The Billionaire's Apprentice: The Rise of the Indian-American Elite and the Fall of the Galleon Hedge Fund (24 page)

The advent of “Reg FD” changed all that. It transformed the discourse between corporate America and Wall Street by requiring companies to disclose corporate news to everyone or to no one at all. In leveling the playing field between small investors and big institutions, the new SEC rule aimed to diminish the “edge” that investment managers and the Wall Street analysts that provided research to them had long enjoyed. What it effectively meant was that investment managers like Rajaratnam had to work harder than ever to beat the market, even if it meant trafficking in “hot” information.

One of the ways for funds like Galleon around Reg FD was to develop deep nonofficial sources at companies who could pass information on the sly. In the technology space, no one was more skilled at ferreting out corporate moles than Rajaratnam. The only difference between his days at Needham and his days at Galleon was that he and his employees at Galleon had to be more vigilant about the way information was received and passed. Rajaratnam was generally careful about not saying too much in emails and instant messages. Whenever an IM chat drifted in the direction of the passing of sensitive information, he would suggest speaking “on fon” or offer to “call u?” He urged all his traders and analysts to exercise the same caution.

Soon after former Morgan Stanley employee Adam Smith joined Galleon as an analyst in 2002, he had a conversation with Rajaratnam about putting confidential, nonpublic information in emails. Rajaratnam told Smith to avoid it and if, for whatever reason, news had to be conveyed via email, he suggested Smith be vague. Galleon did not want any record of the passing of nonpublic information in its computer system. It was all the more important since in January 2006 Galleon had registered with the SEC. A fund registered with the SEC is required to deliver books and records such as emails and IMs to the agency upon demand.

Smith quickly mastered the art of communicating nonpublic information in a cryptic way. He had a unique style, a form of Wall Street Morse code that he developed in his early years as an investment banker at Morgan Stanley. As at most banks, one of the tasks assigned to young bankers at Morgan Stanley is dreaming up clever code names for companies involved in an impending merger so that if deal documents are accidentally left on a copy or fax machine, others within the firm have no way of divining the deal.

In 2005, while at Galleon, Smith learned from a former Morgan Stanley colleague, that Integrated Circuit Systems, a public company that sold electronic components, was being acquired by Integrated Device Technology. In the spring of 2005, Smith sent a flurry of emails in which he referred to the “Two Eyes” or sometimes simply “Eyes.” It was code for the tie-up between Integrated Circuit and Integrated Device, two companies whose names began with the letter
I
. On April 21, 2005, Smith sent Rajaratnam an email entitled “Eyes”: “the date is set for May 16,” he wrote in the body of the message.

Smith had learned from his former colleague that the merger was set to be unveiled on that date, but he sent the email only to Rajaratnam. He was nervous that others at Galleon would come to know that he had confidential information. In the past, when he passed on nonpublic information to traders at Galleon, they had circulated it among their friends on Wall Street, but in this instance, because it was highly sensitive information, he wanted to make sure it didn’t come back to haunt him.

Smith turned out to be off by a month in his timing, but he was correct about the most important fact: a tie-up between the two “eyes,” Integrated Circuit and Integrated Device. On June 15, the companies unveiled a $1.7 billion merger deal; Galleon’s technology fund wound up making nearly $2.7 million on the Integrated Circuit stock it held. After the deal was announced, Rajaratnam told Smith that his old Morgan Stanley pal was a good contact and he should stay in touch with him. It left Smith with a sinking feeling in his stomach. Knowing that it was his inside information that led Galleon to buy the stock made him feel queasy.

As word of AMD’s interest in acquiring ATI Technologies spread around town, it inevitably triggered public speculation. “Need to move quick,” McKinsey consultant Paul Roche tapped out in an email. It was May 31, 2006, and Apjit Walia, a well-connected analyst at Royal Bank of Canada Capital Markets, had just published a report saying that a rumored tie-up between AMD and ATI Technologies “may be likely.” It was a gutsy call; almost as soon as Walia published his piece, other analysts mocked the idea. “This rumor surfaces occasionally, and has been making the rounds within Taiwan in the past several weeks,” wrote David Hodgson at Genuity Capital Markets. “We heard from ATI’s CEO this morning and he…had also heard the ATYT/AMD [rumors] in Taiwan in the past few weeks but he didn’t have a clue where the information came from.” Hodgson added that another ATI source “laughed at the suggestion of the link-up” and Hodgson rated the probability as “very low.”

