Hedge Fund Magnate Raj Rajaratnam Sentenced To 11 Years In Prison For Insider Trading

On Thursday, disgraced billionaire hedge fund manager Raj Rajaratnam was sentenced to 11 years in federal prison for insider trading. Rajaratnam’s sentence represents the longest criminal sentence ever handed out in the United States for insider trading.

Federal prosecutors sought a heftier sentence in the range of 19 to 24 years according to federal sentencing guidelines. Rajaratnam’s lawyers argued for a sentence in the 6 to 8 year range, arguing that insider trading is a victimless crime. Judge Holwell cited a number of factors in mitigating Rajaratnam’s sentence. Among these mitigating factors, Judge Holwell identified Rajaratnam’s financial support of victims of the tsunami in Sri Lanka, Rajaratnam’s native country, victims of the major earthquake in Pakistan several years ago, and his support of victims of the September 11^th terrorist attacks. Rajaratanm’s health also factored into the mitigation of his sentence; Rajaratnam suffers from advanced diabetes and kidney failure.

Previously, I wrote on this blog about the unprecedented and first-time use of wiretaps to convict Raj Rajaratnam, the then head of the Galleon Fund. The SEC and federal prosecutors have been very aggressive in their crackdown on “expert networks” and insider trading generally. Raj Rajaratnam’s conviction and sentence marks a growing trend to increase jail time and other penalties meted out to white collar criminals based on the monetary impact of their crimes. Rajaratnam’s sentence sends a stern message that insider trading does not pay. We might never see insider trading come to an end on Wall Street. However, one thing is certain, Wall Street titans will be careful to watch what they say and the conversations that they keep. What are your thoughts? Should Rajaratnam have received the maximum sentence? Is insider trading really a victimless crime?

A New Twist on Insider Trading: Expert Network Consultant Firms

A little over a week ago, Reuters broke a news story about Joseph "Chip Skowron's arrest on criminal securities fraud and conspiracy charges. Skowron is an Ivy League-educated doctor who left a Harvard University residency program to become a stock picker on Wall Street. Skowron worked for several prominent hedge funds, before he became the manager of FrontPoint Partners' healthcare funds. FrontPoint is a spinoff from Morgan Stanley.

Skowron violated trading restrictions imposed by FrontPoint, in attempting to avoid a loss from adverse hepatitis drug trials conducted at Human Genome Sciences, Inc., a company Skowron's hedge fund invested in. According to the U.S. Attorney's allegations, FrontPoint avoided $30 million in losses by selling their Human Genome holdings prior to Human Genome's public announcement of problems with its hepititis C drug treatment on January 23, 2008. FrontPoint Partners has not been accused of any wrongdoing, but agreed to pay to a $33 million settlement to the Securities and Exchange Commission (SEC), without any admission of guilt.

Where did Skowron's insider tips come from? FrontPoint paid $900,000 to a firm named Guidepoint Global to gain access to that company's network experts or consultants. Guidepoint Global is in the business of matching hedge funds with industry analysts. In this case, Dr. Yves Benhamou, a 51 year old Parisian infectious disease expert, a consultant to both a biotech firm and the expert networking firm (Guidepoint Global), was paired with Skowron and FrontPoint. According to prosecutor's allegations, Skowron, in violation of FrontPoint ethics rules, cut a side deal with Dr. Benhamou beginning in 2007. Dr. Benhamou, the network expert, allegedly provided insider trading tips to Skowron about Human Genome Sciences, Inc.

What is an expert network? By definition, it is a group of professionals who are paid by outsiders for their specialized information and research services. Expert networks can be very large, encompassing tens of thousands of individuals with high-level knowledge of a variety of subjects. Experts are commonly paid the high fees associated with the provision of consulting services and may work under the umbrella of a large company that assembles the expert-professionals, markets their services and contracts their work.

The facts and allegations brought forward by the SEC read like an international spy novel. to seal their secret arrangment Skowron met Dr. benhamou at a hotel in Barcelona in April 2007 and gave him an evelope with over $7,000 in cash. A few months later, Skowron paid for a lavish stay at a New York hotel for Dr. Benhamou and his wife. Finally, after getting tipped off about Human Genome, Skowron and Dr. Benhamou met in a Milan hotel bar, where Skowron passed an evelope filled with at least $10,000 in cash to Dr. Benhamou in April 2008. Dr. Benhamou has since pled guilty to securities fraud charges, conspiracy charges, and for making false statements to FBI agents. Dr. Benhamou is cooperating with federal investigators and prosecuters according to the terms of his plea agreement.

The lesson learned is that we need to watch the relationships between hedge funds and expert network firms and consultants. Let me be clear--not all of these relationships are inherently wrong nor evil, nor merit oversight and scrutiny. Some bad apples are spoiling the cart. Not all expert networks are bad, most provide legitimate information to hedge fund managers in areas outside the manager's expertise. However, it is clear that the SEC and federal investigators are paying more attention to relationships between hedge funds and expert network firms, and their temptation to engage in insider trading. "Prosecuters say expert network relationships are not inherently wrong but that some consultants have crossed the line by taking fees to leak corporate secrets to hedge fund traders and analysts."

Undoubtedly, expert networks are creating new regulatory challenges for the SEC. The jury is somewhat out on how these organizations will be treated or regulated. In the coming months and years the SEC's approach to expert networks will be interesting to watch. I will try to keep you posted.