the government is having prosecuting insider trading, some argue that the current investigation is having significant unintended consequences — including a negative impact on both the hedge fund and independent research industry.
In fact, some have linked hedge funds’ poor performance in 2011 to the effort by the FBI and federal prosecutors to catch investors, company managers, and consultants who traffic in inside information. These market participants contend that the poor performance seen in 2011 was not the result of hundreds of hedge funds suddenly stopping to engage in insider trading. Instead, they believe that legitimate analysts at hedge funds have become fearful of engaging in legal research efforts. This fear has led to subpar industry performance.
Certainly, the team at Integrity Research has spoken with a number of buy-side compliance officers and research directors who have expressed these concerns. They have noted that many of the controls and restrictions they have put in place will reduce their analysts’ ability to conduct high quality research. However, they admit that these controls are necessary to protect the firm from potential legal liability.
This development has also had a negative impact on independent research providers who have historically sold their primary research, proprietary data points, and unique insights to hedge funds seeking a legitimate informational advantage over their peers. In fact, many research providers have acknowledged that a majority of hedge funds were unwilling to bring on board new research firms in 2011 for fear of inadvertently obtaining questionable information.
As we have mentioned in the past, some buy-side firms even decided to rely on sell-side research in 2011 to mitigate their concerns of getting inside information from unregulated independent research providers. However, we think asset managers will find this a difficult strategy to defend given the growing evidence that tipping has been taking place with well-established regulated firms like Goldman Sachs.
It will be interesting to find out who the fourth person from Goldman Sachs is who allegedly provided insider information to Raj Rajaratnam. It will also be compelling to see how the legal case against Rajat Gupta unfolds, as the defense tries to prove that others provided Rajaratnam the tips that led to his illicit gains. However, whatever the results of the courtroom battle, it is clear to the team at Integrity Research that legitimate hedge funds, and the independent research firms that have traditionally served them have become collateral damage in the government’s current war against insider trading.