The Billionaire's Apprentice: The Rise of the Indian-American Elite and the Fall of the Galleon Hedge Fund (16 page)

The sudden wealth gave the Khans a foothold in a new and unfamiliar world of opulence. Roomy liked to spend money, and she spent it extravagantly. She bought a seventeen-carat diamond at Neiman Marcus. For running up a shopping tab of more than $1 million, the department store gave her a BMW.

In 2000, the couple splurged on their biggest purchase yet, a nine-thousand-square-foot mansion with six bedrooms and six and a half bathrooms and more than half a dozen marble fireplaces, in Atherton, California, the richest town in Silicon Valley, which locals call the “home of the bazillionaires.” The price tag was $10.5 million. The Khans paid all cash. Their new house was on Isabella Avenue, several doors down from Oracle billionaire Larry Ellison’s exquisitely simple but exorbitantly expensive Japanese-style abode. In their seven years living in Atherton, the Khans never got an invitation to visit Ellison’s place or drop by the home of another neighbor, Carol Bartz, the former chief executive of Yahoo! Inc.

Set on one and a half acres of land, the Khans’ new house had a pool, a tennis court, and a two-story guesthouse, which Roomy turned into an office. For the couple, who enjoyed throwing lavish parties, it was the perfect pad. After the acquisition of Agate Semiconductor, Sakhawat kicked back. He stopped working and went to business school and took up flight-training classes so he could learn to pilot a plane by himself. The Khans, who had been trying to have a child for some time, adopted a daughter, Priyanka, from Bangladesh, whom Sakhawat doted on. He went from being someone who was always focused on business to someone more devoted to family. In 2002, the Khans hired a housekeeper, a woman from El Salvador named Vilma Serralta. Every day, Serralta would start by waking the couple’s daughter, who was three years old when Serralta joined the Khans, and feeding her breakfast. Then she would spend the day cleaning the huge main house, mopping, dusting, and vacuuming it before turning to the guesthouse that Roomy Khan used as an office. Khan insisted that the five bathrooms in the main house be cleaned every day and the ones in the guesthouse twice a week. When the Khans’ daughter returned from school in the afternoon, Serralta would watch her, play with her, and keep her occupied while she prepared dinner. She adored the Khans’ daughter, who was just as attached to Serralta, whom she called “Auntie Vilma.” During her fourteen-hour days, the only respite Serralta got was occasional five- to ten-minute breaks. She dared not sit for longer because Sakhawat Khan was always keeping tabs on her, following her around the house to make sure she was never idle.

The Khans probably would have been able to weather the financial squall if they hadn’t loaded up on debt to support their extravagant lifestyle. Even though the couple had paid cash for their Atherton house in 2000, the Khans took out a $5 million mortgage after the tech stock meltdown. To meet their monthly expenses—property taxes alone in Atherton were $200,000 a year—the Khans had to pull in $60,000 a month. At first, Roomy was printing enough money to generate the income the family needed, but the trading losses hit her hard.

To make matters worse, she was also reeling from the aftershocks of a real estate deal that went awry. In December 2002, an agent acting for the Khans cut a $26 million deal to sell two homes to an Englishman who said he was a Stanford University professor with a passing interest in real estate investing. Little did the Khans know that the man was on the lam after failing to pay more than £1,188,000 for six French masterpieces at auction. At the time he entered into the deal with the Khans, the UK authorities were seeking him as a con man. To the Khans’ chagrin, he wound up pulling out of the real estate deal at the eleventh hour, leaving them with tens of thousands of dollars in lost fees that they were not able to recoup.

In 2005, Deutsche Bank sued Khan, alleging that she did not pay $600,000 in trading fees. Meanwhile, her domestic help, Serralta, was chafing at having to work eighty to ninety hours a week with only a day and a half off every other week; for all her duties, she said Khan paid her $250 a week.

Now strapped for cash, Roomy Khan tried to get a job, but this was easier said than done because of her earlier run-in with the FBI. After she had left Galleon, she pleaded guilty to wire fraud in April 2001 for her theft of corporate secrets from Intel—secrets she’d passed to Rajaratnam. It was a crime that carried a maximum prison sentence of five years and a fine of $250,000. But a year later, when Khan was sentenced, she was given probation. Her light sentence came at the behest of prosecutors, who disagreed with a presentencing report that called for a stiffer sanction. They said Khan deserved a lighter sentence because she “has provided the United States with substantial assistance in the investigation of another person.” Neither the prosecutors nor Khan revealed the individual’s name, but behind the scenes and unbeknownst to Rajaratnam, Khan had worked with the FBI to build a case against him.

