Securities and Exchange Commission v. Galleon Management, LP et al Doc. 196 Att. 1
UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK
SECURITIES AND EXCHANGE COMMISSION, Plaintiff, No. 09-CV-8811-JSR ECF CASE v.
GALLEON MANAGEMENT, LP, et al., Defendants.
EXPERT REPORT
of
GREGG A. JARRELL*
April 29, 2011
* William E. Simon Graduate School of Business Administration, University of Rochester, Rochester, NY 14627
Dockets.Justia.com TABLE OF CONTENTS
I. INTRODUCTION AND SUMMARY OF OPINIONS ...... 1
II. QUALIFICATIONS AND COMPENSATION ...... 2
III. MATERIALS REVIEWED ...... 4
IV. BACKGROUND ...... 4 A. GALLEON ...... 4 B. THE INSIDER TRADING ALLEGATIONS ...... 5
V. ANALYSES AND OPINIONS ...... 6 A. OVERVIEW OF RAJARATNAM’S TRADING ...... 6 B. MIX OF INFORMATION IN THE MARKET AND WITHIN GALLEON ...... 8 i. Event Study Evidence ...... 8 ii. Consensus Driven Market Prices ...... 10 iii. The Mosaic Theory ...... 16 iv. Economic Perspective on Insider Trading ...... 18 v. Akamai – Q2’08 Earnings ...... 20 vi. Google – Q2’07 Earnings ...... 30 vii. Intel – Q4’06 Earnings ...... 43 viii. Intel – Q1’07 Earnings ...... 52 ix. Intel – Q3’07 Earnings ...... 64 x. Polycom – Q4’05 Earnings ...... 72 xi. Polycom – Q1’06 Earnings ...... 81 xii. ATI – Takeover ...... 87 xiii. Hilton – Takeover ...... 106 xiv. PeopleSupport – Takeover ...... 119 xv. AMD – Joint Venture ...... 125 xvi. Clearwire – Joint Venture ...... 136 xvii. eBay – Workforce Reduction ...... 156
I. INTRODUCTION AND SUMMARY OF OPINIONS
1. As described in greater detail in the next Section of this report, I am a tenured
Professor of Economics and Finance at the University of Rochester’s William E. Simon
Graduate School of Business Administration and a former Chief Economist for the United States
Securities and Exchange Commission (“SEC”). I have been retained by Akin Gump Strauss
Hauer & Feld LLP, counsel to defendant Raj Rajaratnam (“Mr. Rajaratnam”), to opine on the mix of information available in the marketplace and within Galleon Management, L.P.
(“Galleon”) relating to the SEC’s allegations of insider trading by Mr. Rajaratnam in the following ten securities: (i) Advanced Micro Devices, Inc. (“AMD”); (ii) Akamai Technologies,
Inc. (“Akamai”); (iii) ATI Technologies Inc. (“ATI”); (iv) Clearwire Corporation (“Clearwire”);
(v) eBay Inc. (“eBay”); (vi) Google, Inc. (“Google”); (vii) Hilton Hotels Corporaation (“Hilton”);
(viii) Intel Corporation (“Intel”); (ix) PeopleSupport, Inc. (“PeopleSupport”); and (x) Polycom,
Inc. (“Polycom”) (collectively referred to as the “SEC Selected Companies”). I have also been asked to opine on Mr. Rajaratnam’s transactions in these securities.
2. I offer several opinions in this report. Dettailed explanations and the bases for these opinions are provided in the sections that follow. I opine that:
i) A substantial level of discussion by Wall Street analysts and the financial press about each of the ten SEC Selected Companies was publicly- available before those companies aannounced certain corporate information;
ii) Based on my understanding of the information the SEC is alleging was conveyed in each tip, it is my opinion that the information allegedly tipped to Mr. Rajaratnam was not private information, but rather was substantially similar to information that was already included in the mix of publicly available information; and
iii) It would be reasonable for a well-informed, professional innvestor (such as a hedge fund manager) to trade in the shares of each of the ten SEC Selected Companies as I indicate below in this report.
1 3. I understand that discovery in this case is ongoing and has not yet been completed. Therefore, I reserve the right to amend this report in light of the ongoing discovery process.
II. QUALIFICATIONS AND COMPENSATION
4. I am currently a tenured Professor of Economics and Finance at the University of
Rochester’s William E. Simon Graduate School of Business Administration, where I have been a
member of the faculty since 1988. I hold a Ph.D. in Business Economics from the University of
Chicago (1978), with major concentrations in Industrial Organization and Finance, as well as an
MBA (1976) from the University of Chicago. I received a B.S. in Business Administration from
the University of Delaware (1974). I attended high school at New York Military Academy
(1967-70).
5. From 1977 to 1981, I was an Assistant Professor of Economics at the Graduate
School of Management at the University of Rochester. From 1981 to 1983, I was a Post-
Doctoral Research Fellow at the University of Chicago’s Center for the Study of the Economy
and the State. Thereafter, from 1983 to 1984, I was a Senior Economist with Lexecon, Inc., a
Chicago-based economics consulting firm specializing in antitrust and securities litigation. I also
served as an expert in mergers and acquisitions on the 1983 SEC Advisory Committee on Tender
Offer Policy.
6. From 1984 through 1987, I was the Chief Economist for the SEC in Washington,
D.C. I also served as an Adjunct Professor at the Georgetown University Law School in
Washington, D.C. during 1985 and 1986, where I co-taught a course on securities regulation.
After leaving Washington, D.C. in 1987, I was the AT&T Foundation Resident Management
Fellow at the University of Rochester’s Simon School. From 1987 to 1988, I was the Senior
2 Vice President and Director of Research at the Alcar Group, Inc., a Chicago-based management
consulting and software firm specializing in financial valuations of businesses and securities.
7. Since joining the Simon School faculty at the University of Rochester as a tenured
professor, I have served (from 1988 to 1990) as director of the school’s Managerial Economics
Research Center. I also served as director of the Bradley Policy Research Center at the Simon
School from 1990 to 1994. While at the Simon School, I have taught a course titled “Cases in
Finance” to second-year MBA students that covers, among other subjects, the operation of financial markets and the market for corporate control, the economics of mergers and acquisitions, valuation analysis for businesses and securities, the response of stock prices to public information, and financial regulation of securities markets. I also teach a price theory course called Managerial Economics that includes applications of intra-company pricing of transfers of products and services. I have received eleven Superior Teaching Awards. I have authored or co-authored more than two dozen articles and studies in scholarly journals generally on the topics of mergers and acquisitions, the regulation of financial markets, and the response of stock prices to the release of information, among other things. My curriculum vitae, with a list of publications and of recent cases in which I have testified as an expert at deposition or trial, is attached as Exhibit 1.
8. My compensation, which is not contingent upon the outcome of this matter, is based on the number of hours worked on this assignment, as well as reimbursement of out-of- pocket expenses. My hourly rate is $600. To assist me in this assignment, I have worked with
Forensic Economics, Inc., whose employees acted under my supervision and direction for this assignment. Forensic Economics, Inc., located in Rochester, New York, was founded in 1989.
3 The hourly rates of the employees of Forensic Economics who worked on this assignment range
from $145 to $475.
III. MATERIALS REVIEWED
9. In the course of my assignment in this case, I (or employees of Forensic
Economics acting under my supervision) have reviewed numerous documents, including: the
Second Amended Complaint dated January 29, 2010 (the “Complaint”); the Criminal Complaint
dated October 15, 2009 (the “Criminal Complaint”); the Indictment; the Bill of Particulars dated
July 26, 2010 (the “Bill of Particulars”); the Answer on Behalf of Defendant Raj Rajaratnam
dated November 24, 2009; various Galleon trading records; various Galleon emails and instant
messages; various wiretaps; criminal trial transcripts; my demonstrative exhibits used in the
criminal trial (see Appendix A) and analyst reports, news stories, stock prices and volume for
each of the ten SEC Selected Companies. Attached as Exhibit 2 is a comprehensive list of
materials reviewed in connection with this report. I have cited in the text of the report specific documents and information, upon which I have relied in reaching my opinions.
IV. BACKGROUND
A. GALLEON
10. Mr. Rajaratnam co-founded Galleon and was Galleon’s Managing General
Partner and a portfolio manager for the Galleon Tech Funds.1
11. Galleon was a global alternative asset management firm (commonly referred to as
a “hedge fund”) that specialized over its 17-year history in long/short equity strategies with a
focus on growth sectors and emerging markets. Galleon had offices in New York, Menlo Park,
1 See Complaint, ¶7.
4 London, Singapore and Mumbai.2 According to Forbes, investors in Galleon’s hedge funds had
earned an average annual return of 21%, net of fees, since 1997.3 At its peak in 2008, Galleon
managed approximately $7.2 billion in assets and had 150 employees. These employees were
comprised of 17 portfolio managers, 45 analysts, 20 traders, 10 quant traders and 58 other staff.4
Within the $1.1 billion Galleon Tech Fund, there was a dedicated investment team of 18
technology analysts and nine traders.5
12. At Galleon, each analyst typically covered approximately 30 companies.
Information was obtained from over 400 company meetings each month, as well as from
regulatory filings and trade shows. In an effort to keep the Galleon investment professionals
constantly informed, Galleon routinely internally disseminated written reports and earnings
models, had daily morning meetings before the markets opened and had weekly research
meetings lasting two to three hours.6
13. Galleon’s investment philosophy included to “seek out inflection points and take
contrarian approach” and to “focus on variant view to arbitrage consensus thinking.”7
B. THE INSIDER TRADING ALLEGATIONS
14. The SEC alleges that Mr. Rajaratnam received and traded on the basis of material
nonpublic information in the securities of the ten SEC Selected Companies. According to the
2 See “Frank Wong Named Chairman of Galleon Asia,” PR Newswire, February 4, 2009 at 9:33am. 3 See “Market Masters; The Often Secretive, Always Brash Dealmakers of The Forbes 400 Have the Power to Move Markets,” Forbes, October 6, 2008. 4 See Galleon Group Presentation, July 2008, p. 2. 5 See Galleon Group Presentation, Galleon Technology, April 2008, p. 6. 6 See Galleon Group Presentation, Galleon Technology, August 2005, p. 5. 7 See Galleon Group Presentation, Galleon Technology, April 2008, p. 7; Galleon Group, October 2009, p. 7 (emphasis added).
5 SEC, the nature of the inside information generally falls into four categories: (i) earnings; (ii) takeovers; (iii) joint ventures; and (iv) workforce reductions.
15. The table below summarizes the insider trading allegations:
SEC Alleged Selected Inside Companies Information Description
Akamai Earnings Q2’08 Google Earnings Q2’07 Intel Earnings Q4’06, Q1’07, Q3’07 Polycom Earnings Q4’05, Q1’06
ATI Takeover Acquisition by AMD Hilton Takeover Acquisition by Blackstone PeopleSupport Takeover Acquisition by Aegis
AMD Joint Venture Spinoff of manufacturing Clearwire Joint Venture Partnering with Sprint
eBay Workforce Reductions Layoffs
V. ANALYSES AND OPINIONS
A. OVERVIEW OF RAJARATNAM’S TRADING
16. I have examined data from the Galleon Order Management System (“OMS”) database consisting of 1,163,591 transactions in securities between 2005 and 2009.8 I identified
42,168 transactions made by Mr. Rajaratnam based on the various “manager codes” that he used over time at Galleon.9 From this set of transactions, I limited my analysis of Mr. Rajaratnam’s
8 I requested and obtained from counsel electronic spreadsheets that were exported from Galleon’s OMS database. To select data between 2005 and 2009, I used the “TradeDate” variable. 9 The manager codes associated with Mr. Rajaratnam are as follows: ASO, DIV (excluding DIV-MC), GLT (6/7/06 – 7/24/06 only), GRC, TAM, TMP and TMT. I also excluded cancelled transactions designated with the status code of “CXLD” and transactions with no shares executed.
6 trades to only include the 36,437 transactions in U.S. traded equities with security symbols that I
was able to match to ticker symbols or other identifiers used in the FactSet database (the
“Galleon OMS Database”).10 Mr. Rajaratnam’s trades are summarized as follows:11
Average Average Number of Number of Number of Unique Number of Transactions Transactions Value of Securities Transactions Per Week Per Day Transactions
2005 416 7,911 152 31 $24,379,723,298 2006 460 5,309 102 21 $15,698,707,976 2007 560 7,084 136 28 $43,620,388,539 2008 454 7,772 149 31 $52,592,146,514 2009 602 8,361 190 40 $35,813,542,072
Total 1,223 36,437 145 30 $172,104,508,398
17. To put the allegations of insider trading in perspective with the rest of Mr.
Rajaratnam’s uncontested trading, I note that between 2005 and 2009 the SEC contends there were 133 transactions based on inside information according to my analysis of the OMS data.12
10 I matched the security symbols in the entire OMS database to U.S. traded equity FactSet identifiers by: excluding symbols that did not start with an alphabetical character; excluding symbols with either a “+” or blank character within the symbol; excluding symbols greater than five characters or having a last character that was a number; adjusting symbols with a “/” to “.” allowing for retrieval of “class” shares on FactSet; searching on Bloomberg for any remaining symbols that were not retrieved by FactSet and matching the company name from Bloomberg to the appropriate FactSet symbol. 11 Mr. Rajaratnam’s trades spanned from January 3, 2005 through October 27, 2009. Average number of transactions per week based on 52 weeks per year (except for 44 weeks in 2009). Average number of transactions per day based on 252 trading days in 2005, 251 trading days in 2006 and 2007, 253 trading days in 2008 and 209 trading days in 2009. 12 I used the same alleged insider transactions identified in the Complaint for Intel Q4’06, Intel Q3’07, Polycom Q1’06 and Clearwire; and used by the Government in United States of America v. Raj Rajaratnam per GX 41 (Akamai), 21 (ATI), 3534-K (ATI), 24 (eBay), 60 (Google), 50 (Hilton), 4 (Intel) and 65 (Polycom). For those allegations where United States of America v. Raj Rajaratnam did not indicate which trades were alleged insider transactions, I classified a transaction as an alleged insider transaction if it occurred between the date of the alleged tip and the disclosure of the alleged information by the company in question. To determine the timing of a transaction on the date of a company disclosure, I used intraday data, transaction time stamps and/or the time when the news was released. I further required the transaction to be directionally consistent with the allegation (i.e., purchasing on good news or
7 These 133 transactions represent less than one percent (0.4%) of Mr. Rajaratnam’s 36,437 transactions over this time period.
B. MIX OF INFORMATION IN THE MARKET AND WITHIN GALLEON
18. In the following sections, I examine the specific inside information that the SEC alleges was in the possession of Mr. Rajaratnam to determine whether such information was also publicly-available in the market before Mr. Rajaratnam allegedly traded on such inside information. I also analyze the stock prices for the SEC Selected Companies to assess whether the alleged information was impounded in the prices of those companies before Mr. Rajaratnam allegedly traded on such information.
19. I rely on my investigation of thousands of news stories and media reports retrieved from Bloomberg and Factiva, which include major news sources such as Reuters,
Bloomberg News and The Wall Street Journal, as well as Wall Street analyst reports, internal
Galleon analyst reports and Galleon emails.
i. Event Study Evidence
20. I performed several event study analyses to assess whether the alleged inside information was already reflected in stock prices before Mr. Rajaratnam received such information or traded on the basis of such information (see Appendix B).
21. An event study is an empirical technique that measures the effect of new information on the market prices of a company’s publicly traded securities. This is done by comparing the day-to-day percentage change in the market price of a company’s common stock
selling short on bad news). If a transaction during this period was directionally inconsistent with the allegation (i.e., a sale when an alleged insider trade would be a purchase), I did not consider this as an alleged insider transaction.
8 (known as a “return”) to the return predicted by a “market model” that uses a market index, such
as the S&P 500 Index or the Nasdaq Composite Index, and possibly an industry index.13
22. The market model describes the normal relation between the return on the company’s common stock and the return on the market and industry indexes. When significant new information about the company (i.e., earnings reports, dividend changes, stock-splits, regulatory rulings or investigations, acquisition bids, asset sales, or tax legislation) is disclosed to the market, the market model is used to determine the component of the stock return that would be expected based on the return of the overall market and industry. The remaining component of the stock return (that which cannot be explained by the return on the market and industry) is attributed to the new company-specific information. If the disclosure of company-specific information is accompanied by a stock return that is outside of the stock’s normal volatility range
(as measured by the market model), then the return is said to be “statistically significant.”14
23. Because event study methodology measures the market’s response to new information, it has been widely used in the courtroom to assess the market’s consensus about the economic materiality of new information on the value of the stock.15 I have previously testified
at dozens of trials and depositions about the event study methodology and the application of
market models.
13 See J. Campbell, A. Lo, & A. Craig MacKinlay, The Econometrics of Financial Markets, Princeton University Press, 1997, pp. 150-156. 14 The determination of a statistically significant return must account for the individual stock’s normal volatility. Accordingly, event studies start by computing “excess returns” (the percentage change in the company’s stock price including dividends, net of market-wide and industry-wide influences) and the volatility of these excess returns. 15 See M. Mitchell, J. Netter, 1994, “The Role of Financial Economics in Securities Fraud Cases: Applications at the Securities and Exchange Commission,” The Business Lawyer 49 (February), 545-90; D. Tabak, F. Dunbar, “Materiality and Magnitude: Event Studies in the Courtroom,” in Litigation Services Handbook: The Role of the Financial Expert, Third Edition, ed. by R. Weil, M. Wagner and P. Frank, Wiley, 2001, 19.2.
9 24. Attached as Exhibit 3 is a summary of the market models I used for the common stock of each of the ten SEC Selected Companies, where each respective company’s stock return is regressed against the market and net-of-market industry variables to estimate the historical relation between the “independent” index variables and the “dependent” company common stock returns.16 In essence, the indexes “explain” or account for some portion of the day-to-day
movements in the company’s gross return, so that the “unexplained” portion of the company’s
stock return can be attributed to “firm-specific” factors besides any co-movement in the market-
wide and net-of-market industry indexes.
ii. Consensus Driven Market Prices
25. As a general proposition, modern finance theory holds that the market price of a
stock reflects the expected discounted value of future cash flows to equity holders. Thus, new
information that causes the market to significantly alter its expectation of future cash flows will
cause a prompt repricing of the stock to reflect the new expectations.17 When new information is
announced publicly, the market price responds quickly to reflect this new information.18 In addition to new corporate announcements, market prices also reflect new information uncovered by the legitimate research of stock analysts and other sophisticated investors (i.e., channel
16 The return on the industry index is generally measured “net of market” to minimize the effects of a statistical phenomenon called multicolinearity. 17 See E. Fama, “Efficient Capital Markets: II,” Journal of Finance 46, 1575-1617 (December 1991). 18 See R. Jennings, and L. Starks, “Information Content and the Speed of Stock Price Adjustments,” Journal of Accounting Research 23, 336-350 (Spring 1985); J. Patell and M. Wolfson, “The Intraday Speed of Adjustment of Stock Prices to Earnings and Dividend Announcements,” Journal of Financial Economics 13, 223-252 (June 1984); and C. Woodruff and J. Senchack, Jr., “Intradaily Price-Volume Adjustments of NYSE Stocks to Unexpected Earnings,” Journal of Finance 43, 467-491 (June 1988).
10 checks, mosaic theory).19 If institutional investors perceive that a particular stock is undervalued by the market, their demand for the stock increases. As these institutions are buying the stock, the demand for shares exceeds supply, and the stock price begins to rise. Since informed investors will demand more shares as long as the market price is less than their perceived value, trading by informed investors causes the market price to reflect their private information. Such trading by informed investors generally is perceived to be beneficial to financial markets. The trading makes capital markets more efficient, it aligns actual stock prices with their theoretically correct values, and it improves the allocation of scarce capital between competing uses.
Takeovers
26. Basic economics guarantees that investors will devote considerable resources to the legitimate collection of information with respect to potential corporate control contests. The prospect of large takeover premiums and the many kinds of clues legally available to skillful specialists assures that a competitive market for pre-takeover information will arise. For example, John Pound and Richard Zeckhauser note that, “[v]ery few takeover bids for publicly held corporations are true surprises. Rather, in the weeks before a bid is announced rumors circulate among Wall Street professionals and in the business press, allowing the market to predict that the firm in question may be a takeover target.”20
19 See A. Kyle, “Continuous Auctions and Insider Trading,” Econometrica 53, 1315- 1335 (1985); K. French and R. Roll, “Stock Return Variances: The Arrival of Information and the Reaction of Traders,” Journal of Financial Economics 17, 5-26 (1986); M. Barclay, R. Litzenberger and J. Warner, “Private Information, Trading Volume, and Stock Return Variances,” Review of Financial Studies 3, 233-253 (1990). 20 See J. Pound and R. Zeckhauser, “Clearly Heard on the Street: The Effect of Takeover Rumors on Stock Prices,” Journal of Business 63, p. 291 (1990).
11 27. There is ample evidence that stock prices and trading volumes of target companies increase in the weeks preceding the public announcement of a takeover bid.21 The high trading volume and stock-price runup generally are interpreted as evidence that information
about the increased likelihood of a tender offer is being incorporated in the market price before
the first public announcement of the deal.22 By examining the stock prices prior to the first
public announcement of the deal, it is possible to draw inferences about what information was
available to investors at a particular time.
28. In general, when a company becomes the subject of significant takeover
speculation, its stock price no longer depends only on its expected value as an independent
entity. Rather, the rumored target’s price will depend also on the market-consensus probability
of a successful deal, and on the magnitude of the takeover premium relative to the target’s value
if it remained independent. Equation (1) is a useful way to model how the company’s market
price is related to these factors when it is a possible takeover candidate.23
21 See S. Heitzman, S. Klasa, “Causes and Consequences of Preannouncement Runups in Acquisition Targets: Evidence from Deal Negotiations and Earnings News,” Working Paper, January 3, 2010; G. Jarrell and A. Poulsen, “Stock Trading before the Announcement of Tender Offers: Insider Trading or Market Anticipation,” Journal of Law, Economics and Organizations 5, 225-248 (1989); G. W. Schwert, “Markup Pricing in Mergers and Acquisitions,” Journal of Financial Economics 41, 153-192 (1996). 22 See A. Keown and J Pinkerton, “Merger Announcements and Insider Trading Activity: An Empirical Investigation,” Journal of Finance 36, 855-869 (1981); G. Jarrell and A. Poulsen, “Stock Trading before the Announcement of Tender Offers: Insider Trading or Market Anticipation,” Journal of Law, Economics and Organizations 5, 225-248 (1989); J. Pound and R. Zeckhauser, “Clearly Heard on the Street: The Effect of Takeover Rumors on Stock Prices,” Journal of Business 63, p. 291-308 (1990); G. W. Schwert, “Markup Pricing in Mergers and Acquisitions,” Journal of Financial Economics 41, 153-192 (1996). 23 See J. Weston, K. Chung, and S. Hoag, Mergers, Restructuring, and Corporate Control, Prentice-Hall, Chapter 22, p. 556 (1990); D. Larcker and T. Lys, “An Empirical Analysis of the Incentives to Engage in Costly Information Acquisition: The Care of Risk Arbitrage,” Journal of Financial Economics 18, 111-126 (1987); and, K. Brown and M.
12 PM = Prob ( PD ) + ( 1 - Prob ) ( PI ) (1)
where: PM = market price, Prob = probability of a successful deal, PD = deal price for target, PI = target price if it remains independent.
29. For example, assume Company T is trading for $10 before rumors of a potential
merger affect its traded price. Assume that rumors circulate that Company A might pay $20 cash
for Company T. If the market-consensus probability is 50% that the deal will be successful, then
equation (1) indicates that Company T will trade at $15 (50% x $10 + 50% x $20).
30. If some professional market participants believe that, contrary to the market
consensus, the mix of publicly-available information better supports a 75% (not 50%) probability
for a $20 deal, then those traders would value Company T at $17.50 (25% x $10 + 75% x $20).
The perception that the market has placed too little emphasis on the contrarian 75% viewpoint, as
evidenced by the prevailing consensus market price of $15, presents professional traders with an
opportunity for profit. These traders will purchase the “undervalued” $15 stock in an attempt to
arbitrage the value gap between these competing viewpoints. If enough traders believe the
market consensus of 50% is “wrong” and trade on such belief, then Company T’s price will
increase toward $17.50, resulting in a new market consensus.24
Earnings
31. Each quarter, investors focus on corporate earnings announcements that gauge the
progress of companies compared to expectations, with some companies even providing guidance
for upcoming quarters as well. An entire industry of Wall Street analysts has developed around
Raymond, “Risk Arbitrage and the Prediction of Successful Corporate Takeovers,” Financial Management, 554-63 (Autumn 1986) for discussion of this equation. 24 This example also applies to the market’s perception about potential joint ventures.
13 the ritual of the quarterly earnings season. The research reports that are published both before
and after earnings announcements often contain earnings forecasts, investment recommendations
(“buy,” “neutral,” or “sell”) and price targets. A substantial literature has documented the
statistical association between analyst earnings forecasts and stock recommendations, and stock
prices.25 Studies have shown that changes in analyst stock recommendations and earnings
forecast revisions have information content that, on average, stock prices change when these analyst disclosures are announced.26
32. Despite Wall Street analyst efforts to correctly predict earnings, earnings surprises
still arise. So-called earnings “surprises” are generally considered to be the difference between
reported earnings and the analyst consensus (expected) earnings just prior to the earnings report.
Generally, stock prices should react positively to positive surprises, and prices should react
negatively to negative surprises regarding earnings.27 In attempts to better anticipate earnings
surprises, unofficial “whisper” forecasts of earnings circulate among traders and investors. The
phenomenon of such whisper forecasts are particularly common in technology stocks.
25 See L. Brown, P. Griffin, R. Hagerman, M. Zmijewski, 1987a, “Security Analyst Superiority Relative to Univariate Time-Series Models in Forecasting Quarterly Earnings,” Journal of Accounting & Economics 9, 61-87; L. Brown, P. Griffin, R. Hagerman, M. Zmijewski, 1987b, “An Evaluation of Alternative Proxies for the Market’s Expectation of Earnings,” Journal of Accounting & Economics 9, 159-193; L. Brown, M. Rozeff, 1978, “The Superiority of Analyst Forecasts as Measures of Expectations: Evidence from Earnings,” Journal of Finance 33, 1-16; and S. Kothari, 2001, “Capital Markets Research in Accounting,” Journal of Accounting & Economics 31, 105-231. 26 See K. Womack, 1996, “Do Brokerage Analysts’ Recommendations Have Investment Value?” Journal of Finance 51, 137-167; and T. Lys, S. Sohn, 1990, “The Association Between Revisions of Financial Analysts’ Earnings Forecasts and Security Price Changes,” Journal of Accounting & Economics 13, 341-363. 27 Stock price responses to earnings surprises is a highly studied area in financial economics. See the seminal article by R. Ball and P. Brown, “An Empirical Evaluation of Accounting Income Numbers,” Journal of Accounting Research, 6 (1968), pp. 159-78. See also, S. Kothari, 2001, “Capital Markets Research in Accounting,” Journal of Accounting & Economics 31, 105-231.
14 Professionals sometimes describe whisper forecasts as “...increasingly becoming the true
expectation.”28
33. Academic empirical studies have found that whisper forecasts tend to appear very
close to the earnings announcement date, whereas the official consensus estimates are often from
much earlier in the quarter. These studies have also found that whisper forecasts can be more
accurate than the official consensus estimates, which can result in “significant economic profits”
by trading on the difference between the whisper and the official estimate. Researchers believe
that whisper forecasts “...are widely enough disseminated so that at least part of this information
is incorporated in stock prices prior to the earnings release.”29
34. To see how whisper numbers can affect a stock’s price, assume a company is
scheduled to announce its quarterly earnings on Friday morning. As of Monday before the
announcement, the consensus earnings estimate by analysts is $0.25 per share and the company
is trading for $10. Assume the $10 stock price reflects a market-consensus probability of 50%
that the company will meet the consensus estimate and trade at $10, a 25% probability it will
miss the estimate and trade at $6 and a 25% probability it will beat the estimate and trade at $14
($10 = {50%x$10} + {25%x$6} + {25%x$14}).
28 For example, an analyst at Montgomery Securities stated, “[t]he whisper... becomes in effect more important than the published number. The whisper is increasingly becoming the true expectation.” An analyst at Cowen & Co. stated, “...that although he thought that the company would beat his estimate, he saw no point in changing it because most investors knew the whisper number and were discounting [his estimate].” See M. Bagnoli, M. Beneish, S. Watts, “Whisper Forecasts of Quarterly Earnings Per Share,” Journal of Accounting and Economics, 28 (1999) 27-50. 29 See M. Bagnoli, M. Beneish, S. Watts, “Whisper Forecasts of Quarterly Earnings Per Share,” Journal of Accounting and Economics, 28 (1999) 27-50. See also, S. Machuga, K. Teitel, R. Pfeiffer, “Explaining the Surprising Performance of Whisper Forecasts of Earnings,” Working Paper, July 2008; M. Baker, L. Litov, J. Wachter, J. Wurgler, “Can Mutual Fund Managers Pick Stocks? Evidence from their Trades Prior to Earnings Announcements,” Working Paper, November 13, 2007.
15 35. Contrary to analysts’ expectations, professional investors start hearing a whisper number that will beat Wall Street estimates. In response, the professional traders increase the probability of the company beating analyst estimates to 50% (from 25%), indicating a value for those traders of $12 ({50%x$10} + {0%x$6} + {50%x$14}). The perception that the market has placed too little emphasis on the whisper number, as evidenced by the prevailing consensus market price of $10, presents professional traders with an opportunity for profit. These traders will purchase the “undervalued” $10 stock in an attempt to arbitrage the value gap between these competing viewpoints. If enough traders believe the market consensus is “wrong” and trade on such belief, then the company’s price will increase toward $12, resulting in a new market consensus.
iii. The Mosaic Theory
36. Securities analysts and investment managers legally gather, analyze and interpret large quantities of information from multiple sources. From this information, investment recommendations and decisions are routinely made. Not until the “bits and pieces” of stray information are compiled together into a “complete picture of the company” does it sometimes reveal material, non-public information. It is my understanding that under the “mosaic theory,” analysts and investment managers are free to act on this compilation of information without risking liability under the insider trading laws.30
37. The United States Supreme Court recognized the importance to the markets for analysts to “ferret out and analyze information” in its 1983 opinion Dirks v. Securities and
Exchange Commission:
30 See Standards of Practice Handbook: The Code of Ethics and The Standards of Professional Conduct, Eighth Edition, Association for Investment Management and Research, 1999, pp. 228-231.
16 Imposing a duty to disclose or abstain solely because a person knowingly receives material nonpublic information from an insider and trades on it could have an inhibiting influence on the role of market analysts, which the SEC itself recognizes it necessary to the preservation of a healthy market. It is commonplace for analysts to ‘ferret out and analyze information’ . . . and this often is done by meeting with and questioning corporate officers and others who are insiders. And information that analysts obtain normally may be the basis for judgments as to the market worth of a corporation’s securities. The analyst’s judgment in this respect is made available in market letters or otherwise to clients of the firm. It is the nature of this type of information, and indeed of the markets themselves, that such information cannot be made simultaneously available to all of the corporation’s stockholders or to the public generally.31
38. Likewise, the SEC also noted the value of analysts that “actively seek” information:
[Analysts] are in the business of formulating opinions and insights–not obvious to the general investing public–concerning the attractiveness of particular securities. In the course of their work, analysts actively seek out bits and pieces of corporate information not generally known to the market for the express purposes of analyzing that information and informing their clients who, in turn, can be expected to trade on the basis of the information conveyed. The value to the entire market of these efforts cannot be gainsaid; market efficiency in pricing is significantly enhanced by such initiatives to ferret out and analyze information, and thus the analyst’s work redounds to the benefit of all investors.32
39. In modern times, hedge fund analysts and portfolio managers such as Mr.
Rajaratnam perform much the same function, which is equally beneficial to pricing accuracy and capital allocation for publicly traded companies.
31 See Standards of Practice Handbook: The Code of Ethics and The Standards of Professional Conduct, Eighth Edition, Association for Investment Management and Research, 1999, p. 230. 32 See Standards of Practice Handbook: The Code of Ethics and The Standards of Professional Conduct, Eighth Edition, Association for Investment Management and Research, 1999, p. 230.
17 iv. Economic Perspective on Insider Trading
40. Economic theory and evidence implies that professional traders naturally will have powerful economic incentives to discover valuable information that is not yet fully reflected in market prices. Moreover, economists generally regard such information-gathering and trading activity to be vital to the efficiency with which stock prices accurately reflect earnings and other information material to valuation.33
41. Such information could be unknown to the market or it could be in the mix of publicly-available information, but not yet fully incorporated in market prices. Thus, insider trading must be rigorously defined in the law to be distinguishable from this natural and economically beneficial search-and-trade behavior of professional traders. Speccifically, insider trading by a trader having no fiduciary duty, whether created by contract or otherwise, to the firm must satisfy all of the following conditions to constitute iillegal activity:
i) the trader must violate a contractual duty to the company that is the subject of the information;
ii) the allegedly inside information must be private information not available in the mix of publicly-available information; and
iii) the information must be economically “material,” such that it has the potential to significantly move the market price when it is incorporated into that price.
