Last week the financial community was rocked by the arrest of Raj Rajaratnam, the founder of The Galleon Group, one of the largest hedge fund investors in technology companies with approximately $3.7 billion in assets last Friday. Mr. Rajaratnam was arrested along with five highly placed business executives from other companies in what is alleged to be one of the largest insider trading schemes in U.S. history.
A lot is at stake in this case. The gang of six faces both criminal and civil charges. The Galleon hedge fund is also named as a defendant in the Security and Exchange Commission’s civil suit. This case will require the engagement of a huge amount of legal machinery. You can also bet that with this much on the line the courtroom battle will most likely be expensive and protracted.
We all know that there is a presumption of innocence in the courtroom. In other words, the burden of proof is on the prosecution and the accused is innocent until proven guilty. Unfortunately for the defendants, the presumption of innocence has no authority in the court of public opinion. It does not prevent people from jumping to conclusions and therein lies the problem for Galleon.
While the defendants were lawyering-up, Galleon investors were voting with their feet. As of Monday, Galleon had already received $1.3 billion in redemption requests – a significant portion of its $3.7 billion in holds. Apparently some of those redemption requests were triggered by investor bylaws that prohibit investing in funds subject to felony charges or whose senior executives are accused of a felony. Oops.
Unlike a commercial bank where you can walk up to the teller window and make an immediate withdrawal, hedge funds require considerably more advance notice because their need to unwind positions, some of which may not be highly liquid. Like most hedge funds, Galleon requires a significant period of advance notice of any withdrawal requests.
The pressure of mounting withdrawal requests, however, came to a head today when Mr. Rajaratnam sent a letter to Galleon employees and investors announcing that it will “conduct an orderly wind down of Galleon’s funds” (click here for the announcement in the Times Deal Book, including the full text of Rajaratnam’s letter).
Tragically, a business Mr. Rajaratnam had spent twelve years to build was brought to its knees less than a week after his arrest. In the court of public opinion, the party is over. Such is the economics of reputation loss.
So the next time someone asks you whether reputation matters, the answer is yes. When they ask what its worth, the answer is priceless.