SEC Fraud

Raj Rajaratnam may be taking up all the headlines, as the jury continues to deliberate, but a trader who worked with Galleon has pleaded guilty. Craig C. Drimal pleaded guilty to insider trading and sentencing is set for early September, with Drimal looking at anywhere from 70 to 87 months in prison.

Drimal earned $6.4 million in illegal profits trading on insider information he received from lawyers at Ropes & Gray, who were advising on deals involving 3Com and Axcan Pharma back in 2007. He’s the 21st of 26 people charged in the insider trading ring and yet another in a line that has pleaded guilty to the charges.

I would feel some compassion for Drimal’s plight but he knew what he was doing:

“At the time I did these trades, I believed my conduct was illegal and wrong, and I deeply regret these actions which caused so much pain to my family and friends,” said Mr. Drimal, a former trader with a clean-shaved head.

If you break the law, you deserve to be punished.

This week, two hedge fund managers and an associate of Minnesota businessman Tom Petters were indicted in federal court on charges of fraud. Frank Vennes, David Harrold, and Bruce Prevost were charged with four counts of securities fraud.

Tom Petters is currently serving a 50-year sentence, a conviction that was handed down last year for masterminding a $3.7 billion Ponzi scheme that involved electronics. Prosecutors had been asking for a 335 year sentence while his attorneys asked for one of just four years – end result was fifty. By comparison, Madoff’s Ponzi scheme took nearly $65 billion (though a court-appointed trustee estimates the actual losses to around $18 billion).

How were Harrold and Prevost involved? They allegedly told investors that Tom Petters’ company, Petters Co. Inc., was profitable and Vennes told those two to only communicate with him when dealing with PCI. For their work, they received $60 million in commissions.

The Minneapolis Star Tribune reports that the hedge funds began investing with Petters in 2002 and eventually rolled about $8 billion into PCI notes – substantially all of their investors’ funds, the indictment said. When the alleged scheme collapsed in September 2008, the hedge funds reportedly held about $1 billion in PCI investments. Harrold and Prevost’s companies allegedly grossed more than $58 million in management fees.

3 Fla. men indicted in wake of $3.7B Ponzi scheme [Miami Herald]

If you’ve been following the insider trading trial of Raj Rajaratnam, one thing seems pretty clear – he’s very guilty. There’s plenty of evidence, much of it audio tapes, implicating him at the center of the whole inside trading scheme and it seems like the perfect opportunity to take advantage of a plea deal. So why didn’t he?

Holding and Arnold share their thoughts why:

The choices were all rotten for Mr. Rajaratnam. He could have pleaded guilty and agreed with prosecutors on a sentence. But doing so would have locked him into a tight range of possible time behind bars, with no leeway to argue for less. Alternatively, he could have pleaded guilty with no deal and asked for leniency when sentenced. Either choice would have precluded an appeal.

[...]

Even so, forgoing a plea has already produced benefits. The judge knocked down the number of charges to 14, from 37. As important, Mr. Rajaratnam’s lawyers had six weeks to spin the idea that Galleon gathered information from all over to create a mosaic of data on a company. Any single tidbit, even from the inside, was not important enough to be material to an investment decision, the defense contended. So trading on individual nuggets couldn’t have been illegal.

I guess there are times to go to trial, even when you look dead in the water.

The first lawsuit over David Sokol’s suspect trades in shares of Lubrizol, prior to Berkshire Hathaway acquiring the company, has been brought by a Berkshire Hathaway shareholder. Last month, we learned that David Sokol purchased $10 million in shares of Lubrizol last December, prior to bringing the company to Buffett’s attention. In March, Berkshire announced it would purchase the company for $9 billion, causing the stock price to jump 30%. For those doing the math at home, that’s a $3 million return (assuming he sold it).

The complaint was filed in Delaware Court of Chancery by shareholder Mason Kirby, who demanded that the court disgorge the profits and award damages to shareholders because of the goodwill lose in the matter. The SEC is currently investigating if any wrongdoing was committed.