Walia’s reasons for a merger—expected synergies from a deal that were consistent with AMD’s strategy—were not particularly compelling. But at Galleon, traders paid attention to Walia’s report. It was well known he was a friend of Rajaratnam’s. He was often seen visiting the Galleon offices, and Rajaratnam told colleagues that he wanted to be a mentor to the young, up-and-coming analyst. They suspected Walia had learned of the proposed acquisition from none other than Rajaratnam.

By late May, Kumar knew the AMD-ATI deal was going to happen—it was just a matter of when and at what price. AMD’s board gave Ruiz, the company’s chief executive, the green light to offer as much as $24 a share for ATI, which was trading at around $16.51 at the time. Kumar briefed Rajaratnam, telling him management was very keen to do the deal and had a lot of leeway from the board to craft a transaction.

Not surprisingly, now that the deal had moved from rumor to reality, the Walia report was discomforting. At McKinsey and AMD, it sparked consternation. AMD was hoping to get the deal consummated in secret. How had word leaked? After all its meticulous planning and code names to keep its deal with ATI supersecret, AMD’s worst fears—of a leak—were coming true. Between the start of May and the end of the month, ATI Technologies’ stock jumped 6.4 percent. More worrisome, a number of large investors like the powerful mutual fund group Janus voiced their opposition to the deal. The talks were still supposed to be confidential, however, so AMD’s spin doctors found their hands tied. There was little they could do to sell the merits of the merger to some of the company’s largest shareholders.

On the morning of Thursday, June 29, before the market opened, Rajaratnam dropped by the office of Adam Smith, who’d made a bundle of money a year earlier on the merger of two technology companies, the “eyes” deal. He and Rajaratnam had talked recently about another technology deal possibly in the offing. In early May, Smith lunched with his former colleague, the Morgan Stanley banker. For months, Smith had been hearing rumors about a possible acquisition of ATI by AMD. He knew his boss, Rajaratnam, was accumulating ATI stock. But Smith didn’t think the speculation was credible. When Smith asked his Morgan Stanley friend about ATI, he was surprised by his response.

“They are not just rumors,” the former colleague of Smith’s said. “A deal is under way.” After his lunch, Smith called Rajaratnam. When he reached him, he told him that he had met with a banker at Morgan Stanley, who said a deal between AMD and ATI Technologies was happening. Smith was one of the more promising hires Rajaratnam made for Galleon. Even though he was a banker by background, Smith quickly caught on to the business of managing money. It was comforting for Rajaratnam to have some extra reassurance that the huge bet Galleon was making on ATI stock was a smart gamble. Not only had many of Galleon’s funds been accumulating ATI stock, but even the hedge fund’s risk book, which was supposed to take positions to offset the holdings in Galleon’s individual portfolios, was loading up on ATI stock. Galleon was betting its franchise on the deal.

That morning in late June, ATI reported its fiscal third-quarter earnings and said its outlook for the rest of the year was bleak. Rajaratnam wanted to capitalize on the expected dip in ATI stock and add to Galleon’s position when the market opened. After the morning meeting, he stopped by Smith’s office with a specific purpose in mind. He wanted Smith to write an email outlining the reasons to buy ATI stock. Smith needed no explanation. He had worked long enough at Galleon and understood the reason Rajaratnam was making the request. He simply wanted to have a written record of the “legitimate” reasons that had prompted Galleon to buy ATI stock on a day when most investors were dumping it indiscriminately in the face of a torrent of unexpected negative news. He wanted to make sure that Galleon had a credible cover story, an email it could point to outlining every possible reason to buy ATI stock except for the real reason, a possible acquisition, so that in the event regulators starting looking into Galleon’s purchase of stock, they would be convinced that it was rooted in sound investment analysis and not in inside information.

Shortly after Rajaratnam left his office, Smith crafted an email entitled “ATYT—what to do.” Even though “the guidance” ATI Technologies had provided was worse than expected, Smith said he was “FIRMLY” convinced it was a conservative number. He told Rajaratnam that he strongly advised buying the stock and he listed a number of reasons to own it—the company had a great product cycle, its margins were increasing, and it had market share to gain. He omitted the imminent acquisition by AMD.

At 9:10 a.m., Smith sent the email to Rajaratnam. Shortly thereafter, when the market opened for trading, Galleon began loading up on ATI stock.

