Galleon's Fait Accompli : Investor's Move the Dial Towards a Conservative Approach to Hedge Fund Research Now that the Galleon verdict has been rendered, there is little question that the federal government's program to target and prosecute insider trading in the hedge fund community has been emboldened. As well it should - insider trading is illegal and should be deal with as such. However, with all the guilty pleas from accomplices and related parties surrounding Raj Rajaratnam and Galleon's activities already in place before the trial began, coupled with the damming wire tap evidence - it begs the question if there really any doubt that a guilty verdict of some sorts would be announced. It seems that the initial inquiry into Galleon and the subsequent depth and scope of the evidence collected do more to bolster the message that regulators and the government are taking a hard stance towards market manipulation and insider trading. This effort arguably sends a much stronger message than any jail sentence, albeit one which could result in over 15 years in prison, Rajaratnam could receive. What the Galleon case and other similar inquiries will likely do, is to push both investors and hedge funds towards more conservative approaches towards gathering investment research. Prior to the Galleon inquiry many hedge funds may have felt comfortable casting a broad net across a variety of external research resources, including third-party expert networks, to bolster or drive their own internal research processes. After the Galleon inquiry began many hedge funds and investors likely paused for a moment to consider whether the research programs in place were touching too many external sources. Indeed, in the post-Galleon the environment both investors and hedge funds may begin to question the auspices of their research safe harbor anchored in mosaic theory defenses. At least for the short term there will likely begin a shift away from any questionable external sources. In many hedge funds and investors minds the thin gray-line between insider trading and legal research, has likely widened to a more bright line in the sand. As much as hedge fund's desire to be on the right side of the law, it is likely that investors may be the driving market force in motivating hedge funds to steer clear of such types of questionable external research. Many hedge funds and investors may choose the more cautious route and move away, at least temporarily, from the use of any suspect or questionable expert network relationships. It is not only expert networks that hedge funds and investors need to be wary of. Depending on the investment style of the fund, speaking with other industry experts or service providers who are not part of any formal expert network referral service is often a common practice. As an example, many event driven funds will speak to networks of attorney's who can advise them on such things as deal flow and they way in which hard catalyst events such as trials may shake out. Similarly, many energy focused managers will commonly speak, and give business to, smaller prime brokers or trading counterparties who specialize in the space. Depending on the nature of the conversation and the
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person making the judgment, such research may be a hedge fund's perfectly legal source of information and competitive edge or material non-public information which can result in insider trading allegations, in addition to other charges. Many investors would rather not take the risk of being involved with a hedge fund that may be susceptible to such charges in part, because even if the fund is able to successfully defend itself the associated reputational risk and legal costs might be damaging to the firm. A thorough operational due diligence program can help investors identify the risks related to the ways in which a hedge fund may be in receipt of material non-public information. Corgentum Consulting works with investors to gain an understanding of the approach a hedge fund takes towards working with third-party sources for research. Corgentum also helps investors analyze a hedge fund's compliance structure to determine if an appropriate infrastructure, policies and controls are in place to adequately insulate a hedge fund from unnecessary operational risk with regards to insider trading. By taking appropriate measures during the operational due diligence process investors can take measures to avoid exposure to unnecessary operational risks related to hedge fund insider trading. Originally posted on the Corgentum Consulting blog at www.Corgentum.com/blog For More Information
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