After exhausting all avenues and not knowing where to turn, Khan in mid-2005 reached out to Rajaratnam. She’d stayed away from him for several years on the advice of her lawyer. But now that her legal troubles were behind her, she saw no harm in getting in touch. When she telephoned, he seemed happy to hear from her, even though it had been ages since the two had spoken. He always treated Khan as more than just a business acquaintance. She felt that he was more inclined to take her calls and listen to her ideas because she and his wife, Asha, came from the same part of India. When Khan told Rajaratnam that she was looking for a job, he seemed surprised.

“You are too wealthy to work for me,” he said flatly.

At that point, Khan confided in him, telling him about the depth of the cash crunch that she and her husband, Sakhawat, faced. The interest rate on the mortgage of their Atherton house had doubled, driving her monthly expenses higher. She was having a hard time finding a job, though she failed to mention to Rajaratnam the real reason for her difficulty: her criminal record.

In the course of their conversation, Rajaratnam, who had no idea that Khan had snitched on him in the past, asked Khan what companies she had an “edge” on. Having worked for Rajaratnam before, Khan knew that he was asking her at which companies she had an insider. She said she had an “edge” on Polycom, the company where her friend Bhalla worked. Rajaratnam didn’t hire Khan, but the two rekindled their relationship. When Rajaratnam came out to California in December 2005 for a Lehman conference at the St. Regis hotel in San Francisco, the two met. Khan, still hoping to parlay her tips into a job, invited Rajaratnam to her home. She wanted to show him her office space in her guesthouse so that Rajaratnam would know she was serious about working at Galleon. Rajaratnam told her he planned to fire his Internet analyst by year-end and hire her. A couple of months later, when Khan got wind that Rajaratnam had fired the analyst, she broached the topic of a job at Galleon again. This time, he said he wanted to wait until earnings season passed before having a discussion about it. She was starting to wonder if Rajaratnam was being sincere or stringing her along.

In an effort to ingratiate herself to Rajaratnam, Khan started to feed him a steady diet of tips on tech stocks and companies in other sectors. Her information on Polycom was uncannily on the money. In December 2005, she invited Bhalla and his new wife to her home for a holiday dinner. Khan liked to mix business with pleasure, and as Bhalla was leaving the party, she asked him how the quarter was going. He told her it was looking very good.

After the holidays, Khan followed up with him. Sometime early in January, around the tenth or eleventh of the month, she set up a meeting with him. To help focus the discussion, she arrived with an earnings model of Polycom and a snapshot of the company’s profit estimates.

“So what’s the expectation?” Bhalla asked. He wanted to know the revenue that Wall Street expected Polycom to generate that quarter. Khan threw out a number—$145 million or so.

“Oh, we can easily beat that,” Bhalla replied.

Bhalla’s information flew completely in the face of the prevailing view on Wall Street, where analysts were predicting that Polycom would have a weak fourth quarter. As soon as Khan got the upbeat news, she started spreading the word, telling Rajaratnam and others in her circle that Polycom’s fourth quarter was going to be good and the general outlook on future earnings was positive. On Thursday, January 12, at 10:30 a.m., Khan instant-messaged Rajaratnam: “hi u there?” There is no record of a phone conversation between Rajaratnam and Khan but three minutes later Rajaratnam messaged his favorite trader and said: “buy 60 PLCM,” which is the ticker symbol for Polycom.

That morning in January 2006, just two days after Khan had bought 3,000 Polycom call options, making a calculation that Polycom’s stock would rise, Rajaratnam’s Technology fund started buying the stock. At 10:36 a.m., the fund acquired 60,000 shares. It was a nerve-racking position. Sometimes when a company is expected to unveil strong earnings, its stock starts to rise in anticipation, but in this case, Polycom’s stock was not moving higher. Khan was worried and from time to time checked in with Bhalla, who reassured her that Polycom’s earnings report would surpass expectations.

Over the next week, Galleon steadily acquired more shares of Polycom, and on Saturday, January 21, Rajaratnam called his brother Rengan from home; two days later, on Monday, when trading resumed, Rengan also began to acquire Polycom shares in his personal account and at his hedge fund Sedna.