42. The first condition concerning contractual duty is a legal issue that I have not been asked to consider or discuss. But, the condition that the information must be private and material to constitute insider trading are economic questions that I have been asked to consider in this case.
33 The social benefits of the activities of professiional traders who make a living identifying and arbitraging information-related mispricing include more accurate stock prices and a more efficient allocation of capital across publicly-traded companies.
18 43. Thus, from an economic perspective, in order to support allegations of illegal possession and abuse of inside information, such information should be: (i) nonpublic, new information that is absent from the mix of publicly-available information in the marketplace on the date such information is allegedly used in a securities transaction; and (ii) economically material as evidenced by an event study.
44. The causality element implies that the alleged inside trader could not have learned the information from any legal public source. Therefore, if the information is publicly-available, then it was known by traders in the efficient market and incorporated in the price based on the consensus viewpoint of the value of that information. Likewise, if the information was not economically material, then even if the market was unaware of this information, the stock price response would also lack economic materiality.
45. As a threshold consideration for economic materiality, the alleged inside tip must constitute information that with reasonable confidence the recipient can predict the direction the stock price will move when the tip-information is disseminated into the market. Obviously, insider trading is risky even if the tip itself unambiguously implies the stock will go up (or down), because other intervening events can move the price the opposite way or because of some other case specific factor. But, a stock-trading tip cannot be economically material by definition if it fails to be informative at all about the future direction of the stock price absent all other influences.
46. Materiality also requires a significant, economically nontrivial, movement in the stock price due solely to the dissemination of the tipped information.
47. I next examine the allegations of insider trading in each of the ten SEC Selected
Companies.
19 v. Akamai – Q2’08 Earnings
48. The SEC alleges that:
...on July 24, [2008], Chiesi told Rajaratnam that she learned from the Akamai Source that Akamai was going to guide down and that people at Akamai were saying that Akamai’s stock price was going to decline to $25.00 per share based on the Q2 2008 Earnings Announcement.34
49. Below, I examine the mix of information available in the marketplace and within
Galleon about Akamai’s second quarter earnings prior to Akamai’s earnings announcement on
July 30, 2008.
Mix of Information
50. On April 30, 2008 (three months before the SEC contends Mr. Rajaratnam
received inside information), Akamai reported its first quarter results. AP Newswires reported
that “...shares of Akamai Technologies Inc. fell after the Web services provider reported first-
quarter revenue below analysts’ expectations. Akamai said late Wednesday that its first-quarter
adjusted earnings beat analysts’ views, but sales of $187 million fell short of the $188.2 million
analysts polled by Thomson Financial anticipated.”35 Akamai’s CEO stated that “[w]e haven’t
detected any shift or pullback due to economic concerns. We’re cautiously optimistic that that
will continue through the rest of the year in terms of Internet initiative.”36
51. Despite Akamai’s “cautious optimism” about the economy, Wall Street analysts
expressed doubts:
34 See Complaint, ¶123. 35 See “Opening Glance: Most Internet Software, Services Stocks Rise,” AP Newswires, May 1, 2008 at 10:19am. 36 See “Akamai CEO Sees No Hit from Economy,” Reuters News, April 30, 2008 at 4:30pm.
20 Citi downgrades Akamai Technologies... from Buy to Hold.... Investment risks include increased competition which may erode its customer base and deflated pricing and an uncertain demand outlook for customers engaged in emerging business models...37
We [Goldman Sachs] are adding Akamai Technologies to the Americas Investment Sell List... Based on competitive and pricing concerns as we move through the year, we are trimming our estimates for CY08 and CY09... Looking pricey, particularly in light of potential 2008 risks... The CDN [content delivery network] marketplace is growing increasingly crowded, creating what we believe to be a supply/demand imbalance that could intensify pricing pressure in the industry this year.38
Indications are that [for CDN operators] pricing declines are accelerating at the high-end (i.e. greater than the 25-30% seen in recent periods). We believe this will challenge incumbents and emerging players are poised to gain share.39
We [Oppenheimer] believe the competitive environment in the CDN marketplace continues to intensify... We believe pricing is declining in the range of 25-30% (30%+ on large deals) and see this as a challenge to AKAM. We anticipate the company to report a mixed-to-in line quarter... Longer term we remain cautious on the name, as continued pricing pressure in the space will have the most profound effect on Akamai. Our 2008-09 estimates are lower than consensus.40
We [Raymond James] are trimming our forecasts for Akamai to account for potential increased impact of Level 3... on pricing in the media vertical... Some checks since [last report] indicate increased, or anticipated increased, impact on pricing as Level 3 improves services... We are lowering our 2008E and 2009E non- GAAP EPS from $1.70 and $2.15 to $1.68 and $2.05. There is no
37 See “Citi Downgrades Akamai Technologies (AKAM) to Hold,” StreetInsider.com, May 19, 2008 (emphasis added). 38 See Email from Goldman Sachs to Galleon containing Goldman Sachs analyst report, May 22, 2008 at 4:40am (emphasis added). 39 See Email from Oppenheimer to Galleon containing Oppenheimer analyst report, June 6, 2008 at 7:51am (emphasis added). 40 See Email from Oppenheimer to Galleon containing Oppenheimer analyst report, July 22, 2008 at 8:25am (emphasis added).
21 change to our 2Q08 EPS forecast of $0.41...... we believe a reduced outlook is largely discounted in the stock.41
Long term, we fear AKAM faces considerable headwinds. Beyond exposure to a weakening consumer and broader macroeconomic concerns, we believe intensifying competition (estimate over 40 players) will continue to drive pricing lower (now 30%+ on large deals).... In light of the longer-term headwinds, we believe AKAM will struggle to maintain its premium valuation.42
Some have expressed concern that a guide-down is coming, we don’t see it, but do see continued tempering of growth in the M&E vertical.... The stock has been under pressure, along with the market, and it seems that many investors fear a miss.43
We [Goldman Sachs] conclude that gross margins likely have incremental downside potential beyond current consensus, given Akamai’s margin mix and a look at the gross margins of a variety of other network service providers.44
52. These doubts were repeatedly reported on in the financial press.45
41 See Email from Raymond James to Galleon containing Raymond James analyst report, July 29, 2008 at 6:38am (emphasis added). 42 See Email from Oppenheimer to Galleon containing Oppenheimer analyst report, July 29, 2008 at 8:20am (emphasis added). 43 See Email from American Technology Research to Galleon containing American Technology Research analyst report, July 29, 2008 at 10:16am (emphasis added). 44 See Email from Goldman Sachs to Galleon containing Goldman Sachs analyst report, July 29, 2008 at 8:53pm (emphasis added). 45 See “AKAM: Citigroup Cuts to Hold,” Bloomberg News, May 19, 2008 at 6:37am; “Smith Barney Citigroup,” JagNotes.com, May 19, 2008 at 6:57am; “Analyst Actions: Akamai Seeing Lower Pre-Bell Ask on Downgrade,” MidnightTrader, May 19, 2008 at 7:15am; “Akamai Technologies Downgraded to Hold at Citigroup,” AFX Asia, May 19, 2008 at 7:35am; “Akamai Tech Off 2% After Analyst Downgrade; Valuation Cited,” MidnightTrader, May 19, 2008 at 3:31pm; “MidnightTrader’s Analyst Notebook: AKAM,” MidnightTrader, May 19, 2008 at 4:25pm; “Goldman Sachs Cuts Akamai Technologies (AKAM) To Sell,” StreetInsider.com, May 22, 2008; “Goldman Cuts Akamai Technologies To Sell,” Dow Jones News Service, May 22, 2008 at 6:21am; “Analyst Actions: Akamai Declining on Goldman Sachs Downgrade,” MidnightTrader, May 22, 2008 at 8:26am; “DJ Hot Stocks to Watch: AKAM,” Dow Jones Chinese Financial Wire, May 22, 2008 at 8:37am; “Goldman Sachs,” JagNotes.com, May 22, 2008 at 8:59am; “Akamai, BCE, Evergreen Solar, Ford, Moody’s: U.S. Equity Movers,” Bloomberg News, May 22, 2008 at 9:59am; “Akamai Down 8%; Goldman Adds to Sell List on Recent Price Rise,” MidnightTrader, May 22, 2008 at 11:21am; “RESEARCH ALERT-
22 53. In addition to the analysis and commentary from sell-side Wall Street analysts,
Galleon’s internal analysts also performed their own proprietary in-house research on Akamai.
54. Beginning in early May 2008, Jessica Kourakos, a Galleon analyst that followed
Akamai, began to build a short position by selling 75,000 shares in Akamai for her “paper
portfolio.”46 The analyst believed that:
...the bar is set higher this qtr versus last qtr [and]... will likely make improving these metrics more challenging in the existing environment.
I also believe intra-quarter jitters over how the quarter closed will put incremental pressure on the shares from current levels.47
55. This analyst shorted an additional 70,000 Akamai shares on May 7, 2008 and
50,000 shares on May 19, 2008. The analyst noted that “...from a valuation perspective, I
believe stock has gotten ahead of itself...”48
Goldman Cuts Akamai to Sell; Shares Fall,” Reuters News, May 22, 2008 at 11:26am; “Akamai Technologies Drops as Goldman Recommends Selling Stock,” Bloomberg News, May 22, 2008 at 12:21pm; “MidnightTrader’s Analyst Notebook: AKAM,” MidnightTrader, May 22, 2008 4:22pm; “Akamai Drops After Goldman Recommends Selling Shares,” Bloomberg News, May 22, 2008 at 4:29pm; “BCE, ExpressJet, Ford, Level 3, Sovereign: U.S. Equity Movers,” Bloomberg News, May 22, 2008 at 5:16pm; “Akamai Tech: AmTech Expects a Solid Quarter with Moderating M&E Growth and Gross Margin Upside,” Bloomberg News, July 29, 2008 at 9:18am. 46 It is my understanding that bonuses for Galleon’s analysts were determined in part upon the performance of their “paper portfolios.” These hypothetical portfolios would mirror the advice each analyst provided to Galleon’s portfolio managers. The level of confidence an analyst had in their stock recommendation could be evaluated by portfolio managers based upon the size of the position that the analyst took in their paper portfolio. See, for example, Galleon Group Presentation, April 2008, p. 3. 47 See Email from Galleon analyst, May 6, 2008 at 3:57pm (emphasis added). 48 See Email from Galleon analyst, May 7, 2008 at 3:37pm; Email from Galleon analyst, May 19, 2008 at 12:02pm.
23 56. On May 22, 2008, the analyst took a profit in Akamai by covering 70,000 shares after Goldman Sachs added Akamai to its conviction sell list. The analyst continued to be short
125,000 shares.49
57. On June 13, 2008, Galleon’s proprietary research noted:
Spoke with large media reseller.... He says AKAM customers are definitely more interested in diversifying and dual sourcing their CDN this year. ...he also commented that AKAM has only reduced pricing by about 10% this year on average – one of the reasons why customers are eager to diversify. ...I will continue recommending a short position...... I think medium term fundamentals appear challenging on the competitive front in their core media business and will get significantly worse in 2009, which is the reason behind my short thesis.50
58. On June 25, 2008, a Galleon analyst advised a colleague that AT&T’s entrance into the CDN market “...is a negative for large CDN incumbents like AKAM and is only the beginning of more formidable entrants into this market.”51
59. On June 26 and 30, 2008, the analyst covered another 30,000 shares and 57,000 shares, respectively, of her Akamai short position. The analyst noted that she “...believe[s] the qtr is on track and stock could move back up in the near term as we get closer to earnings.
Longer term, I am sticking with my short thesis on shares.”52
60. On July 3, 2008 (three weeks before the SEC contends Mr. Rajaratnam received inside information), Galleon’s proprietary research noted:
Heard that AKAM had an inline qtr but that discussions with customers suggested business was slowing substantially. Also hearing that application acceleration sales cycles are lengthening.
49 See Email from Galleon analyst, May 22, 2008 at 9:59am. 50 See Galleon Proprietary Research, June 13, 2008 (emphasis added). 51 See Email from Galleon analyst, June 25, 2008 at 10:16am. 52 See Email from Galleon analyst, June 26, 2008 at 10:08am; Email from Galleon analyst, June 30, 2008 at 10:31am.
24 Heard from one industry source that company is potentially looking to layoff employees to reign in costs. Revised my revenue and EBITDA estimates downward. New PT [price target] of $30 (down from $34)...53
61. On July 11, 2008, Galleon’s proprietary research noted:
I think downside to the stock from here is $28 which is why I’m still keeping it on the short list as opposed to the no conviction list. Incremental data points this week continue to suggest tougher competitive environment, market share loss, and longer sales cycles for their app acceleration business.... I continue now to pick up more datapoints of softness in their business and lower traffic on their network.... Direction to likely estimate changes... AKAM - ...54
I’m starting to hear word in the marketplace that online advertising revenue in Q3 is going to take an almighty hit and the earliest of signs suggests to me it might be worse than dotcom bubble bursting in 2002 in terms of an unexpected shock to the system. I’m not sure people are expecting quite this much of a problem perfect storm.55
62. On July 15, 2008, a Galleon analyst commented to a Raymond James analyst that
“[t]here have been concerns of business softening and risk to guidance.”56
63. In a July 21, 2008 email to Galleon, an analyst at Goldman Sachs commented on
Akamai’s upcoming quarterly announcement:
We expect 2Q results to show signs of ongoing competitive pressures.57
64. In a July 23, 2008 email to Galleon, an analyst at Goldman Sachs indicated that
Akamai was one of “[o]ur least favorite stocks…”58
53 See Galleon Proprietary Research, July 3, 2008 (emphasis added). 54 See Galleon Proprietary Research, July 11, 2008 (emphasis added). 55 See Galleon Proprietary Research, July 11, 2008 (emphasis added). 56 See Email from Galleon analyst, July 15, 2008 at 10:35am (emphasis added). 57 See Email from Goldman Sachs to Galleon containing Goldman Sachs analyst report, July 21, 2008 at 3:24am (emphasis added).
25 65. On July 25, 2008 (the same day Mr. Rajaratnam allegedly traded on inside information), Galleon’s proprietary research by Jessica Kourakos noted:
...spoke to competitor of AKAM and they said that AKAM is seeing significant price erosion in longer term deals that are coming up for renewal. He estimates that deals that were 18 months old are renewing at price points that are 50% below what they originally were and that deals that were entered into 12 months ago are initiating at 30% below original pricing.... He also believes that company is tapped out as far as market share and that there (sic) ability to increase growth through adding new customers will be very difficult.59
66. Also on July 25, 2008, Peter Swartz of Galleon indicated in his “weekly” review to Galleon’s portfolio managers that Akamai was one of his “top 3 shorts” and that he had a “2% position. Leveraging jessica’s thesis.”60
Rajaratnam’s Trades
67. In the twelve months before July 24, 2008 (when Mr. Rajaratnam allegedly received inside information), Mr. Rajaratnam bought and sold 8.0 million shares of Akamai with a total transaction value of $261.4 million. Prior to Mr. Rajaratnam’s alleged receipt of inside information, he had sold short61 300,000 shares of Akamai between July 2, 2008 and July 18,
2008. Mr. Rajaratnam continued to hold this short position until Akamai announced its earnings on July 30, 2008.62
58 See Email from Goldman Sachs to Galleon containing Goldman Sachs analyst report, July 23, 2008 at 12:19am. 59 See Galleon Proprietary Research, July 25, 2008 (emphasis added). 60 See Email within Galleon, July 25, 2008 at 1:16pm (emphasis added). 61 Unlike the typical long position, where an investor first “buys low” and hopes to “sell high” for a profit, a short sale reverses that order. In a short sale, the investor first “sells high” and hopes to cover or close out her short position when she “buys low” also for a profit. 62 Source: Galleon OMS Database.
26 68. After the alleged receipt of inside information, Mr. Rajaratnam sold short an
additional 575,000 shares of Akamai between July 25, 2008 (one day after the alleged tip) and
July 30, 2008 (the day earnings were announced). These short sales were made over three
separate trading days and consisted of four transactions that ranged from 50,000 shares to
250,000 shares each. The total investment value of these short sales was $18.1 million.63
Earnings Announcement
69. On July 30, 2008, after the market closed, Akamai reported that second quarter
2008 revenue was $194.0 million, slightly below Wall Street consensus estimates of $196.6
million. Akamai’s earnings of $0.41 per share met analysts’ estimates.64 During Akamai’s
earnings conference call with analysts, the company lowered third quarter revenue guidance to a
range of $193 million to $198 million, below the consensus estimate on Wall Street of $206.4
million.65 The company also lowered third quarter earnings guidance to a range of $0.39 to
$0.40 per share, below the consensus estimate of $0.42 per share.66 Management also lowered
full year 2008 earnings guidance to a range of $1.63 to $1.69 per share, below analysts’
63 Source: Galleon OMS Database; United States of America v. Raj Rajaratnam per GX 41. 64 See “Akamai Reports Second Quarter 2008 Financial Results,” Business Wire, July 30, 2008 at 4:01pm; “Akamai Q2 EPS Match Street, Sales Shy - Lower Evening Ask,” MidnightTrader, July 30, 2008 at 4:22pm. 65 See “Akamai Says Economy Hurting Growth Rate, Stock Drops,” Reuters News, July 30, 2008 at 4:27pm. 66 See “Akamai Tech Earnings Call Summary,” Bloomberg News, July 30, 2008 at 5:40pm.
27 estimates of $1.70 per share.67 Akamai’s CEO acknowledged that “[c]learly the economic climate has changed significantly from where we were even a couple of months ago.”68
70. On July 31, 2008, Akamai’s common stock price decreased 25.3% to close at
$23.34 per share. The excess return is statistically significant at the 99% confidence level (see
Exhibit 4).
71. After Akamai announced earnings and coompleted its cconference call, a Galleon analyst recapped the quarter as follows:
Summary – June qtr revenue was light relative to the Street, EBITDA was better. Company lowered full year guidance, citing weakening macro environment, longer sales cycles and decelerating growth in media businesses – consistent with our checks into the print.69
Conclusion
72. In summary, my review of the mix of information in the market shows that contrary to Akamai’s “cautious optimism,” several Wall Street analysts were beginning to express concerns that Akamai would lower its guidance. These concerns were publicly disseminated in analyst reports. This publicly-available information includes:
i) Akamai faced increased competitiion that was driving pricing for its services downward;
ii) Indications that pricing declines were accelerating; and
iii) Analysts were reducing earnings estimates and expected Akamai’s guidance to be lowered.
67 See “Akamai Tech Earnings Call Summary,” Bloomberg News, July 30, 2008 at 5:40pm. 68 See “Akamai Earnings Teleconference AKAM US,” Bloomberg News, July 30, 2008 at 5:44pm (emphasis added). 69 See Email from Galleon analyst, July 30, 2008 at 10:21pm.
28 73. Additionally, a Galleon analyst recommended to Galleon’s portfolio managers that they short Akamai, which Mr. Rajaratnam did before receiving any allegedly inside information. Galleon’s proprietary research reflected conncerns similar to those expressed by
Wall Street analysts:
i) Channel checks indicated that Akamai’s business was slowing substantially;
ii) Competitor indicated that Akamaii was seeing significant price erosion due to tougher competitive environmennt;
iii) Galleon analyst lowered revenue and EBITDA estimates;
iv) Galleon analyst cut price target from $34 down to $30;
v) Rumors of layoffs at Akamai; and
vi) Risk to guidance.
74. Based on the substantial level of discussion by Wall Street analysts and the financial press about Akamai’s upcoming second quarter results andd guidance, in my opinion, all of this commentary and analysis was publicly-available before Akamai announced its quarterly financial results on July 30, 2008.
75. Based on the market reaction to Akamai’s earnings and guidance announcement
(-25%), I conclude that Akamai’s market price prior to the disclosure did not adequately reflect the negative expectations by these analysts. This was despite the fact that some analysts were expressly warning investors to “sell” due to “competitive headwinds” that would likely result in guidance being lowered.
76. Based on this evidence, I conclude that a wwell-informed, professional investor
(such as a hedge fund manager) that engages in legal inffoormation gathering and related arbitrage trading in the shares of Akamai would have been aware of the mix of information in the market
29 that I have discussed above. Further, a hedge fund manager employed at Galleon would
additionally be aware of Galleon’s internal research on Akamai.
77. Based upon the mix of information available in the marketplace and within
Galleon prior to Akamai’s earnings announcement on July 30, 2008, in my opinion, it would be
reasonable for such an investor to short Akamai’s common stock, just as Mr. Rajaratnam had
done. In my opinion, this publicly-available information provided ample justification to take an
arbitrage position in Akamai immediately ahead of its earnings release.
78. Moreover, based on my understanding of the information the SEC is alleging was
conveyed in the tip, it is my opinion that the information allegedly tipped to Mr. Rajaratnam was
not private information, but rather was substantially similar to information that was already
included in the mix of publicly available information.
vi. Google – Q2’07 Earnings
79. The SEC alleges that:
Shortly after receiving the Google tip [on or about July 10, 2007] from the Google Source, Khan passed the Google tip to Rajaratnam [apparently on July 13, 2007], telling him to short Google because earnings would fall below the analyst expectations.70
[O]n or about July 17, 2007, at approximately 7:17 a.m., a telephone call was made from the Rajaratnam Cell Phone to CW’s [cooperating witness] home phone, lasting approximately five minutes.71
80. Below, I examine the mix of information available in the marketplace and within
Galleon about Google’s second quarter earnings prior to Google’s earnings announcement on
July 19, 2007.
70 See Complaint, ¶¶69-70. 71 See Criminal Complaint, ¶46.
30 Mix of Information
81. On April 19, 2007 (three months before the SEC contends Mr. Rajaratnam
received inside information), before Google reported its first quarter results, The Wall Street
Journal suggested that Google’s streak of beating earnings could come to an end:
Google’s search growth has blown past analyst expectations for so long that Wall Street might now be setting the bar too high. Thirty-three of the 38 Google analysts have a buy rating or better on the stock.... Google hasn’t undershot earnings targets since the fourth quarter of 2005, and it blew past its 2006 fourth-quarter estimates. An earnings miss now would be a shock to many. But with expectations so high, perhaps it shouldn’t be.72
82. The article was discussed at Galleon in an email.73
83. After the market closed on April 19, 2007, Google reported first quarter results that once again beat estimates. Market commentary was as follows:
Google’s first-quarter profit rose 69%, maintaining the online search leader’s penchant for obliterating analyst estimates.74
Pleasant earnings surprises have become routine for Google, which has succeeded in beating analyst estimates in all but one of 11 quarters since its ballyhooed initial public offering of stock in August 2004.... It has become more difficult for Google to impress Wall Street because its stock is scaling lofty heights and investors have become accustomed to the company’s eye-popping earnings growth...75
84. On May 6, 2007, Galleon’s proprietary internal research posed the following
questions:
72 See “Ahead of the Tape: High Hopes Pose a Risk,” The Wall Street Journal, April 19, 2007 (emphasis added). 73 See Email from Galleon analyst, April 19, 2007 at 8:24am. 74 See “Google Profits Rise in First Quarter; Internet Company Up 69%,” Daily Variety, April 19, 2007 (emphasis added). 75 See “Google 1Q Profit Rises 69 Percent to Blow Past Analyst Views,” AP Newswires, April 19, 2007 at 7:31pm (emphasis added).
31 Revenue growth – In its seasonally slowest quarter can GOOG beat 5-6% q/q growth expectations?
Margins – 2Q07 Street operating and EBITDA margins are expected to drop 200 bps and 100 bps q/q. Can the leverage in cost controls exhibited in Q1 be repeated?76
85. On May 23, 2007, The Wall Street Journal cautioned that Google’s margins could
come under pressure:
There are still warnings from analysts that Google’s margins could erode from competition from its big rivals, which has helped keep a damper on Google’s share price.77
86. On June 22, 2007, analysts at Sanford C. Bernstein raised expectations on Google
when they initiated coverage with an “outperform” rating and a price target of $635 per share
compared to the prior day’s price of $514.11. Commenting on their above consensus estimates
for Google’s revenue and EPS, they stated: “[w]e believe that consensus estimates are not
capturing the full new-business revenues.”78
87. On June 25, 2007, AP Newswires reported that “[s]hares of major Internet companies mostly rose in trading Monday, with Google Inc. rising to a new high after receiving some positive comments from analysts.” JMP Securities raised its price target from $580 to
$625.79
88. On June 27, 2007 (two weeks before the SEC contends Mr. Rajaratnam received
inside information), analysts at RBC Capital cautioned investors about Google’s stock near-term:
76 See Email from Galleon analyst to Galleon portfolio managers, May 6, 2007 at 12:13pm. 77 See “Common Sense: Google’s Story of Growth Has Chapters to Go,” The Wall Street Journal, May 23, 2007 (emphasis added). 78 See “RESEARCH ALERT-Bernstein Starts U.S. Internet Sector,” Reuters News, June 22, 2007 at 10:23am. 79 See “Shares of Major Internet Companies Rise, Google Hits New High After Positive Analyst Notes,” AP Newswires, June 25, 2007 at 1:16pm (emphasis added).
32 ...we believe European seasonal weakness and efforts to curtail search arb spending may limit upside in the quarter. Third party data gives a mixed early read on the quarter, with US search query volumes tracking up mid-teens q/q, but paid clicks only up marginally sequentially.... We are cautious near term, but positive long term.80
89. The RBC Capital analysts also questioned whether Microsoft was gaining market
share: “MSN Picking Up Market Share in June?”81
90. A Galleon analyst noted that RBC Capital saw “limited upside to estimates for
Q2” and advised Galleon portfolio managers that:
Given the recent rally in the stock from $505 to $530 [it] would be natural to see some give back. My game plan is initiate long position on weakness, ideally in $500-$515 range.82
91. The RBC Capital analyst report was also reported on in the financial press. AP
Newswires noted that “upside to the company’s second-quarter results is minimal and likely
priced in to the stock” and that the Wall Street analyst saw some “‘key’ short-term negatives”
that could “pressure” Google’s revenue.83
92. On July 9, 2007, a Galleon analyst emailed to Galleon’s portfolio managers an analyst report by ThinkEquity Partners that raised its price target from $620 to $700:
We are reiterating our Buy rating and raising our price target on GOOG shares from $620 to $700, as checks indicate that GOOG
80 See Email from RBC Capital to Galleon containing RBC Capital analyst report, June 27, 2007 at 4:10am (emphasis added). 81 See Email from RBC Capital to Galleon containing RBC Capital analyst report, June 27, 2007 at 4:10am. 82 See Email from RBC Capital to Galleon containing RBC Capital analyst report, June 27, 2007 at 8:00am (emphasis added). 83 See “Internet Stocks Mixed, Google Inches Lower,” AP Newswires, June 27, 2007 at 1:41pm.
33 should continue to capture incremental share of search queries/marketer budgets...84
93. Bloomberg News noted that $700 was the highest price target by any analyst following Google.85
94. On July 11, 2007, Cowen and Company and Merrill Lynch emailed to Galleon analyst reports that discussed Google’s market share:
When Will Google Stop Gaining Market Share?... Our View: We believe Google will achieve a share of at least 90% of the search mkt over the next decade...86
ComScore data has been positive.... Our channel checks and industry checks data indicate Google is continuing to take share of both user time and advertiser spend.87
95. Bloomberg News ran a headline titled: “Google to Grab 90% of Search Market in
10 Years, Analyst Says.”88
96. On July 11, 2007, Merrill Lynch emailed to Galleon an analyst report indicating that there was risk to margins, especially if the acceleration of hirings overwhelmed Google’s operating expense leverage:
...we assume EBITDA margins will fall 80bpts to 62.6% as Google continues to invest in partnerships and personnel.... Operating margin outlook. Google is investing in numerous businesses that are expected to have lower margins than Google’s existing search business, including YouTube, On-demand software and Checkout,
84 See Email from Galleon analyst containing ThinkEquity Partners analyst report, July 9, 2007 at 8:33am (emphasis added). 85 See “AFX: Google Hits New High With Postini Buy,” Bloomberg News, July 9, 2007 at 12:23pm. 86 See Email from Cowen and Company to Galleon containing Cowen and Company analyst report, July 11, 2007 at 7:11am (emphasis added). 87 See Email from Merrill Lynch to Galleon containing Merrill Lynch analyst report, July 11, 2007 at 5:42am (emphasis added). 88 See “Google to Grab 90% of Search Market in 10 Years, Analysts Say,” Bloomberg News, July 11, 2007 at 4:53pm.
34 and has been increasing headcount and capex at growth rates above revenue growth. Our outlook for flat EBITDA margins in 2007 could be optimistic if operating expense leverage is overwhelmed by hiring and new business investment.
Given recent run in the stock, we believe 2Q upside is largely reflected in the stock price...89
97. On July 11, 2007, a Galleon analyst viewed a “downtick” in revenue expectations
from an analyst at Majestic as a “slight negative” for Google’s stock:
Majestic GOOG preview out this morning suggesting Q2 rev $2.72B, +7% q/q vs Street +5% q/q. Want to flag this as a slight downtick from his last work published 6/22 where he believed Q2 was tracking +7.5% q/q. Back in May he believed +8.5% q/q for Q2.... I take Majestic’s downtick as a slight negative given the recent run-up in the stock.90
98. The Galleon analyst also reiterated on July 11, 2007 his “near-term” price target for Google of $550.91
99. On July 13, 2007, Lehman Brothers emailed to Galleon an analyst report
indicating margins were expected to be lower:
We attribute our lower net EBITDA margin projection due to higher operating expenses associated with continued investment in R&D and new products and services as well as continued increases in headcount. We project Google to hire at least an additional 1,450 employees in 2Q, +25% Y/Y...92
100. On July 13, 2007, ThinkEquity Partners emailed to Galleon an analyst report expecting strong results from Google due to market share gains:
89 See Email from Merrill Lynch to Galleon containing Merrill Lynch analyst report, July 11, 2007 at 5:42am (emphasis added). 90 See Email from Galleon analyst, July 11, 2007 at 8:25am (emphasis added). 91 See Email from Galleon analyst, July 11, 2007 at 8:25am. 92 See Email from Lehman Brothers to Galleon containing Lehman Brothers analyst report, July 13, 2007 at 7:19am (emphasis added).
35 We believe that Google continues to gain global share and drive superior monetization in its core search business, which should lead to strong revenue and profitability.93
101. On July 13, 2007, after Google traded above $550 per share for its first time ever,
Mr. Rajaratnam instructed Ian Horowitz to “se ll (sic) all the goog in all accounts..reached my price [t]arget.”94
102. On July 13, 2007, Bloomberg News reported that Microsoft’s share of internet
search queries had risen about 2% based on conversations it had with ComScore and its own
internal data.95 Within three minutes of this story’s publication, a Galleon analyst alerted
Galleon’s portfolio managers and traders via an instant message.96 In a follow-up instant
message, the Galleon analyst noted the negative implications for Google:
...comscore has just released the June q search data. shows MSFT taking share of search in US from GOOG, YHOO, and AOL, while ASKJ maintained. important to note the accuracy of comscore data is often called into question but sell side may spin with some caution Monday for YHOO and GOOG ahead of their earnings reports Tues and Thurs, respectively.97
103. One minute after this update, a Galleon portfolio manager was asked in an email:
Do you wanna trim any [Google] here at 552 on the strength today?98
93 See Email from ThinkEquity Partners to Galleon containing ThinkEquity Partners analyst report, July 13, 2007 at 8:43am (emphasis added). 94 See Instant Message within Galleon, July 13, 2007 at 1:38pm. 95 See “Microsoft Predicts Gain in Monthly Web Search Share of About 2%,” Bloomberg News, July 13, 2007 at 3:07pm. 96 See Instant Message from Galleon analyst, July 13, 2007 at 3:10pm. 97 See Instant Message from Galleon analyst, July 13, 2007 at 3:52pm (emphasis added). 98 See Email from Galleon, July 13, 2007 at 3:53pm.
36 104. On July 15, 2007, Galleon’s proprietary research was cautious about owning
Google shares the week of its earnings report now that Google had reached Galleon’s price
target. As a result, the risk/reward was skewed to the downside:
Having closed above near-term target I am holding position but now less enthusiastic/more cautious about set-up into this week’s print [earnings release].
...stock currently at 2H07 [Galleon] target $550 making near-term risk/reward less favorable into print at current levels (thinking $15 up/$40 down).
...unwilling to take speculative long into print.... Prefer adds closer $505-$520 area...99
105. On July 16, 2007, JMP Securities emailed to Galleon an analyst report that
viewed the comScore data showing “dramatic Microsoft search share growth” as
“misleading.”100
106. On July 16, 2007, a Galleon analyst told Galleon’s portfolio managers that he was
reducing his “paper portfolio” long position in Google by one-third because he was “unwilling to take speculative long into print” due to increased “expectations” this quarter and his view of a significant $40 per share downside.101
107. On July 17, 2007 (less than three hours after Mr. Rajaratnam shorted Google), a
Galleon analyst sold 1,400 shares of Google in his paper portfolio:
Sticking to my game plan laid out in weekly and 2Q previews to reduce long exposure in GOOG to 2% from 3% in front of EPS report 7/19. Continue to like fundamentals and no change to 12 month target $650, but stock currently above near-term $550
99 See Galleon Proprietary Research, July 15, 2007 at 7:35am (emphasis added). 100 See Email from JMP Securities to Galleon containing JMP Securities analyst report, July 16, 2007 at 7:21am. 101 See Email from Galleon analyst, July 16, 2007 at 12:22pm.
