7 Ways Hedge Funds Lie, Cheat and Steal

The verdict is in: Raj Rajaratnam, the billionaire head of the Galleon hedge fund, was found guilty of 14 counts of securities fraud and conspiracy on Wednesday: 5 counts of conspiracy, and 9 counts of insider trading – which means he could be joining Bernie Madoff in prison for the rest of his life. The prosecution, which played 43 secretly recorded conversations that revealed how insider information was sought, received and covered-up, provides the clearest view to date of how far billionaires will go to earn their riches.    

Which raises an even more perplexing question: Why would a billionaire go out of his way to break the law in order to make “only” a few million more?  ($63 million to be exact, which is less than 5 percent of his net worth.) 

Greed? Ambition? Status?  Sure all of these personal characteristics and more are in play. But maybe there’s a more basic explanation: Perhaps the entire hedge fund industry rests upon tens of thousands of instances of lying, cheating and stealing. The Raj, as he likes to be called, may not be that different from the other 8,000 hedge fund managers who amass riches beyond our imagination.   

The reality uncovered by the feds is far different from the usual PR about hedge fund elites -- how they develop the best research, the best trading programs, the best analysis of the economy, and how they translate all their brilliance into hard headed trades that pay off big.  If you have the stomach to read the vacuous literature about their daring deeds, you’ll find odes to their courage, their intelligence and their cojones.  

But, what a number of prosecutions -- including the latest -- show is a set of guys (and a few gals) who will take any edge they can find, legal or not, to make more money. In their minds, laws are for little people. A billionaire, almost by definition, is someone who thinks he is above it all. (Maybe we would too if we made $2.4 million an HOUR, which is what the leading hedge fund manager walked off with in 2010.) 

But why worry? We are repeatedly told that hedge funds only take money in very large chunks from very sophisticated investors who should know what they are doing. You don’t walk into this casino unless your six-shooter is fully loaded. And besides, the story goes, who cares if they cheat since the money the winners rake in only comes from the losers. But the truth is far more complex. When all the facts are in, we’ll see that hedge funds take a little bit from us all. And when they cheat, they take even more. 

Here are seven ways hedge funds typically bend or break the law: 

1. Insider Trading:

The Raj is not alone. If the Feds could tape every hedge fund we’d get an earful of how hedge funds use “expert networks" to transfer bits of illegal information that provide hedge fund managers with knowledge of events that are sure to move markets and make them a bundle. The Raj investigation already has upended several other hedge funds that benefited from this common phenomenon. 

2. Tax Evasion:

No surprise here. Wherever you find billionaire financiers, you’ll find schemes to move money around the globe to dodge taxes. Fortunately, Rudolf M. Elmer, a Swiss banker, has blown the whistle on an international web of rich investors, banks and hedge funds that evade taxes by illegally shifting money to low-tax jurisdictions. There's something particularly slimy about hedge fund tax dodging, given that they only pay a 15 percent federal tax rate no matter how much they make. 

3. Ponzi Schemes:

Madoff isn’t the only one. Hedge funds and Ponzi schemes are made for each other since the funds are designed to evade so many disclosure regulations. It's virtually a sure thing that every new year will reveal another Ponzi scheme through which a hedge fund steals money from investors and then uses new investor money to pay returns to the old investors. It’s so easy to do when no one is watching.