The Billionaire's Apprentice: The Rise of the Indian-American Elite and the Fall of the Galleon Hedge Fund

by Anita Raghavan

  Over the years, Rajaratnam learned that one of the easiest ways to build a network of loyal informants was to invest in fledgling hedge funds set up by young and hungry investment managers—and then make them dependent on you to beat the market. Whenever they could, they paid you back in the best currency around, information. It was exactly the course Rajaratnam took with his own brother Rengan when he invested $1 million in Rengan’s family and friends fund at Sedna Capital. It was Rengan’s trades in AMD that had launched the SEC investigation in 2006.

  Rajaratnam had seeded more than forty hedge funds, typically giving their founders $1 million to get rolling. A handful of funds got $5 million. Most of the funds—Slattery’s Symmetry Peak or Peter Wright’s Paw Partners—flew below the radar; they were too small to draw any attention. But for Rajaratnam they were a gold mine. The funds he seeded “became an informal information network because the people who started the hedge funds were beholden to him” says one former Galleon employee. (The nature of the information Slattery and Wright provided was not known and neither man was ever charged with wrongdoing.)

  When Rajaratnam first began on Wall Street, before 2000, information flowed more freely and frequently from companies to money managers and stock analysts. Before the millennium, when the SEC put in place Regulation FD—short for “fair disclosure”—chief executives regularly gave previews of their companies’ profit picture or lifted the veil on new, groundbreaking products at private meetings with institutional investors and research analysts. It was such a common practice that some hedge fund managers freely touted their strategy of “information arbitrage”—a way of making money by having confidential information that is at variance with the prevailing market view—in their pitch books to new investors.

  The advent of “Reg FD” changed all that. It transformed the discourse between corporate America and Wall Street by requiring companies to disclose corporate news to everyone or to no one at all. In leveling the playing field between small investors and big institutions, the new SEC rule aimed to diminish the “edge” that investment managers and the Wall Street analysts that provided research to them had long enjoyed. What it effectively meant was that investment managers like Rajaratnam had to work harder than ever to beat the market, even if it meant trafficking in “hot” information.

  One of the ways for funds like Galleon around Reg FD was to develop deep nonofficial sources at companies who could pass information on the sly. In the technology space, no one was more skilled at ferreting out corporate moles than Rajaratnam. The only difference between his days at Needham and his days at Galleon was that he and his employees at Galleon had to be more vigilant about the way information was received and passed. Rajaratnam was generally careful about not saying too much in emails and instant messages. Whenever an IM chat drifted in the direction of the passing of sensitive information, he would suggest speaking “on fon” or offer to “call u?” He urged all his traders and analysts to exercise the same caution.

  Soon after former Morgan Stanley employee Adam Smith joined Galleon as an analyst in 2002, he had a conversation with Rajaratnam about putting confidential, nonpublic information in emails. Rajaratnam told Smith to avoid it and if, for whatever reason, news had to be conveyed via email, he suggested Smith be vague. Galleon did not want any record of the passing of nonpublic information in its computer system. It was all the more important since in January 2006 Galleon had registered with the SEC. A fund registered with the SEC is required to deliver books and records such as emails and IMs to the agency upon demand.

  Smith quickly mastered the art of communicating nonpublic information in a cryptic way. He had a unique style, a form of Wall Street Morse code that he developed in his early years as an investment banker at Morgan Stanley. As at most banks, one of the tasks assigned to young bankers at Morgan Stanley is dreaming up clever code names for companies involved in an impending merger so that if deal documents are accidentally left on a copy or fax machine, others within the firm have no way of divining the deal.

  In 2005, while at Galleon, Smith learned from a former Morgan Stanley colleague, that Integrated Circuit Systems, a public company that sold electronic components, was being acquired by Integrated Device Technology. In the spring of 2005, Smith sent a flurry of emails in which he referred to the “Two Eyes” or sometimes simply “Eyes.” It was code for the tie-up between Integrated Circuit and Integrated Device, two companies whose names began with the letter I. On April 21, 2005, Smith sent Rajaratnam an email entitled “Eyes”: “the date is set for May 16,” he wrote in the body of the message.

