Accused inside trader is Bear Stearns alumni
As the fraud trial of two former hedge-fund managers from Bear gets underway, the former head of their division gets arrested in the Galleon insider-trading scandal
NEW YORK (Fortune) -- The $20 million insider-trading ring that the U.S. government alleges was masterminded by billionaire hedge-fund manager Raj Rajaratnam also included two former Bear Stearns hedge-fund managers. According to two federal complaints, two of Rajaratnam's partners in the alleged crimes were Mark Kurland, of Mount Kisco, N.Y., and Danielle Chiesi of New York City. Both Kurland, 60, and Chiesi, 43, were arrested last week, along with Rajaratnam, and charged with insider trading. Bail for Kurland was set at $3 million and for Chiesi at $2 million (Rajaratnam's was set at $100 million).
Kurland was a senior managing director and a general partner at New Castle Funds, where Chiesi was a portfolio manager. The New Castle Funds were once part of Bear Stearns Asset Management and were apparently spun-off after JPMorgan Chase (JPM, Fortune 500) closed its acquisition of Bear Stearns at the end of May 2008. Kurland's and Chiesi's alleged wrongdoing started in July 2008 and continued until January 2009. Several of Kurland's former Bear colleagues paint a mixed portrait of him, describing him alternatively as a "shy and quiet, nuts-and-bolts kind of guy" but also as a "pompous, arrogant gun-slinger."
Kurland had longstanding ties to Bear Stearns. He joined the firm in 1991 as head of its equity research department and grew that group from 27 analysts to 48 analysts, 30 of whom were Institutional Investor All-Stars. In August 1995, Jimmy Cayne, then Bear Stearns' CEO, named Kurland to be the chief of Bear Stearns Asset Manangement, a relative fledgling in the asset-management world with $20 billion under management. "We have hit a home run in Mark's decision to head our asset management team," Cayne said at the time. "His leadership, experience and track record in managing the impressive growth of the equity research department will mesh perfectly with his new responsibilities."
In January 1999, Kurland gave up his CEO role at BSAM and joined his BSAM colleague, Robert Reitzes, as a general partner of New Castle Partners, a $1 billion-or-so hedge fund that Bear Stearns started at BSAM in 1995. New Castle has been primarily focused on buying the equities of large-cap, multi-national corporations with, as Kurland once said, "no lock-ups, gating or leverage."
The strategy of allowing Bear's well-regarded research analysts and other high-performing executives to become hedge-fund managers, even though they had not previously managed money, became one of the trademark moves at Bear Stearns. This strategy kept costs low, and it allowed the firm to accommodate bankers and traders the firm did not want to lose to the hedge- industry by giving them their own funds to manage as part of BSAM.
This is how Ralph Cioffi and Matthew Tannin, the two Bear hedge-fund managers currently on trial for fraud, started their hedge funds at BSAM. Cioffi had been an institutional bond salesman at Bear Stearns until his boss, Warren Spector, gave Cioffi a grubstake of $10 million to start a hedge fund and then another, which together eventually grew to around $1.6 billion in investors' money. The two Cioffi hedge funds imploded during the summer of 2007.
To catch Kurland and Chiesi in their alleged insider trading, the government used a combination of wiretaps and informants, co-conspirators who later turned into government-protected witnesses. While it may be nothing more than a coincidence that another pair of BSAM alumni have found themselves in legal difficulties, there clearly was at BSAM a cowboy culture designed to coddle the managers while providing a minimal level of oversight. From all appearances, a typical and rigorous compliance culture was lacking at BSAM toward the end.
The alleged evidence against Kurland and Chiesi, if true, is breathtaking and involved trading in the stocks of four technology companies -- Akamai Technologies, IBM, AMD and Sun Microsystems -- using material, non-public information. Chiesi, as a portfolio manager, appeared to be on the front lines of gathering the information at these companies after talking repeatedly to senior executives. She would then relay what she was finding out, the government alleged, first to Kurland, who would then urge her to buy meaningful long or short equity stakes -- depending on the circumstances -- so that New Castle could profit. Chiesi would then have conversations with Rajaratnam, the head of another hedge fund, Galleon Management, so that he could profit as well.
Nowhere was the alleged scheme at its boldest than in the trading of the shares of chip-maker AMD (AMD, Fortune 500). In June 2008, AMD entered into exclusive negotiations with investors in Abu Dhabi about splitting AMD into two pieces, a chip-manufacturer and a design business. AMD intended to keep its design business and spin off the manufacturing business to a joint venture funded by Abu Dhabi investors. AMD would also unload about $1.2 billion of debt to the joint-venture. IBM (IBM, Fortune 500) was involved in the lengthy negotiations to split off the AMD manufacturing business because IBM licensed technology to AMD.