June was a busy month for AMD. Ruiz and his bankers were busy negotiating the terms of the company’s acquisition of ATI, which entered its final stretch with a deal set to be unveiled on July 10. At the same time, the company held separate discussions with the big computer maker Dell. AMD was seeking to extend the relationship between the two companies and get Dell to use AMD chips in its desktops and laptops. If it was successful, it would be a coup for AMD, allowing the semiconductor company to make new inroads into Intel’s turf and pave the way for it to gain market share. On June 26, Dell’s chief executive officer, Kevin Rollins, hosted a dinner for AMD’s CEO, Ruiz, and some other executives. At the dinner, Rollins told Ruiz that they should target August 12 as the day to launch their tie-up. As a member of AMD’s inner circle, Kumar naturally was briefed on the plan.

Investigators suspect but did not prove that Kumar told Rajaratnam about the pending announcement with Dell. It was exciting news. A month after its ATI acquisition, AMD was poised to unveil another strategic breakthrough to help close the gap with longtime rival Intel. It was the kind of news that got Kumar, the consultant, jazzed. And it likely was the reason Rajaratnam decided to hold AMD stock until at least August 13, a day after the expected public disclosure that Dell and AMD would be doing more business.

It was this news and the suspicious instant messaging about August 13 that first piqued SEC lawyer Andrew Michaelson’s investigative instincts.

On July 5, a week before AMD was set to unveil its ATI deal, Bharath Rangarajan, AMD’s strategy czar, sent an email to the merger team. “Due to a variety of circumstances, we will need to push out the Go Big announcement by two weeks.” Unbeknownst to players in the market, AMD and ATI Technologies were still a dollar apart on the share price that AMD would pay to acquire ATI. Rangarajan, naturally worried about an eleventh-hour leak, cautioned, “I would appreciate it if all of you would please let those already involved know and not pull in any more people.”

When Kumar got the news, he was excited. “So july 24 is action week!” he emailed from his BlackBerry. But others on the McKinsey team were on edge. The longer it takes to negotiate a merger deal, the higher the risk that details of the deal will leak out, forcing up the price of the target company and making the acquisition more expensive. Vanessa Colella, a member of the McKinsey team, suggested a discussion the next day “about whether or not there should be a communication to people in the know about the critical importance of NDA” or the nondisclosure agreement that McKinsey signed as part of its engagement by AMD.

On July 24, a little over six months after they started talking, AMD and ATI announced a $5.4 billion merger that would create a “processing powerhouse.” As part of the deal, AMD would pay $4.2 billion in cash to ATI shareholders and 57 million shares of AMD common stock, or a total of $20.47 a share. It was a big payday for Rajaratnam, who had accumulated $89.4 million worth of ATI shares, snapping up the stock whenever it slipped. He booked a profit of nearly $23 million on the deal.

He was so elated that he hosted an impromptu celebration in his office. As his traders toasted the huge win with champagne, Rajaratnam placed a call to Kumar at home to thank him.

“That was fantastic,” he said. “We are all cheering you right now.”

Kumar got a sinking feeling in his stomach. The last thing he wanted was to have a crowd of people gathered in Rajaratnam’s office celebrating him with champagne. His anxiety would soon dissipate. In early 2007, as SEC lawyers were rooting around Sedna Capital’s trades in AMD and starting to focus on Galleon, Raj Rajaratnam paid Kumar a $1 million bonus for the AMD information. It was a huge sum. Instead of sending the money through circuitous channels, Rajaratnam simply transferred the $1 million from Galleon’s HSBC account in New York to Kumar’s in India. Affixed at the bottom of a fax effecting the transfer was Rajaratnam’s signature.

Whenever Rajaratnam flew out to California, he made it a point to stop by the Goels’ house. Rajiv Goel had been Rajaratnam’s buddy since the two were at Wharton in the early eighties, getting their MBAs together. Over
chaat
—an Indian savory snack that Goel’s wife, Alka, was particularly good at making—Goel and Rajaratnam would kibitz about their kids and their jobs. Unlike so many of the relationships in Rajaratnam’s life, which were all business, his relationship with Goel was purely social. But that was about to change. Goel was now working as an executive at Intel Treasury, which supported the venture capital arm of Intel Corp., the semiconductor giant that went head-to-head with AMD. Rajaratnam boasted to Goel that he was astonishingly accurate when it came to predicting Intel’s financial results. He said he knew two women who were privy to Intel’s book of orders—a tally that would give a savvy investor a window into Intel’s future revenue. The women would routinely fill him in on the information. As a thank-you, Rajaratnam said he gave each a BMW. Goel was in awe.

What he didn’t know was that Rajaratnam’s boast was more bravado than anything else. By 2001, Rajaratnam was in the market for a new source on Intel. Since Roomy Khan had left the company, he found himself at a loose end. He no longer had an insider in one of the biggest companies in the technology universe that he covered. He’d tried to find replacements for Khan to no avail.