  Smith had learned from his former colleague that the merger was set to be unveiled on that date, but he sent the email only to Rajaratnam. He was nervous that others at Galleon would come to know that he had confidential information. In the past, when he passed on nonpublic information to traders at Galleon, they had circulated it among their friends on Wall Street, but in this instance, because it was highly sensitive information, he wanted to make sure it didn’t come back to haunt him.

  Smith turned out to be off by a month in his timing, but he was correct about the most important fact: a tie-up between the two “eyes,” Integrated Circuit and Integrated Device. On June 15, the companies unveiled a $1.7 billion merger deal; Galleon’s technology fund wound up making nearly $2.7 million on the Integrated Circuit stock it held. After the deal was announced, Rajaratnam told Smith that his old Morgan Stanley pal was a good contact and he should stay in touch with him. It left Smith with a sinking feeling in his stomach. Knowing that it was his inside information that led Galleon to buy the stock made him feel queasy.

  * * *

  As word of AMD’s interest in acquiring ATI Technologies spread around town, it inevitably triggered public speculation. “Need to move quick,” McKinsey consultant Paul Roche tapped out in an email. It was May 31, 2006, and Apjit Walia, a well-connected analyst at Royal Bank of Canada Capital Markets, had just published a report saying that a rumored tie-up between AMD and ATI Technologies “may be likely.” It was a gutsy call; almost as soon as Walia published his piece, other analysts mocked the idea. “This rumor surfaces occasionally, and has been making the rounds within Taiwan in the past several weeks,” wrote David Hodgson at Genuity Capital Markets. “We heard from ATI’s CEO this morning and he…had also heard the ATYT/AMD [rumors] in Taiwan in the past few weeks but he didn’t have a clue where the information came from.” Hodgson added that another ATI source “laughed at the suggestion of the link-up” and Hodgson rated the probability as “very low.”

  Walia’s reasons for a merger—expected synergies from a deal that were consistent with AMD’s strategy—were not particularly compelling. But at Galleon, traders paid attention to Walia’s report. It was well known he was a friend of Rajaratnam’s. He was often seen visiting the Galleon offices, and Rajaratnam told colleagues that he wanted to be a mentor to the young, up-and-coming analyst. They suspected Walia had learned of the proposed acquisition from none other than Rajaratnam.

  By late May, Kumar knew the AMD-ATI deal was going to happen—it was just a matter of when and at what price. AMD’s board gave Ruiz, the company’s chief executive, the green light to offer as much as $24 a share for ATI, which was trading at around $16.51 at the time. Kumar briefed Rajaratnam, telling him management was very keen to do the deal and had a lot of leeway from the board to craft a transaction.

  Not surprisingly, now that the deal had moved from rumor to reality, the Walia report was discomforting. At McKinsey and AMD, it sparked consternation. AMD was hoping to get the deal consummated in secret. How had word leaked? After all its meticulous planning and code names to keep its deal with ATI supersecret, AMD’s worst fears—of a leak—were coming true. Between the start of May and the end of the month, ATI Technologies’ stock jumped 6.4 percent. More worrisome, a number of large investors like the powerful mutual fund group Janus voiced their opposition to the deal. The talks were still supposed to be confidential, however, s
o AMD’s spin doctors found their hands tied. There was little they could do to sell the merits of the merger to some of the company’s largest shareholders.

  On the morning of Thursday, June 29, before the market opened, Rajaratnam dropped by the office of Adam Smith, who’d made a bundle of money a year earlier on the merger of two technology companies, the “eyes” deal. He and Rajaratnam had talked recently about another technology deal possibly in the offing. In early May, Smith lunched with his former colleague, the Morgan Stanley banker. For months, Smith had been hearing rumors about a possible acquisition of ATI by AMD. He knew his boss, Rajaratnam, was accumulating ATI stock. But Smith didn’t think the speculation was credible. When Smith asked his Morgan Stanley friend about ATI, he was surprised by his response.

