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>The sinking feeling about Galleon


The Wall Street Journal’s editorial page jumped to the defense of Galleon yesterday. “When Wall Street and business are as politically unpopular as they are now, the media temptation is to chalk up every indictment to “greed” and assume prosecutors are always right. In this case they may be right, but when political calls for scalps are in the air is precisely when the rest of us should reserve judgment until they prove it in court.”

It is a curious move for the Journal’s editorial board, which has been pretty muted about hedge funds, despite ample opportunities to address issues like short selling, risk management, compensation, etc. Yes, the accused are innocent until proven guilty, but there seems to be a lot of smoke in this case. The market seems to sense this too and Galleon is facing $1.3 bn in redemptions — more than one-third of its assets under management — and counterparties like Merrill Lynch and Barclays are cutting Galleon off from trading.

The New York Times explains that insider trading is difficult to prove, but author Dan Strachman suggests on CNBC (see clip below) that trading on insider information could be an issue for the entire money management industry, not just hedge funds. Indeed, Reuters reports that the SEC is poised to announce more cases involving insider trading and people in the financial industry.

How big a black eye the Galleon episode is for the hedge fund industry is unclear. Certainly it is not a good thing. However, for the first time in a year, the industry is net positive for asset inflows and many funds are posting solid performance amid the broad recovery in the markets since March.

We can expect that cases like Galleon, so close on the heels to the Madoff fraud, will rightly make investors even more cautious. Hedge funds need to embrace a higher bar for transparency and they must be prepared to communicate better with investors about their strategy and the specific drivers of performance. Funds which cannot explain their performance to proactive investors are going to be told to walk the plank.

Update: Galleon is winding down the fund. In a letter dated October 21, founder Raj Rajaratnam wrote to clients, “I have decided that it is now in the best interest of our investors and employees to conduct an orderly wind down of Galleon’s funds while we explore various alternatives for our business.”

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