37 target. I view risk/reward for print as approx $565 on upside/and $510 on downside.102
108. On July 18, 2007, Susquehanna Financial Group emailed to Galleon an analyst
report that tempered its enthusiasm because “expectations are quite high entering the quarter”
for Google.103
109. On July 18, 2007, American Technology Research emailed to Galleon an analyst
report that hoped stronger than expected revenue would be sufficient to “offset” the increased
expense of new hires:
Stronger than expected top-line could offset higher headcount expenses... Our EPS forecast is more conservative than consensus, assuming over 1,500 new hires again this quarter, which is 75% year-year headcount growth. We see potential for top-line upside to offset our higher expense forecast.104
110. On July 19, 2007, a Galleon analyst commented on Bank of America’s
“heightened expectations”:
Preview this morning [from Bank of America] is first i (sic) have seen in print from sell side suggesting +8 to +10% q/q rev growth for 2Q. I view this as heightening expectations for tonights (sic) print from 7-7.5% whispers.105
111. Ten minutes before Google reported its earnings on July 19, 2007, Bloomberg
News reported that expectations were “extremely” high and that there was “chatter” that earnings might miss expectations:
Google (GOOG) is set to report earnings after the close with expectations extremely higher for the co to blow out numbers for
102 See Email from Galleon analyst, July 17, 2007 at 2:51pm (emphasis added). 103 See Email from Susquehanna Financial Group to Galleon containing Susquehanna Financial Group analyst report, July 18, 2007 at 8:42am (emphasis added). 104 See Email from American Technology Research to Galleon containing American Technology Research analyst report, July 18, 2007 at 9:13am (emphasis added). 105 See Email from Galleon analyst, July 19, 2007 at 8:08am (emphasis added).
38 the sixth straight quarter. Co has been beating bottom line expectations by ~$0.27 on average over the last five quarters. Revenue growth has been falling steadily but not enough to alarm investors sliding to just below 65% in Q1. Shares have responded to the positive earnings report and now the stock is trading close to all time highs. Of course when one set[s] the bar so high it can be difficult to keep up with expectations so it will certainly be interesting to see if GOOG is able to deliver to a crowd just waiting for the first slip up from this Wall Street darling. Stock was selling off earlier today on chatter that earnings may disappoint expectations and that an important executive would be leaving the team but we believe that was just speculation and did not have a basis behind the rumors.106
Rajaratnam’s Trades
112. In the twelve months before July 13, 2007 (when Mr. Rajaratnam allegedly
received inside information), Mr. Rajaratnam bought and sold 2.1 million shares of Google with
a total transaction value of $979.6 million.107
113. After the alleged receipt of inside information, Mr. Rajaratnam sold short 348,170
shares of Google between July 13, 2007 and July 19, 2007 (the day earnings were announced).
These short sales were made over three separate trading days and consisted of seven transactions
that ranged from 10,000 shares to 125,000 shares each. The total investment value of these short
sales was $191.8 million.108
Earnings Announcement
114. On July 19, 2007, after the market closed, Google reported that second quarter
2007 net revenue was $2.72 billion, beating Wall Street consensus estimates of $2.68 billion.
106 See “GOOG: Google Earnings Preview,” Bloomberg News, July 19, 2007 at 3:51pm (emphasis added). 107 Source: Galleon OMS Database. 108 Source: Galleon OMS Database; United States of America v. Raj Rajaratnam per GX 60.
39 Google’s earnings of $3.56 per share missed analysts’ estimates of $3.59.109 During Google’s
earnings conference call, there were several questions from analysts about headcount. Google’s
CEO acknowledged that “we overspent against our own plan in the area of headcount... because
we hired a little faster than we had planned.... [W]e will continue to watch this very carefully in
the future.”110
115. On July 20, 2007, Google’s common stock price decreased 5.2% to close at
$520.12 per share. The excess return is statistically significant at the 99% confidence level (see
Exhibit 5).
116. A Galleon analyst summarized Wall Street analysts’ reactions after Google announced earnings and completed its conference call:
[Sanford C. Bernstein] This could have been a great quarter for Google, but the hiring spiraled out of control – takes us back to 1999/2000 when some firms like AOL were hiring out of control...
[Citigroup] ...this quarter was all about expenses. Management said that headcount adds were above expectations...111
117. Additional commentary included:
...we think that per head count yield is worsening at a steep rate.112
...Google came in below expectations on both EBITDA and pro forma EPS largely due to a combination of inflated bonus accruals and increased headcount.113
109 See “Google Announces Second Quarter 2007 Results,” Business Wire, July 19, 2007 at 4:01pm; “Google Earnings Jump In Second Quarter, But Miss Targets,” Dow Jones Business News, July 19, 2007 at 5:14pm. 110 See “GOOG - Q2 2007 Google Earnings Conference Call,” Thomson StreetEvents, July 19, 2007 at 4:30pm. 111 See Email from Galleon analyst, July 19, 2007 at 7:42pm. 112 See Email from Oppenheimer & Co. to Galleon containing Oppenheimer & Co. analyst report, July 20, 2007 at 7:23am (emphasis added).
40 Google Inc.’s earnings growth decelerated dramatically in the second quarter as the Internet search leader spent more money hiring new employees...114
During the quarter, Google’s profit margiins also narrowed as management spent more money to hire employees and buy more content for its Web sites. The disappointing margins left some on Wall Street bearish on expenses in the neaar-term, and several analysts lowered their price targets. “We think there are many question marks for investors on the cost side of the quarter that need to be addressed in order to feel comfortable to drrive the stock in the near term,” Bear Stearns analyst... wrote...115
Conclusion
118. In summary, my review of the mix of information in the market shows that earnings expectations for Google were very high for the second quarter despite concerns expressed by some analysts. This publicly-available information includes:
i) Concern that Wall Street was “setting the bar ttoo high” making it “more difficult for Google to impress Wall Street;”
ii) With Google trading at all-time highs, any upside from earnings announcement was “minimal and likely priced in to the stock;”
iii) Analyst “warnings” that Google’s margins could “erode” and concern that margins could be “overwhelmed by hiring” and “increases in headcount;” and
iv) “Chatter” that earnings may disappoint expectations.
119. Additionally, a Galleon analyst recommended to Galleon’s portfolio managers to be cautious about owning Google going into its earnings release due to near-term risk that the stock could fall as much as $40 with the release of its earnings:
113 See Email from Lehman Brothers to Galleon containing Lehman Brothers analysst report, July 20, 2007 at 7:33am (emphasis added). 114 See “AFX: Google’s Profit Falls Short, Shares Drop,” Bloomberg News, July 19, 2007 at 11:24pm (emphasis added). 115 See “Analysts Lower Price Targets on Google After Margin Weakness Disappoints Wall Street,” AP Newswires, July 20, 2007 at 7:21am (emphasis added).
41 i) Questioned whether Google’s “cost controls” in the first quarter could be “repeated;”
ii) Given the recent rally in Google’ss stock, it would be “natural to see some give back;”
iii) Would be a buyer in the $500-$5115 range, not $530-$550;
iv) Viewed slight “downtick” in revenue expectations by a Wall Street analyst as a “slight negative given the recent run-up in the stock;”
v) With Google trading above Galleon’s target prrice of $550, “less enthusiastic/more cautious” about holding stock going into earnings;
vi) “Near-term risk/reward less favorable” going into earnings release, upside limited to $15 per share whereas downside was $40 per share;
vii) Galleon analyst was reducing long position inn “paper portfolio” by one- third; and
viii) Galleon analyst was “unwilling to take speculative long into print” due to increased expectations and significant $40 per share downside.
120. Based on the substantial level of discussion by Wall Street analysts and the financial press about Google’s upcoming second quarter results, in my opinion, all of this commentary and analysis was publicly-available before Google announced its quarterly financial results on July 19, 2007.
121. Based on the market reaction to Google’s earnings announcement (-5%), I conclude that Google’s market price prior to the disclosure placed too great an emphasis on the heightened expectations and did not adequately reflect the concerns eexpressed by some analysts.
122. Based on this evidence, I conclude that a wwell-informed, professional investor
(such as a hedge fund manager) that engages in legal inffoormation gathering and related arbitrage trading in the shares of Google would have been aware of the mix of information in the market that I have discussed above. Further, a hedge fund manager employed at Galleon would additionally be aware of Galleon’s internal research on Google.
42 123. Based upon the mix of information available in the marketplace and within
Galleon prior to Google’s earnings announcement on July 19, 2007, in my opinion, it would be reasonable for such an investor to short Google’s common stock, just as Mr. Rajaratnam had done. In my opinion, this publicly-available information provided ample justification to take an arbitrage position in Google immediately ahead of its earnings release.
124. Moreover, based on my understanding of the information the SEC is alleging was conveyed in the tip, it is my opinion that the information allegedly tipped to Mr. Rajaratnam was not private information, but rather was substantially similar to information that was already included in the mix of publicly available information.
vii. Intel – Q4’06 Earnings
125. The SEC alleges that:
Beginning on or about January 8 [2007], and continuing through January 16 [2007], Goel communicated to Rajaratnam material nonpublic information that Goel secured through his position at Intel about Intel’s fourth quarter 2006... financial results and outlook.116
On January 8, 2007, approximately one week before Intel’s scheduled Q4 2006 earnings announcement, Rajaratnam contacted Goel.117
Goel and Rajaratnam communicated again multiple times over the Martin Luther King Day weekend that followed.118
126. Below, I examine the mix of information available in the marketplace and within
Galleon about Intel’s fourth quarter earnings prior to Intel’s earnings announcement on January
16, 2007.
116 See Complaint, ¶94. 117 See Complaint, ¶95. 118 See Complaint, ¶96.
43 Mix of Information
127. On December 22, 2006 (two weeks before the SEC contends Mr. Rajaratnam
received inside information), FBR Research emailed to Galleon an analyst report that reiterated
its “outperform” rating and expected Intel to report “in line” fourth quarter results. FBR
Research’s recommendation was based on its belief that gross margins would increase:
Our positive stance on the stock continues to be predicated on the potential for margin improvement over the next several quarters.119
128. On January 4, 2007, Bank of America emailed to Galleon an analyst report that
raised estimates in anticipation of better than expected fourth quarter sales:
Our industry/channel checks suggest the Intel’s Dec qtr revs finished at $9.6b.... [W]e remain comfortable with the Intel’s ability to drive higher gross/operating margins....120
129. On January 10, 2007, UBS emailed to Galleon an analyst report that believed
Intel’s “gross margin has bottomed” in the third quarter and should “steadily increase through
2007.”121
130. On January 10, 2007, Deutsche Bank emailed to Mr. Rajaratnam an analyst report
that indicated fourth quarter revenue and earnings could exceed estimates based on recent
channel checks. The analysts also were expecting fiscal 2007 gross margin guidance of 55%.122
119 See Email from FBR Research to Galleon containing FBR Research analyst report, December 22, 2006 at 6:49am (emphasis added). 120 See Email from Bank of America to Galleon containing Bank of America analyst report, January 4, 2007 at 12:11am (emphasis added). 121 See Email from UBS to Galleon containing UBS analyst report, January 10, 2007 at 6:45am. 122 See Email from Deutsche Bank to Mr. Rajaratnam containing Deutsche Bank analyst report, January 10, 2007 at 6:49pm.
44 The analysts advised that the options market was anticipating a 4%-5% price move (either up or down) around the upcoming earnings announcement.123
131. On January 11, 2007, after the market closed, AMD announced an earnings warning for the fourth quarter:
Fourth quarter operating income... is expected to be positive but substantially lower than in the third quarter. The fourth quarter gross margin and operating income were impacted by significantly lower microprocessor average selling prices...124
132. As a result, on January 12, 2007, AMD’s stock fell 9.5%, but Intel rose 1.0%.
133. There were numerous reports in the financial press about AMD’s earnings warning.125
134. On January 12, 2007, JPMorgan emailed to Galleon an analyst report regarding the Intel/AMD “price war”:
123 See Email from Deutsche Bank to Mr. Rajaratnam containing Deutsche Bank analyst report, January 10, 2007 at 7:11pm. 124 See “AMD Updates Fourth Quarter Outlook,” Business Wire, January 11, 2007 at 7:50pm (emphasis added). 125 See “AMD Sees Soft 4Q as Competition Increases with Intel,” Dow Jones News Service, January 11, 2007 at 9:36pm; “AMD Warns of Revenue Shortfall Citing Lower Prices,” Reuters News, January 11, 2007 at 11:07pm; “AMD Sees Q4 Rev Below Analysts’ Estimates,” Reuters News, January 11, 2007 at 11:17pm; “AMD Sees Lower Prices Cutting Quarterly Results,” Dow Jones Business News, January 11, 2007 at 11:33pm; “AMD Warns of ‘Substantially’ Lower Q4 Operating Profit,” AP Newswires, January 12, 2007 at 12:21am; “Before the Bell -AMD, Intel Fall After AMD Forecast,” Reuters News, January 12, 2007 at 7:23am; “AMD Continues to Crack Under Intel Pressure,” Bloomberg News, January 12, 2007 at 8:50am; “Before the Bell: Advanced Micro Falls On 4Q Warning,” Dow Jones Commodities Service, January 12, 2007 at 8:58am; “AMD Preannounces 4Q; Lowering Estimates and Price Targets,” Bloomberg News, January 12, 2007 at 9:40am; “AMD Shares Slump After Sales Forecast Cut,” Reuters News, January 12, 2007 at 9:56am; “Bear Stearns Cuts AMD to Peer Perform,” Reuters News, January 12, 2007 at 9:56am; “AMD Warns Chip Price War Hurting Profit,” Dow Jones Business News, January 12, 2007 at 2:08pm; “AMD Shares Plunge 10 Pct. On Q4 Warning,” AP Newswires, January 12, 2007 at 4:48pm; “Jim Cramer: Nike, Crocs, CarMax, MRV Communications, Diageo,” Bloomberg News, January 12, 2007 at 8:43pm; “A.M.D., in Price War With Intel, Warns of Disappointing Revenue,” The New York Times, January 13, 2007.
45 Lowering [AMD] Estimates Due to Processor Price War... Aggressive processor pricing the culprit, we expect more downside [at AMD]. We believe the downside was driven by Intel’s aggressive pricing...126
135. The financial press also reported on January 11 and 12, 2007 that the Intel/AMD price war would negatively impact gross margins and Intel’s guidance:
AMD, the world’s No. 2 maker of PC and corporate server chips, has been locked in a heated battle with Intel Corp. (INTC), the No. 1 maker, for sales.127
We [ThinkEquity Partners] expect the Intel/AMD price war to continue for some time to come...128
We [SBSH] are downgrading the shares of AMD to Hold (2H) from Buy (1H) reflecting concerns that gross margin may face more persistent pressure than anticipated.129
We [PRUS] believe that it is evidence that the industry is shifting from a near monopoly to a duopoly, at the same time that the MPU (Micro Processor Unit) is being commoditized.130
Avoid Tech Price Wars.... AMD is locked in a vicious price war with Intel. [Jim Cramer said] There are enough places where there are no price wars – you don’t need a price war.131
Intel may report a good quarter [said Jim Cramer on CNBC’s Mad Money], “but its outlook is messed [up] because [of] its price war with” AMD.132
126 See Email from JPMorgan to Galleon containing JPMorgan analyst report, January 12, 2007 at 8:31am (emphasis added). 127 See “AMD Sees Lower Prices Cutting Quarterly Results,” Dow Jones Business News, January 11, 2007 at 11:33pm (emphasis added). 128 See “”Morning Alert for Advanced Micro Devices Inc.,” M2 Presswire, January 12, 2007 (emphasis added). 129 See “Advanced Micro Devices-AMD Implied Volatility Flat Prior to 4Q Profit Warnings,” Bloomberg News, January 12, 2007 at 7:39am (emphasis added). 130 See “Intel-INTC January 22.5 Straddle Priced at $1.25 into 1/16 EPS & Outlook,” Bloomberg News, January 12, 2007 at 8:11am. 131 See “Cramer’s TheStreet.com TV Recap: Avoid Tech Price Wars,” TheStreet.com, January 12, 2007 at 1:41pm (emphasis added).
46 136. On January 13, 2007, a New York Times story titled “A.M.D., in Price War With
Intel, Warns of Disappointing Revenue” was emailed to Galleon:
A.M.D.... issued a warning late Thursday that its fourth-quarter revenue would miss Wall Street’s forecasts because of lower unit prices, signaling that the price war between A.M.D. and its main rival, Intel, has taken its toll.
[A Prudential analyst]... did not expect the price war to be resolved anytime soon.
[A Bear Stearns analyst said he]... expected further pricing pressure as A.M.D. tries to prevent Intel from “clawing back” share.133
137. The New York Times article was also carried by Bloomberg News.134
138. On January 15, 2007, Morgan Stanley emailed to Galleon an analyst report that
expressed concern about Intel’s gross margins for fiscal 2007:
We believe that Intel will be able to slightly exceed fourth-quarter consensus EPS estimates on in-line revenues.... However, we continue to believe that Intel will face margin pressure as they undertake an aggressive pricing campaign to regain market share this year.
Our 2007 EPS estimate is unchanged, and it remains about 15% below the consensus, as we believe that an aggressive pricing environment will combine with excess capacity to pressure Intel’s gross margins.135
132 See “Jim Cramer: Nike, Crocs, CarMax, MRV communications, Diageo,” Bloomberg News, January 12, 2007 at 8:43pm (emphasis added). 133 See Email to Galleon, January 13, 2007 at 3:49pm (emphasis added). 134 See “A.M.D., in Price War With Intel, Warns of Disappointing Revenue,” Bloomberg News, January 13, 2007 at 1:00am. 135 See Email from Morgan Stanley to Galleon containing Morgan Stanley analyst report, January 15, 2007 at 11:00pm (emphasis added).
47 139. On January 15, 2007, Electronic News reported that, according to Lehman
Brothers, “...Intel should not become too comfortable at the top. Looking ahead, Lehman said it
expects ongoing share pressure from” AMD.136
140. On January 16, 2007 (before Mr. Rajaratnam sold his Intel shares and before Intel
announced earnings scheduled for later in the afternoon), Bloomberg News reported about the
adverse impact Intel’s price war with AMD would likely have on margins:
Intel Corp.... may say today that profit fell for a fourth straight quarter as demand dropped and the company cut prices to compete with Advanced Micro Devices Inc.
If they [Intel] want to gain back market share, they’re going to have to price aggressively.... There’s going to be a continuation of this price war in the first half [of 2007].137
141. On January 16, 2007 (before Mr. Rajaratnam sold his Intel shares and before Intel
announced earnings scheduled for later in the afternoon), Dow Jones News Service reported that
Intel had been struggling with “softer” demand and “stiff” competition from AMD that was causing “margin pressure”:
Cutthroat pricing has squeezed Intel’s closely watched gross-profit margin, and a recent profit warning from AMD indicates there was no let-up in the year’s final quarter.138
142. On January 16, 2007 (before Mr. Rajaratnam sold his Intel shares and before Intel
announced earnings scheduled for later in the afternoon), an analyst at ThinkEquity Partners
predicted first quarter guidance would be “disappointing” for chip makers such as Intel.139
136 See “Firm Sees Short-Term Strength for Intel, Long-Term Success for AMD,” Electronic News, January 15, 2007. 137 See “Intel May Say Profit Fell Again as Chip Demand, Prices Dropped,” Bloomberg News, January 16, 2007 at 12:09am (emphasis added). 138 See “Earnings Preview: Intel Reports Tuesday,” Dow Jones News Service, January 16, 2007 at 11:00am (emphasis added).
48 Rajaratnam’s Trades
143. In the twelve months before January 8, 2007 (when Mr. Rajaratnam allegedly
received inside information), Mr. Rajaratnam bought and sold 26.2 million shares of Intel with a
total transaction value of $519.7 million.140
144. After the alleged receipt of inside information, Mr. Rajaratnam purchased an
additional 1.5 million shares of Intel between January 9, 2007 (one day after the alleged tip) and
January 11, 2007. Mr. Rajaratnam sold these 1.5 million shares of Intel on January 16, 2007
before Intel reported its earnings that day.141 These transactions were made over three separate
trading days and consisted of three transactions that ranged from 500,000 shares to 1.5 million shares. The total investment value of these transactions was $65.0 million.142
Earnings Announcement
145. On January 16, 2007, after the market closed, Intel reported that fourth quarter
2006 net revenue was $9.7 billion, beating Wall Street consensus estimates of $9.4 billion.
Intel’s earnings of $0.30 per share beat analysts’ estimates of $0.25.143 During Intel’s earnings conference call with analysts, the company provided first quarter revenue guidance of between
$8.7 billion and $9.3 billion, compared to the consensus estimate on Wall Street of $8.9 billion.
The company also indicated that its gross margin for fiscal 2007 was expected to be about 50%,
139 See “OmniVision Shares Fall Sharply, Himax Shares Jump,” AP Newswires, January 16, 2007 at 1:53pm. 140 Source: Galleon OMS Database. 141 Source: Galleon OMS Database. See also Complaint, ¶¶95-96. 142 Source: Galleon OMS Database. 143 See “Intel Fourth-Quarter Revenue $9.7 Billion,” Business Wire, January 16, 2007 at 4:10pm; “Intel Profit Dips 39 Pct., Beats Views,” AP Newswires, January 16, 2007 at 6:15pm.
49 slightly lower than expected.144 On a conference call with analysts, Intel’s CFO indicated that
2006 had been “a very tough pricing year” and that Intel would continue to price aggressively as
they “fight to win orders.”145
146. On January 17, 2007, Intel’s common stock price decreased 5.7% to close at
$21.04 per share. The excess return is statistically significant at the 99% confidence level (see
Exhibit 6).
147. After Intel announced earnings and completed its conference call, commentary in the financial press focused on Intel’s margins and its price war with AMD:
Intel Makes Inroads Vs AMD But Margins Suffer.146
Intel’s profit plunged 39% in the fourth quarter, as the company signaled that its bottom line would continue to be pressured by a price war with rival Advanced Micro Devices.
We [Intel] do believe it’s going to be a competitive business environment and we’re going to have to fight to win orders.147
With competition from rival Advanced Micro Devices as intense as ever, Intel projected that its gross margins would remain stunted at a 50% level for 2007...
...[CIBC] predicted that the “severe” pricing environment will persist as Intel and AMD duke it out for market share.148
144 See “Intel Profit Dips 39 Pct., Beats Views,” AP Newswires, January 16, 2007 at 6:15pm. 145 See “Intel’s Fight for Share in Chip Market Cuts Its Margins,” Bloomberg News, January 17, 2007 at 1:00am. 146 See “Intel Makes Inroads Vs AMD But Margins Suffer,” Dow Jones News Service, January 16, 2007 at 6:15pm (emphasis added). 147 See “Price War Pounds Intel,” TheStreet.com, January 17, 2007 at 9:41am (emphasis added). 148 See “Intel Grows Battle-Weary,” TheStreet.com, January 17, 2007 at 1:16pm (emphasis added).
50 Conclusion
148. In summary, my review of the mix of information in the market shows that the earnings outlook by some analysts for Intel was adversely impacted bby AMD’s earnings warning issued just five days prior to Intel’s announcement. This publicly-available information includes:
i) Prior to AMD’s earnings warning, analysts were “comfortable” with Intel’s gross margins and expected them to “steadily increase” in 2007;
ii) After AMD’s earnings warning, analysts were concerned about the negative impact a “price war” would have on Intel’s gross margins;
iii) Expectation that price war would continue for duration of fiscal 2007;
iv) Recommendation that investors “avoid” shares of companies involved in price wars; and
v) Expectation that price war with AMD would cause Intel’s guidance to be “messed up.”
149. Based on the substantial level of discussion by Wall Street analysts and the financial press about Intel’s upcoming fourth quarter results, in my opinion, all of this commentary and analysis was publicly-available before Intel announced its quarterly financial results on January 16, 2007.
150. Based on the market reaction to Intel’s earnings annouuncement (-6%), I conclude that Intel’s market price prior to the disclosure placed too little emphasis on Intel’s price war with AMD and did not accurately reflect the concerns expressed by some analysts.
151. Based on this evidence, I conclude that a wwell-informed, professional investor
(such as a hedge fund manager) that engages in legal inffoormation gathering and related arbitrage trading in the shares of Intel would have been aware of the mix of information in the market that
I have discussed above. Further, a hedge fund manager employed at Galleon would additionally be aware of Galleon’s internal research on Intel.
51 152. Based upon the mix of information available in the marketplace and within
Galleon prior to Intel’s earnings announcement on January 16, 2007, in my opinion, it would be
reasonable for such an investor to sell Intel’s common stock, just as Mr. Rajaratnam had done.
In my opinion, this publicly-available information provided ample justification to take an arbitrage position in Intel immediately ahead of its earnings release.
153. Moreover, based on my understanding of the information the SEC is alleging was
conveyed in the tip, it is my opinion that the information allegedly tipped to Mr. Rajaratnam was
not private information, but rather was substantially similar to information that was already
included in the mix of publicly available information.
154. The Complaint apparently takes issue with Mr. Rajaratnam’s January 16, 2007
sale of Intel shares, characterizing it as “abruptly shift[ing] course with respect to Intel....”149
Given that Mr. Rajaratnam held this Intel position for more than five days (an eternity for some hedge fund managers), I fail to understand how the SEC concludes that this represents an “abrupt shift.” Moreover, I note that the Complaint completely ignored the salient fact that AMD’s earnings warning materially changed the mix of information in the marketplace and that this news came in between Mr. Rajaratnam’s decisions to purchase and sell the Intel shares.
viii. Intel – Q1’07 Earnings
155. The SEC alleges that:
...Rajaratnam and Galleon established a sizable short position in Intel after Rajaratnam learned of Intel’s lower revenue numbers from Goel on or around April 9, [2007]...150
Goel and Rajaratnam communicated again on April 11 and 13, 2007.151
149 See Complaint, ¶96. 150 See Complaint, ¶103.
52 ...Goel told Rajaratnam, on or around April 13, [2007], that Intel would be raising its profitability target for the rest of the year.152
On Saturday, April 14, 2007, Goel reached out again to his contact in Intel’s IR department and then communicated with Rajaratnam.153
[On April 16, 2007]... Rajaratnam and Goel spoke...154
156. Below, I examine the mix of information available in the marketplace and within
Galleon about Intel’s first quarter earnings prior to Intel’s earnings announcement on April 17,
2007.
Mix of Information
157. On January 16, 2007, Intel reported that fourth quarter 2006 net revenue was $9.7
billion and provided first quarter revenue guidance of between $8.7 billion and $9.3 billion,
indicating it expected revenue to decline by as much as 10.3% in the first quarter.155 On a
conference call with analysts, Intel’s CFO indicated that 2006 had been “a very tough pricing
year” and that Intel would continue to price aggressively as they “fight to win orders.”156
158. On March 5, 2007 (one month before the SEC contends Mr. Rajaratnam received inside information), AMD announced it was “unlikely to meet its previously estimated revenue
151 See Complaint, ¶100. 152 See Complaint, ¶103. 153 See Complaint, ¶101. 154 See Complaint, ¶101. 155 See “Intel Fourth-Quarter Revenue $9.7 Billion,” Business Wire, January 16, 2007 at 4:10pm. 10.3% equals guidance of $8.7 billion divided by actual fourth quarter revenue of $9.694 billion, then minus one. 156 See “Intel’s Fight for Share in Chip Market Cuts Its Margins,” Bloomberg News, January 17, 2007 at 1:00am.
53 guidance of $1.6 to $1.7 billion for the first quarter of 2007....”157 This reduction in guidance at
AMD was discussed in an email at Galleon.158
159. Following AMD’s revenue warning, Intel’s CEO stated: “[i]n terms of pricing it
continues to be very competitive.”159 These comments were discussed in an email at Galleon.160
160. On March 6, 2007, JPMorgan emailed to Galleon an analyst report that reduced
estimates due to the ongoing Intel/AMD price war:
...the price war between Intel and AMD continues, with pricing lower than expected.... [E]xpect the price war to last through at least 3Q07.
We are lowering our Intel estimates due to the price war and an inventory correction.... Still like semis [semiconductor industry] but stay away from INTC/AMD... due to our fears of further downside.161
161. On March 22, 2007, Lehman Brothers emailed to Galleon an analyst report that
indicated, “[w]e are concerned by the pricing environment with industry participants describe
pricing as aggressive with Intel committed to regaining share....” As a result, Lehman Brothers
lowered their earnings estimate.162
162. On March 22, 2007, FBR Research emailed to Galleon an analyst report
indicating:
157 See “AMD to Present at Morgan Stanley Technology Conferences and Update First Quarter Guidance,” Business Wire, March 5, 2007 at 9:00am. 158 See Email within Galleon, March 5, 2007 at 9:30am. 159 See “Intel Says Pressure On Chip Prices Continues,” Reuters News, March 5, 2007 at 12:47pm (emphasis added). 160 See Email within Galleon, March 5, 2007 at 12:39pm. 161 See Email from JPMorgan to Galleon containing JPMorgan analyst report, March 6, 2007 at 8:34am (emphasis added). 162 See Email from Lehman Brothers to Galleon containing Lehman Brothers analyst report, March 22, 2007 at 6:30am (emphasis added).
54 Our checks indicate significant price cuts on INTC server processors scheduled for July... [W]e think these cuts likely delay margin improvement until later in 2H...163
163. On April 2, 2007, several analysts expressed concern about pricing pressure:
MPU continues to be impacted by pricing pressures as Intel and AMD battle each other… We expect ongoing challenges for Intel and AMD…164
…[T]hese latest [microprocessor] numbers do not give us much hope that Intel will upside the midpoint of its guidance…165
We would continue to avoid Intel and AMD due to our fears of an inventory correction in PC components.166
164. In an April 3, 2007 email to Galleon, a Merrill Lynch analyst noted:
Q1 looks to have been a tough quarter for both processor vendors [AMD and Intel], with two months of industry data suggesting the worst sequential revenue comps so far this decade. Selling prices appear to be the culprit, as OEMs and distributors work to liquidate inventory taken on during Q4.167
165. On April 9, 2007, Goldman Sachs emailed to Galleon an analyst report that expressed concern Wall Street’s earnings estimates for Intel were “too high”:
While we continue to warm up to Intel at current valuations, we believe Street estimates heading into earnings are too high given the challenging pricing environment.168
163 See Email from FBR Research to Galleon containing FBR Research analyst report, March 22, 2007 at 7:09am (emphasis added). 164 See Email from Lehman Brothers to Galleon containing Lehman Brothers analyst report, April 2, 2007 at 7:21am (emphasis added). 165 See Email from A.G. Edwards to Galleon containing A.G. Edwards analyst report, April 2, 2007 at 7:36am (emphasis added). 166 See Email from JPMorgan to Galleon, April 2, 2007 at 8:45am (emphasis added). 167 See Email from Merrill Lynch to Galleon, April 3, 2007 at 3:11 am (emphasis added). 168 See Email from Goldman Sachs to Galleon containing Goldman Sachs analyst report, April 9, 2007 at 7:24am (emphasis added).
55 166. On April 9, 2007 (hours before Mr. Rajaratnam shorted Intel shares), AMD
announced it expected to report first quarter revenue of $1.23 billion, 21% below analyst estimates of $1.55 billion.169 The AMD press release was emailed to Galleon.170
167. In response to AMD’s cut in guidance, analysts reduced their estimates for Intel:
...INTC and AMD will continue a price war, which will negatively impact profitability and margins for both.
...[Prudential Equity] are lowering our MarQ revenues from $9.0B [to] $8.8B...171
[FBR Research] are trimming our 2Q estimates...172
What we’ve [FTN Midwest Securities] been hearing is that the battle between Intel and AMD has been particularly severe at the high end. We expect to see evidence of a decline in prices across the board, and that’s likely to hurt both AMD and Intel.173
168. On April 12, 2007 (after Mr. Rajaratnam completed his short sales, but before
covering), UBS emailed an analyst report to Galleon that raised its estimates of Intel’s gross
margins for the second-half of 2007 and fiscal 2008:
...following AMD’s capitulation [when it cut guidance], we expect a more benign ASP [average selling price] trend in 2H07; coupled with benefits of restructuring, new product launches and 45nm ramp, we raise our 2H07 gross margin...
169 See “AMD Updates First Quarter Outlook,” Business Wire, April 9, 2007 at 9:00am; “Advanced Micro Devices Sees 1Q Rev Below Street View,” Dow Jones News Service, April 9, 2007 at 9:58am. 170 See Email from AMD to Galleon, April 9, 2007 at 9:08am. 171 See Email from Prudential Equity to Galleon, April 9, 2007 at 1:03pm (emphasis added). 172 See Email from FBR Research to Galleon containing FBR Research analyst report, April 9, 2007 at 1:05pm. 173 See “AMD Sees Revenue Shortfall, Cuts Spending Plans,” Reuters News, April 9, 2007 at 9:16am (emphasis added).
