Galleon on the Politics of Financial Fiascoes

Shepard_trial_art.jpgAt one point, Galleon Group was one of the largest and most impressive set of hedge funds operating in the United States.  However over the past year, its founder Raj Rajaratnam has dominated the front pages of the papers for all the wrong reasons, culminating with the conclusion of his trial on allegations of insider trading – one of the most complex, interesting, and difficult legal cases to cut through the heart of Wall Street in recent memory.

Given the legal ramifications of what is assumed to be one of the largest wiretapping cases by the U.S. government against business in history, Robert Amsterdam has a piece up on Huffington Post looking into how the Galleon case could change the hedge fund industry’s future.  Excerpt:

As someone with extensive experience working in countries whose governments eavesdrop often without blinking, and some of whose wiretap initiatives have directly targeted me,I know firsthand the effects that government interference can have onbusiness. With this in mind, I have no doubt that regardless of Mr.Rajaratnam’s guilt or innocence, this trial and the tactics thegovernment deployed in building a case against him will surely changeseveral aspects of how the hedge fund industry conducts its affairs, ifit hasn’t already. In light of the proportion of capital that hedgefunds control in our world economy, I think it worth our while toreflect on just what this will mean going forward for Mr. Rajaratnam’scolleagues who have been watching this trial both from within the US andabroad.

If the Galleon case hasn’t scared the hedge fund community, it at thevery least must be prompting interested parties to consider how tocontinue their fiduciary duties to investors while staying on the rightside of the law without any detrimental effect to day-to-day execution.There are three main fronts in the hedge fund world where the bulk ofthe ramifications are likely to play out: strategy, compliance andinvestor relations.

Regarding strategy, that a full paper trail for each and every tradeidea is necessary must now be taken as a given. This in turn must affectprocedures, which will essentially lengthen the time to tradeexecution. Changes in trading frequency and/or volume are also no doubtin store. Less rapid-fire trading would presumably result in slightlylower profits, while simultaneously triggering fewer legal audits butalso fewer commission dollars to spread around.

That said, the means by which these ideas are communicated willnecessarily change as well. I have no doubt that electroniccommunications use in hedge funds will certainly decrease if it has notalready done so in the 18 months since Mr. Rajaratnam’s arrest. Onefriend of mine at a prominent US hedge fund told me he thinks that forevery investment professional at his firm, he believes there to be atleast two regulatory officials monitoring activities inside the firm.Since Mr. Rajaratnam’s arrest, this friend of mine has had been calledto account for one instant message and one email correspondence byin-house compliance and was subsequently reprimanded.

Generally, the use of IM and email will surely decline amongst thosewho are really aware of things. An acquaintance of mine at another hedgefund has said that although she does occasionally log into her personalemail at work, she makes a point to delete her browsing history everyday before leaving the office. Nevertheless, there are still plenty ofpeople in her firm who use the same personal electronic communicationsdevice–mostly Blackberries–for work as they do for their personallives. To what extent people are thinking about the ubiquity ofBloomberg instant messenger I do not know, but I would imagine thatanybody who has nothing to hide will continue using it.

On the compliance front, legal audits and requirements cannot beblown off as easily as they once were, but more importantly, thecompliance function will no longer be seen as an annoyance. Hedge fundprofessionals would be well-advised to operate under the assumption thatregulators can physically enter the premises at any moment. Granted,this may have always seemed obvious, but until the Feds took Mr.Rajaratnam out of his own house in handcuffs, I seriously doubt anyonethought it could really happen. In keeping with this assumption is thatthose very same Feds could be listening to any phone conversationsundertaken by hedge funds. What was once thought of as a rarity must nowbe looked upon as a likely probability.

For Wall Street lawyers, of course, all of this only opens moreopportunities to provide legal services. Resources within a hedge fundthat in previous days may have been assigned to analytics or systemswill now be allocated to compliance. This is not a bad thing or a goodthing, but a merely a reallocation of resources.