  “They are not just rumors,” the former colleague of Smith’s said. “A deal is under way.” After his lunch, Smith called Rajaratnam. When he reached him, he told him that he had met with a banker at Morgan Stanley, who said a deal between AMD and ATI Technologies was happening. Smith was one of the more promising hires Rajaratnam made for Galleon. Even though he was a banker by background, Smith quickly caught on to the business of managing money. It was comforting for Rajaratnam to have some extra reassurance that the huge bet Galleon was making on ATI stock was a smart gamble. Not only had many of Galleon’s funds been accumulating ATI stock, but even the hedge fund’s risk book, which was supposed to take positions to offset the holdings in Galleon’s individual portfolios, was loading up on ATI stock. Galleon was betting its franchise on the deal.

  That morning in late June, ATI reported its fiscal third-quarter earnings and said its outlook for the rest of the year was bleak. Rajaratnam wanted to capitalize on the expected dip in ATI stock and add to Galleon’s position when the market opened. After the morning meeting, he stopped by Smith’s office with a specific purpose in mind. He wanted Smith to write an email outlining the reasons to buy ATI stock. Smith needed no explanation. He had worked long enough at Galleon and understood the reason Rajaratnam was making the request. He simply wanted to have a written record of the “legitimate” reasons that had prompted Galleon to buy ATI stock on a day when most investors were dumping it indiscriminately in the face of a torrent of unexpected negative news. He wanted to make sure that Galleon had a credible cover story, an email it could point to outlining every possible reason to buy ATI stock except for the real reason, a possible acquisition, so that in the event regulators starting looking into Galleon’s purchase of stock, they would be convinced that it was rooted in sound investment analysis and not in inside information.

  Shortly after Rajaratnam left his office, Smith crafted an email entitled “ATYT—what to do.” Even though “the guidance” ATI Technologies had provided was worse than expected, Smith said he was “FIRMLY” convinced it was a conservative number. He told Rajaratnam that he strongly advised buying the stock and he listed a number of reasons to own it—the company had a great product cycle, its margins were increasing, and it had market share to gain. He omitted the imminent acquisition by AMD.

  At 9:10 a.m., Smith sent the email to Rajaratnam. Shortly thereafter, when the market opened for trading, Galleon began loading up on ATI stock.

  June was a busy month for AMD. Ruiz and his bankers were busy negotiating the terms of the company’s acquisition of ATI, which entered its final stretch with a deal set to be unveiled on July 10. At the same time, the company held separate discussions with the big computer maker Dell. AMD was seeking to extend the relationship between the two companies and get Dell to use AMD chips in its desktops and laptops. If it was successful, it would be a coup for AMD, allowing the semiconductor company to make new inroads into Intel’s turf and pave the way for it to gain market share. On June 26, Dell’s chief executive officer, Kevin Rollins, hosted a dinner for AMD’s CEO, Ruiz, and some other executives. At the dinner, Rollins told Ruiz that they should target August 12 as the day to launch their tie-up. As a member of AMD’s inner circle, Kumar naturally was briefed on the plan.

  Investigators suspect but did not prove that Kumar told Rajaratnam about the pending announcement with Dell. It was exciting news. A month after its ATI acquisition, AMD was poised to unveil another strategic breakthrough to help close the gap with longtime rival Intel. It was the kind of news that got Kumar, the consultant, jazzed. And it likely was the reason Rajaratnam decided to hold AMD stock until at least August 13, a day after the expected public disclosure that Dell and AMD would be doing more business.

  It was this news and the suspicious instant messaging about August 13 that first piqued SEC lawyer Andrew Michaelson’s investigative instincts.

  On July 5, a week before AMD was set to unveil its ATI deal, Bharath Rangarajan, AMD’s strategy czar, sent an email to the merger team. “Due to a variety of circumstances, we will need to push out the Go Big announcement by two weeks.” Unbeknownst to players in the market, AMD and ATI Technologies were still a dollar apart on the share price that AMD would pay to acquire ATI. Rangarajan, naturally worried about an eleventh-hour leak, cautioned, “I would appreciate it if all of you would please let those already involved know and not pull in any more people.”