56 ...we raise gross margin from 52.8% to 53.2% on flat ’08 ASPs...174
169. On April 13, 2007, Investor’s Business Daily reported that Intel was within weeks
of launching a major upgrade to its Centrino chip platform:
Advanced Micro Devices has gained momentum in the key market for chips used to run portable PCs, but archrival Intel says it has a stopper – the first major upgrade to its successful Centrino chip platform. Intel has said it plans to roll out the line, code-named Santa Rosa, this quarter.... With Santa Rosa, Intel likely will start to take back share in the notebook chip sector in the second half of the year... Santa Rosa could extend the Centrino brand for years...175
170. This Investor’s Business Daily story was distributed within Galleon via email.176
A Galleon analyst noted that “this is at heart of bull thesis in 2h – new product cycle.”177
171. On April 13, 2007, JPMorgan emailed an analyst report to Galleon (which was
forwarded to Mr. Rajaratnam) that lowered expectations (similar to the Goldman Sachs report
from April 9) for Intel’s upcoming earnings announcement:
Trimming Estimates On Pricing and Channel Inventory Risk.... We believe the company should report results at the low end of company guidance of revenues of $8.7-$9.3 billion (down 4%-10% QoQ) and gross margins of 47%-51%.
Pricing and mix worse than expected.... Although Intel gained significant market share during 1Q07, excess inventory and aggressive pricing continue to hamper the company’s margins and revenue.
174 See Email from UBS to Galleon containing UBS analyst report, April 12, 2007 at 6:47am (emphasis added). 175 See “Intel Within Weeks of Major Upgrade To Its Centrino Line; AMD Countermove Also Near; Battle Escalates in Market for Chips that Power Laptop and Notebook Computers,” Investor’s Business Daily, April 13, 2007. 176 See Email within Galleon, April 13, 2007 at 6:44am. 177 See Email within Galleon, April 13, 2007 at 6:53am (emphasis added).
57 Pricing and inventory add risk to 2Q07 outlook. We believe Intel should guide for revenue to decrease 1%-6% QoQ in 2Q07.... We also expect the company to guide 2Q07 gross margins to decline 1% QoQ, in line with our 47% estimate.178
172. The JPMorgan analyst report was also reported on in the financial press.179
173. On April 16, 2007 (before Mr. Rajaratnam covered his short sale and before
purchasing Intel shares), Goldman Sachs emailed an analyst report to Galleon. Unlike the April
9, 2007 Goldman Sachs report that expressed concern Wall Street’s earnings estimates for Intel were “too high,” this analyst report advised investors to “Look to be more aggressive on INTC
post Street estimate cuts.”180
174. On April 16, 2007, AP Newswires reported that American Technology Research
thinks “...Intel’s recent share gains and new product releases should strengthen the company’s
price power and gross margin in the later half of the year.”181
175. Also on April 16, 2007, The New York Times reported that Intel would reveal
details for a new class of wireless handheld devices:
Intel is planning to announce a number of technology advances this week at a conference in Beijing, including an initiative that could give rise to a new class of wireless hand-held computers, according to several people close to the efforts.182
178 See Email from JPMorgan to Galleon containing JPMorgan analyst report, April 13, 2007 at 8:21am; Email to Mr. Rajaratnam, April 13, 2007 at 12:20pm. 179 See “Intel May Report Revenue at Low end of Forecast, Says, JPMorgan,” Bloomberg News, April 13, 2007 at 1:37pm; “Semiconductor Stocks Edge Lower Ahead of Intel Earnings Report Scheduled for Tuesday,” AP Newswires, April 13, 2007 at 2:17pm. 180 See Email from Goldman Sachs to Galleon containing Goldman Sachs analyst report, April 16, 2007 at 7:21am (emphasis added). 181 See “Intel Earnings Seen Getting Pinched by Price Cuts,” AP Newswires, April 16, 2007 at 7:07pm (emphasis added). 182 See Email from Variant Group to Galleon containing news story, April 16, 2007 at 6:18am.
58 176. On April 17, 2007 (before Mr. Rajaratnam purchased shares of Intel later in the
day), Bloomberg News reported that “Intel May Say It Won Back Chip Orders, Ending Decline
in Sales.”183
Rajaratnam’s Trades
177. Between January 17, 2007 (the day after Intel’s previous earnings announcement)
and April 8, 2007 (one day prior to Mr. Rajaratnam alleged receipt of inside information), Mr.
Rajaratnam bought and sold 6.5 million shares of Intel with a total transaction value of $136.4
million.184
178. After the alleged receipt of inside information, Mr. Rajaratnam (i) sold short and
covered an additional 1.2 million shares of Intel between April 9, 2007 and April 16, 2007 (one
day before Intel announced earnings) and (ii) purchased 1.5 million shares of Intel on April 16
and 17, 2007. These transactions were made over five separate trading days and consisted of
seven transactions that ranged from 150,000 shares to 1.0 million shares each. The total
investment value of these transactions was $77.6 million.185
Earnings Announcement
179. On April 17, 2007, after the market closed, Intel reported that first quarter 2007 net revenue was $8.85 billion, meeting Wall Street consensus estimates of $8.9 billion. Intel’s earnings of $0.22 per share were in line with analysts’ estimates of $0.22. Intel also provided second quarter revenue guidance of between $8.2 billion and $8.8 billion, below the consensus
183 See “Intel May Say It Won Back Chip Orders, Ending Decline in Sales,” Bloomberg News, April 17, 2007 at 12:01am. 184 Source: Galleon OMS Database. 185 Source: Galleon OMS Database; United States of America v. Raj Rajaratnam per GX 4.
59 estimate on Wall Street of $8.86 billion. The company indicated that its gross margin for fiscal
2007 was expected to be about 51%.186
180. On April 18, 2007, Intel’s common stock price increased 1.8% to close at $21.35 per share. The excess return is not statistically significant at the 95% confidence level (see
Exhibit 6).
181. After Intel announced earnings and completed its conference call, an analyst at
Stifel Nicolaus commented:
Intel reported numbers that were somewhat mixed, and guidance that was generally below consensus. However, we believe the market was widely anticipating a somewhat lighter first half revenue and gross margin performance.
Intel delivered first quarter revenue of $8.852 billion,... below our estimate of $9.06 billion. EPS of $0.27 matched the Street consensus after adjusting for a one-time $0.05 tax benefit.
INTC’s gross margin of 50.1% was well ahead of our forecast for 49.2%... 2Q gross margin is expected to decline along with revenue to 48% +/- a couple points generally in line with what we believe most investors were preparing for. The company did increase its FY07 gross margin view by 100 basis points, to 51% +/- a few points from 50% +/- a few points.
With a somewhat lower than anticipated revenue and gross margin projected for 2Q, we are reducing our FY07 revenue estimate...187
186 See “Intel First-Quarter Revenue $8.9 Billion,” Business Wire, April 17, 2007 at 4:15pm; “Intel Earnings Jump Sharply In the Quarter, But Sales Slip,” The New York Times, April 18, 2007. 187 See “INTC: A Back Half Gross Margin Ramp May Yet Impress,” Bloomberg News, April 18, 2007 at 1:48am (emphasis added).
60 Conclusion
182. In summary, my review of the mix of information in the market shows that the earnings outlook for Intel was initially adversely impacted by AMD’s earnings warning, but then improved prior to Intel’s announcement. This publicly-available infoformation includes:
i) In March 2007, AMD warned that first quarter revenue waas unlikely to meet its prior guidance;
ii) After the AMD warning, Intel indiicated that pricing continued to be “very competitive;” Wall Street analysts lowered Intel’s estimates due to concern about the Intel/AMD price war; and JPMorgan advised investors to “stay away” from Intel’s sharess;
iii) In early April 2007, Goldman Sachs told investors it thought Wall Street’s estimates for Intel were “too high;”
iv) Before Mr. Rajaratnam began shorrting Intel shares, AMD pre-announced first quarter revenues that were 21% below expectations despite AMD’s explicit warning in March;
v) In mid April 2007, UBS raised Intel’s gross margin estimate for the second-half of 2007 and Mr. Rajaratnam began covering his short sales;
vi) Unlike Goldman Sachs’ prior advice, it advised investors to be “more aggressive” with Intel’s shares; Mr. Rajaratnaam covered his remaining short position in Intel; and
vii) Before Mr. Rajaratnam began purchasing Intel’s shares, the financial press reported that Intel’s pricing power and gross margins should “strengthen” in the second half of 2007.
183. Based on the substantial level of discussion by Wall Street analysts and the financial press about Intel’s upcoming first quarter results, in my opinion, all of tthis commentary and analysis was publicly-available before Intel announced its quarterly financial results on April
17, 2007.
184. Based on the market reaction to Intel’s earnings releaase (+2%), I cconclude that
Intel’s market price prior to the disclosure and prior to Mr. Rajaratnam’s transactions already accurately incorporated the expectations by Wall Street analysts, as well as any information
61 contained in the alleged tips. I reach this conclusion after observing that Intel’s stock price movement on April 18, 2007 was not economically material.
185. Based on this evidence, I conclude that a well-informed, professional investor
(such as a hedge fund manager) that engages in legal information gathering and related arbitrage trading in the shares of Intel would have been aware of the mix of information in the market that
I have discussed above. Further, a hedge fund manager employed at Galleon would additionally be aware of Galleon’s internal research on Intel.
186. Based upon the mix of information available in the marketplace and within
Galleon prior to Intel’s earnings announcement on April 17, 2007, in my opinion, it would be reasonable for such an investor to transact in Intel’s common stock, just as Mr. Rajaratnam had done. In my opinion, this publicly-available information provided ample justification to take an arbitrage position in Intel immediately ahead of its earnings release.
187. Moreover, based on my understanding of the information the SEC is alleging was conveyed in the tip, it is my opinion that the information allegedly tipped to Mr. Rajaratnam was not private information, but rather was substantially similar to information that was already included in the mix of publicly available information. Furthermore, it is my opinion that the announcement was not economically material.
188. The Complaint alleges that Mr. Rajaratnam “...established a sizable short position in Intel after Rajaratnam learned of Intel’s lower revenue numbers from Goel on or around April
9....”188 The Complaint then notes that “...Intel’s revenues were down 9% compared with Q4
2006, which ties closely with what Rajaratnam had told Khan, as reflected in Khan’s April 9,
188 See Complaint, ¶103.
62 2007”189 email stating “Also spoke to Raj[aratnam] . . This is what I got . . . [Intel] dn
10% . . .”190
189. But, as discussed above, Intel had already told the market that it expected revenue
to decline by as much as 10.3% in the first quarter,191 well before the SEC alleges that Mr.
Rajaratnam received the same information as an “inside tip” from Mr. Goel. Moreover,
Goldman Sachs advised Galleon on April 9th that it also expected Intel’s first quarter revenues to
be down 10.3%,192 which information was available to Mr. Rajaratnam prior to his alleged
receipt of an “inside tip” containing exactly the same information. Finally, when Intel reported
its first quarter’s results, its revenues met Wall Street’s expectations, because these expectations
reflected the widely publicized information that Intel’s revenues would be down approximately
10% in the first quarter.193
190. Therefore, in light of these facts, it is clear that the alleged inside information that
Intel’s revenues were expected to decline 10% was not the kind of private, non-public
information that is necessary to support an allegation of insider trading. In addition, the SEC’s
contention that Mr. Rajaratnam shorted Intel because he “knew” based on inside information that
revenue would be 10% lower appears to ignore the fact that this information was publicly
189 See Complaint, ¶102. 190 See Complaint, ¶99. 191 See “Intel Fourth-Quarter Revenue $9.7 Billion,” Business Wire, January 16, 2007 at 4:10pm. 10.3% equals guidance of $8.7 billion divided by actual fourth quarter revenue of $9.694 billion, then minus one. 192 See Email from Goldman Sachs to Galleon containing Goldman Sachs analyst report, April 9, 2007 at 7:24am (emphasis added). 10.3% equals estimate of $8.7 billion divided by actual fourth quarter revenue of $9.694 billion, then minus one. 193 See “Intel Earnings Jump Sharply In the Quarter, But Sales Slip,” The New York Times, April 18, 2007.
63 available and already reflected in Wall Street’s consensus estimates and fully incorporated in
Intel’s stock price by the time Mr. Rajaratnam traded.
ix. Intel – Q3’07 Earnings
191. The SEC alleges that:
On October 8, 2007, a week or so before Intel’s scheduled Q3 2007 earnings announcement, Goel contacted Rajaratnam [and provided material nonpublic information concerning Intel’s earnings and financial guidance].194
On October 15, 2007, the day before Intel’s earnings announcement, Goel and Rajaratnam communicated again.195
192. Below, I examine the mix of information available in the marketplace and within
Galleon about Intel’s third quarter earnings prior to Intel’s earnings announcement on October
16, 2007.
Mix of Information
193. On July 18, 2007 (three months before the SEC contends Mr. Rajaratnam
received inside information), in response to Intel’s second quarter earnings report and guidance,
Goldman Sachs advised its clients to start building a position in Intel:
Buy the stock on secular benefits from AMD outsourcing.
...we expect incremental upside over the next 12-18 months and would use any such pull back to build positions. Our Buy rating continues to be driven by: (1) continued share gains as the year progresses, particularly given the disappointing launch of [AMD’s] Barcelona, (2) margin expansion in CY2H07..., (3) better full cycle profitability over the longer term, if AMD moves to a more outsourced business model...
CY3Q2007 REVENUE GUIDANCE IS IN-LINE, BUT GROSS MARGIN IS HIGHER.
194 See Complaint, ¶104. 195 See Complaint, ¶105.
64 CY3Q2007 gross margins were guided to 52%..., plus or minus a couple of points, above our original 50.5% estimate...
We are raising our CY2007 estimate to $1.08 from $1.00 to reflect higher gross margin assumptions in CY2H2007 and a lower tax rate.196
194. On September 10, 2007, Intel updated its guidance for third quarter revenue and
gross margin:
As a result of stronger than expected worldwide demand for its computing products, Intel Corporation now expects revenue for the third quarter to be between $9.4 billion and $9.8 billion as compared to the previous range of $9.0 billion to $9.6 billion.
The gross margin percentage for the third quarter is expected to be in the upper half of the previous range of 52 percent plus or minus a couple of points.197
195. On October 1, 2007, the Semiconductor Industry Association (“SIA”) reported
worldwide chip sales increased 6.2% in August. AP Newswires reported that “Intel [was] up on
semiconductor sales report.”198 Responding to the SIA report, Wall Street analysts noted:
We [UBS] continue to see a further re-acceleration ahead into 2H07.... Top picks: INTC...199
August 2007 SIA Data Above Seasonal.... August revenue marks the third consecutive month of above seasonal results.... 3Q Tracking Above Normal Seasonal.... We think this trend of better than seasonal revenue growth is likely to continue into 4Q as well... [W]e highlight INTC... as our top picks.200
196 See Email from Goldman Sachs to Galleon containing Goldman Sachs analyst report, July 18, 2007 at 7:34am. 197 See “Intel Updates Third-Quarter Revenue and Gross Margin Expectations,” Business Wire, September 10, 2007 at 9:00am (emphasis added). 198 See “Intel Up on Semiconductor Sales Report, Pfizer Rises as Dow Sets Intraday High,” AP Newswires, October 1, 2007 at 12:12pm. 199 See Email from UBS to Galleon containing UBS analyst report, October 1, 2007 at 12:26am. 200 See Email from Credit Suisse to Galleon containing Credit Suisse analyst report,
65 196. On October 1, 2007, DigiTimes reported that Intel was “seeing increased demand
in emerging markets” for one of its entry-level motherboards.201 Galleon was alerted to this
story via email.202
197. On October 2, 2007, JPMorgan emailed an analyst report to Galleon titled:
“Demand and Pricing Stronger Than Expected, Raising Estimates”:
Our checks indicate that Intel is continuing to benefit from a robust PC market.... We believe unit demand and the pricing environment are stronger than expected in 3Q07. As a result, we are raising our C07 estimates on Intel.... [W]e are raising our gross margin estimate to 54% for 3Q07...
...we are raising our C07 revenue and EPS estimates [and]... also raising our C08 revenue and EPS estimates...203
198. On October 3, 2007, Morgan Stanley emailed an analyst report to Galleon that told investors to sell Intel “ahead of what we expect will be an inventory correction and
increasingly aggressive price environment.”204
199. Bloomberg News reported that “Intel... fell as much as 3 percent in Nasdaq trading
after a Morgan Stanley analyst said price cuts may drag down profit.”205
200. After Morgan Stanley advised selling Intel, shares of Intel declined for three
consecutive trading days.
October 1, 2007 at 8:14am. 201 See “Intel to Expand the Cooperating with SiS, Says Paper - Dig,” Bloomberg News, October 1, 2007 at 9:48am (emphasis added). 202 See Email to Galleon, October 1, 2007 at 9:48am. 203 See Email from JPMorgan to Galleon containing JPMorgan analyst report, October 2, 2007 at 8:21am (emphasis added). 204 See Email from Morgan Stanley to Galleon containing Morgan Stanley analyst report, October 3, 2007 at 2:56am. 205 See “Intel Shares Fall After Analyst Says Chip-Price War Looming,” Bloomberg News, October 3, 2007 at 10:18am.
66 201. On October 8, 2007 (two days before Mr. Rajaratnam purchased shares of Intel),
Goldman Sachs emailed an analyst report to Galleon that discussed the buying opportunity presented by the recent decline in Intel’s shares:
We continue to recommend that investors buy the stock/add to positions, particularly given the pull back/underperformance in the stock over the last several days.
...we expect 4Q07 to exceed suddenly depressed expectations and would expect upside in the shares post the earnings report.206
202. On October 9, 2007, AP Newswire noted positive comments from analysts at
Citigroup and Lehman Brothers:
[Citigroup] listed Intel... as likely to post better-than-expected results...
[Lehman Brothers]... expects Intel to report revenue ahead of Wall Street’s expectations, which, coupled with improved gross margins, could lead to better-than-expected earnings per share.207
203. On October 10, 2007 (before Mr. Rajaratnam purchased shares of Intel later that day), Jefferies & Co. emailed to Galleon an analyst report discussing better than expected results from their recent channel checks:
We believe that current PC demand remains seasonally strong, with an uptick projected for 2H 2007 starting with Back to School sales. Our recent Taiwan Motherboard Channel checks indicate Intel (INTC) and Intersil (ISIL) remain in the best position to benefit by the strong PC market in 2H 2007 and 2008.208
206 See Email from Goldman Sachs to Galleon containing Goldman Sachs analyst report, October 8, 2007 at 7:04am (emphasis added). 207 See “Analysts Expect Solid 3rd-Quarter Results for Chip Makers but Forecasts May Prove Lackluster,” AP Newswires, October 9, 2007 at 12:15pm. 208 See Email from Jefferies & Co. to Galleon containing Jefferies & Co. analyst report, October 10, 2007 at 9:22am (emphasis added).
67 204. On October 12, 2007, Dow Jones News Service reported “Healthy PC Market
Seen Boosting Intel”:
...Intel Corp. (INTC), is expected to benefit from a healthy personal-computer market and the back-to-school shopping period. After losing market share to rival Advanced Micro Devices Inc. (AMD) in past years, Intel has fought back with technology advances, streamlined manufacturing and aggressive pricing.209
205. On October 14, 2007 (two days before Mr. Rajaratnam purchased shares of Intel),
Bank of America emailed an analyst report to Galleon that “Expect[ed] Some Upside” in Intel’s upcoming earnings announcement:
Given the potential upside to sales and GMs [gross margins] our GAAP EPS of $0.31 (in line with consensus) may prove modestly conservative.
...we expect upside to consensus GMs (55% GAAP), with the forecast likely coming in closer to our est. of 56.1%...
We believe business momentum has improved across the sector.... [K]ey cyclical indicators (channel inventory, utilization trends) are favorable.210
206. On October 15, 2007, Citigroup emailed an analyst report to Galleon that previewed the third quarter results:
Strong MPU sales through August suggest Intel will likely beat even the mid-point of its raised guidance.... We expect strong gross margin performance from Intel given these strong revenue results...
Intel remains our top idea. We see a combination of several positive factors: 1) a strong product cycle creating potential for share gain sustainability (not currently forecasted by the Street); 2) a strong gross margin cycle as evidenced by peaking die sizes and
209 See “US EQUITIES WEEK AHEAD: Tough 3Q for Big Banks,” Dow Jones News Service, October 12, 2007 at 1:21pm (emphasis added). 210 See Email from Bank of America to Galleon containing Bank of America analyst report, October 14, 2007 at 10:59pm (emphasis added).
68 stable pricing (price increases not expected by the Street); 3) continued share buyback...211
207. On October 16, 2007, (before Intel announced results and before Mr. Rajaratnam
purchased shares of Intel), analysts at Stifel Nicolaus commented:
We’re increasing our 3Q07 earnings estimate from $0.30 to $0.31.... The current consensus projections call for earnings of $0.30... We expect Intel’s 4Q guidance should also provide upside to the current consensus...
...we believe the company will post third quarter results at the high end of its guidance range and above the current consensus projections for revenue of $9.6 billion.
We believe there is likely to be earnings upside driven by a higher gross margin, which should come in above consensus that appears to be just north of 52%.212
208. In addition to the analysis and commentary from sell-side Wall Street analysts,
Galleon’s internal analysts also performed their own proprietary in-house research on Intel that advised Galleon portfolio managers to “be long into print” of Intel’s earnings announcement.
The earnings preview also stated:
Expecting upside to pos pre & guide slightly above street on absolute basis with better GM... GM has upside, INTC has the lead in both product line-up & manufacturing over AMD...213
Rajaratnam’s Trades
209. Between May 15, 2007 (no allegations of insider trading) and October 7, 2007
(one day prior to Mr. Rajaratnam alleged receipt of inside information), Mr. Rajaratnam bought,
sold, shorted and covered 12.0 million shares of Intel with a total transaction value of $299.7
211 See Email from Citigroup to Galleon containing Citigroup analyst report, October 15, 2007 at 12:52pm (emphasis added). 212 See “Semi: Week One Semi Earnings Preview - INTC, ISIL, PMCS, AMD,” Bloomberg News, October 16, 2007 at 8:02am (emphasis added). 213 See Galleon Internal Proprietary Research (emphasis added).
69 million. As recently as October 5, 2007 (three days before Mr. Rajaratnam was allegedly
tipped), Mr. Rajaratnam purchased 500,000 shares of Intel for $12.9 million. Additionally, Mr.
Rajaratnam was already holding 3.1 million Intel shares immediately before receiving the
alleged tip.214
210. After the alleged receipt of inside information, Mr. Rajaratnam purchased
950,000 shares of Intel between October 10 and 16, 2007. These purchases consisted of three
transactions that ranged from 250,000 shares to 450,000 shares each. The total cost of this
investment was $24.5 million.215
Earnings Announcement
211. On October 16, 2007, after the market closed, Intel reported that third quarter
2007 net revenue was $10.1 billion, beating Wall Street consensus estimates of $9.6 billion.
Intel’s earnings of $0.31 per share were above analysts’ estimates of $0.30. Intel also provided fourth quarter revenue guidance of between $10.5 billion and $11.1 billion, above the consensus estimate on Wall Street of $10.4 billion. The company indicated that its gross margin for the fourth quarter was expected to be about 57%.216
212. On October 17, 2007, Intel’s common stock price increased 4.9% to close at
$26.72 per share. The excess return is statistically significant at the 99% confidence level (see
Exhibit 6).
214 Source: Galleon OMS Database. 215 Source: Galleon OMS Database. See Complaint, ¶¶104-105. 216 See “Intel Posts Record Third-Quarter Revenue,” Business Wire, October 16, 2007 at 4:14pm; “Intel Quarterly Profit Rises 43 Percent,” Reuters News, October 16, 2007 at 4:53pm.
70 Conclusion
213. In summary, my review of the mix of information in the market shows that the earnings outlook for Intel was improving and that a sell recommendation from Morgan Stanley created a buying opportunity prior to Intel’s earnings announcement. This publicly-available information includes:
i) After reporting second quarter results in July 2007, Intel increased its gross margin guidance;
ii) In September 2007, Intel increased its revenue and gross margin guidance due to “stronger than expected worldwide demand;”
iii) On October 1, 2007, worldwide chip sales were reported to have increased by 6.2% in August; and Intel was “seeing increased demand;”
iv) On October 2, 2007, JPMorgan inndicated “demand and pricing stronger than expected;” “checks indicate that Intel is continuing to benefit;” “raising our gross margin estimate;”
v) On October 3, 2007, Morgan Stanley told investors to “sell” Intel; shares of Intel declined for three consecutive days after the Morgan Stanley report;
vi) On October 8, 2007, Goldman Sachs recommended buying Intel “particularly given the pull back... over the last several days;” “expect 4Q07 to exceed suddenly depressed expectations;” “expect upside in the shares post the earnings report;” and
vii) Other analysts followed with expectations of “an uptick projected for 2H 2007;” “expected some upside;” “ppotential upside to sales and GMs;” “Intel will likely beat... its raised guidance;” “expect strong gross margin.”
214. Additionally, a Galleon analyst recommended to Galleon’s portfolio managers that they “be long into print” of Intel’s earnings announcement.
215. Based on the substantial level of discussion by Wall Street analysts and the financial press about Intel’s upcoming third quarter results, in my opinion, all of this commentary and analysis was publicly-available before Intel announced its quarterly financial results on October 16, 2007.
71 216. Based on the market reaction to Intel’s earnings release (+5%), I conclude that
Intel’s market price prior to the disclosure placed too much emphasis on Intel’s price war with
AMD and did not accurately reflect the optimism expressed by some analysts, such as Goldman
Sachs and internal Galleon analysts.
217. Based on this evidence, I conclude that a well-informed, professional investor
(such as a hedge fund manager) that engages in legal information gathering and related arbitrage trading in the shares of Intel would have been aware of the mix of information in the market that
I have discussed above. Further, a hedge fund manager employed at Galleon would additionally be aware of Galleon’s internal research on Intel.
218. Based upon the mix of information available in the marketplace and within
Galleon prior to Intel’s earnings announcement on October 16, 2007, in my opinion, it would be reasonable for such an investor to transact in Intel’s common stock, just as Mr. Rajaratnam had done. In my opinion, this publicly-available information provided ample justification to take an arbitrage position in Intel immediately ahead of its earnings release.
219. Moreover, based on my understanding of the information the SEC is alleging was conveyed in the tip, it is my opinion that the information allegedly tipped to Mr. Rajaratnam was not private information, but rather was substantially similar to information that was already included in the mix of publicly available information.
x. Polycom – Q4’05 Earnings
220. The SEC alleges that:
On or about January 10, 2006, Khan told Rajaratnam that Polycom’s revenues for Q4 2005 would beat street estimates.217
217 See Complaint, ¶49.
72 221. Below, I examine the mix of information available in the marketplace and within
Galleon about Polycom’s fourth quarter earnings prior to Polycom’s earnings announcement on
January 25, 2006.
Mix of Information
222. On October 19, 2005 (three months before the SEC contends Mr. Rajaratnam
received inside information), during the Polycom earnings conference call with analysts,
Polycom provided the following revenue guidance for the upcoming fourth quarter:
The Co. believes nearly $15m growth in backlog and deferred revenues bodes well for 4Q05 revenues.... Looking forward into 4Q05, sharp bookings increase in 3Q05 is expected to provide early fuel to what is typically a seasonally strong qtr... Based on the overall visibility, the Co.’s strength in bookings and the growth benefits of the sales and marketing investments made YTD, PLCM expects 4Q05 revenues to be up 3-5% from 3Q05 levels.218
223. In response to Polycom’s earnings report and guidance, Wall Street analysts
reacted favorably:
Polycom-PLCM recent weakness a buying opportunity following lackluster Q3... Firm [Cowen] believes long-term growth drivers are intact and business momentum is improving. Also, the broker believes Street estimates and expectations are low.219
Polycom Inc. (PLCM US) was raised to “buy” from “hold” by analyst Ivan Feinseth at Matrix USA.220
Polycom Inc. (PLCM US) was rated new “buy” in new coverage by analyst Sanjiv R Wadhwani at Miller Johnson Steichen Kinnard, Inc.221
218 See “Event Brief of Q3 2005 Polycom Incorporated Earnings Conference Call - Final,” Voxant FD (Fair Disclosure) Wire, October 19, 2005 (emphasis added). 219 See “Polycom-PLCM Recent Weakness A Buying Opportunity Following Lackluster Q3,” Bloomberg News, October 25, 2005 at 6:04am (emphasis added). 220 See “Polycom Raised to ‘Buy’ at Matrix,” Bloomberg News, October 24, 2005 at 9:25am.
73 224. In mid-November 2005, one of Polycom’s competitors provided an earnings guidance update:
Shares of Tandberg ASA, the world’s second-largest maker of videoconferencing equipment, fell to their lowest level since January 2004 after the company said sales will slow this quarter. The stock fell... 10.6 percent.... Tandberg expects “below traditional seasonality continuing from the third quarter into the fourth quarter,”... Tandberg faces greater competition from companies including... Polycom Inc.222
225. In an email to Galleon, an analyst at Wedbush Morgan Securities commented on
Tandberg’s earnings warning and contrasted it with her “bullish” outlook for Polycom:
Tandberg’s results do not change our outlook on Polycom. ...we believe [Tandberg’s] qualitative comments prior to its mid-quarter update were more bullish than Polycom’s. Thus, Tandberg’s modest taming of Q4 expectations appears to bring Tandberg more in line with Polycom’s Q4 outlook
...the company has continued to build up backlog and deferred revenue... with a $9.5 million increase in backlog and $5.5 million increase in deferred revenue last quarter, we believe Polycom has ample breathing room to make our estimates.
Maintain BUY rating and $20 price target. Despite Tandberg’s slightly subdued outlook, we believe Polycom is on track to meet or beat expectations.223
226. In early December 2005 (one month before the SEC contends Mr. Rajaratnam received inside information), analysts at Thomas Weisel and Kaufman Bros. also emailed analyst reports to Galleon regarding expectations for the upcoming fourth quarter results:
221 See “Rating Changes, New Coverage on North American Stocks,” Bloomberg News, October 19, 2005 at 5:04pm. 222 See “Tandberg Shares Slump After Forecasts of Slower Sales,” Bloomberg News, November 18, 2005 at 12:30pm. 223 See Email from Wedbush Morgan Securities to Galleon containing Wedbush Morgan Securities analyst report, November 17, 2005 at 1:06pm (emphasis added).
74 4Q Looks to be Tracking Ahead of Plan. Checks for 4Q so far positive: Our preliminary industry checks suggest that the first two months of the December quarter were above plan for Polycom.224
Views Weakness as a Buying Opportunity... Price Target $20... We spoke to management and they maintained their optimistic outlook... We maintain our positive outlook on Polycom...225
227. On December 6, 2005, an analyst at Morgan Stanley downgraded his rating on
Polycom from “overweight” to “equal-weight.” Polycom’s shares declined 4.7% on this news.
Despite the analyst’s rating cut, he noted:
the company has given a “relatively uninspiring outlook for future results,” and because consensus estimates for revenue and earnings per share are down by 6 percent and 17 percent, respectively, this year, Polycom may be in a position to beat expectations.226
228. The Morgan Stanley analyst also estimated that “...Polycom’s revenue will
increase 7 percent in 2005,” which implies a 6.3% growth rate from the third quarter to the
fourth quarter.227 This was considerably above management’s guidance of 3-5%.
229. The Morgan Stanley analyst report was also reported on several times in the
financial press.228
224 See Email from Thomas Weisel to Galleon containing Thomas Weisel analyst report, December 1, 2005 at 11:00pm. 225 See Email from Kaufman Bros. to Galleon containing Kaufman Bros. analyst report, December 6, 2005 at 1:54pm (emphasis added). 226 See “Polycom Shares Fall on Analyst Downgrade,” AP Newswires, December 6, 2005 at 1:31pm (emphasis added). 227 See “Polycom Shares Fall on Analyst Downgrade,” AP Newswires, December 6, 2005 at 1:31pm. Based on fiscal 2004 revenues of $540.3 million and Morgan Stanley’s estimated 7% growth rate, fiscal 2005 revenues are estimated to be $578.1 million. Given that revenues for the first nine months of fiscal 2005 were $424.6 million, then fourth quarter revenues are estimated to be $153.5 million ($578.1 million - $424.6 million). This indicates fourth quarter revenues would be 6.3% higher than third quarter revenues of $144.4 million ($153.5 million / $144.4 million - 1). Source for historical revenues: FactSet. 228 See “Polycom Inc - Factory Orders +2.2% (Forecast +2.0%); Pending Home Sales Fall 3.2%,” Knobias, December 6, 2005 at 2:51am; Polycom-PLCM Downgraded to Equal
75 230. In a December 15, 2005 email to Galleon, an analyst at Cowen commented on
Polycom’s building momentum in the fourth quarter:
Our proprietary checks indicate that Polycom’s business momentum through 2+ months of Q4 remains strong... We believe that valuation multiples, which are now near historic lows, are unjustified in light of the company’s improving results and record backlog coming into the quarter. We expect ongoing solid execution to result in improved investor sentiment, which will drive PLCM shares to outperform the market...229
231. On December 16, 2005, Polycom’s stock fell 4.9% after competitor Tandberg
ASA again warned investors that its revenues would be “weak” in the fourth quarter. Tandberg
also announced that the company’s CFO was replacing the CEO “effective immediately.”