In June, the government alleged Chiesi and Rajaratnam began their discussions about the AMD restructuring. On June 6, Chiesi told Rajaratnam the "deal" was "not close" and then Rajaratnam told Chiesi to sell AMD stock short and then to "go long it before the deal" to restructure AMD was announced. On Aug. 15, the two allegedly spoke again about the AMD deal and Chiesi informed Rajaratnam that her contact -- an unnamed AMD executive -- would be in town the following Monday to meet with IBM. She said she heard from "IBM" that the deal would be announced by Sept. 9.
They discussed buying AMD shares and Rajaratnam asked Chiesi if the AMD executive would give her "the full low down." She replied, "Oh, yeah. Plus IBM will too." Chiesi ended the call with Rajaratnam by telling him that she would see Robert Moffat, her contact at IBM (who was also accused in the scheme) the Sunday before the scheduled Monday meeting and promise to call him after their call to "see what he knows." Moffat, 52, was the senior v.p. of the Systems and Technology Group at IBM. He had been at IBM for 31 years and was considered a possible successor to CEO Sam Palmisano.
After speaking with Rajaratnam that day, Chiesi spoke with Kurland. "I'm working hard on this IBM thing," she told him and would be meeting with Moffat "on f---ing Sunday at my mom's house. I'm meeting with [the AMD executive] on Monday because [he] is meeting with Moffat, with IBM. They want IBM's technology." They discussed whether AMD's stock would rise on the news and Kurland urged Chiesi to be careful. "Don't put anything on email," he told her. "Don't email even Raj [Rajaratnam] or anybody...Be careful." They agreed as well that Chiesi would buy "300 [thousand shares] of AMD across the board." On August 15, New Castle bought 199,400 shares of AMD for $5.44 per share.
On August 19, Chiesi called Rajaratnam on his cell phone and told him that she had spoken with the AMD executive who told her that "Wall Street will be shocked" by the AMD restructuring, which now wouldn't be announced until AMD's earning announcement toward the end of September. "Between my guy and your guy, we can nail this," Rajaratnam told Chiesi. They spoke again about confidentiality. Chiesi said that "if it leaks, I think I'm out of business. Because...who knows IBM? And who, who's in bed with AMD? Put Danielle's name on the f---in' ticket."
Three days later, Chiesi and Moffat had another conversation about the timing of the deal that Moffat now placed at "six to eight weeks from my meeting" and that the chances the deal would not happen were "zero ... I see no way that it doesn't get done" because IBM had "already signed" the deal.
The calls between the defendants continued. On Aug. 26, Chiesi and Rajaratnam spoke about how AMD's revenues and earnings would be better than Wall Street analysts expected and to catch up on the latest about the AMD restructuring. At one point during the call, Chiesi said, "If the two of us weren't close to the company as we are, would you be long the stock?" When Rajaratnam responded that he wouldn't, Chiesi said she "wouldn't have touch[ed] it with a f---ing 10-foot pole."
On Aug. 27, Chiesi called an unnamed co-conspirator, who is not a defendant, and brought him up to speed on the AMD restructuring. "You just gotta trust me on this. Here's how scared I am about what I'm gonna tell you on AMD" and then told him about what she knew and that the deal would get announced in September. "I swear to you in front of God," she continued. "You put me in jail if you talk...I'm dead if this leaks. I really am...and my career is over. I'll be like Martha F---ing Stewart."
More calls back and forth throughout September helped Chiesi and Kurland establish that the AMD deal would be announced on Oct. 7. By the end of September, New Castle owned 2.3 million shares of AMD. The restructuring did get announced on Oct. 7, with AMD getting $700 million in cash and transferring $1.2 billion of its debt to the manufacturing joint venture. For the $700 million, an Abu Dhabi investment firm got a 56% ownership stake (and a 50%) voting stake in the AMD manufacturing business. AMD's stock rocketed up some 25% from its closing price the day before the restructuring was announced.
Unfortunately for New Castle, the market as a whole was collapsing because of the ongoing financial crisis. By the time New Castle began to sell its AMD shares, the AMD stock had fallen to around where New Castle had purchased it, so no money was made but millions in losses were certainly avoided. In the end, the government alleged, New Castle made more than $2.4 million trading Akamai Technologies (AKAM), approximately $500,000 trading IBM shares and more than $900,000 trading Sun Microsystems' (JAVA, Fortune 500) shares after Moffat, who was leading the charge for IBM's efforts to acquire Sun in January 2009, passed along to Chiesi -- the government alleged -- inside information about Sun's earnings and the deal process. On April 20, 2009, Oracle announced it was buying Sun for $9.50 a share. By then, Chiesi had taken her Sun profit and had decided to short Sun and got her "ass kicked" when Oracle bought the company. She had thought Moffat was going to give her a "heads up" if IBM were going to buy Sun. 
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