Breaking Views

A lesson from the Galleon scandal

Allegations of insider trading against fund founder Raj Rajaratnam is a reminder that investors should check up on fund governance.

EMAIL  |   PRINT  |   SHARE  |   RSS
 
google my aol my msn my yahoo! netvibes
Paste this link into your favorite RSS desktop reader
See all CNNMoney.com RSS FEEDS (close)
By Richard Beales, breakingviews.com

(breakingviews.com) -- Galleon may have been holed below the waterline. The indictment of Raj Rajaratnam, the technology-focused hedge fund firm's founder, on insider trading charges is likely to scare investors away. Amid the shock and the intriguing details of the allegations, there's a broader lesson for investors about hedge fund governance.

Rajaratnam is alleged to have made more than $20 million for his funds by using inside information -- from tipsters at places ranging from chip maker Intel (INTC, Fortune 500) to rating agency Moody's (MCO) and consultancy McKinsey.

If he is guilty, it's hard to see why he bothered. The winnings were a drop in the ocean compared to Galleon's $3.7 billion under management and its Sri Lankan founder's $1.3 billion personal wealth, as calculated by Forbes.

Galleon said it was "shocked" and hadn't even known about the investigation. That's alarming. If the boss did the things he's accused of and the compliance staff didn't check, didn't spot them or didn't have the clout to follow up, it sounds like the firm's controls were inadequate.

The prominent figurehead of the fund firm now faces a barrage of potentially ruinous allegations, although he will be free on $100 million bail. With such a close association between founder and firm, and questions over the solidity of internal processes, it's hard to see how most investors can justify anything other than taking their money out of Galleon as soon as possible.

That would be a blow to Galleon's unsuspecting staff. It might cost the investors some money, too. Although the group said its assets were "highly liquid", rival hedge funds and traders could try to try to profit from any scramble at Galleon to liquidate positions.

All hedge fund investors should learn from the Galleon example: take a hard look beneath the performance and portfolio composition. Weaknesses in the infrastructure -- internal checks and balances, outside verification, depth of leadership and investors' rights -- can sink a fund group. Many managers could do a better job. Investors should insist they do. To top of page

Company Price Change % Change
Bank of America Corp... 30.26 -0.55 -1.79%
Advanced Micro Devic... 13.00 0.18 1.40%
Applied Materials In... 49.51 -4.45 -8.25%
Micron Technology In... 53.39 -1.31 -2.39%
General Electric Co 14.97 -0.06 -0.40%
Data as of May 18
Index Last Change % Change
Dow 24,715.09 1.11 0.00%
Nasdaq 7,354.34 -28.13 -0.38%
S&P 500 2,712.97 -7.16 -0.26%
Treasuries 3.07 -0.04 -1.35%
Data as of 6:34am ET
More Galleries
5 radical technologies that will change how you get to work From Uber's flying cars to the Hyperloop, these are some of the neatest transportation concepts in the works today. More
Royal wedding: How much will it cost? Meghan Markle's wedding to Prince Harry could cost millions once security is included in the bill. See how the costs break down. More
Robot co-workers? 7 cool technologies changing the way we work Experts believe humans and machines will work much more closely together. More
Sponsors
Worry about the hackers you don't know 
Crime syndicates and government organizations pose a much greater cyber threat than renegade hacker groups like Anonymous. Play
GE CEO: Bringing jobs back to the U.S. 
Jeff Immelt says the U.S. is a cost competitive market for advanced manufacturing and that GE is bringing jobs back from Mexico. Play
Hamster wheel and wedgie-powered transit 
Red Bull Creation challenges hackers and engineers to invent new modes of transportation. Play