Tandberg’s shares plunged 36%.230
232. On December 19, 2005, an analyst at Kaufman Bros. commented on how
Tandberg’s problems were company-specific and not reflective of the videoconferencing market:
Kaufman Bros views the recent decline in PLCM as a buying opportunity as the co appears to be on track to meet Q4 expectations and the recent turmoil with its largest competitor are company-specific and not an indication of weakness in the overall market.231
Weight from Overweight@MSCO,” Bloomberg News, December 6, 2005 at 7:23am; “Research Alert - Morgan Stanley Lowers Polycom to ‘equal-weight,’” Reuters News, December 6, 2005 at 9:18am; “Polycom Cut to ‘Equal-weight’ at Morgan Stanley,” Bloomberg News, December 6, 2005 at 9:34am; “Polycom Shares Fall on Analyst Downgrade,” AP Newswires, December 6, 2005 at 1:31pm; “Ratings Changes, New Coverage on North American Stocks,” Bloomberg News, December 6, 2005 at 5:04pm. 229 See Email from Cowen to Galleon containing Cowen analyst report, December 15, 2005 at 3:43am (emphasis added). 230 See “Tandberg Drops as It Cites ‘Weak Sales Development,” Bloomberg News, December 16, 2005 at 10:58am. 231 See “Polycom Recent Pullback is a Buying Opportunity,” Bloomberg News, December 19, 2005 at 7:55am.
76 233. In a December 21, 2005 email to Galleon, an analyst at Thomas Weisel upgraded his rating to “outperform” from “peer perform.” The upgrade was based on the thesis that:
...the near-term competitive dynamics in video have shifted in Polycom’s favor in light of Tandberg’s recent troubles and the modest progress of upstarts Codian and Lifesize...232
234. The Thomas Weisel analyst report was also reported on several times in the financial press.233
235. In a December 27, 2005 email to Galleon (two weeks before the SEC contends
Mr. Rajaratnam received inside information), an analyst at Wedbush Morgan Securities upgraded his rating to “outperform” from “peer perform.” The upgrade was based on:
Despite Tandberg’s warning, our channel checks indicate some modest growth in Q4. We believe Tandberg’s issues were partially company specific, as we estimate the market grew modestly in the 3%-5% range in Q4. While this is somewhat less than typical Q4 seasonality, it is slightly above our expectations for Polycom’s organic growth of 2%-3% with an additional 1% contribution from the DSTMedia acquisition. The solid increases in backlog and deferred revenue in Q3 provide us additional confidence in Polycom’s ability to meet or even exceed expectations.234
236. The Wedbush Morgan Securities analyst report was also reported on in the financial press.235
232 See Email from Thomas Weisel to Galleon containing Thomas Weisel analyst report, December 21, 2005 at 6:17pm. 233 See “Early Research Calls,” Bloomberg News, December 22, 2005 at 6:34am; “Briefing.com: In Play Daily,” Bloomberg News, December 22, 2005 at 6:08pm; “Briefing.com: Upgrades/Downgrades,” Bloomberg News, December 22, 2005 at 6:09pm; “Briefing.com: In Play Daily,” Bloomberg News, December 23, 2005 at 12:36pm; “Briefing.com: Upgrades/Downgrades,” Bloomberg News, December 23, 2005 at 12:42pm. 234 See Email from Wedbush Morgan Securities to Galleon containing Wedbush Morgan Securities analyst report, December 27, 2005 at 4:58pm (emphasis added). 235 See “PLCM: Polycom: Positive Checks, Solid Backlog Levels, and Recent Mgmt Meeting Give Confidence that PLCM Will Meet Expectations,” Bloomberg News, December 28, 2005 at 10:08am; “PLCM: Polycom: Positive Checks, Solid Backlog Levels, and Recent Mgmt
77 237. In a January 9, 2006 email to Galleon, a Lehman Brothers analyst noted that
Tandberg’s problems were firm-specific and presented Polycom with an opportunity:
…we note that although PLCM’s main competitor Tandberg pre- announced weaker than expected Q4 results, we believe this is more a reflection of Tandberg specific issues as opposed to industry-wide slowdown. Furthermore, we consider it possible for Polycom to take the advantage of Tandberg’s misstep to regain some of the lost market share over the last 12-18 months.236
238. On January 10, 2006 (the same day the SEC contends Mr. Rajaratnam received inside information), a Galleon analyst distributed an email to the “Tech & Trading Group:”
My analysis suggests: Tone on trends in both voip and video constructive and doesn’t see similar issues that tandberg saw this qtr.237
Rajaratnam’s Trades
239. In the twelve months before January 10, 2006 (when Mr. Rajaratnam allegedly received inside information), Mr. Rajaratnam bought and sold 140,000 shares of Polycom with a total transaction value of $2.1 million.238
240. After the alleged receipt of inside information, Mr. Rajaratnam purchased
210,000 shares of Polycom between January 12, 2006 (two days after the alleged tip) and
January 24, 2006 (the day prior to announcing earnings). These purchases were made over four
Meeting Give Confidence that PLCM Will Meet Expectations,” Bloomberg News, December 31, 2005 at 9:56am. 236 See Email from Lehman Brothers to Galleon containing Lehman Brothers analyst report, January 9, 2006 at 8:29am (emphasis added). 237 See Email from Galleon analyst dated January 10, 2006 at 11:42am (emphasis added). 238 Source: Galleon OMS Database.
78 separate trading days and consisted of four transactions that ranged from 25,000 shares to 75,000 shares each. The total cost of this investment was $3.5 million.239
Earnings Announcement
241. On January 25, 2006, after the market cloosed, Polycom reported that fourth quarter 2005 revenue was $156.1 million, which exceeded Wall Street consensus estimates of
$150.9 million. Polycom’s earnings of $0.23 per share also beat estimates of $0.21 per share.240
242. On January 26, 2006, Polycom’s common stock price increased 15.1% to close at
$19.54 per share. The excess return is statistically significant at the 99% confidence level (see
Exhibit 7).
Conclusion
243. In summary, my review of the mix of information in the market clearly indicates that the supposedly “material non-public” information was in fact publicly-available and acttively discussed by analysts and the financial press. Such publiicly-available information includes:
i) Channel checks for the fourth quaarrter were widely reported as “tracking ahead of plan,” “momentum remaiins strong,” and “positioned to beat expectations;”
ii) After the first two months of quarter were completed, management maintained their optimistic outlookk;
iii) Polycom’s market price was being unduly depressed by bad news from its largest competitor, Tandberg;
iv) Analysts believed Tandberg’s earnings warning was an isolated, company- specific problem that did not reflect upon the industry as a whole; and
v) At least four Wall Street analysts upgraded their rating on Polycom.
239 Source: Galleon OMS Database; United States of America v. Raj Rajaratnam per GX 65. 240 See “Polycom Reports Fourth Quarter Earnings; Record Revenues of $156.1M; Record Operating Cash Flow of $41.5M,” PR Newswire, January 25, 2006 at 4:01pm; “Polycom Beats By $0.02,” Bloomberg News, January 25, 2006 at 4:46pm.
79 244. Based on the substantial level of discussion by Wall Street analysts and the
financial press about Polycom’s upcoming fourth quarter revenues, in my opinion, all of this
commentary and analysis was publicly-available before Polycom announced its quarterly
financial results on January 25, 2006.
245. Based on the market reaction to Polycom’s earnings release (+15%), I conclude
that Polycom’s market price prior to the disclosure did not adequately reflect the positive
expectations by many Wall Street analysts. Despite analyst recommendations that Tandberg’s
problems presented a “buying opportunity” in Polycom shares, the market apparently did not
reflect this view until after Polycom announced its earnings results. This, however, does not
change the mix of information in the market.
246. Based on this evidence, I conclude that a well-informed, professional investor
(such as a hedge fund manager) that engages in legal information gathering and related arbitrage
trading in the shares of Polycom would have been aware of the mix of information in the market
that I have discussed above. Further, a hedge fund manager employed at Galleon would
additionally be aware of Galleon’s internal research on Polycom.
247. Based upon the mix of information available in the marketplace and within
Galleon prior to Polycom’s earnings announcement on January 25, 2006, in my opinion, it would
be reasonable for such an investor to purchase Polycom’s common stock and call options, just as
Mr. Rajaratnam had done. In my opinion, this publicly-available information provided ample justification to take an arbitrage position in Polycom immediately ahead of its earnings release.
248. Moreover, based on my understanding of the information the SEC is alleging was
conveyed in the tip, it is my opinion that the information allegedly tipped to Mr. Rajaratnam was
80 not private information, but rather was substantially similar to information that was already included in the mix of publicly available information.
xi. Polycom – Q1’06 Earnings
249. The SEC alleges that:
On or about April 13, 2006, Khan passed this information [that Polycom’s revenues for Q1 2006 would beat market expectations] on to Rajaratnam....241
250. Below, I examine the mix of information available in the marketplace and within
Galleon about Polycom’s first quarter earnings prior to Polycom’s earnings announcement on
April 19, 2006.
Mix of Information
251. On January 25, 2006 (three months before the SEC contends Mr. Rajaratnam received inside information), during the Polycom earnings conference call with analysts,
Polycom announced it expected first quarter 2006 revenues of between $150 million to $153 million, which was above the consensus estimate by analysts of $147 million.242
252. In response to Polycom’s earnings report and guidance, Bloomberg reported that
Wall Street analysts reacted favorably:
Kaufman raises their tgt on PLCM to $23 from $20 following Q4 results. The firm is encouraged... that guidance for 1Q06 was solid.243
Polycom tgt upped to $22 from $20 at Wedbush.244
241 See Complaint, ¶¶52-53. 242 See “Polycom, Inc. Issues Q1 2006 Revenue Guidance Above Analysts’ Estimates - Conference Call,” Reuters Significant Developments, January 26, 2006. 243 See “PLCM: Polycom Tgt Upped to $23 at Kaufman,” Bloomberg News, January 26, 2006 at 8:23am (emphasis added). 244 See “PLCM: Polycom Tgt Upped to $22 from $20 at Wedbush,” Bloomberg News,
81 253. On March 13, 2006, Piper Jaffray increased its price target:
Polycom tgt raised to $25 from $21 at Piper Jaffray based on valuations and favorable business trends.245
254. Shortly after the first quarter ended, in an April 3, 2006 email to Galleon, an analyst at Piper Jaffray commented on the growing “Momentum” at Polycom and that “Q1
Checks [were] Upbeat:”
We believe Polycom closed out a solid March quarter with better- than-expected results.... Several of PLCM’s channel partners have reported strong Q1 sales and experienced shortages and extended lead times later in the quarter, which we believe is an indication of strong end-user demand.
...Polycom’s channel partners... believe demand in Q1 was stronger than expected.
...a majority of our contacts indicated Q1 sales were exceptionally strong.
We believe actual demand was better than Polycom’s original Q1 guidance of $150-$153M, which should result in revenue upside...
...we believe PLCM will be able to beat our estimate and provide upbeat guidance for Q2. We... anticipate PLCM to meet or modestly exceed the high end of guidance ($153M).246
255. The Piper Jaffray analyst report was also reported on in the financial press.247
256. In an April 4, 2006 email to Galleon, an analyst at Thomas Weisel also noted
“[c]hecks point to strong Q1:”
January 26, 2006 at 10:32am. 245 See “PLCM: Polycom Tgt Raised to $25 from $21 at Piper Jaffray,” Bloomberg News, March 13, 2006 at 8:19am. 246 See Email from Piper Jaffray to Galleon containing Piper Jaffray analyst report, April 3, 2006 at 6:53am (emphasis added). 247 See “PLCM: Polycom: Momentum Growing; Q1 Checks Upbeat – Piper,” Bloomberg News, April 3, 2006 at 7:44am.
82 Our checks with 18 U.S. and European VARs and VADs indicate a robust March quarter... This leads us to expect that the company could post upside to our 1Q estimates of $152mn in revenue...
Given Tandberg’s recent execution issues, we expect Polycom will take share again in 1Q.248
257. The Thomas Weisel analyst report was also reported on in the financial press.249
258. In an April 11, 2006 email to Galleon (two days before Mr. Rajaratnam allegedly traded on inside information), an analyst at Thomas Weisel provided more details about its recent channel checks:
We continue to detect [in 1Q enterprise networking survey] broad optimism for 2006 spending.... We also found that respondents were more bullish about their sales pipeline...... the channel continues to be extremely optimistic about 12-month spending prospects, as 80% of respondents said they were feeling more optimistic than they did a quarter ago (versus 69% in 4Q), the highest level we have seen since 1Q05. We think this should lead to solid second quarter results...250
259. In an April 12, 2006 email to Galleon, an analyst at Kaufman Bros. raised his price target:
According to our channel checks, we conclude that Polycom will report solid 1Q06 results and should at least meet, if not exceed, its conservative guidance. ...our confidence in 2006 continues to improve...
We reiterate our BUY rating and are raising our price target to $25 [from $23]...251
248 See Email from Thomas Weisel to Galleon containing Thomas Weisel analyst report, April 4, 2006 at 10:27pm (emphasis added). 249 See “PLCM: Polycom Checks Point to Strong 1Q, Share Gains,” Bloomberg News, April 5, 2006 at 7:44am. 250 See Email from Thomas Weisel to Galleon containing Thomas Weisel analyst report, April 11, 2006 at 8:05am (emphasis added). 251 See Email from Kaufman Bros. to Galleon containing Kaufman Bros. analyst report, April 12, 2006 at 12:42pm (emphasis added).
83 260. The Kaufman Bros. analyst report was also reported on in the financial press.252
261. In an April 17, 2006 email to Galleon (the same day Mr. Rajaratnam allegedly
traded on inside information), an analyst at MJSK raised his price target:
Given the positive [channel] checks, we believe that the company is likely to beat consensus estimates of $152 million... Our checks indicate that the March quarter started off on a strong note and momentum continued to build as the quarter progressed. March was a very strong month for most resellers.
We are raising our price target on Polycom to $25 [from $23] due to the positive feedback on the performance of the March quarter.253
262. In an April 18, 2006 email to Galleon, an analyst at Lehman Brothers raised his
price target:
Following our latest round of channel checks, we believe strong biz at beg of Mar-Q continued thru end of Q. We now expect PLCM to report strong results this Wed w/ revs ahead of our est & high end of guid...
...we are raising tgt to $23.50 (from $21.50)...254
263. I also note that an internal analyst at Galleon received detailed models on
Polycom from both Lehman Brothers and Piper Jaffray in April 2006. These models were
provided in the form of apparently fully functional spreadsheets that contained these analysts’
quarterly and annual projections through 2007.255
252 See “Briefing.com: Live Upgrades/Downgrades,” Bloomberg News, April 12, 2006 at 12:33pm; “PLCM: Polycom Tgt Raised to $25 from $23 at Kaufman,” Bloomberg News, April 12, 2006 at 12:34pm; “Briefing.com: Upgrades/Downgrades,” Bloomberg News, April 12, 2006 at 11:00pm. 253 See Email from Miller Johnson Steichen Kinnard Investment Securities to Galleon containing MJSK analyst report, April 17, 2006 at 8:58am (emphasis added). 254 See Email from Lehman Brothers to Galleon containing Lehman Brothers analyst report, April 18, 2006 at 2:26pm (emphasis added). 255 See Email from Lehman Brothers to Galleon containing Lehman Brothers model,
84 Rajaratnam’s Trades
264. Mr. Rajaratnam purchased 250,000 shares of Polycom between April 13, 2006 and April 18, 2006 (the day prior to announcing earnings). These purchases were made over three separate trading days and consisted of four transactions that ranged from 50,000 shares to
100,000 shares each. The total cost of this investment was $5.3 milllion.256
Earnings Announcement
265. On April 19, 2006, after the market closed, Polycom reported that first quarter
2006 revenue was $157.7 million, which exceeded Wall Street consensus estimates of $151.7 million. Polycom’s earnings of $0.22 per share also beat estimates of $0.19 per share.257 On
April 20, 2006, Polycom’s common stock price decreased 2.0% to close at $22.08 per share.
The excess return is not statistically significant at the 95% confidence level (see Exhibit 7).
Conclusion
266. In summary, my review of the mix of information in the market clearly indicates that the supposedly “material non-public” information was in fact publicly-available and acttively speculated upon by analysts and the financial press. Such publicly-available information includes:
i) Channel checks for the first quarter were widely reported as “upbeat,” “better than expected,” “exceptionally strong,” better than the company’s guidance, “likely to beat consensus estimates,” “extremely optimistic,” and “more bullish;” andn
April 13, 2006 at 11:47am; Email from Piper Jaffray to Galleon containing Piper Jaffray model, April 13, 2006 at 1:29pm; Email from Piper Jaffray to Galleon containing Piper Jaffray model, April 17, 2006 at 11:37am. 256 Source: Galleon OMS Database. See Complaint, ¶54. 257 See “Polycom Reports First Quarter Earnings; Revenues of $157.7M; Year-Over- Year Revenue Growth of 15 Percent,” PR Newswire, April 19, 2006 at 4:05pm; “Polycom 1Q Profit Falls on Stock Expenses,” AP Newswires, April 19, 2006 at 4:53pm.
85 ii) At least four Wall Street analysts raised their price targets on Polycom.
267. Based on the substantial level of discussion by Wall Street analysts and the financial press about Polycom’s upcoming first quarter revenues, in mmy opinion, all of this commentary and analysis was publicly-available before Polycom announced its quarterly financial results on April 19, 2006.
268. Based on the market reaction to Polycom’s earnings release (-2%%), I conclude that
Polycom’s market price prior to the disclosure and prior to Mr. Rajaratnam’s purchases already accurately incorporated the positive expectations by Wall Street analysts, as well as any information contained in the alleged tip. I reach this conclusion after observing that: (i) the direction of Polycom’s stock price movement on April 20, 2006 was directionally inconsistent with the SEC’s allegation and (ii) such price movement was not economically material.
Furthermore, the price movements between April 17, 2006 and April 19, 2006 also were not economically material.
269. Based on this evidence, I conclude that a wwell-informed, professional investor
(such as a hedge fund manager) that engages in legal inffoormation gathering and related arbitrage trading in the shares of Polycom would have been awaree of the mix of information in the market that I have discussed above. Further, a hedge fund manager employed at Galleon would additionally be aware of Galleon’s internal research on Polycom.
270. Based upon the mix of information available in the marketplace and within
Galleon prior to Polycom’s earnings announcement on April 19, 2006, in my opinion, it would be reasonable for such an investor to purchase Polycom’s common stock, just as Mr. Rajaratnam had done. In my opinion, this information provided ample justification to take an arbitrage position in Polycom immediately ahead of its earnings release.
86 271. Moreover, based on my understanding of the information the SEC is alleging was
conveyed in the tip, it is my opinion that the information allegedly tipped to Mr. Rajaratnam was
not private information, but rather was substantially similar to information that was already
included in the mix of publicly available information. Furthermore, it is my opinion that the
announcement was not economically material.
xii. ATI – Takeover
272. The SEC alleges that:
By in or around March 2006, AMD had settled on ATI as its acquisition target and had begun confidential negotiations with ATI concerning a potential acquisition.258
Kumar tipped Rajaratnam to this information and, based on the information, Rajaratnam, in or around March 2006, caused the Galleon Tech funds to begin acquiring ATI stock.259
Negotiations between AMD and ATI continued over the next several months, and, during that span, Kumar updated Rajaratnam periodically on the progress of those negotiations.260
273. The SEC contends that Mr. Rajaratnam was provided inside information on an unspecified date in March 2006. There are several reasons to doubt that an allegedly credible tip was provided to Mr. Rajaratnam in that time period.261
258 See Complaint, ¶134. 259 See Complaint, ¶134. 260 See Complaint, ¶134. 261 Assuming Mr. Rajaratnam received a credible takeover tip in March 2006, that does not explain why Mr. Rajaratnam purchased shares of ATI roughly five months before the ATI takeover was announced on July 24, 2006. I would expect individuals trading on inside information to trade in much closer proximity to the announcement date, in an attempt to avoid any adverse movements in the market and to avoid any exposure to aborted or failed deals. Mr. Rajaratnam’s purchases in March (five month before announcement), April (four months before announcement) and May (three months before announcement) suggest to me that he was not in possession of material nonpublic information.
87 274. First, although both AMD and ATI were having “preliminary discussions” during
March, I note that according to the Proxy, these discussions do not appear to have involved any
discussion of price or terms. Instead, the parties discussed the operational and industry
ramifications of such a combination. ATI’s board met on March 29, 2006 to review ATI’s strategic alternatives and instructed its management team to continue discussions with AMD and to “report back to the Board in late April/early May” at which time the board would determine whether or not to continue pursuing any further discussions. I interpret the board’s lack of urgency in scheduling a follow-up meeting more than one month later to be a reflection of the
“preliminary” nature of the talks between the two companies.
275. Around this same time, on March 24, 2006, ATI announced plans to repurchase up to 25.1 million shares of its common stock, representing approximately 10% of the public float. The company indicated its shares “are an attractive investment” that “represent an excellent opportunity to enhance value for shareholders.” Based on the previous day’s closing price, such a repurchase would cost $374 million. ATI said the repurchases would be done in accordance with SEC Rule 10b-18.262
276. The ATI stock buyback was widely discussed in the financial press and at
Galleon.263
262 See “ATI Announces Normal Course Issuer Bid,” Business Wire, March 24, 2006 at 8:00am; Form 6-K filed with the SEC on March 24, 2006 at 2:14pm. 263 See “ATY ATI Technologies To Buy Back 25.1 Million Shares,” Canada Stockwatch, March 24, 2006; “Highlights of Rising and Falling U.S. Stocks,” AFX Asia, March 24, 2006; ATI Technologies Inc - Normal Course Issuer Bid,” Market News Publishing, March 24, 2006 at 12:36am; “ATI Announces Normal Course Issuer Bid,” CCNMatthew, March 24, 2006 at 3:00am; “ATI Announces Normal Course Issuer Bid to Buyback Shares - Shares Rise,” MidnightTrader, March 24, 2006 at 3:11am; “ATI Tech To Buy Back Up To 25.1M Shares,” Dow Jones News Service, March 24, 2006 at 8:01am; “ATI Technologies Normal Course Issuer Bid,” Reuters News, March 24, 2006 at 8:05am; ATI Announces Share Buyback Plan Renewal,”
88 277. Between April 24, 2006 and May 2, 2006, ATI repurchased 1.5 million shares at a
cost of $24.7 million.264
278. Assuming that ATI’s board acted in the best interest of all its shareholders, then
two factors – (i) the “preliminary” nature of ATI’s exploration of its strategic alternatives and
(ii) ATI’s sizeable stock buyback program – strongly suggest ATI’s board was not in possession
of material non-public information regarding its talks with AMD on or before May 2, 2006 (the
date of the last repurchase under the buyback plan).
279. Clearly, if ATI was serious about a transaction with AMD at that time, then its
plans to repurchase $374 million of its own stock would deprive certain selling shareholders of
any control premium to be offered by AMD while benefitting the remaining shareholders. Such
a serious and intentional reallocation of wealth amongst shareholders likely would constitute a
breach of fiduciary duty by ATI’s board. Since I have found no allegations that ATI breached its fiduciary duty to shareholders, I reasonably conclude the lack of such litigation is because ATI
was not in possession of material non-public information while conducting its stock buyback.
280. Based on this reasoning, the earliest Mr. Rajaratnam could have been allegedly
provided information that the board of ATI regarded as material was after May 2, 2006 when
ATI ceased repurchasing its common stock.
Reuters News, March 24, 2006 at 8:11am; “ATI, Encysive, Idenix, Nortel, WatchGuard: U.S. Equity Preview,” Bloomberg News, March 24, 2006 at 8:32am; “ATI Announces Normal Course Issuer Bid,” Bloomberg News, March 24, 2006 at 8:36am; “ATI Tech Inc: Normal Course Issuer Bid, Bloomberg News, March 24, 2006 at 11:10am; “ ATI Technologies May Buy Back as Much as 10% of Stock,” Bloomberg News, March 24, 2006 at 4:15pm; “ATI Technologies To Continue Share Buyback: ‘An Attractive Investment,’” The Canadian Press, March 24, 2006 at 4:55pm; “ATI Plans to Buy Back Up To 10 Per Cent of Shares,” The Globe and Mail, March 25, 2006; “ATI Technologies Inc. May Buy Back 25.1 Million Shares by March 2007,” The Philadelphia Inquirer, March 25, 2006; “ATI To Buy Back More Shares,” Calgary Herald, March 25, 2006; Instant Message within Galleon, March 24, 2006 at 8:05am. 264 See Email from RBC Capital Markets to Galleon, May 3, 2006 at 3:00pm.
89 281. Second, the Complaint fails to acknowledge that negotiations with AMD were
terminated by ATI’s management team on May 26, 2006 and by ATI’s board on May 30, 2006,
thereby rendering any prior alleged tips as irrelevant and non-material. This arguably could move Mr. Rajaratnam’s “tip” date to after May 30, 2006.
282. Third, on May 31, 2006, ATI’s CEO and an ATI spokesman both denied rumors that ATI would be acquired:
We [Genuity Capital Markets] heard from ATI’s CEO this morning, and he also hears the ATYT/INTC rumours every few months, had also heard ATYT/AMD in Taiwan in the past few weeks, but he didn’t have a clue where the information came from.265
ATI threw cold water on speculation about a deal with AMD. “There’s been speculation like this for at least a decade and nothing has changed,” said Chris Evenden, ATI’s spokesman. “It was only last week there was a rumour that Intel was interested.”266
283. These affirmative public denials by ATI stand in stark contrast to the typical
corporate mantra of “no comment.”267 I infer from these denials and the lack of a “no comment”
statement that any negotiations ATI was having with any third party was officially terminated
and that ATI was back to simply running its business, thereby rendering any prior alleged tips as
moot and non-material. This also arguably could move Mr. Rajaratnam’s “tip” date to after May
31, 2006.
265 See Email from Genuity Capital Markets to Galleon, May 31, 2006 at 12:12pm. 266 See “ATI Jumps on AMD ‘Tie-Up’ Speculation,” The Globe and Mail, May 31, 2006. 267 The “Carnation Rule” states that “an issuer that wants to prevent premature disclosure of nonpublic preliminary merger negotiations can, in appropriate circumstances, give a ‘no comment’ response to press inquiries concerning rumors or unusual market activity.” See Securities and Exchange Commission, In the matter of Carnation Company, July 8, 1985.
90 284. Moreover, Mr. Rajaratnam’s own trades in ATI reveal that he did not benefit from
any perceived informational advantage. This is shown by comparing his purchases before and
after the May 31, 2006 denials. The weighted average purchase price of shares bought in March,
April and May 2006 was $15.88, slightly higher than the $15.19 weighted average purchase
price of shares bought in June and July 2006.268 This further indicates that Mr. Rajaratnam’s alleged “tip” date should be no earlier than June 1, 2006, not March 2006.
285. Below, I examine the mix of information available in the marketplace and within
Galleon about expectations that ATI (a Canadian company) would be acquired prior to ATI’s actual announcement on July 24, 2006.
Mix of Information
286. Beginning as early as July 2005 (one year before the ATI takeover was
announced), ATI takeover rumors began. On July 7 and 8, 2005, ATI’s stock price was up 5.0%
and 8.5%, respectively. The price reaction on both days was statistically significant. In response
to this run-up, the National Post published a story titled “ATI Technologies Rally Sparks
Takeover Rumours”:
A mini-rally in ATI Technologies Inc. shares has sparked speculation the computer graphics chip maker could be a takeover candidate. In a research report, Andrew Lee, an analyst with TD Securities, said the potential suitors include Broadcom Corp., Advanced Micro Devices Inc., Intel Corp. and Texas Instruments Inc. Mr. Lee said takeover rumours surfaced last month after ATI issued its third-quarter results and provided “weak” fourth-quarter guidance.
...ATI could be an intriguing takeover target because there are concerns the company has failed to launch a new high-end, high-
268 Source: Galleon OMS Database. Based on transactions classified as alleged insider transactions in United States of America v. Raj Rajaratnam per GX 50.
91 margin chip in time for the back-to-school and holiday sales seasons.
...ATI’s value could suffer a short-term decline – providing an opportunity for suitors to move before ATI can rebound in the next product cycle. “I’m suggesting that if someone does buy them, it may be an opportune time,” Mr. McWhirter [portfolio manager of Selective Asset Management] said.269
287. The National Post story was repeated in the financial press.270
288. In September and October 2005, Bernstein Research analyst reports discussed the
prospects of AMD and ATI combining businesses in a merger.271
289. In late October 2005, a Galleon analyst indicated he was long 15.4 million shares
of ATI in his “paper portfolio” and after meeting with ATI’s CEO commented “keep long, buy
more [at] $12.50.”272
290. On December 27, 2005 and January 3, 2006, Bernstein Research indicated that
ATI and AMD would make for an “attractive” merger.273
291. In a January 9, 2006 email to Galleon, analysts at Bernstein Research noted that
the “strong rally” in AMD’s stock price provided it with a valuable currency for M&A
transactions:
Potential for M&A activity is higher. We believe the floor value for AMD’s shares has been structurally elevated from levels seen
269 See “ATI Technologies Rally Sparks Takeover Rumours,” National Post, July 9, 2005 (emphasis added). 270 See “ATY Post Says ATI Looks Like a Takeover Candidate,” Canada Stockwatch, July 11, 2005. 271 See Bernstein Research analyst report, September 20, 2005; Bernstein Research analyst report, October 10, 2005. 272 See Email from Galleon analyst to Galleon portfolio managers, October 21, 2005 at 1:17pm; Email from Galleon analyst to Galleon portfolio managers, October 23, 2005 at 8:56pm. 273 See Email from Bernstein Research to Galleon containing Bernstein Research analyst report, December 27, 2005 at 7:56am; Email from Bernstein Research to Galleon containing Bernstein Research analyst report, January 3, 2006 at 7:32am.
92 early in 2005 due to the specter of M&A activity. Combinations with companies like NVDA, ATYT [ATI], BRCM, or Samsung may make sense, boosting AMD’s attractiveness.274
292. On January 26, 2006, Reuters News reported that ATI is setting a “faster pace” for takeovers. ATI’s CEO stated:
Even though we are looking to accelerate (mergers and acquisitions), we are also looking to make sure we are prudent about it. We’ve got an active funnel, but there’s nothing major pending.275
293. This Reuters News story was discussed within Galleon.276
294. On May 15, 2006, Galleon was emailed a story by The Inquirer reporting on a
rumor that Intel might be looking to acquire ATI. Both Intel and ATI declined to comment on
the rumor.277 The story was distributed to Galleon’s portfolio managers.278
295. On May 16, 2006, Credit Suisse, Bass Trading and Bay Point Trading sent three
separate emails to Galleon discussing the Intel/ATI rumor.279
296. On May 31, 2006 (prior to Mr. Rajaratnam receiving any credible tip), there was a considerable amount of “chatter” that AMD would take over ATI. ATI’s stock price rose 9.0%, a statistically significant amount. Discussion within Galleon was as follows:
274 See Email from Bernstein Research to Galleon containing Bernstein Research analyst report, January 9, 2006 at 7:40am. 275 See “ATI To Set Faster Pace for Takeovers, CEO Says,” Reuters News, January 26, 2006 at 12:16pm (emphasis added). 276 See Instant Message within Galleon, January 26, 2006 at 12:17pm. 277 See Email from StreetAccount to Galleon, May 15, 2006 at 6:24pm. 278 See Email from Galleon analyst to Galleon portfolio managers, May 15, 2006 at 7:36pm. 279 See Email from Credit Suisse to Galleon, May 16, 2006 at 8:53am; Email from Bass Partners to Galleon, May 16, 2006 at 6:57am; email from Bay Point Trading to Galleon, May 16, 2006 at 8:19am.
93 6:53am: Apjit [an RBC analyst] is telling us a tie up between AMD and ATYT [ATI] is “imminent”. [He] covers neither name and is not getting this from contacts within either co. From what he calls good, credible sources in the manufacturing foodchain, both co’s behavior indicates a deal seems very close.280
7:57am: Apjit @ RBC saying:... its likely for AMD & ATYT [ATI] to combine or form a strong alliance...281
9:11am: Pacific Crest *ATYT* Acquisition by AMD is Unlikely.... An AMD-ATI tie-up is unlikely. The only reason we see why this happens is an attempt by AMD to diversify its product offering considering its planned capacity additions over the next few years. AMD has stated that it does not want to lever its balance sheet. With ATI’s current market cap of $3.9B and AMD’s net cash of $4, AMD would have to leverage its balance sheet further, something management has stated they will avoid going forward.282
12:10pm: The rumour [that ATI is a takeover target] surfaces occasionally, and has been making the rounds within Taiwan in the past several weeks. We [Genuity Capital Markets] heard from ATI’s CEO this morning, and he also hears the ATYT/INTC rumours every few months, had also heard ATYT/AMD in Taiwan in the past few weeks, but he didn’t have a clue where the information came from. Another source from within ATI laughed at the suggestion of the linkup.... We believe ATI holds good value here, but would rate the probability of a buyout as very low.283
1:57pm: Apjit [an RBC analyst] has been invited to appear on Maria Bartiromo’s show at 3:10pm EST today to discuss his views on the semiconductor space and the call we made this morning regarding AMD & ATI tie-up.284
297. Also on May 31, 2006, The Globe and Mail discussed the AMD/ATI takeover rumors:
280 See Instant Message within Galleon, May 31, 2006 at 6:53am. 281 See Instant Message within Galleon, May 31, 2006 at 6:53am. 282 See Email from Pacific Crest to Galleon, May 31, 2006 at 9:11am. 283 See Email from Genuity Capital Markets to Galleon, May 31, 2006 at 12:12pm. 284 See Instant Message within Galleon, May 31, 2006 at 1:57pm.