Born in Bombay, now Mumbai, Goel, with his tidy mustache, looked more like an efficient bookkeeper than an executive at a technology company. Awkward and inept to the point of being comical, Goel was always stuck in one kind of jam or another. He bounced around from job to job after graduating from Wharton in 1983. For a time, he left America and returned to India, but then he came back. He was forever unhappy with his work and pay and saw Rajaratnam as a lifeline. Unlike Kumar, whose speech was clipped and who rarely engaged in pointless small talk, Goel enjoyed an easy camaraderie with Rajaratnam. Their conversations were freewheeling and they kidded each other like brothers. While Rajaratnam and Goel had stayed in touch intermittently during the eighties and nineties, their friendship blossomed after Goel started working at Intel’s Treasury department in January 2000.

In 2003, reeling from the aftershocks of the collapse in the technology bubble, Galleon closed its California office. Rajaratnam asked Goel to do him a favor: could he keep an eye out for the happenings in Silicon Valley? He told Goel he was interested in learning about the ups and downs of the real estate market and getting a sense of people’s moods. The questions seemed innocuous enough. Goel was happy to oblige an old friend he admired. He promised to keep his eyes peeled.

Rajaratnam knew that Goel had not prospered in the way he had since leaving Wharton. Like Kumar, Goel returned to work in India at the wrong time (when the lumbering Indian economy was still muddling along) and came back to the United States as Silicon Valley started to crest. He missed out on the Indian boom and all the riches that fell to entrepreneurs who staked their futures on it, and he came back to a California that was so effervescent it would take years before he and his wife could even afford to buy a house.

Sensing that Goel felt left behind, Rajaratnam tried to help whenever he could. In 2005, Goel asked Rajaratnam if he would trade stocks on his behalf in his brokerage account.

“You’re a star trader,” Goel declared. “I don’t know how to trade stocks…Can you help me make some money?” Rajaratnam readily agreed. To make it easier, Goel gave him the log-in details and the password to his account at Charles Schwab. It never would have occurred to him not to trust Rajaratnam with his personal financial details. If there was a friend he trusted, it was Rajaratnam.

It was around this time that Goel was feeling more settled at Intel. After being promoted to director a year earlier, he planned on buying his first house in California. The property he and his wife, Alka, liked was in Los Altos, an elegant suburban village outside San Francisco known for its stellar schools. Goel was nervous about the investment and worried it was way above his budget. At the time he was making around $400,000 a year. When Rajaratnam saw that Goel dithered, he stepped in.

“Hey, I can help you,” Rajaratnam said. He lent Goel $100,000 for the down payment on a four-bedroom house with a landscaped garden and pool. Even with the outlay from Rajaratnam, Goel struggled to buy the $2.1 million property. He borrowed $1.68 million from the bank to finance his new house. Though he promised to pay back the personal loan to Rajaratnam, he never did.

The relationship between the two deepened a year later when an unexpected calamity hit Goel. His father, who was in his late eighties, was hospitalized and put in intensive care. Goel flew to India several times and even took to sleeping on the hospital floor to keep an eye on his dad. At one point, he confided in Rajaratnam that something had been preying on his mind: if his father died and the family property had to be divided, would he and his brother be able to keep their dad’s apartment, which was valued at as much as $1 million? Without giving it a second thought, Rajaratnam wired $500,000 from a bank account that he and his wife had at Chase Manhattan Bank. Goel had never seen so much money in his life. While he was growing up in India, there had always been a mystique surrounding wealthy people and their Swiss bank accounts, so Goel set up an account at Credit Suisse and had the money, ultimately meant for India, sent to Switzerland. Before the money could reach its final destination, though, another disaster hit the Goels. The house they’d bought a year earlier, the one Rajaratnam lent them the money to buy, had become infested with rats, which had eaten through the ground floor. Goel had to fork out a few hundred thousand dollars to get rid of the infestation.

When Goel was at Wharton, he’d looked up to Rajaratnam, and in the years since, his respect for him had only grown. Rajaratnam had succeeded beyond anyone’s wildest imagination, and he had done so on his terms. Unlike Goel, he worked for no one; he was his own boss. It was a position Goel sometimes wished for himself. In his role at Intel Treasury, Goel was a salaryman, but he knew from working closely with colleagues at Intel Capital, who were paid bonuses and compensated more lavishly, that there were great riches to be reaped in the investing world. In 2008, just as he was coming off a career coup, his disaffection hit a peak.