As a Berkshire Hathaway shareholder and as an investor, I think that if Sokol broke any laws, he should be punished accordingly. I am not familiar enough with securities law but it seems like he didn’t break any laws. If he didn’t, there certainly should be some law against this. He may not have known that Berkshire would buy Lubrizol but he was one of only a handful of people capable of pulling this off.

On the flip side, if it’s not against the law, kudos to him.

One of the most high profile insider trading cases, in which Galleon co-founder Raj Rajaratnam is the defendant, has now seen the defense rest without calling the defendant up to the stand. In the last seven days, several individuals have taken the stand in his defense and hundreds of documents were reviewed in support of his innocence but Rajaratnam himself has not taken the stand.

The key argument of the defense was that the information used by Rajaratnam was already publicly available and thus not considered insider information.

In many respects, the defense’s final witness was its most important. Research and analysis by Gregg A. Jarrell, a professor at the business school of the University of Rochester, underpinned the defense’s case. Shortly after Mr. Rajaratnam’s arrest in October 2009, Mr. Jarrell and a litigation research firm that is operated by former students of his were contracted to dig through bank research and news reports.

In addition, Mr. Jarrell analyzed numbers that supported the assertion that the trades at the center of the accusations represented a small fraction of the activity at the trade-heavy hedge fund. And Mr. Jarrell conducted what are known as event studies, or analyses that assess whether a given event — say, an earnings release or a merger — has a significant effect on a given company.

It will be interesting to see how this drama plays out, especially since the prosecution has plenty of recorded conversations in which Rajaratnam himself is heard talking about seemingly inside information.

The government finished its rebuttal the same way it began: with a tape. Prosecutors played for jurors a recorded conversation between Mr. Rajaratnam and Danielle Chiesi, a hedge fund consultant, from September 2008 relating to the spinoff of A.M.D.’s business.

“That’s a very bold move to make unless you know what we know,” Ms. Chiesi told Mr. Rajaratnam.

Despite rampant speculation about the deal, he said, “what people don’t know is the time.”

“I think it’s the seventh,” he said on the tape. The deal was announced a week later, on Oct. 7

Galleon Chief Is Silent As Defense Rests Its Case [NYT Dealbook]

Joseph Skowron, former hedge fund manager at FrontPoint Partners, was charged with inside trading this week. It’s a charge that many had seen coming, since his name first appeared in a related investigation back in November last year. Back in November, a French doctor, Yves Benhamou, allegedly leaked “private and material information” to Skowron. Benhamou pleaded guilty this week to those charges.

The information involved problems in the drug trials for Albuferon, used to treat Hepatitis C. Showron is to have allegedly used this information to sell shares of Human Genome Sciences, which owns Albuferon, and avoided about $30 million in losses.

Former FrontPoint Manager Charged With Insider Trading [NYTimes Dealbook]

The SEC suspended trading in Rino International Corp (RINO) because it believes the China-based water-treatment equipment manufacturer may have falsified financial statements.

Rino failed to disclose that an outside law firm and forensic accountants hired to investigate allegations of financial fraud resigned on March 31, the SEC said today in an e-mail statement. The company also failed to tell investors that the head of the audit committee and all the remaining independent directors also quit, the SEC said.

That fraud inquiry was triggered by a report from Muddy Waters Research, an HK based firm that analyzes Chinese companies, in which Muddy Waters stated that the company had falsified financial documents.

The whole story sounds very shady and the SEC doesn’t suspend trading in a company unless it has a good reason to. The suspension will remain in effect until midnight April 25th.

The SEC has filed a civil suit against Alex Martinez and Ralph Sanchez, of MAM Wealth Management LLC and MAMW Real Estate General Partner LLC in Los Angeles, for steering client funds into risky mortgages. Allegedly, they convinced fifty of their clients into riskier investments between July 2007 and March 2009. They were allegedly portrayed as safe conservative investments despite being extremely risky.

Martinez and Sanchez, according to the lawsuit, misrepresented the investment, MAMW Wealth Management Real Estate Fund LLC, as a safe, relatively liquid investment that earned 9% per year and would show a profit in three years.