94 Speculation that graphics chip creator ATI Technologies Inc. could be about to hook up with Advanced Micro Devices Inc. sent shares of Markham, Ont. company up more than 9 per cent in trading Wednesday morning.
The two chip players could announce a “tie-up” shortly, Apjit Walia, an analyst with RBC Dominion Securities in New York, said in a research note on Wednesday.
“It has long been discussed that the graphics-companies are likely to be bought by one of the microprocessor companies. Our recent checks in the PC-food chain suggest a tie-up between AMD and ATI may be likely,” he said. “The synergies of this seem consistent with the recent announcements by AMD to significantly increase capacity over the next few years.”
ATI threw cold water on speculation about a deal with AMD. “There’s been speculation like this for at least a decade and nothing has changed,” said Chris Evenden, ATI’s spokesman. “It was only last week there was a rumour that Intel was interested.”285
298. The takeover rumors were extensively reported on in the financial press and were
highlighted on CNBC’s Mad Money by Jim Cramer.286
285 See “ATI Jumps on AMD ‘Tie-Up’ Speculation,” The Globe and Mail, May 31, 2006. 286 See “ATI Technologies (ATYT) SqueezeTrigger Price is $15.36. Short Sellers Are Down Approximately $8.7 Million on Buyout Speculation,” M2 Presswire, May 31, 2006; “Analyst: ATI is a Possible AMD Acquisition Target,” San Jose Mercury News, May 31, 2006; “Canadian, U.S. Stocks Rise,” The Globe and Mail, May 31, 2006; “Shopping Spree: Should AMD Buy ATI? Should We Buy New HP, Dell Gear?” San Jose Mercury News, May 31, 2006; “Will AMD Buy ATI?” Electronic News, May 31, 2006; “ATI Technologies Seeing Spike in Pre-Bell Volume on Talk of AMD Deal,” MidnightTrader, May 31, 2006 at 4:30am; “ATI Tech: Checks Suggest Tie-Up Between AMD and ATYT May Be Likely,” Bloomberg News, May 31, 2006 at 8:14am; “Is a Tie-Up Between AMD & ATYT Possible?” Bloomberg News, May 31, 2006 at 8:14am; “ATI Tech Follow Up,” Bloomberg News, May 31, 2006 at 9:01am; “ATI Technologies, Catapult, L-3, Senomyx: U.S. Equity Movers,” Bloomberg News, May 31, 2006 at 11:09am; “ATI Shares Surge on AMD Takeover Talk,” Reuters News, May 31, 2006 at 1:42pm; “Analyst: Graphics Chip Maker ATI Possible AMD Acquisition Target,” AP Newswires, May 31, 2006 at 2:14pm; “ATI Tech: RBC Analyst Appears on CNBC to Discuss This Mornings ATYT/AMD Call,” Bloomberg News, May 31, 2006 at 3:52pm; “ Abreast of the Market: NRG, ATI, Tiffany Climb Wed,” Dow Jones Commodity Service, May 31, 2006 at 4:15pm; “Toronto Stks End Higher; ATI Gains on Takeout Speculation,” Dow Jones News Service, May 31, 2006 at 4:20pm; “ATI, BSD, Ciena, Ivanhoe, NRG, West: U.S. Equity Movers Final,” Bloomberg
95 299. Continuing the prior day’s discussion of takeover rumors, on June 1, 2006, the following was discussed within Galleon:
AMD, ATYT [ATI] - re speculation of a merger btw the two companies (raised in RBC report yesterday) - “other analysts familiar with the graphics chip market say investors are making much ado about nothing”... the talk may be little more than idle speculation. TheStreet.com287
AMD - we are not going to comment on rumors (i.e. ATYT)288
AMD management in their analyst day is asked about 30 minutes ago about the ATI call. Company reverting “they do not comment on mergers”. Our take on what we know of AMD management is that if company believed this was ridiculous, they would dismiss it.289
300. On June 2, 2006, a DigiTimes article noted that some thought Intel was a more likely bidder for ATI than AMD. This article was shared within Galleon:
In response to recent speculation that ATYT is an acquisition target for AMD..., Taiwan based chipset and motherboard makers feel an INTC buyout of ATYT would make more sense. The makers do not believe a purchase of ATYT by AMD is a reasonable idea given the purchase would not provide any production facilities.290
301. Also on June 2, 2006, The Inquirer highlighted that “AMD [was] Tight Lipped
About ATI Buyout”:
News, May 31 2006 at 4:30pm; “Analyst: Graphic Chip Maker ATI Possible AMD Acquisition Target,” AP Newswires, May 31, 2006 at 5:34pm; “Analyst: Graphics Chip Maker ATI Possible AMD Acquisition Target,” The Canadian Press, May 31, 2006 at 5:53pm; “Stocks Gain Ground Led By Rise in Commodity Shares,” Dow Jones Business News, May 31, 2006 at 9:21pm; “ATI Shares Soar on Rumours of AMD Deal: Stock Up 9% to $18.10,” National Post, June 1, 2006; “ATI Stock Jumps on ‘Tie-Up’ Rumours,” The Globe and Mail, June 1, 2006; “Globe Says ATI Helps May End on High Note,” Canada Stockwatch, June 1, 2006; “Globe Says ATI Shares Surge on ‘Tie-Up’ Rumour,” Canada Stockwatch, June 1, 2006. 287 See Instant Message within Galleon, June 1, 2006 at 7:06am. 288 See Instant Message within Galleon, June 1, 2006 at 2:50pm. 289 See Instant Message within Galleon, June 1, 2006 at 3:42pm. 290 See Instant Message within Galleon, June 2, 2006 at 6:42am.
96 SENIOR EXECS at AMD shifted around uncomfortably when asked if it was interested in buying ATI at an analyst conference yesterday. Dirk Meyer, the firm’s chief operating officer, and Hector Ruiz, the firm’s CEO, eyed each other for seconds when asked the unusually hard question, before Meyer picked up the baton…. [H]e courageously dodged the question by saying AMD never commented on speculation.291
302. On June 6, 2006, The Inquirer reported that:
I AM NOW UTTERLY convinced that AMD will buy or merge with ATI, and I am also nearly as convinced that it will happen as soon as Computex, which opens today.292
303. On June 6, 2006, ATI’s stock price rose 3.3%, a statistically significant amount.
The article was discussed within Galleon and reported on in Bloomberg News.293
304. On June 7, 2006, a Bear Stearns email alerted Galleon that according to The
Inquirer, “AMD won’t buy ATI”:
WE CANNOT name names but a few important people from both camps have confirmed that AMD won’t buy ATI. Charlie [the reported for the June 6, 2006 story in The Inquirer] is convinced that it will happen... Well, sorry to disappoint him but at this time there are no serious talks between the two.294
305. ATI’s stock price decline 5.6%, a statistically significant amount. The article was
discussed within Galleon and reported on in Bloomberg News.295
291 See “AMD Tight Lipped About ATI Buyout,” The Inquirer, June 2, 2006 at 9:20am (emphasis added). 292 See “I Am Convinced AMD Will Buy ATI,” The Inquirer, June 6, 2006 at 3:43am. 293 See Instant Message within Galleon, June 6, 2006 at 7:24am; “AMD: Advanced Micro: Inquirer.net Columnist Convinced AMD Will Buy ATYT,” Bloomberg News, June 6, 2006 at 8:59am. 294 See Email from Bear Stearns to Galleon, June 7, 2006 at 8:02am. 295 See Instant Message within Galleon, June 7, 2006 at 7:16am; “AMD: Advanced Micro: Inquirer.net Now Says AMD Won’t Buy ATYT,” Bloomberg News, June 7, 2006 at 9:12am.
97 306. On June 8, 2006, AP Newswires reported that a JMP Securities analyst “dismissed
notions that Intel or AMD could acquire either ATI or Nvidia”:
We believe that Intel or AMD is unlikely to merge with graphics chip vendors ATI Technologies and Nvidia for several reasons, including Intel’s preoccupation with its own company-wide restructuring efforts and AMD’s need to have a vendor-neutral stance on graphics co-processors for strategic partnerships.296
307. On June 12, 2006, an analyst at Friedman Billings commented on speculation that
AMD would acquire ATI:
...checks suggest that no such acquisition (ATYT by AMD) is in the offing, based on their conversations with several contacts connected with both ATYT and AMD.297
308. Also on June 12, 2006, a news story posed the question “AMD + ATI: Does It
Add Up?”:
Last week at Computex… Intel allegedly began telling folks behind closed doors that AMD is planning to acquire ATI.
Over dinner tonight in downtown Taipei it was explained to me that Intel was making the rounds with their customers explaining exactly how the AMD/ATI merger/acquisition was going to impact their business. Closure of the deal is expected to pass in 2 weeks.
This looks fairly definitive, but only time will tell if the rumor turns out to be true. As of this writing, the AMD-ATI merger/acquisition is still in the realm of informed speculation and anonymous sources.298
309. This story was also reported on in the financial press.299
296 See “Semiconductor Stocks Slip,” AP Newswires, June 8, 2006 at 3:56pm (emphasis added). 297 See “ATYT: ATI Tech Tgt Cut to $13 at Friedman Billings,” Bloomberg News, June 12, 2006 at 8:47am (emphasis added). 298 See “AMD + ATI: Does It Add Up?” ArsTechnica.com, June 12, 2006 at 10:00pm (emphasis added). 299 See “AMD, ATYT, INTC: Periodicals,” Theflyonthewall.com, June 13, 2006 at
98 310. On June 22, 2006, Goldman Sachs viewed the rumored takeover of ATI as a “low probability”:
The high volatility associated with ATI Tech, a factor which has pushed up options prices, was likely exacerbated by recent takeover rumors which were overdone, [a Goldman Sachs strategist] said. “Our Goldman Sachs team does not expect a large move for ATI Tech this quarter and sees low probability of a near term acquisition.”300
311. On July 5, 2006 at 3:01 pm, Galleon portfolio managers were alerted in an instant message about “hearing chinabite saying amd for atyt in chinese.”301 At 3:09 pm, Bloomberg
News reported that according to Chinese language website ChinaByte.com, “AMD has reached a purchase agreement with ATI”:
ATYT has traded to new session highs in the past 10 min. We are hearing that an English translation of a page on Chinese website ChinaByte.com reports that “...AMD has reached a purchase agreement with ATI...” However, we cannot vouch for the accuracy of this site – or the quality of the translation for that matter – and would take this with a degree of caution. It’s worth noting that some analysts had speculated on an AMD/ATYT combination a few weeks ago... However, we’re just passing this chatter along because it’s out there.302
312. At 3:11 pm, the Bloomberg News story was emailed directly to Mr.
Rajaratnam.303
313. At 3:44 pm, another instant message updated Galleon’ portfolio managers that:
chatter is that ATYT is up b/c of a english translation on a chinese website ChinaByte.com that says “...AMD has reached a purchase
10:31am. 300 See “Rich ATI, Micron Options Could Lure Sellers-Analysts,” Reuters News, June 22, 2006 at 11:33am (emphasis added). 301 See Instant Message within Galleon, July 5, 2006 at 3:01pm. 302 See “ATYT: ATI Tech: Color on Stock Action,” Bloomberg News, July 5, 2006 at 3:09pm (emphasis added). 303 See Email to Mr. Rajaratnam, July 5, 2006 at 3:11pm (emphasis added).
99 agreement with ATI...” I can’t confirm the rumor or the translation, just want to make sure you hear.304
314. ATI’s stock price increased 5.0%, a statistically significant amount.
315. Later on July 5, 2006, a Goldman Sachs analyst report was emailed to Galleon that discussed the implications to Taiwanese chipset makers “if AMD acquires ATi.”305
316. On July 6, 2006, more takeover rumors were reported on in the press:
ATI shares – the subject of periodic deal rumors – rallied briefly in late May on talk about a possible strategic pacts with chip maker Advanced Micro Devices Inc., but no accord has been announced. AMD and ATI declined to comment on any potential pact.306
ATI set to rise on fresh takeover rumours. MORE RUMOURS are doing the Interweb rounds that AMD could snap up ATI. The latest to emerge is on a Chinese site, which claims that it’s a foregone conclusion...307
317. In an instant message sent to Galleon’s portfolio managers on July 6, 2006, BMO
Canada commented on the AMD/ATI rumors:
There is a rumour making the rounds at several sources including the Inquirer that it is imminent that AMD will purchase ATI. This rumour get recycled regularly, so it should be treated with skepticism. We question the logic of an AMD-ATI merger or strategic tie-up for that matter, considering that ATI and NVIDIA both support AMD microprocessors.... However, while we believe this acquisition makes no sense, this has not impeded tech mergers in the past. After all, we expect consolidation of the Canadian technology sector, primarily due to U.S. tech companies with too
304 See Instant Message within Galleon, July 5, 2006 at 3:44pm. 305 See Email from Goldman Sachs to Galleon containing Goldman Sachs analyst report, July 5, 2006 at 7:25pm. 306 See “ATI Has Been Off Its Game — Maker of Graphics Chips Looks to PC-Sales Boost to Lift Fortunes,” The Wall Street Journal, July 6, 2006 (emphasis added). 307 See “ATI Set To Rise On Fresh Takeover Rumours,” The Inquirer, July 6, 2006 at 11:28am (emphasis added).
100 much cash on their hands trying to achieve fundamentally unachievably growth targets.308
318. On July 7, 2006, Bloomberg News again reported on ATI takeover rumors emanating from a Chinese website:
AMD has reached an agreement with ATI to buy the graphics chip company. An official statement will be made shortly - if, that is, you believe a report on a Chinese-language website citing a single source said to be close to the negotiations. We’re taking this with a big pinch of salt. The unnamed source, cited by Sohu.com, would provide no details of the deal...”309
319. ATI’s stock price increased 2.4%, a statistically significant amount.
320. On July 10, 2006, a Credit Suisse analyst report discussed “the Case Against
AMD/ATYT”:
AMD/ATYT Speculation Rampant. While speculation has been around for some time that AMD will acquire ATYT, and while recent press articles have been adding fuel to the fire, we believe the negative effects of such a transaction outweigh the positive effects.310
321. The Credit Suisse analyst report was discussed in a Galleon instant message.311
322. On July 14, 2006, Bloomberg News reported on an analyst report from Thomas
Weisel that thought the much rumored AMD/ATI merger made strategic sense:
Thomas Weisel notes there has been considerable industry speculation that AMD may pursue an acquisition of ATYT, although such an outcome is by no means certain. In light of AMD’s technology roadmap, and specifically its Torrenza technology, they believe that such a merger would not be so far- fetched. They think there would be strategic value to a merger
308 See Instant Message within Galleon, July 6, 2006 at 2:23pm, (emphasis added). 309 See “ATYT: RegHardware.co.uk asks: ‘AMD, ATI Agree Acquisition Deal?” Bloomberg News, July 7, 2006 at 8:51am (emphasis added). 310 See Credit Suisse analyst report, July 10, 2006, Bates Nos. SEC_0063895 (emphasis added). 311 See Instant Message within Galleon, July 10, 2006 at 7:56am.
101 with AMD and ATYT, including: 1) accelerating Torrenza adoption into notebook/desktop, as well as server, 2) bolstering its leadership of ultra-high-end desktop, and 3) establishing AMD- branded chipsets resulting in platformization which could grow computing market share, although with some risk. Firm thinks analysis indicates a merger would likely be 7-12% dilutive to 2007 EPS estimates based on take-out premiums of 20-40% assuming no operating synergy and would be neutral to accretive within a couple of quarters assuming synergy.312
323. The Thomas Weisel analyst report was discussed in a couple Galleon instant messages and noted that Goldman Sachs thinks the AMD/ATI deal is “unlikely.”313
324. In an instant message sent to Galleon’s portfolio managers on July 18, 2006,
Morgan Stanley indicated it “does not think AMD can get the ATYT deal done at its current stock price.”314
325. On July 18, 2006, Monness, Crespi, Hardt & Co. emailed to Galleon an analyst report that believed AMD would acquire only part of ATI’s business:
There is a lot of talk regarding a potential merger. The PM [portfolio manager] does not believe AMD will buy the entire business, only the chipset business.... The deal will be done for cash because AMD does not have strong currency anymore.315
326. On July 21, 2006, The Inquirer reported that “AMD and ATI to ask shareholders for merger approval”:
312 See “ATYT: ATI Tech: AMD/ATYT Merger Would Not Be So Far-Fetched - TW,” Bloomberg News, July 14, 2006 at 7:40am (emphasis added). 313 See Instant Message within Galleon, July 14, 2006 at 7:55am, 7:56am, 8:05am. 314 See Instant Message within Galleon, July 18, 2006 at 7:48am. 315 See Email from Monness, Crespi, Hardt & Co. to Galleon containing Monness, Crespi, Hardt & Co. analyst report, July 18, 2006 at 10:19am.
102 ACCORDING to an extraordinarily reliable source, AMD and ATI will on Monday pitch their shareholders with the proposition that the two companies merge.316
327. The article was discussed within Galleon and reported on in Bloomberg News.317
328. Also on July 21, 2006, Galleon was alerted to a separate report from The Inquirer
that indicated that AMD fabrication plants could produce ATI chips. The Inquirer said this “may
shed light on recent acquisition rumors in the space.”318
329. Later on July 21, 2006, Bloomberg News reported that according to The Globe
and Mail, AMD is planning a bid for ATI “as early as next week”:
The Globe and Mail reports that AMD is considering a $5.6-bln takeover bid for ATI Technologies. ATYT is rising today on rumours that AMD will make a friendly offer of between $21 and $23 as early as next week. The board of directors at AMD have approved a takeover offer, according to an investment banker familiar with the talks. Other sources in the financial industry said AMD executives have been spotted at ATI’s Markham, Ont. head office.319
330. The news was discussed within Galleon and reported on in the financial press.320
316 See “AMD and ATI To Ask Shareholders for Merger Approval,” The Inquirer, July 21, 2006 at 2:53am. 317 See Instant Message within Galleon, July 21, 2006 at 9:21am, 9:24am; “AMD: Advanced Micro and ATYT To Ask Shareholders for Merger Approval - Inquirer.net,” Bloomberg News, July 21, 2006 at 9:23am. 318 See Email from StreetAccount to Galleon, July 21, 2006 at 8:23am. 319 See “ATYT: ATI Tech: AMD Planning to Bid for ATYT at $21-23, Citing Sources,” Bloomberg News, July 21, 2006 at 4:22pm. 320 See Instant Message within Galleon, July 21, 2006 at 3:41pm; Email to Galleon portfolio managers, July 21, 2006 at 4:14pm; “ATI Technologies Gains Sharply In Brisk Evening Volume On Report AMD Could Make a Bid,” MidnightTrader, July 21, 2006 at 12:57am; “Advanced Micro Planning ATI Technologies Bid, Globe Reports,” Bloomberg News, July 21, 2006 at 3:37pm; “Advanced Micro-AMD Considering $5.6B Takeover of ATYT,” Bloomberg News, July 21, 2006 at 4:19pm; “ATI Technologies-ATYT Implied Volatility Elevated With Heavy Volume,” Bloomberg News, July 21, 2006 at 4:36pm; “Advanced Micro Buy ATI for About $5.5 Billion, Person Says,” Bloomberg News, July 21 2006 at 4:39pm; “ATI Tech Shares Rise After Reports of Possible AMD Bid,” Dow Jones News Service, July 21, 2006
103 Rajaratnam’s Trades
331. In the twelve months before March 7, 2006 (when Mr. Rajaratnam allegedly
received inside information), Mr. Rajaratnam bought and sold 3.3 million shares of ATI with a
total transaction value of $50.5 million.321
332. Mr. Rajaratnam purchased 6.4 million shares of ATI between March 7, 2006 and
July 21, 2006. The purchases were made over 27 separate trading days and consisted of 58
transactions that ranged from 654 shares to 375,000 shares each. The total cost of these
purchases was $99.0 million.322
Takeover Announcement
333. On July 24, 2006, before the market opened, ATI announced it was being
acquired by AMD in a combination cash-and-stock transaction valued at approximately $5.4
billion or $20.47 per share.323
334. On July 24, 2006, ATI’s common stock price increased 18.8% to close at $19.67
per share. The excess return is statistically significant at the 99% confidence level (see Exhibit
8).
at 5:18pm; “Advanced Micro May Buy ATI for About $5.5 Billion,” Bloomberg News, July 21, 2006 at 5:19pm; “ATI Shares Surge on Speculation of AMD Bid,” Reuters News, July 21, 2006 at 5:28pm; “AMD Said Near $5.5 Bln Deal to Buy ATI,” Reuters News, July 21, 2006 at 5:44pm; “ATI Shares Rise After Reports of Possible AMD Bid,” Dow Jones News Service, July 21, 2006 at 8:04pm; “WSJ Update: AMD Close to Agreement to Buy ATI Tech,” Dow Jones News Service, July 21, 2006 at 8:31pm. 321 Source: Galleon OMS Database. 322 Source: Galleon OMS Database; United States of America v. Raj Rajaratnam per GX 21, 3534-K. 323 See “AMD and ATI to Create Processing Powerhouse; $5.4 Billion Acquisition Will Drive Growth, Innovation and Choice,” Business Wire, July 24, 2006 at 4:31am.
104 Conclusion
335. In summary, my review of the mix of information in the market clearly indicates that the supposedly “material non-public” information was in fact publicly-available and acttively speculated upon by analysts and the financial press. Such publicly-available information includes:
i) The widely-held view that ATI was a takeover target with AMD the most likely buyer as early as July 2005 (one year before the ATI/AMD deal was announced);
ii) In January 2006, Bernstein Research indicated that ATI and AMD would make for an “attractive” merger and that the “potential for M&A activity is higher;”
iii) In mid-May 2006, rumors began circulating that Intel would acquire ATI;
iv) On May 31, 2006, a Wall Street analyst advised clients thaat a merger between AMD and ATI was “imminent” based on his discussions with credible sources at manufacturers in the supply chain; ATI’s stock jumped 9.0% on this news, which was covered extensiively in the financial press;
v) On June 6, 2006, a reporter at The Inquirer was “utterly convinced that AMD will buy or merge with ATI;” ATI’s stock price increased 3.3%, a statistically significant amount;
vi) On July 5, 2006, Bloomberg News reported that according to Chinese language website ChinaByte.com, “AMD has reached a purchase agreement with ATI;” ATI’s stock price increased 5.0%, a statistically significant amount;
vii) On July 14, 2006, a Thomas Weisel analyst report noted there had been “considerable industry speculation that AMD may pursue an acquisition of ATYT” and thought there was “strategic value to a merger with AMD and ATYT;”
viii) On Friday, July 21, 2006 (one trading day before the deal was announced), The Inquirer reported that “AMD and ATI willl on Monday pitch their shareholders with the proposition that the two companies merge;” and The Globe and Mail reported on “rumours that AMD will make a friendly offer of between $21 and $23 as early as next week.”
336. Based on the substantial level of discussion by Wall Street analysts and the financial press about an anticipated acquisition of ATI by AMD, in my opinion, all of this
105 commentary and analysis was publicly-available before AMD’s acquisition of ATI was announced on July 24, 2006.
337. Based on the market reaction to the ATI takeover announcement (+19%), I conclude that ATI’s market price prior to the disclosure did not adequately reflect the expectations by many Wall Street analysts of a takeover. Despite analyst beliefs that ATI was a takeover target that would garner a sizeable control premium, the market apparently did not reflect this view until after ATI announced its was being acquired by AMD. This, however, does not change the mix of information in the market.
338. Based on this evidence, I conclude that a well-informed, professional investor
(such as a hedge fund manager) that engages in legal information gathering and related arbitrage trading in the shares of ATI would have been aware of the mix of information in the market that
I have discussed above.
339. Based upon the mix of information available in the marketplace and within
Galleon prior to ATI’s takeover announcement on July 24, 2006, in my opinion, it would be reasonable for such an investor to purchase ATI’s common stock, just as Mr. Rajaratnam had done. In my opinion, this publicly-available information provided ample justification to take an arbitrage position in ATI in anticipation of a takeover.
340. Moreover, based on my understanding of the information the SEC is alleging was conveyed in the tip, it is my opinion that the information allegedly tipped to Mr. Rajaratnam was not private information, but rather was substantially similar to information that was already included in the mix of publicly available information.
xiii. Hilton – Takeover
341. The SEC alleges that:
106 [O]n or about July 2, 2007, Khan told Rajaratnam that Hilton was going to be taken private at a price somewhere in the mid-$40s per share in a deal to be announced the following day.324
342. Below, I examine the mix of information available in the marketplace and within
Galleon about expectations that Hilton would be acquired by a private equity fund prior to
Hilton’s actual announcement on July 3, 2007.
Mix of Information
343. Beginning as early as January 2007 (five months before the Hilton takeover was
announced), expectations were mounting that private equity firms would attempt to take Hilton
private:
Private equity groups are likely this year to continue to snap up hotels, and maybe even major brand operators, according to industry experts. “Everybody’s in play,” Barry Sternlicht, chairman and CEO of real estate investment firm Starwood Capital Group, said at a lodging industry conference here this week.
…deals could involve major hotel operators such as Hilton Hotels Corp. and Starwood Hotels & Resorts Worldwide. The Equity Office deal “opened eyes to the fact that Hilton or Starwood would support a private equity transaction,”…325
344. On February 2, 2007, credit analysts at Merrill Lynch expressed concern that
Hilton could be taken private in a leveraged buyout, which would adversely affect Hilton’s
bondholders. The analysts noted “[t]he robust market for hotel acquisitions puts investors at risk
if Hilton were to pursue a going-private transaction.”326
324 See Complaint, ¶58. 325 See “Private Equity Has Yawning Appetite for Hotels,” Reuters News, January 26, 2007 at 8:32pm (emphasis added). 326 See “Hilton LBO Prospects Spark Diverging Bond Calls at Merrill, UBS,” Bloomberg News, February 2, 2007 at 6:57am.
107 345. On February 21, 2007, an analyst at JPMorgan identified Hilton as a “potential
LBO target” that was “potentially attractive to private equity.”327
346. On March 5, 2007, in an email to Galleon, an analyst at Bear Stearns discussed the impact of Hilton’s recently announced plans to sell its Scandic Hotel chain:
Do we think this sale reduces the likelihood that HLT [Hilton] will be sold or bought out? No. The math at $41+ still makes sense.328
347. On March 7, 2007, in an email to Galleon, an analyst at Lehman Brothers commented:
I am a little surprised we haven’t heard more about potential LBO’s in the lodging space of late. It would be incredibly difficult to creat (sic) a lodging company like HOT [Starwood Hotels and] HLT [Hilton] etc with the barrier of entry to big cities and good locations in todays (sic) real estate environment.... [T]hese stocks... have an LBO catalyst to support [their] valuations.329
348. On March 27, 2007 (more than three months before the SEC contends Mr.
Rajaratnam received inside information), an analyst at Jefferies & Co. alerted Galleon in an email that Hilton announced the early expiration of its shareholder rights plan, a “poison pill” used to defend against hostile takeover. The plan was originally set to expire on November 29,
2009, but instead its expiration was accelerated to March 22, 2007. The Jefferies analyst noted that “...in the past that private equity interest in the lodging space has been high.”330
349. Several analysts viewed the expiration of the shareholder rights plan as possible indication that Hilton was testing the market for a LBO:
327 See Email from StreetAccount to Galleon, February 21, 2007 at 9:00am (emphasis added). 328 See Email from Bear Stearns to Galleon containing Bear Stearns analyst report, March 5, 2007 at 6:55am (emphasis added). 329 See Email from Lehman Brothers to Galleon, March 7, 2007 at 2:55pm (emphasis added). 330 See Email from Jefferies & Co. to Galleon, March 27, 2007 at 9:49am.
108 [Another company’s board]... voted in 7/06 to allow its shareholders rights plan to expire, and ultimately received a formal LBO bid in 9/06.
[Bank of America also noted that]... reports over the past several months have highlighted HLT (as well as other lodging stocks) as a potential LBO or M&A candidate.331
[A]ppears to put Hilton in a more vulnerable position to a hostile acquisition.... [I]ts almost like they’re testing the waters for a sale, to see what the market will bear and see if they can get a price that would make sense.332
...this brings back the LBO talk to the marketplace. There have been rumors about HLT and HOT in the past. If someone is ever going to take a run at these companies now certainly seems to be the time. Its almost like both companies are asking for it (HOT fires CEO, HLT eliminates poison pill and still doesn’t have a replacement for their CEO).333
350. On April 11, 2007, Bear Stearns emailed to Galleon an analyst report titled “HLT and HOT LBO Analyses Revisited,” in which the analyst noted:
There is renewed investor interest in evaluating the possibility of a potential private equity (PE) take out of HLT... [W]e revisit our LBO analyses for HLT & HOT from a PE point of view (originally published 11/29/06).334
351. In mid-April 2007, three separate hotel acquisition were announced: (i)
Innkeepers USA agreed to a $1.5 billion deal with Apollo Investment, (ii) Extended Stay Hotels
331 See “HLT: Hilton Hotels: BofA Comments on Termination of ‘Stockholder Rights” Plan,” Bloomberg News, March 28, 2007 at 8:23am (emphasis added). 332 See “US CREDIT-Hilton Wider as Filing May Signal Change,” Reuters News, March 29, 2007 at 3:53pm (emphasis added). 333 See Email from Lehman Brothers to Galleon, April 2, 2007 at 7:12am (emphasis added). 334 See Email from Bear Stearns to Galleon containing Bear Stearns analyst report, April 11, 2007 at 6:41am (emphasis added).
109 agreed to an $8 billion deal with Lightstone Group and (iii) Highland Hospitality agreed to a
$1.7 billion deal.335
352. In late April 2007 (two months before the SEC contends Mr. Rajaratnam received inside information), analysts at Morgan Stanley and JPMorgan commented about private equity’s appetite for hotel acquisitions:
HLT’s leverage is relatively low, as far as LBO candidates go. Private equity investors have been swarming the lodging space and at this point we believe that there are enough private equity dollars out there chasing hotel assets to take all lodging companies with real estate component private.336
Private Equity Eyeballing Public Lodging Companies. In our view, the recent interest of private capital in the real estate sector, including hotels, is likely to continue and possibly accelerate in 2007. The first reason is the abundance of capital that has yet to be committed. Second, financing terms are likely to be liberal until either interest rates increase or a prior transaction goes belly-up.337
353. On May 24, 2007, Hilton announced that its president and COO would become
CEO once the current CEO retires at the end of the year.338 Analysts commented on the implications this had on a possible buyout bid:
HLT just names a sucessor (sic) as CEO, Matthew Hart, I have a feeling the street will read this as a note they are NOT going private. . . . . we [Morgan Stanley] don’t necessarily think that is the case...339
335 See “Innkeepers USA Agrees to $1.5B Buyout Offer,” Cox News Service, April 17, 2007; “Extended Stay Hotels is Sold for $8 Billion to Equity Group,” Bloomberg News, April 18, 2007 at 1:00am; “SL Green, Hampton Homes, Highland: Global Real Estate Deals,” Bloomberg News, April 24, 2007 at 1:15pm. 336 See Morgan Stanley analyst report, April 30, 2007 (emphasis added). 337 See Email from JPMorgan to Galleon containing JPMorgan analyst report, April 30, 2007 at 8:26pm (emphasis added). 338 See “Matthew J. Hart to Become Chief Executive Officer of Hilton Hotels Corporation Effective Jan. 1, 2008,” Business Wire, May 24, 2007 at 12:50pm. 339 See Email from Morgan Stanley to Galleon, May 24, 2007 at 12:54pm.
110 While many may choose to extrapolate that today’s news means the company is not exploring strategic alternatives, we do not agree. In our view, if the company were to consider potential strategic options, the announcement of a new CEO would not be a deterrent in many cases.340
[W]e [Citigroup] view Mr. Hart’s promotion as neutral from a deal perspective.341
354. Also on May 24, 2007, a Citigroup analyst noted that:
We believe a number of investors own HLT based strictly on the prospect of a near-term take-private transaction. While we have no specific knowledge of a deal, we point out: (1) private market demand for real estate is robust; (2) HLT’s valuation is significantly below peers & recent deals in sector.342
355. On May 31, 2007, in emails to Galleon, an analyst at Lehman Brothers commented:
...this [hotel] group is always thought of as an attractive LBO candidate. I like HLT & HOT best...343
Even if they don’t get LBO’d these stocks are still cheap. I would be a buyer of HLT and HOT especially...
...if HLT or HOT were to be LBO’d using an MGM type valuation you are talking about major premiums to where the stocks are trading now.344
356. On June 6, 2007, Merrill Lynch emailed to Galleon comments about private equity interest in hotels:
340 See Email from Lehman Brothers to Galleon, May 24, 2007 at 1:50pm. 341 See Email from Citi Investment Research to Galleon, May 24, 2007 at 2:00pm. 342 See Email from Citi Investment Research to Galleon, May 24, 2007 at 2:00pm (emphasis added). 343 See Email from Lehman Brothers to Galleon, May 31, 2007 at 8:29am (emphasis added). 344 See Email from Lehman Brothers to Galleon, May 31, 2007 at 12:42pm (emphasis added).