  When Kumar got the news, he was excited. “So july 24 is action week!” he emailed from his BlackBerry. But others on the McKinsey team were on edge. The longer it takes to negotiate a merger deal, the higher the risk that details of the deal will leak out, forcing up the price of the target company and making the acquisition more expensive. Vanessa Colella, a member of the McKinsey team, suggested a discussion the next day “about whether or not there should be a communication to people in the know about the critical importance of NDA” or the nondisclosure agreement that McKinsey signed as part of its engagement by AMD.

  On July 24, a little over six months after they started talking, AMD and ATI announced a $5.4 billion merger that would create a “processing powerhouse.” As part of the deal, AMD would pay $4.2 billion in cash to ATI shareholders and 57 million shares of AMD common stock, or a total of $20.47 a share. It was a big payday for Rajaratnam, who had accumulated $89.4 million worth of ATI shares, snapping up the stock whenever it slipped. He booked a profit of nearly $23 million on the deal.

  He was so elated that he hosted an impromptu celebration in his office. As his traders toasted the huge win with champagne, Rajaratnam placed a call to Kumar at home to thank him.

  “That was fantastic,” he said. “We are all cheering you right now.”

  Kumar got a sinking feeling in his stomach. The last thing he wanted was to have a crowd of people gathered in Rajaratnam’s office celebrating him with champagne. His anxiety would soon dissipate. In early 2007, as SEC lawyers were rooting around Sedna Capital’s trades in AMD and starting to focus on Galleon, Raj Rajaratnam paid Kumar a $1 million bonus for the AMD information. It was a huge sum. Instead of sending the money through circuitous channels, Rajaratnam simply transferred the $1 million from Galleon’s HSBC account in New York to Kumar’s in India. Affixed at the bottom of a fax effecting the transfer was Rajaratnam’s signature.

  Chapter Twenty-Four

  “You’ve Gotta Be a Hustler”

  Whenever Rajaratnam flew out to California, he made it a point to stop by the Goels’ house. Rajiv Goel had been Rajaratnam’s buddy since the two were at Wharton in the early eighties, getting their MBAs together. Over chaat—an Indian savory snack that Goel’s wife, Alka, was particularly good at making—Goel and Rajaratnam would kibitz about their kids and their jobs. Unlike so many of the relationships in Rajaratnam’s life, which were all business, his relationship with Goel was purely social. But that was about to change. Goel was now working as an executive at Intel Treasury, which supported the venture capital arm of Intel Corp., the semiconductor giant that went head-to-head with AMD. Rajaratnam boasted to Goel that he was astonishingly accurate when it came to predicting Intel’s financial results. He said he knew two women who were privy to Intel’s book of orders—a tally that would give
a savvy investor a window into Intel’s future revenue. The women would routinely fill him in on the information. As a thank-you, Rajaratnam said he gave each a BMW. Goel was in awe.

  What he didn’t know was that Rajaratnam’s boast was more bravado than anything else. By 2001, Rajaratnam was in the market for a new source on Intel. Since Roomy Khan had left the company, he found himself at a loose end. He no longer had an insider in one of the biggest companies in the technology universe that he covered. He’d tried to find replacements for Khan to no avail.

  Born in Bombay, now Mumbai, Goel, with his tidy mustache, looked more like an efficient bookkeeper than an executive at a technology company. Awkward and inept to the point of being comical, Goel was always stuck in one kind of jam or another. He bounced around from job to job after graduating from Wharton in 1983. For a time, he left America and returned to India, but then he came back. He was forever unhappy with his work and pay and saw Rajaratnam as a lifeline. Unlike Kumar, whose speech was clipped and who rarely engaged in pointless small talk, Goel enjoyed an easy camaraderie with Rajaratnam. Their conversations were freewheeling and they kidded each other like brothers. While Rajaratnam and Goel had stayed in touch intermittently during the eighties and nineties, their friendship blossomed after Goel started working at Intel’s Treasury department in January 2000.

  In 2003, reeling from the aftershocks of the collapse in the technology bubble, Galleon closed its California office. Rajaratnam asked Goel to do him a favor: could he keep an eye out for the happenings in Silicon Valley? He told Goel he was interested in learning about the ups and downs of the real estate market and getting a sense of people’s moods. The questions seemed innocuous enough. Goel was happy to oblige an old friend he admired. He promised to keep his eyes peeled.