After the market closed on Wednesday, January 25, Polycom released its fourth-quarter 2005 earnings, which showed revenue of $156.1 million, easily surpassing Wall Street estimates as Bhalla promised. Polycom’s stock, which trades under the ticker symbol PLCM, rose 13 percent.

The next day, Rajaratnam instant-messaged Khan: “hey…tks for plcm idea.” After the earnings were released, Bhalla also got in touch. Khan says he suggested she sell the Polycom stock in the midst of the rally and then, lapsing into Hindi, he asked her to put some of the winnings from the Polycom trade into his money-losing account at Lehman. But Khan, now worried that she might be forced to sell her sprawling Atherton estate, told Bhalla that she could not give him the money. She first had to attend to repairing her own finances. Getting a job at a hedge fund like Galleon would be a start to fixing her problems.

A few weeks after the profitable Polycom trade, Khan met with Rajaratnam again while he was on a trip to San Francisco. Earnings season was over and Khan had helped Rajaratnam make money in the profit-reporting period that had just ended. Her tip on Polycom alone netted his Technology fund $482,960 in gains. There was no better time than now to bring up the subject of a job at Galleon. But when she raised the topic with Rajaratnam in San Francisco, he stalled. He said he would need to confer with his head trader before hiring her, and he now said that he thought she needed connections in New York before Galleon could bring her on board. Over the next couple of years, Khan and Rajaratnam stayed in touch; she continued to provide inside information on Polycom and stocks such as Google. Rajaratnam reciprocated, giving her his gleanings on stocks such as AMD and Intel. He never hired her. He didn’t have to; she was already supplying him with insider tips.

A little before 4 p.m. on July 2, 2007, two days before Rajaratnam headed off for his family vacation in France, Khan called him to tell him about a hot tip she’d received from another source in her wide circle of South Asian informants. During the brief call, Khan told Rajaratnam she heard that Blackstone Group, the New York private equity firm, was planning to acquire Hilton Hotels Corp. The information was red-hot, meaning that the deal was going to be announced the next day.

An investor seeking to make money needed to act fast, buying shares before Blackstone unveiled the price it planned to pay for Hilton. Khan had already placed a trade in Hilton for her own account, buying 550 call options that would allow her to buy Hilton stock at a specified price at a future date. Over the next ten minutes, Rajaratnam and Khan spoke briefly two more times. It was too late for Galleon to place a trade that afternoon because the stock market was about to close. But the next morning, Tuesday, July 3, seven minutes after the market opened, one of Rajaratnam’s lieutenants placed an order with J.P. Morgan to buy 500,000 shares of Hilton. Of that, 400,000 shares, or about $14 million of stock, were purchased for the Galleon Technology fund, the flagship fund at Galleon, which Rajaratnam ran—an odd trade for a tech fund considering that Hilton Hotels was as much a tech company as Intel was a hotelier. When Khan caught up with Rajaratnam later that day and asked if he had snapped up some Hilton stock, he said he missed it. The SEC probe had done little to curtail his bad behavior, but clearly it had made him more circumspect.

By the end of the trading day, purchases by Rajaratnam and scores of others who caught wind of the Hilton deal before it was announced pushed the company stock 6.4 percent higher, to $36.05. After the market closed, Blackstone said it would pay $47.50 a share in cash to buy Hilton for a total of $20 billion plus debt. The deal was a windfall for Rajaratnam, who netted a profit of almost $4.1 million, and for Khan and a host of others. When Rajaratnam eventually caught up with his friend Rajiv Goel in France, he mentioned making a boatload for him on Hilton. A purchase of 7,500 shares of Hilton stock was placed in Goel’s Schwab account at 10:39 a.m. the day before Rajaratnam headed off to France, from an Internet protocol address at Galleon. The trade would ultimately become a costly one for Goel.

July 3 was only a half trading day because of the upcoming Independence Day holiday, but 7,470,686 shares of Hilton changed hands, more than twice as much as the average trading volume in the stock on a daily basis in the preceding fifty-two-week period. It was clear that someone knew Hilton was going to be acquired.

Israel Friedman, an SEC staff attorney, was struck by the hockey-stick-like rise in Hilton stock, and immediately after the Independence Day holiday he requested information on trading activity in Hilton from the NYSE. Friedman was a seasoned lawyer and a dogged digger. As a matter of practice, when he investigated cases, he not only subpoenaed phone records but also liked to obtain Internet protocol addresses, the unique numerical label identifying a certain computer in a network. It was an investigative tool that would prove important in unlocking the Galleon case.