111 PE [private equity] interest will continue as long as supply & demand is favorable. Demand is still far outstripping supply and expect this to continue as people travel more and more. Do not see a surge of supply coming in just yet. PE love good brands and Hilton is a good brand.345
357. On June 26, 2007, Jefferies & Co. emailed to Galleon an analyst report that
named Hilton a “Jefferies Tuesday Value Pick”:
Recent private equity activity in lodging REITs should have positive implications for our lodging universe, in particular HLT, as private market valuations continue to track significantly ahead of the public markets.
Over the past 2 months, 3 major lodging REITs (ENN, HIH, and KPA) have been acquired by private equity firms for 12.3-14.5x forward EBITDA. This compares to HLT’s 2007 multiple of 11.3x.... [W]e believe HLT is better positioned in the industry yet continues to trade at a significant discount.... [O]ne could argue that [Hilton’s] owned hotels should trade at a premium to recent transactions.346
358. The Jefferies & Co. analyst report was also reported on in the financial press.347
359. On June 28, 2007, in an email to Galleon, Bear Stearns noted that “a large trade
in call options on the hotel operator [Hilton] has turned some heads.”348
360. On June 30, 2007 (two days before receiving the alleged tip), Galleon had already
accumulated holdings in Hilton of 475,700 shares as was reflected in Galleon’s quarterly filing
of Form 13-F filed with the SEC on August 15, 2007.
345 See Email from Merrill Lynch to Galleon, June 6, 2007 at 2:43pm (emphasis added). 346 See Email from Jefferies & Co. to Galleon containing Jefferies & Co. analyst report, June 26, 2007 at 7:27am (emphasis added). 347 See “HLT: Hilton Hotels: Private Equity Activity in Lodging REITs Should Have Positive Implications for Lodging Universe, In Particular HLT,” Bloomberg News, June 26, 2007 at 7:30am. 348 See Email from Bear Stearns to Galleon, June 28, 2007 at 7:20am (emphasis added).
112 361. On July 3, 2007 (after Mr. Rajaratnam received the alleged tip, but before trading in shares of Hilton), before the market opened, Citigroup alerted Galleon in an email that on the prior trading day Hilton had the single largest percentage increase in its implied volatility of all consumer discretionary companies followed by Citigroup.349
362. On July 3, 2007, before the market opened, Jefferies & Co. emailed to Galleon an analyst report that named Hilton the “Pick of the Week” following its previous week’s selection as “Jefferies Tuesday Value Pick.”350
363. Several Wall Street analysts pointed out in emails to Galleon that Jefferies had named Hilton its “Pick of the Week.”351 Additionally, the Jefferies & Co. analyst report was reported on in the financial press.352
364. After the first half-hour of trading on July 3, 2007, Hilton’s stock price jumped
3.2% and was trading at $34.94 at 10:00 am. Commenting on this sudden price increase, a
Lehman Brothers analyst emailed Galleon:
The reason Hilton is up.... [T]he folks over at Jeffries (sic) are getting credit for the call .. their analysts note on 6/26 is now evidentally (sic) Jeffries’ (sic) firm wide best research pick (or so I am hearing) .. I totally agree with their call (and it is also our lodging analysts’ top pick).
Hilton is certainly an LBO candidate with most estimates of their value in the private mkt coming in the mid $40’s. As every one knows there has been billions of dollars of lodging privitizations (sic) this year.... [C]oncerns about the lodging cycle ending seem
349 See Email from Citigroup to Galleon, July 3, 2007 at 7:23am (emphasis added). 350 See Email from Jefferies & Co. to Galleon containing Jefferies & Co. analyst report, July 3, 2007 at 7:44am. 351 See Email from Pali Capital to Galleon, July 3, 2007 at 8:31am; Email from Lehman Brothers to Galleon, July 3, 2007 at 9:59am; Email from Bear Stearns to Galleon, July 3, 2007 at 11:15pm. 352 See “Hilton Shares Rise After Analyst Calls It ‘Pick of the Week,’” Bloomberg News, July 3, 2007 at 2:31pm.
113 overblown with HLT now trading below 10x EBITDA (especially considering rivals have privitized (sic) b/t 12x and 14x EBITDA). The risk reward metrics around Hilton seem really attractive here. Good buying opp.353
365. This Lehman Brothers email was forwarded within Galleon several times in the
minutes after it was originally received.354
366. At 11:15 am on July 3, 2007, Bear Stearns emailed Galleon regarding the
morning’s movement in Hilton’s stock price:
We have received multiple questions regarding the strength in lodging this morning (mainly HLT +4.6%... HLT was named Jeffries’ (sic) pick of the week this morning. The firm noted that HLT should command a higher valuation.... Equity Options. Front month options seeing higher volumes as well as catching a better bid this morning.355
367. At 12:03 pm on July 3, 2007, an analyst at Wachovia sent an instant message to
Galleon that he was seeing “Chatter Blackstone lookin at HLT stock rippin.”356
368. At 1:04 pm on July 3, 2007, Bloomberg News reported that Hilton’s option
volume and volatility were “elevated.”357
369. On July 3, 2007, 7.5 million shares of Hilton traded on the NYSE. This was more than double the average 3.2 million shares that typically trade (see Appendix A, p. 250).
Moreover, the stock market was only open for half a day of trading before the Fourth of July
holiday. Further evidence that knowledge of the forthcoming deal had leaked into the
353 See Email from Lehman Brothers to Galleon, July 3, 2007 at 9:59am (emphasis added). 354 See internal Galleon email, July 3, 2007 at 10:00am, 10:01am and 10:02am. 355 See Email from Bear Stearns to Galleon, July 3, 2007 at 11:15am (emphasis added). 356 See Instant Message from Wachovia to Galleon, July 3, 2007 at 12:03pm (emphasis added). 357 See “Hilton Hotels-HLT Option Volume & Volatility Elevated as HLT Rallies 6%,” Bloomberg News, July 3, 2007 at 1:04pm.
114 marketplace is reflected in options trading. On July 3, 2007, option volume increased nearly 10 fold to 22,008 contracts compared to average volume of only 2,347 contracts (see Appendix A, p. 251).
370. After the takeover of Hilton was announced, Dow Jones News Service focused on traders that bought Hilton options just hours before the deal was announced:
Nearly 22,000 call options on Hilton changed hands in the half session Tuesday [July 3, 2007] before the company said Blackstone will buy it for $47.50 a share. That compared with an average daily volume in June of just under 2,900 call options.
Many speculators in the options market have taken to trying to spot insiders or institutions that are acting with conviction - buying large blocks of call options for example - and following their lead.
That’s exactly what prompted Jon Najarian, the trader who tracks unusual activity for OptionMonster.com to buy call options on Hilton last week. He spotted a buyer of an unusually large amount of call options on June 27, he said, something that prompted him to alert his clients and add his own position in the calls.358
371. This unusual trading in call options noticed by Mr. Najarian was also observed by
Bear Stearns, who alerted Galleon on June 28, 2007 (as previously discussed) about this large trade that “turned some heads.”359
Rajaratnam’s Trades
372. Mr. Rajaratnam purchased 400,000 shares of Hilton on July 3, 2007 (the day after receiving the alleged tip). This purchase consisted of one transaction at a total investment cost of
$14.0 million.360
358 See “Traders Bought Options Just Hours Before Hilton Deal News,” Dow Jones News Service, July 5, 2007 at 10:12am (emphasis added). 359 See Email from Bear Stearns to Galleon, June 28, 2007 at 7:20am. 360 Source: Galleon OMS Database; Complaint, ¶59; United States of America v. Raj Rajaratnam per GX 50.
115 373. The SEC apparently takes issue with Mr. Rajaratnam’s decision to purchase
shares of Hilton within Galleon’s tech fund. The Complaint points out that “...Rajaratnam and
Galleon purchased 400,000 shares of Hilton for the Galleon Tech funds, whose stated purpose is
to make investments in the technology sector.”361
374. I examined Mr. Rajaratnam’s trading in the Galleon OMS Database for
transactions that used the manager code “TMT,” “TAM” and “GRC” (the Galleon technology
funds). I then separated these transactions into tech companies and non-tech companies based on
a review of SIC Codes and company descriptions.362 From this data, I analyzed whether or not
purchases of non-tech related companies such as Hilton was a common occurrence.
375. I found that even though Mr. Rajaratnam was one of the portfolio managers for
Galleon’s tech funds, 18% of the dollar value of his transactions under manager code “TMT,”
“TAM” and “GRC” between 2005 and 2009 was for non-tech related companies and ETFs.
Therefore, I draw no negative inference regarding the alleged insider trading by the fact that Mr.
Rajaratnam purchased shares of Hilton (a non-tech company) within Galleon’s tech funds.
376. I also examined the Galleon OMS Database for transactions where Mr.
Rajaratnam took an opening position (i.e., buy or short) in a security that he had not previously traded during the 2005 to 2009 time period and after taking such a position did not make any additional buy or short trades on any subsequent days. In other words, transactions where Mr.
Rajaratnam only traded a stock on a single day, similar to his trading in Hilton. In addition to
361 See Complaint, ¶59 (emphasis added). 362 The screening of the “TMT,” “TAM” and “GRC” manager codes required that a SIC Code be available from FactSet (except for exchange traded funds or “ETFs”). For my initial screening process, I considered the following SIC Codes to be technology-related: 3570-3579; 3600-3699; 3801-3899; 4801-4899; 5045; and 7370-7379. I further reviewed company/ETF descriptions (sources: FactSet, Bloomberg, SEC and company websites) for the companies to determine the final classification of non-tech securities.
116 Hilton, I found 213 separate securities where Mr. Rajaratnam only traded those securities on a single day.363
Takeover Announcement
377. On July 3, 2007, after the market closed, Hilton announced it had entered into a definitive merger agreement with The Blackstone Group (a private equity firm) in an all-cash transaction valued at approximately $26 billion or $47.50 per share.364
378. On July 5, 2007, the next trading day, Hilton’s common stock price increased
25.9% to close at $45.39 per share. The excess return is statistically significant at the 99% confidence level (see Exhibit 9).
Conclusion
379. In summary, my review of the mix of information in the market clearly indicates that the supposedly “material non-public” information was in fact publicly-available and acttively speculated upon by analysts and the financial press. Such publicly-available information includes:
i) The widely-held view that Hilton wwas a LBO ttarget and that private equity funds were the most likely acquirors;
ii) Accelerated expiration of Hilton’s poison pill, which analysts viewed as a sign the company was “testing the waters for a sale;”
iii) Private equity’s interest in acquiring lodging companies was “accelerating” in 2007 with the billion dollar plus deals for Innkeepers USA, Extended Stay Hotels and Highland Hospitality;
iv) Hilton was “undervalued” and a takeover would likely result in a “major [control] premium;”
363 I only counted securities with an SIC Code available. 364 See “Hilton Hotels Corporation to be Acquired by Blackstone Investment Funds,” Business Wire, July 3, 2007 at 5:58pm.
117 v) Options market volume and volatility was inddicating investors believed a major event was forthcoming;
vi) Galleon owned 475,700 shares of Hilton as of June 30, 2007;
vii) Jefferies named Hilton its “Tuesday Value Pick” and “Pick of the Week;”
viii) Investor interest in Hilton surged in the morning hours of July 3, 2007;
ix) Estimated takeover price for Hilton was “in the mid $40’s;” and
x) “Chatter” that Blackstone was looking to acquire Hilton.
380. Based on the substantial level of discussion by Wall Street analysts and the financial press about an anticipated acquisition of Hilton by a private equity fund, in my opinion, all of this commentary and analysis was publicly-available before Hilton’s takeover announcement on July 3, 2007.
381. Based on the market reaction to the Hilton takeover announcement (+26%), I conclude that while many Wall Street analysts had correcctly anticipated that Hilton would be acquired, not until July 3, 2007 did analysts expect a takeover price as high as $47.50 per share.
382. Based on this evidence, I conclude that a wwell-informed, professional investor
(such as a hedge fund manager) that engages in legal inffoormation gathering and related arbitrage trading in the shares of Hilton would have been aware of the mix of information in the markket that I have discussed above.
383. Based upon the mix of information available in the marketplace and within
Galleon prior to Hilton’s takeover announcement on July 3, 2007, in my opinion, it would be reasonable for such an investor to purchase Hilton’s common stock, jjust as Mr. Rajaratnam had done. In my opinion, this publicly-available information provided ample justification to take an arbitrage position in Hilton in anticipation of a takeover.
118 384. Moreover, based on my understanding of the information the SEC is alleging was conveyed in the tip, it is my opinion that the information allegedly tipped to Mr. Rajaratnam was not private information, but rather was substantially similar to information that was already included in the mix of publicly available information.
xiv. PeopleSupport – Takeover
385. The SEC alleges that:
...Rajaratnam purchased securities of PeopleSupport through Goel’s personal Schwab Account based on material nonpublic information. First, Rajaratnam purchased 30,000 shares in advance of PeopleSupport’s August 4, 2008 announcement that PeopleSupport would be acquired by Aegis....
Second, on the afternoon of October 7, 2008, in advance of PeopleSupport’s October 8, 2008 announcement that the merger with Aegis was confirmed (PeopleSupport had announced the prior morning that it had received a request to delay the merger, which sent prices down amidst investor concerns that the deal might·be in jeopardy), Rajaratnam purchased 30,000 PeopleSupport shares for Goel’s Schwab Account.365
386. Below, I examine the mix of information available in the marketplace and within
Galleon about expectations that Aegis’ pending acquisition of PeopleSupport would be completed.
Mix of Information
387. On August 22, 2007, Galleon filed a Schedule 13D with the SEC reporting that it had increased its stake in PeopleSupport to 23.96%.366
388. On August 27, 2007, PeopleSupport announced its board of directors adopted a stockholder rights plan or “poison pill” that was designed to:
365 See Complaint, ¶¶117-118. 366 See Galleon Schedule 13D filed with the SEC on August 22, 2007.
119 ...deter coercive takeover tactics, including the accumulation of shares in the open market or through private transactions, and to prevent an acquirer from gaining control of PeopleSupport without offering fair and adequate price and terms to all of PeopleSupport’s stockholders.367
389. On November 30, 2007, IPVG Corp. and AO Capital Partners made an unsolicited offer to acquire PeopleSupport for $15 per share. The board of directors of
PeopleSupport indicated it would “carefully consider and evaluate” the offer.368
390. In a December 3, 2007 email to Galleon, an analyst at ThinkEquity Partners indicated that better offers may be available:
$15 Per Share Offer Is Good, But Is It Good Enough?
We believe PeopleSupport is ripe to be acquired, and an acquirer could be willing to pay an EV/EBITDA multiple of 15x, or $18/share.... [T]hus we believe there could be better offers yet to come.369
391. On December 12, 2007, PeopleSupport’s board of directors rejected the offer from IPVG Corp. and AO Capital Partners. PeopleSupport also provided revenue and earnings guidance for fiscal 2008 that was above Wall Street estimates.370
392. On December 18, 2007, based on PeopleSupport’s new guidance, ThinkEquity
Partners increased its price target for PeopleSupport from $18 to $24 and indicated that a potential acquirer could be willing to pay $24 per share.371
367 See “PeopleSupport Adopts Stockholder Rights Plan,” Business Wire, August 28, 2007 at 8:45pm. 368 See “PeopleSupport Confirms Receipt of Unsolicited Proposal to be Acquired,” Business Wire, November 30, 2007 at 4:40pm. 369 See Email from ThinkEquity Partners to Galleon containing ThinkEquity Partners analyst report, December 3, 2007 at 5:30am (emphasis added). 370 See “PeopleSupport Board Rejects IPVG Corp. and AO Capital Partners Unsolicited Proposal,” Business Wire, December 12, 2007 at 6:09pm; “PeopleSupport Projects 2008 Profit and Revenue Above Wall Street Estimates; Shares Rise,” AP Newswires, December 12, 2007 at 6:58pm.
120 393. On January 11, 2008, IPVG Corp. and AO Capital Partners made a revised
unsolicited offer to acquire PeopleSupport for $17 per share, up from the original $15 proposal.372
394. On January 31, 2008, PeopleSupport rejected IPVG Corp. and AO Capital
Partners’ revised bid “due to lack of evidence of financing.”373
395. On March 3, 2008, PeopleSupport agreed to appoint Krish Panu to its board of
directors in conjunction with Galleon’s agreement to support PeopleSupport’s nominees at the
next annual shareholder meeting.374
396. On July 1, 2008, Zacks.com featured PeopleSupport in its Analyst Blog
PeopleSupport, Inc…. is well-positioned to benefit from the fast- growing offshore BPO (business process outsourcing) market. The company’s rapid revenue growth and investments production capacity in the Philippines and Costa Rica resulted in a negative earnings surprises and significant near-term margin contraction. The news drove the stock down to reasonable valuation levels as earnings momentum investors exited their stock positions.
PeopleSupport’s long-term prospects are still promising despite the loss of the Vonage… contract in 2007. The management strengthened the company’s position by pursuing industry verticals and expanding geographically. It maintains a strong balance sheet with minimal debt. The stock is rated a Buy.375
371 See “PeopleSupport Should Jump On ThinkEquity Note,” Seeking Alpha, December 18, 2007. 372 See “PeopleSupport Confirms Receipt of an Unsolicited Revised Proposal from IPVG Corp. and AO Capital Partners Ltd.; PeopleSupport Board to Review Proposal in Due Course,” Business Wire, January 11, 2008 at 7:27pm; “PeopleSupport Gains After IPVG Raises Takeover Offer,” Bloomberg News, January 11, 2008 at 9:07pm. 373 See “PeopleSupport Board Unable to Evaluate IPVG Corp. and AO Capital Partners Revised Proposal Due to Lack of Evidence of Financing,” Business Wire, January 31, 2008 at 9:00am. 374 See “PeopleSupport and Galleon Group Reach Agreement; PeopleSupport to Appoint Krish Panu to Board of Directors,” Business Wire, March 3, 2008 at 3:28pm. 375 See “Zacks Analyst Blog Highlights: PeopleSupport, Vonage, Goodyear Tire &
121 397. On July 21, 2008, PeopleSupport was named to “Fortune Small Business
Magazine’s 100 Fastest-Growing Small Public Companies List.”376
398. On August 4, 2008, PeopleSupport announced it had agreed to be acquired by
Aegis BPO’s Essar Services for $12.25 per share in cash. The transaction was “expected to close in the third or fourth quarter of this year” and the “transaction is not subject to any financing conditions.”377
399. On September 16, 2008, The Financial Express reported that Essar Group “is
looking at more acquisitions after acquiring PeopleSupport for $250 million.” Aegis’ CEO
commented, “We are planning to make acquisitions which could be larger than the
PeopleSupport deal…” adding that “[c]ash is not a constraint for us….”378
400. On September 19, 2008, The Manila Times reported that PeopleSupport expected
to complete its transaction with Aegis BPO’s Essar Services “by the second week of October.”379
401. On September 30, 2008, PeopleSupport received Hart-Scott-Rodino clearance from the Federal Trade Commission.380
402. On October 6, 2008, an internal Galleon analysis indicated that the
“PSPT/ESSAR Deal Spread” implied a 94% probability of closing.381
Rubber, Hittite Microwave and Plexus Corp.” Business Wire, July 1, 2008 at 6:00am (emphasis added). 376 See “PeopleSupport Named to Fortune Small Business Magazine’s 100 Fastest- Growing Small Public Companies List,” Business Wire, July 21, 2008 at 6:02pm. 377 See “PeopleSupport to Merge with Essar Services (Mauritius), a Wholly Owned Subsidiary of Aegis BPO,” Business Wire, August 4, 2008 at 8:00am. 378 See “Aegis to Shop in Europe, Africa,” The Financial Express, September 16, 2008 at 12:54am (emphasis added). 379 See PeopleSupport Buyout Set for October Completion,” The Manila Times, September 19, 2008. 380 See “PeopleSupport and Essar Services (Mauritius) Receive Hart-Scott-Rodino Clearance from the Federal Trade Commission,” Business Wire, September 30, 2008 at 8:00am.
122 403. On October 7, 2008 (before the market opened), PeopleSupport announced it
received a request from Aegis BPO’s Essar Services to “delay closing of merger transaction” to
a date “no later than October 31, 2008.” PeopleSupport indicated it was “...currently evaluating
this request by Essar Services.”382
404. PeopleSupport’s common stock price decreased 23.0% to close at $9.25 per share
on October 7, 2008. The excess return is statistically significant at the 99% confidence level (see
Exhibit 10).
Rajaratnam’s Trade
405. Mr. Rajaratnam allegedly purchased on behalf of Rajiv Goel 15,000 shares of
PeopleSupport on July 2, 2008, 15,000, shares on July 28, 2008 and 30,000 shares on October 7,
2008 using Mr. Goel’s Charles Schwab brokerage account. These purchases consisted of three
transactions for a total investment cost of $543,202.383
Deal-Related Announcement
406. On October 7, 2008 (after the market closed), PeopleSupport and Aegis BPO’s
Essar Services jointly announced a schedule for completing the acquisition no later than October
31, 2008. Aegis confirmed its intention to complete the acquisition and reaffirmed that the
closing is not subject to financing. Aegis indicated it requested the delay in closing “...due to the
unprecedented disruptions in global capital markets affecting movement of funds and its desire
to implement the transaction with an optimal capital structure.” Aegis’s global CEO said, “Aegis
381 See Email within Galleon, October 6, 2008 at 6:12pm. 382 See “PeopleSupport Announces Receipt of Request to Delay Closing of Merger Transaction Up To October, 31, 2008,” Business Wire, October 7, 2008 at 8:30am (emphasis added). 383 See Complaint, ¶¶117-118.
123 is committed and we continue to be excited about the traansaction and the opportunities it presents.... [W]e look forward to the completion of this merger.”384
407. The next day, PeopleSupport’s common stock price increased 22.6% to close at
$11.34 per share on October 8, 2008. The excess return is statisticallly significant at the 99% confidence level (see Exhibit 10).
Conclusion
408. In summary, my review of the mix of information in the market clearly indicates that there were several relevant firm-specific news stories regarding the prospects for completing the PeopleSupport transaction and about the financial wherewithal of Aegis BPO’s Essar
Services. Such publicly-available information includes:
i) On August 4, 2008, PeopleSupport announced it had agreed to be acquired by Aegis BPO’s Essar Services foor $12.25 per share in cash; transaction was expected to close in the third or fourth quarter of 2008; and transaction was not subject to any financing conditions;
ii) On September 16, 2008, Essar Group indicated it was “looking at more acquisitions after acquiring PeopleSupport” adding that “cash is not a constraint for us;”
iii) On September 19, 2008, The Manila Times reported that PeopleSupport expected to complete its transaction with Aegis BPO’s Essar Services “by the second week of October;”
iv) On September 30, 2008, PeopleSupport received Hart-Scott-Rodino clearance from the FTC; and
v) On October 7, 2008 (before the market opened), Aegis BPO’s Essar Services requested a delay to a date “no later than October 31, 2008.”
409. I believe that a well-informed, professionaal investor (such as a hedge fund manager) that engages in legal information-gathering and related arbitrage trading in the shares
384 See “PeopleSupport and Essar Services Announce Schedule for Completion of Merger Transaction,” Business Wire, October 7, 2008 at 7:47pm.
124 of PeopleSupport would have been aware of the mix of information in the market that I have discussed above.
410. Based upon the mix of information available in the marketplace and within
Galleon prior to the requested extension on the morning of October 7, 2008, in my opinion, it would be reasonable for such an investor to purchase PeopleSupport’s common stock, just as Mr.
Rajaratnam had done. Specifically, the market’s expectation was that the transaction would be completed in October 2008, and even after the requested “delay,” the transaction would still be completed in October 2008. Moreover, even though the market was deeply embroiled in the credit crisis, the buyer publicly stated in mid-September its interest in making additional and even larger acquisitions following its deal with PeopleSupport. The buyer further reassured the market in its ability to close by stating that “cash is not a constraint for us.” In my opinion, the market’s reaction to the requested delay was an overly negative reaction that created a temporarily mispriced security and a valuable arbitrage opportunity to investors who continued to believe that the requested delay did not materially change the probability that the transaction would be completed.
411. In my opinion, this publicly-available information provided ample justification to take an arbitrage position in PeopleSupport in anticipation of the acquisition being completed.
xv. AMD – Joint Venture
412. The SEC alleges that:
...on August 15, [2008] Kumar conveyed this material nonpublic information [that the parties to the AMD Transactions had decided to proceed with the deal] to Rajaratnam.385
On August 15, [2008], Rajaratnam communicated with Chiesi. Chiesi told Rajaratnam that she was hearing from her IBM source
385 See Complaint, ¶146.
125 that the AMD Transactions would occur September 9 but the AMD Executive told her they would occur around mid-September.... Rajaratnam informed Chiesi that the parties shook hands on the deals the day before.386
Between August 19 and September 30, 2008, Chiesi and Rajaratnam had numerous communications during which they exchanged material nonpublic information about the AMD Transactions that they received from their respective sources.387
On September 11, 2008, Kumar communicated to Rajaratnam that the deals were on track and that the announcement of the AMD Transactions would be the first week of October.388
[On September 30, 2008], Rajaratnam communicated with Chiesi and indicated that the date for the announcement of the AMD Transaction was October 7, 2008.389
413. Below, I examine the mix of information available in the marketplace and within
Galleon about AMD spinning off its semiconductor manufacturing operations into a joint venture with Advanced Technology Investment Company prior to AMD’s announcement on October 7,
2008.
414. For a more detailed review of the mix of information in the market, see Exhibit
11, which contains excerpts from over 40 news stories and analyst reports that discuss AMD’s
“asset-lite” strategy.
Mix of Information
415. Beginning as early as April 2007 (nearly one and one-half years before AMD’s
“official” announcement), AMD indicated to the market that it was “exploring deeply more asset
386 See Complaint, ¶147. 387 See Complaint, ¶150. 388 See Complaint, ¶146. 389 See Complaint, ¶146.
126 light business models.” In June 2007, analysts were speculating that this involved outsourcing
AMD’s manufacturing, resulting in a transformation into a “fabless” operator (see Exhibit 11).
416. In December 2007, several Wall Street analysts viewed the forthcoming asset-lite
strategy with skepticism:
We [American Technology Research] believe investors will view a restructuring that brings in third-party manufacturing partners and design partners with skepticism....
“Asset light is insufficient to warrant aggressively owning AMD shares,” [a Citigroup analyst] wrote. “While model altering, the change in production format does little to make AMD’s product line-up more competitive.”
...UBS said that while an asset lite strategy “should improve AMD’s free cash flow, it does not address its key areas that we believe are weighing on AMD shares.” He pointed to AMD’s “competitively challenged product portfolio, unfavorable processor cost structure vs. Intel, and increasing process technology gap vs. Intel.” See Exhibit 11.
417. Details of AMD’s plan began to leak into the market in April 2008 when The
Inquirer proclaimed “AMD IS GOING TO go fabless.” The article specifically notes that AMD will spin-off its manufacturing and identifies Abu Dhabi as its partner:
The chipmaker is likely to split into a fabless semi outfit and a foundry.... Spin off the fabs to a separate company and sell that to pay off your debt.... That is exactly what they are going to do. The real question is to whom, and that is easy - Abu Dhabi.... AMD would split into... AMD Design and AMD Foundry.... [Because of the Intel license] [t]hat means that AMD Design would have to own at least 51 percent of AMD Foundry... See Exhibit 11.
418. In May 2008, analysts at JMP Securities reported that “...AMD is making steady
progress in announcing its Asset-Lite/Smart outsourced manufacturing strategy,...” which the
analysts believed could result in a “$1.5-2 billion cash infusion” (see Exhibit 11).
127 419. On June 5, 2008, a Galleon analyst purchased 150,000 shares of AMD for his
“paper portfolio.” The analyst specifically noted the “potential move to fab lite.”390
420. Also on June 5, Mr. Rajaratnam had a conference call with the Abu Dhabi
Investment Company (“ADIC”), in which Mr. Rajaratnam provided his insight on the benefits of
AMD’s fab-lite strategy and its impact on earnings.391
421. In June 2008 (two months before Mr. Rajaratnam allegedly traded on inside
information), Lehman Brothers indicated a “high probability for [an asset lite] deal to be
announced in the next few months” (see Exhibit 11). On June 17, 2008, a Lehman Brothers sales rep sent an instant message to a Galleon analyst indicating that Lehman “exp ‘Asset Smart’ deal
3Q.”392
422. On June 18, 2008, the Mubadala Development Company was linked to AMD’s
asset-lite strategy; however, Goldman Sachs viewed any dilutive investment from Mubadala as a
“negative” for AMD’s stock:
There continues to be speculation in the market that the Mubadala Development Company (funded by the government of the Emirate of Abu Dhabi) will increase its investment in AMD by ~$1bn over the coming months. We believe that a potential capital raise would be positive for AMD’s credit, but a negative for the stock and we continue to recommend that investors sell shares.... Importantly, we believe that AMD’s eventual move to an “asset light business model” could further widen the competitive gap between Intel and AMD over the next several years. See Exhibit 11.
423. Also on July 18, 2008, the Austin American-Statesman published that:
390 See Email from Galleon analyst, June 5, 2008 at 9:32am. 391 See Email from Galleon analyst containing presentation for ADIC, June 5, 2008 at 5:01pm. 392 See Instant Message from Lehman Brothers to Galleon analyst, June 17, 2008 at 8:12am.
128 ...analysts speculate that it will spin off its global manufacturing operations into a separate company with new ownership.... Some analysts speculate that the spinoff will require a substantial investment from the government of Abu Dhabi, a Persian Gulf oil state that invested more than $600 million in AMD stock in December.393
424. On July 17, 2008, a Galleon analyst advised Galleon’s portfolio managers that:
I would start to build a long position…. I think this is as bad as it gets for AMD…. [T]he move to asset light is expected to happen by year end.394
425. On July 18, 2008, a Galleon analyst indicated he had apparently purchased 75,000 shares of AMD for his paper portfolio.395
426. On July 23, 2008 (one month before Mr. Rajaratnam allegedly traded on inside information), AMD’s CEO apparently prematurely announced that it “will” spin-off manufacturing. After the CEO was quoted in the press with affirmatively confirming the spin- off, AMD then stated the CEO was misquoted. The reporter stood by his original story.
Meyer [AMD’s CEO] says the company is just months away from a major restructuring that will spin the manufacturing operations off into a separate company, with new ownership. See Exhibit 11.
427. This same story also indicated that the asset-lite transaction was “a done deal”:
If you have been paying attention, the likely suitor is from Abu Dhabi, but that may have changed. In any case, it was a done deal last winter, it is a done deal now, there is just paperwork left to do. AMD has been busily prepping all close partners, upstream, downstream and governmental, about the shift for a long time, so expect things to go pretty smoothly. See Exhibit 11.
393 See “AMD Shakes Up Top Brass,” Austin American-Statesman, July 18, 2008 (emphasis added). 394 See Email within Galleon, July 17, 2008 at 7:12pm (emphasis added). 395 See Email within Galleon, July 18, 2008 at 9:46am.
129 428. After months of constant speculation and rumors about AMD’s asset-lite plans, on
August 8, 2008, a reporter quipped:
...AMD’s constant leaks about its asset lite plans are getting tiresome. By the time AMD announces its asset lite strategy, will anyone care? See Exhibit 11.
429. On August 11, 2008, Business Week published that:
AMD has said it’s pursuing a new strategy it calls “asset smart,” aimed at saving money while at the same time preserving its manufacturing muscle.... [A Lehman Brothers analyst] suggests splitting AMD into two companies, one devoted to design, the other to manufacturing. “A separate foundry function might enable it to compete with Intel without the capital required to keep up from a manufacturing standpoint,” and manufacturing could be funded by an investment from a partner, probably Chartered.
Brookwood [a consultant at Insight64] thinks AMD will sell the fabs and the equipment in them to a third party, and then lease them back. Such a move would allow AMD to retain full control of the fabs and operate them, yet greatly reduce the operational expenses. AMD would essentially be paying rent on the fabs and the equipment in them to a landlord. So who would that landlord be? Brookwood thinks a leading candidate might be a sovereign wealth fund like Mubadala Development, the Abu Dhabi-based fund that paid $622 million for a stake in AMD last November.396
430. Beginning on August 12, 2008 (three days before Mr. Rajaratnam allegedly traded on inside information) and continuing through the remainder of August, AMD asset-lite rumors were “accelerating”:
AMD split rumors accelerating.... It is widely expected that Asset Light will part AMD into two companies.... Our sources indicated that critical decisions are being made at this time and the official announcement of Asset Light and Asset Smart will be made next month.
AMD - an announcement re “Asset lite/asset smart” just weeks away?
396 See “AMD vs. Intel: The Challenger’s New Plan,” Business Week, August 11, 2008 at 12:01am (emphasis added).
130 ...analysts expect AMD to get a sizable infusion of cash from its partner and to skirt having to fund the cost of building new plants and buying new chipmaking tools.... “That’s something we might expect to see, where AMD donates the fabs and the other partner donates cash,” said Citigroup analyst Glen Yeung.
We [American Technology Research] believe that asset smart, the final piece of AMD’s manufacturing strategy, will likely be announced before the next earnings call... See Exhibit 11.