Goel had spent the previous year structuring a recapitalization of a company in Intel Capital’s portfolio called SMART Technologies. Goel was charged with helping Intel monetize its $1 million investment in the Calgary company, which developed and made interactive whiteboards. At first, the husband-and-wife team that owned a majority stake in SMART Technologies saw Goel’s efforts as a distraction to their plans to grow the company. But Goel’s persistence paid off. He introduced the company to Apax Partners, a London private equity firm, which made an offer for a minority stake in the company. At Goel’s prodding, Apax even boosted its original offer price by more than 10 percent to $925 million. And then, at the eleventh hour, Goel saved the deal by devising “a brilliant structure” that allowed Intel’s ownership stake in SMART Technologies to remain little changed and kept Apax from having control.

“Rajiv’s deal instincts were right all along,” gushed his boss in a letter nominating him for an internal Intel award. “Apax was too invested in the deal to walk away.” The deal turned out to be very lucrative for Intel; it led to $120 million of capital gains. Goel won an award and was invited to a black-tie banquet. But for all his work, he received only a small bonus. The security of a guaranteed $400,000 annual salary paled in comparison to the easy street where his friend Rajaratnam lived.

Goel was feeling underappreciated when one day in late March 2008, he picked up the phone and called Rajaratnam to vent.

“Get me a job with one of your powerful friends, man,” he began. “I’m tired of this company.”

Despite his elevated status in the South Asian community, Rajaratnam never balked at introducing Goel to his powerful friends. In November 2006, when Goel was planning a trip to New York City, he reached out to Rajaratnam. Perhaps “we could meet…I am itching to buy an expensive bottle of wine! (SMILEY FACE),” he emailed. Goel knew that Rajaratnam was close to Parag Saxena, one of Gupta’s partners in his private equity venture. Goel had some expertise investing in companies at Intel and thought he might parlay his experience into a job at the fund.

When Goel came to New York, he met with Rajaratnam’s partners in New Silk Route over drinks in the lobby of the Four Seasons Hotel on Fifty-Seventh Street. Nothing came of the meeting, but Rajaratnam’s gesture was one of the reasons Goel so valued their friendship. Not everyone in Rajaratnam’s place would have made the introduction. Rajaratnam was a real friend; he always put his neck on the line for Goel, even when there didn’t seem to be anything in it for him in return.

When Goel, pleading for help in finding a job, told Rajaratnam of the Intel award he was getting, Rajaratnam cut to the crux of the matter.

“Did you get an award or did you get cash?” asked Rajaratnam. He knew how to press all the right buttons and move people around like pawns on his personal chessboard.

“No, no, they don’t give cash, no,” replied Goel, a little taken aback. “They hold a special banquet for this.”

“Are you gonna speak?” Rajaratnam then asked.

“It’s a formal thing,” Goel said, dodging the question. “You gotta wear a tux and everything. It’s like a big affair.”

When Rajaratnam pressed Goel on what he had done to win the award, Goel portrayed himself as an iconoclast. “You gotta be a hustler and you gotta be a maverick. You gotta say ‘To hell with it’ uh…you know, when your superiors or when your management tells you to do it one way, screw it, I’ll do it the way I want…Basically I’m taking a dig at the management, no?” Goel said, seeking Rajaratnam’s approval. “And I’m saying maverick. I mean, everybody and their mother was opposing the deal…so they’re [
sic
] thinking is ‘Yeah, this guy will never be able to do it.’”

Rajaratnam sensed the depth of Goel’s dissatisfaction. At Galleon he was the boss, not the underpaid and overworked employee, but for a moment he traded places and pretended to put himself in Goel’s shoes.

“You should not have any expectations of financial rewards but a lot of psychic rewards,” Rajaratnam suggested Goel point out in his write-up.

“Yeah,” Goel chuckled, “lot of back-patting.”

After the call, like a child running home with a good report card, Goel sent Rajaratnam the nominating letter his manager wrote for the Intel award. In his forwarding message to Rajaratnam, he remarked, “The deal complexity is much higher than depicted but nonetheless makes good reading.”

Over the years, as the friendship between the two deepened, their families vacationed together and their daughters bonded. After one holiday the families took to Italy in 2008, the Goels left early to visit London. The Rajaratnams stayed behind, but their daughters missed the Goel girls. “Dad has nobody to pick on so he’s picking on us,” the Rajaratnam girls wrote. “Thanks for inviting and planning a great vacation. We will remember you as we eat another pasta tonight. Have fun in London and see you soon.” As a postscript, the Rajaratnam girls added, “New York rocks and California sucks.” Goel wasn’t sure if he agreed with the assessment, but he was happy that his friendship with Raj had grown to encompass his family.