431. On September 3 and 5, 2008, analysts at Jefferies & Co. and Bank of America reported that their “channel checks” indicated there would be an official announcement in two weeks:
Our [Jefferies & Co.] Channel checks indicate upcoming AMD spin-off announcement: Our channel checks indicate that AMD may announce its official fab-lite strategy in 2 weeks.
Middle East investment group to contribute cash for stake in new foundry.... We [Jefferies & Co.] anticipate AMD would receive a substantial cash payment for the spin-off which it could use to pay down debt and R&D activity. IBM to contribute process technology.... Germans get new upgrades for their fabs.
...[Bank of America] checks suggest asset-lite transition is imminent. See Exhibit 11.
432. On September 15, 2008, a Wall Street analyst provided the market with even more detail about the impending AMD announcement, such as AMD’s CEO meeting with New
York’s governor to wrap up loose ends:
A sale of a share of AMD’s manufacturing assets to a financial investor (such as Abu Dhabi’s Mubadala’s Development Company, once again). A new company may be the result, “AMD-Foundry” perhaps, and the cash infusion would help AMD eliminate its long- term debt and gain a partner for future capital requirements.... The creation of a joint venture between AMD and an IDM or a foundry. Such a JV would operate AMD’s current fabs in Dresden and bring future capacity on-line with the help of NY State’s $1.2 billion incentive package to develop Luther Forest.... Contacts report that... AMD’s Hector Ruiz met recently with NY’s governor to discuss modifications to the original agreement – modifications
131 which would allow AMD to develop the facility with a partner. See Exhibit 11.
Rajaratnam’s Trades
433. In the twelve months before August 15, 2008 (when Mr. Rajaratnam allegedly received inside information), Mr. Rajaratnam bought and sold 37.2 million shares of AMD with a total transaction value of $346.8 million.397
434. After the alleged receipt of inside information, Mr. Rajaratnam purchased 27.8 million shares of AMD between August 15, 2008 (the day he received the alleged tip) and
October 3, 2008 (four days before AMD’s announcement). These purchases were made over 15 separate trading days and consisted of 30 transactions that ranged from 40,000 shares to 4.0 million shares each. The total cost of this investment was $157.6 million.398
Joint Venture Announcement
435. On October 7, 2008, before the market opened, AMD announced a spin-off of its semiconductor manufacturing business into a joint venture with Advanced Technology
Investment Company (“ATIC”), an investment company formed by the Abu Dhabi government.
As part of this transaction, the joint venture would assume $1.2 billion of AMD’s existing debt;
ATIC would pay AMD $700 million to purchase additional shares in the joint venture; and
397 Source: Galleon OMS Database. 398 Source: Galleon OMS Database. For AMD, I classified a transaction as an alleged insider transaction if it occurred between the date of the alleged tip and the disclosure of the alleged information by the company in question. To determine the timing of a transaction on the date of a company disclosure, I used intraday data, transaction time stamps and/or the time when the news was released. I further required the transaction to be directionally consistent with the allegation (i.e., purchasing on good news or selling short on bad news). If a transaction during this period was directionally inconsistent with the allegation (i.e., a sale when an alleged insider trade would be a purchase), I did not consider this as an alleged insider transaction.
132 Mubadala Development Company (“Mubadala”) would invest $314 million in newly issued
AMD shares and warrants.399
436. On October 7, 2008, AMD’s common stock price increased 8.5% to close at
$4.59 per share. The excess return is statistically significant at the 99% confidence level (see
Exhibit 12).
437. On October 8, 2008, however, AMD’s common stock price decreased 11.8% on
above average volume to close at $4.05 per share. The news and commentary throughout the
day continued to discuss the AMD spin off. The excess return is statistically significant at the
99% confidence level (see Exhibit 12).
438. I note that before AMD’s announcement, its common stock price closed at $4.23
per share on October 6, 2008. After the market had fully absorbed this news over a two-day
period, AMD’s common stock was lower than before the announcement (i.e., $4.05 after vs.
$4.23 before). The two-day excess return is not statistically significant at the 95% confidence level.
439. It is common practice to expand an event window beyond one day if there is reason to expect that the information would continue to affect market prices over more than one day.400 This is the case with the news and analysis released on October 7 and 8. Therefore, it is
399 See “AMD and Advanced Technology Investment Company of Abu Dhabi to Create New Leading-Edge Semiconductor Manufacturing Company,...” Business Wire, October 7, 2008 at 6:00am. 400 It is common in academic studies to look at periods greater than one day. “In practice the period of interest is often expanded to multiple days, including at least the day of the announcement and they day after the announcement. This captures the price effects of announcements which occur after the stock market closes on the announcement day. The periods prior to and after the event may also be of interest.” A. MacKinlay, “Event Studies in Economics and Finance,” Journal of Economic Literature 35, March 1997, 13-39, 15; “The main advice is to carefully identify the exact dates during which the information in question reached
133 inappropriate to narrowly look at only the increase on October 7, 2008 to assess the statistical
significance of the news being released during that day. In my opinion, to test the complete
effect of the AMD joint venture, it is necessary to examine the returns on both October 7 and 8.
the market, and then restrict the window to a short period if possible, generally two or three days around each release of new information.” M. Mitchell and J. Netter, “The Role of Financial Economics in Securities Fraud Cases: Applications at the Securities and Exchange Commission,” The Business Lawyer 49, February 1994, 545-590, 559; “The end of the event window is somewhat more difficult to define. In securities fraud cases, many experts have adopted the convention of looking at one-day, two-day, or five-day periods following an announcement. The most recent academic pronouncement expresses support for the shorter, one-day or two-day window, though it recognizes that in practice longer windows are often used. [fn omitted]” D. Tabak and F. Dunbar, “Materiality and Magnitude: Event Studies in the Courtroom,” in Litigation Services Handbook: The Role of the Financial Expert, Third Edition, ed. by R. Weil, M. Wagner and P. Frank, Wiley, 2001, 19-4. “As with other expert decisions, it is helpful when there is some rationale for the length of the event window chosen. For example, one can employ a standard period over different cases, cutting short the window when new information reaches the public. Alternatively, one can look at some other indicator of materiality, such as trading volume or the quantity of news coverage, to determine the period in which the market was reacting to the new information.” Ibid., fn 20, 19-19. Academic articles using multi-day event windows include: G. Jarrell and A. Poulsen, “Stock Trading before the Announcement of Tender Offers: Insider Trading or Market Anticipation?” Journal of Law, Economics, and Organization 5(2), Autumn 1989, 225-248; T. Lys and L. Vincent, “An Analysis of Value Destruction on AT&T’s Acquisition of NCR,” Journal of Financial Economics 39, 1995, 353-378; R. Comment and G. Jarrell, “The Relative Signaling Power of Dutch-Auction and Fixed-Price Self-Tender Offers and Open-Market Share Repurchases,” Journal of Finance 46, 1243-1271; G. Schwert, “Markup Pricing in Mergers and Acquisitions,” Journal of Financial Economics 41, 1996, 153- 192; K. Womack, “Do Brokerage Analysts’ Recommendations Have Investment Value?” Journal of Finance 51, 1996, 137-167; R. Comment and G. Schwert, “Poison or Placebo? Evidence on the Deterrence and Wealth Effects of Modern Antitakeover Measures,” Journal of Financial Economics 39, 1995, 3-43; W. Li and E. Lie, “Dividend Changes and Catering Incentives,” Journal of Financial Economics 80, 2006, 293-308; K. Kahle, “When a Buyback Isn’t a Buyback: Open Market Repurchases and Employee Options,” Journal of Financial Economics 63, 2002, 235-261; T. Bates, M. Lemmon and J. Linck, “Shareholder Wealth Effects and Bid Negotiation in Freeze-Out Deals: Are Minority Shareholders Left Out in the Cold?” Journal of Financial Economics 81, 2006, 681-708; G. Jiang, P. Mahoney and J. Mei, “Market Manipulation: A Comprehensive Study of Stock Pools,” Journal of Financial Economics 77, 2005, 147-170.
134 Conclusion
440. In summary, my review of the mix of information in the market clearly indicates that the supposedly “material non-public” information was in fact publicly-available and acttively speculated upon by analysts and the financial press. Such publicly-available information includes:
i) AMD’s pursuit of an asset-lite business model;
ii) Spin-off of AMD’s manufacturing operations into a separate company with AMD retaining design capabilities;
iii) Partnering with Mubadala Developpment Company;
iv) Mubadala increasing its equity stake by $1.5 billion to $2.0 billion;
v) Commentary that transaction is a “done deal” with only “paperwork” remaining;
vi) AMD’s statement that “we’ve begun implementing” the asset-lite program; and
vii) Official announcement is “imminent” and expected within two weeks.
441. Based on the substantial level of discussion by Wall Street analysts and the financial press about AMD’s anticipated transformation into an asset-lite company, in my opinion, all of this commentary and analysis was publiclyy-available before AMD’s announcement on October 7, 2008.
442. Based on the market reaction to AMD’s announcement (-4% two-day return), I conclude that AMD’s market price prior to the disclosure already accurately incorporated all of the positive expectations by Wall Street analysts, as well as any inforrmation contained in the alleged tip. I reach this conclusion after observing that the two-day return from October 6, 2008 to October 8, 2008 was not economically material.
135 443. Based on this evidence, I conclude that a well-informed, professional investor
(such as a hedge fund manager) that engages in legal information gathering and related arbitrage trading in the shares of AMD would have been aware of the mix of information in the market that I have discussed above. Further, a hedge fund manager employed at Galleon would additionally be aware of Galleon’s internal research on AMD.
444. Based upon the mix of information available in the marketplace and within
Galleon prior to AMD’s announcement on October 7, 2008, in my opinion, it would be reasonable for such an investor to purchase AMD’s common stock, just as Mr. Rajaratnam had done. In my opinion, this information provided ample justification to take an arbitrage position in AMD ahead of its announcement.
445. Moreover, based on my understanding of the information the SEC is alleging was conveyed in the tip, it is my opinion that the information allegedly tipped to Mr. Rajaratnam was not private information, but rather was substantially similar to information that was already included in the mix of publicly available information. Furthermore, it is my opinion that the announcement was not economically material.
xvi. Clearwire – Joint Venture
446. The SEC alleges that:
[On February 8, 2008, there were] contacts between Goel and Rajaratnam.401
[O]n March 19 and 20, 2008, Goel and Rajaratnam communicated repeatedly. In the course of these communications, Goel provided Rajaratnam with material nonpublic information about the Clearwire Transaction which Goel obtained through his employment at Intel.402
401 See Complaint, ¶109. 402 See Complaint, ¶110.
136 [O]n March 24 [2008] Goel provided Rajaratnam with additional material nonpublic information concerning the Clearwire Transaction.403
Rajaratnam and Goel communicated again on April 1 and April 2, 2008.... On April 15, 2008, Goel communicated to Rajaratnam that things were not happening as planned with respect to the Clearwire Transaction.404
[On April 20, 23 and 30, 2008 there was] contact between Goel and Rajaratnam.405
447. Below, I examine the mix of information available in the marketplace and within
Galleon about Clearwire’s joint venture with Sprint that combined the two companies’ wireless broadband (“WiMax”) businesses into a new wireless communications company prior to
Clearwire’s announcement on May 7, 2008.
Mix of Information
448. Beginning as early as February 2007 (a full year before Mr. Rajaratnam received any allegedly illegal tips), an analyst noted that Clearwire and Sprint were likely M&A partners since both were developing WiMAX networks.406
449. In March 2007, Galleon employees discussed reports that “Clearwire and Sprint
[could] seek to combine WiMAX networks” and that “Sprint could either buy CLWR or could sell its WiMAX assets to Clearwire.”407
403 See Complaint, ¶110. 404 See Complaint, ¶111. 405 See Complaint, ¶112. 406 See Email from Soleil Securities to Galleon containing Soleil Securities analyst report, February 26, 2007 at 11:47am. 407 See Galleon Email, March 19, 2007 at 3:20pm.
137 450. On July 19, 2007, Clearwire and Sprint announced they had entered into a letter of intent to jointly construct the first nationwide mobile broadband network using WiMAX technology.408
451. On November 9, 2007, Clearwire and Sprint announced the termination of their letter of intent signed in July 2007. The two companies indicated they “...could not resolve complexities associated with the LOI [letter of intent] and failed to reach final agreement on the terms of the transaction.”409
452. On December 13, 2007, an analyst at ThinkEquity stated, “[w]e remain convinced of the logic of a Sprint/Clearwire alliance.... We highlight the fact that the companies continue their discussions on the subject, although we expect no new agreement prior to a new Sprint
CEO coming aboard.”410
453. On December 14, 2007, Clearwire’s stock was up 11.2% on takeover speculation.
According to an analyst at Raymond James, “Clearwire’s stock has been boosted by rumors that an announcement may come as soon as this weekend, with a price tag of about $19 per share.
The rumored buyers include Intel Corp....”411
454. An analyst at Galleon was alerted to both of these December analyst reports.412
408 See “Sprint Nextel and Clearwire to Partner to Accelerate and Expand the Deployment of the First Nationwide Mobile Broadband Network Using WiMAX Technology,” Business Wire, July 19, 2007 at 6:00am. 409 See “Sprint Nextel and Clearwire Terminate WiMAX Letter of Intent,” Business Wire, November 9, 2007 at 6:20am. 410 See “Sprint-Clearwire: On Again in 2008?” Unstrung, December 13, 2007; “Rumors Swirl in WiMAX World: Sprint-Clearwire Detente?” The Register, December 17, 2007 at 10:33pm (emphasis added). 411 See “Clearwire’s Stock Surges on Acquisition Report,” RCR Wireless, December 14, 2007 at 2:11pm (emphasis added). 412 See Email from StreetAccount to Galleon, December 17, 2007 at 9:01pm.
138 455. On December 27, 2007, Clearwire announced that Arvind Sodhani, President of
Intel Capital, resigned from Clearwire’s board to “avoid any conflicts of interest that might
arise.”413
456. A Galleon analyst advised Galleon portfolio managers that if this resignation
“...signals the beginning of a process where INTC [Intel] increases investments in WiMAX
operators, then I think the read-through is its more likely at some point S [Sprint] will spin
WiMAX unit into a combined entity w/CLWR (positive for CLWR).”414
457. Analysts at Pali Capital noted that the Intel resignation “...could fuel speculation
that Sprint (S) and CLWR are engaged in strategic discussions again....”415
458. TheStreet.com reported that the resignation had “...raised speculation among
analysts that a transaction [is] in the works.... This implies that the conflict may not be about
Intel, so much as Intel Capital, and could suggest an imminent investment by Intel Capital....
One potential scenario involves Intel boosting its funding of Clearwire.”416
459. On January 9, 2008, analysts at ThinkEquity Partners noted that Clearwire was
“one step closer” to a deal with Sprint:
We believe the next step will be a resumption of the Sprint/Clearwire alliance.... [T]his lends optimism that the Clearwire alliance could happen soon, perhaps during 1Q08.417
413 See “Intel Corporation to Nominate New Representative to Replace Arvind Sodhani on Clearwire Corporation’s Board of Directors,” Business Wire, December 27, 2007 at 4:18pm. 414 See Email from Galleon analyst, December 28, 2007 at 8:28am (emphasis added). 415 See “Briefing.com: In Play Daily,” Briefing.com, December 29, 2007 at 12:01am (emphasis added). 416 See “Intel Looks Cozy with Clearwire,” TheStreet.com, January 7, 2008 at 4:07pm (emphasis added). 417 See Email from ThinkEquity Partners to Galleon containing ThinkEquity analyst report, January 9, 2008 at 7:26am (emphasis added).
139 460. The ThinkEquity Partners analyst report was also reported on in the financial
press.418
461. On January 29, 2008, The Wall Street Journal reported that Sprint was in talks
with Clearwire:
Sprint Nextel Corp. (S) has revived serious discussions with startup Clearwire Corp. (CLWR) to form a joint venture that would bring in outside funding from the likes of Intel Corp. (INTC), Google Inc. (GOOG) and retailer Best Buy Co. (BBY) to build a high-speed wireless network using WiMAX technology, according to people familiar with the matter.419
462. A Galleon analyst sent an instant message on January 29, 2008 within Galleon
regarding Clearwire that he was “hearing intc buyout rumors” and noted “wsj: s in talks w/clwr
on jv.”420
463. Also in a January 29, 2008 email to Galleon, an analyst at J.P. Morgan
commented on The Wall Street Journal article:
A deal seems likely.... [W]e believe it is likely just a matter of time before a deal is finalized.... We believe discussions have been ongoing since the termination of the LOI.421
464. Barron’s noted that Clearwire’s stock price “soared” 25% on January 29, 2008
after The Wall Street Journal reported that Sprint and Clearwire were “in talks.”422 Numerous other stories reported on this news.423
418 See “CLWR: Clearwire: ThinkEquity Believes There Will Be a Resumption of the Sprint/Clearwire Alliance,” Bloomberg News, January 9, 2008 at 9:47am. 419 See “WSJ: Sprint in Talks with Clearwire to Form Joint Venture,” Dow Jones News Service, January 29, 2008 at 1:03pm (emphasis added). 420 See Instant Message from Galleon analyst, January 29, 2008 at 12:29pm and 1:03pm. 421 See Email from J.P. Morgan to Galleon containing J.P. Morgan analyst report, January 29, 2008 at 2:58pm (emphasis added). 422 See “Clearwire Reportedly in Talks With Sprint on WiMAX Venture; Potential Investments from GOOG, INTC, BBY,” Barron’s, January 29, 2008.
140 465. On January 30, 2008, Clearwire would not comment directly on The Wall Street
Journal story, but said the company is “talking to folks” about the potential for outside investors.424
466. In a January 31, 2008 email to Galleon, an analyst at Canaccord Capital that attended Clearwire’s investor day noted that “management did indicate that it is currently in discussion with potential strategic investors....”425
467. In a January 31, 2008 email to Galleon, analysts at ThinkEquity Partners again stated “[w]e believe the next step is to renew the Sprint/Clearwire alliance, which could be announced this quarter.”426
423 See “Clearwire, Sprint Resume Talks,” Bloomberg News, January 29, 2008 at 12:47pm; “Sprint Starts Talks with Clearwire Over WiMAX Again,” Bloomberg News, January 29, 2008 at 1:23pm; “Sprint Renews Wireless Venture Talks with Clearwire, WSJ Says,” Bloomberg News, January 29, 2008 at 1:38pm; “Clearwire Gains After WSJ Says Talks Restart on Sprint Venture,” Bloomberg News, January 29, 2008 at 1:42pm; “Sprint, Clearwire Said to Revive Talks; Reportedly Seek Deep-Pocketed Partners for WiMAX Venture,” MarketWatch, January 29, 2008 at 1:46pm; “Sprint, Clearwire Shares Rise on WiMAX Report,” Reuters News, January 29, 2008 at 2:11pm; “Sprint in Talks with Clearwire to Form Joint Venture,” Dow Jones Chinese Financial Wire, January 29, 2008 at 2:42pm; “Clearwire-CLWR at the Money Calls-Out of the Money Puts Active on Renewed Chatter,” Bloomberg News, January 29, 2008 at 3:53pm; “Clearwire Gains after WSJ Says Sprint Talks Renewed,” Bloomberg News, January 29, 2008 at 4:05pm; “Telecom Shares Jump; Sprint Nextel, Clearwire Rise on Reports of WiMAX Discussion,” AP Newswires, January 29, 2008 at 4:13pm; “Boeing, Clearwire, Intuitive Surgical: U.S. Equity Movers Final,” Bloomberg News, January 29, 2008 at 4:36pm; “Clearwire, Sprint Said to Resume WiMAX Joint Venture Talks,” AP Newswires, January 29, 2008 at 5:46pm; “Clearwire, Sprint Said to Resume WiMAX Joint Venture Talks,” The Canadian Press, January 29, 2008 at 5:48pm; “Clearwire, Sprint Said to Resume WiMAX Joint Venture Talks,” AP Newswires, January 29, 2008 at 5:50pm. 424 See “Clearwire ‘08 Forecasts Disappoint, Shares Fall,” Reuters News, January 30, 2008 at 4:55pm. 425 See Email from Canaccord Capital to Galleon containing Canaccord Capital analyst report, January 31, 2008 at 7:06am (emphasis added). 426 See Email from Think Equity Partners to Galleon containing ThinkEquity Partners analyst report, January 31, 2008 at 7:15am.
141 468. The ThinkEquity Partners analyst report was also reported on in the financial press.427
469. In a January 31, 2008 email to Galleon, analysts at Bear Stearns corroborated The
Wall Street Journal story:
Our checks concur with press reports (WSJ-1/29/08) that Sprint is negotiating with Intel Capital and Best Buy to invest in its WiMAX effort - a deal which could include an investment in CLWR. We believe this is a high priority for S and wouldn’t be surprised to see an announcement in 1Q.428
470. In a February 1, 2008 email to Galleon, analysts at Sales Pulse Research reported on their recent checks:
Our checks lead us to believe Sprint is moving forward with their XOHM Wimax efforts and their roaming agreements with Clearwire... We also believe Sprint has finalized at least one of the remaining funding commitments and two others are reportedly in final negotiations to enable infrastructure deployments for 2008. Regarding their XOHM efforts we have uncovered evidence of executive and employee movement from legacy Sprint/Nextel within the past 2 weeks to join the XOHM organization.429
471. In a February 5, 2008 email to Galleon, an analyst at ThinkEquity Partners commented that Clearwire was “near the finishing line”:
We believe Clearwire is near the finishing line for solving its funding and strategic nationwide coverage needs.... We believe the announcement of the second version of an Xohm alliance
427 See “Clearwire Shares Climb Slightly After Plunging on Dashed Investor Hopes of Sprint Deal,” AP Newswires, January 31, 2008 at 1:08pm; “Movers Roundup: CVS Caremark Jumps After 4Q Profits Surges, Clearwire Climbs on Analyst Reports,” AP Newswires, January 31, 2008 at 3:12pm; “Telecom Stocks Inch Higher Along with Rest of Wall Street, Clearwire Up,” AP Newswires, January 31, 2008 at 4:11pm; “Clearwire Shares Gain After Plunging on Dashed Investor Hopes of Sprint Deal,” AP Newswires, January 31, 2008 at 7:59pm. 428 See Email from Bear Stearns to Galleon containing Bear Stearns analyst report, January 31, 2008 at 8:46am (emphasis added). 429 See Email from Sales Pulse Research to Galleon, February 1, 2008 at 3:16pm (emphasis added).
142 between Clearwire and Sprint is to be expected sooner rather than later. The form could be a separately-funded venture, with backers including the rumored Intel, Best Buy, Google, and SK telecom among others.430
472. On February 5, 2008, Reuters News reported that Kuwait’s Investment Dar was considering investing up to $800 million in an unnamed U.S. telecom operator. A Stanford
Group analyst thought Sprint and Clearwire were the most likely companies for investment.431
473. On February 8, 2008, Unstrung reported that a ThinkEquity analyst believed a deal “could be announced” by “next week”:
The WiMax relationship between Clearwire… and Sprint Nextel… could be rekindled as early as next week – with a little help from Google… and friends – according to a ThinkEquity LLC analyst.
ThinkEquity analyst Eric Kainer says in a report that Clearwire is “close to the finish line” in striking a new network deal with Sprint, which would be financially backed by Best Buy, Google, and SK Telecom…
Kainer tells Unstrung that a deal could be announced at the Mobile World Congress in Barcelona next week, or soon after. “I believe that’s the most likely time for Clearwire to announce the deal,” he says.432
474. On February 12, 2008, a Galleon analyst apparently added shares of Clearwire to
his “paper portfolio”:
CLWR - I added to my long today as data pointing towards heated discussions keep coming out and i think the company would benefit from a potential jv, infusion of capital, and other potential strategic partnerships like a Q reseller deal, etc.433
430 See Email from ThinkEquity Partners to Galleon, February 5, 2008 at 8:55am (emphasis added). 431 See “Reuters Summit-Kuwait’s Investment Dar Eyes U.S. Telco,” Reuters News, February 5, 2008 at 7:36am. 432 See “Clearwire-Sprint Deal Soon?” Unstrung, February 8, 2008 (emphasis added). 433 See Email from Galleon analyst, February 12, 2008 at 9:08pm (emphasis added).
143 475. In a classic example of the “mosaic theory,” in two February 13, 2008 emails to
Galleon, an analyst at JNK Securities took particular note of Sprint’s “obvious omission” of
WiMAX when communicating with analysts and that Sprint employees were no longer willing to talk about WiMAX:
Sprint recently put out a note to industry analysts highlighting their strengths - at no point did they mention WiMAX even when talking about being “fully committed to enhancing the wireless” assets. This was a change from past statements, and our consultant Iain Gillott believes this is an amazingly obvious omission.
Iain has extensive contacts at the Company whom have gone quiet on WiMAX when recently asked about its future.
Iain believe Sprint should and will divest WiMAX (possibly to CLWR).... We are however unsure on timing but do think such a divestiture is a high probability.434
We know that Sprint and Clearwire are discussing a WiMAX roaming agreement. Intel Capital also had to leave the board of Clearwire due to “potential conflict of interest”. And obviously, new Sprint CEO Dan Hesse is looking to revitalize the company as soon as possible, including the addition of turnaround-specialist Ralph Whitworth to the board. It seems logical that a financial specialist would advise against spending billions on a new technology with potential returns far in the future when the company is loosing (sic) its core base of users. From these happenings and conversations with industry insiders, we are led to believe, more than ever, that Sprint Nextel will pull back from its WiMAX deployment plans.... IGR believes that Xohm is likely to end up as either a separate company or part of a bigger relationship with Clearwire.... [T]his could be accomplished with a minority stake in Clearwire for example.435
476. On February 15, 2008, a Galleon analyst emailed Galleon portfolio managers an article from TheStreet.com, which indicated a Clearwire/Sprint deal was only days away:
434 See Email from JNK Securities to Galleon, February 13, 2008 at 11:37am (emphasis added). 435 See Email from JNK Securities to Galleon, February 13, 2008 at 8:00am (emphasis added).
144 Street.com says clwr/s deal and funding could come soon. The deal... could be announced in the next few days...436
477. In a February 15, 2008 email to Galleon, an analyst at Robert W. Baird & Co.
stated:
Highly likely Sprint spins off its XOHM WiMAX network to partnership of Clearwire, maybe Google, Intel and an investment fund out of Kuwait. Term sheets are out. Sprint would retain 51% controlling stake.437
478. On February 19, 2008, reports surfaced about a pending Clearwire/Sprint deal:
[W]e’re now learning that a deal may be closer than ever. Reportedly, both firms are close to announcing the formation of a WiMAX joint venture funded in part by a $2 billion injection from Intel...438
The MWC [Mobility World Congress] was full of chatter that Intel was preparing to infuse Xohm with a $2 billion investment in some form of merger with Clearwire.439
Intel plays matchmaker with Sprint and Clearwire.... Over the past few months, we’ve heard more than a few rumors that Sprint and Clearwire would kiss and make up - and most of these rumors speculated that Intel would facilitate. We all know that Intel has already invested a fair amount in WiMAX... And now it looks like the rumors were true.440
436 See Email from Galleon analyst, February 15, 2008 at 9:01am (emphasis added). 437 See Email from Robert W. Baird & Co. to Galleon, February 15, 2008 at 3:20pm (emphasis added). 438 See Email from Galleon trader to Galleon portfolio managers, February 19, 2008 at 7:38am (emphasis added). 439 See Email from Deutsche Bank to Galleon containing Deutsche Bank analyst report, February 19, 2008 at 7:56am (emphasis added). 440 See “Intel Plays Matchmaker with Sprint and Clearwire,” The Register, February 19, 2008 at 1:02pm (emphasis added).
145 479. On February 28, 2008, Sprint acknowledged that it was continuing to talk with
Clearwire regarding a possible joint venture, but Sprint’s CEO said no final agreement had been struck.441
480. On March 4, 2008, Clearwire announced its fourth quarter results. During the conference call with analysts, Clearwire’s CEO said they were engaged in “active and regular discussions” with Sprint.442 Market commentary after the earnings announcement was as follows:
The Street continues to nervously wait on any agreement with Sprint or another partner.443
The company is essentially in a holding pattern as it negotiates a transaction with Sprint.... The near term results are weak but frankly they are somewhat irrelevant at this point as the company is in a cash conservation mode.444
Awaiting The Sprint Announcement. Clearwire’s quarterly results were dominated by hopes for a fully-funded national joint venture with Sprint, fueled by company commentary on “active and regular” discussions, “many alternatives,” and “maximizing full potential....” Comments on Clearwire’s 4Q conference call lend hope that the announcement may come soon.445
Clearwire results disappoint; we still think a Sprint tie-up makes sense.446
441 See “Sprint CEO Adjusted OIBDA Down $1.8B-$1.9B in 1Q,” Dow Jones News Service, February 28, 2008 at 8:20am. 442 See “CLWR - Q4 2007 Clearwire Corp Earnings Conference Call,” Thomson StreetEvents, March 4, 2008 at 11:00am. 443 See “Clearwire Quarterly Loss Widens, Shares Tumble,” Reuters News, March 4, 2008 at 8:14am (emphasis added). 444 See “Clearwire Stock Falls on weak Results, Forecast; Investors Wait for Word on Sprint Deal; Stock in Holding Pattern,” MarketWatch, March 4, 2008 at 12:47pm (emphasis added). 445 See Email from ThinkEquity Partners to Galleon containing ThinkEquity Partners analyst report, March 5, 2009 at 10:21am (emphasis added). 446 See Email from Merrill Lynch to Galleon, March 7, 2008 at 1:51am.
146 481. In early March 2008, Intel hosted an analyst day. Based on Intel’s comments, several analysts continued to actively discuss the state of the Clearwire/Sprint negotiations and the prospects for a large capital investment by Intel:
[Stanford] says meetings with executives from INTC’s WiMAX group support their expectation of a WiMAX partnership between Sprint and CLWR.447
Take is they’re in constant negotiations to hammer this out, S wants to spin asset off balance sheet but keep economic benefits down the road, only disconnect with market expect[ation]s of issues is taking time to hammer out the details.448
Heard that the Intel investor day was pretty suggestive iof (sic) a deal…449
Analyst Day Highlights… Intel reiterated its focus on WiMax… [N]ews reports suggest that Intel may be making a $2 billion investment in a remerged Sprint Nextel-Clearwire WiMax network… We note that recent news reports… suggest that Sprint and Clearwire may renew their relationship. We believe investors are likely to be encouraged that Intel has made any capital commitment to Sprint-Clearwire.450
Detwiler saying deal is near, not question of if but when, expect CLWR to have a good deal of control in JV and S to be passive investor – consistent with what I’ve heard and positive.451
We attended Intel’s analyst day last week to learn more about its WiMax plans and the potential for an investment in CLWR and S. Intel is Fully Committed to WiMax…. In our view, Intel appears interested in making an investment in a combined S-CLWR.... There is very little precedent for Intel making a $1-$2BN investment in a non-core business…. However, we believe that
447 See Email from StreetAccounts to Galleon, March 7, 2008 at 7:53am. 448 See Email from Galleon analyst to Galleon portfolio managers, March 7, 2008 at 8:15am (emphasis added). 449 See Email from JPMorgan to Galleon, March 10, 2008 at 10:43pm. 450 See Email from Lehman Brothers to Galleon containing Lehman Brothers analyst report, March 17, 2008 at 8:40am (emphasis added). 451 See Instant Message from Galleon analyst, March 17, 2008 at 9:28am (emphasis added).
147 Intel is only one of a number of parties that will likely provide funding. We continue to believe that parties like Google, other handset manufacturers and wireline or cable partners will be part of the consortium that funds CLWR/S.
Timing of Deal is Unclear. Intel mgmt states WiMAX has no significant time advantage over LTE and therefore there is no reason to rush an investment.452
482. On March 25, 2008, Clearwire filed a Form 8-K with the SEC that added an executive severance plan in the event of a change in control.453 An analyst at Pali Capital found this “golden parachute” announcement to be “...interesting in light of on-going negotiations with
Sprint....”454
483. During the last few days of March, analysts were buzzing with the possibility of a
Clearwire/Sprint announcement at the upcoming CTIA conference in Las Vegas.
There has been some talk that there could be an announcement next week during CTIA, although our analyst believes the parties aren’t close to an announcement because of the bigger issues plaguing S.455
Sprint CEO Dan Hesse is pressing all parties to wrap up discussions in time for the wireless industry’s trade show next week in Las Vegas, so Sprint can have something to present to investors.456
452 See Email from J.P. Morgan to Galleon containing J.P. Morgan analyst report, March 17, 2008 at 11:36am (emphasis added). 453 See “Clearwire Adds Executive Severance Plan for Change of Control,” Bloomberg News, March 25, 2008 at 12:15pm. 454 See Email from Pali Capital to Galleon, March 25, 2008 at 1:06pm (emphasis added). 455 See Email from Pali Capital to Galleon, March 25, 2008 at 1:06pm (emphasis added). 456 See “WSJ: Comcast, Time Warner Cable in Wireless Talks,” Dow Jones Chinese Financial Wire, March 25, 2008 at 11:31pm (emphasis added).
148 [Analyst at Pali Capital] thinks deal may not get done before CTIA next week, doesnt (sic) think cable guys care about S CEO hesse’s deadlines...457
We [J.P. Morgan] remain confident that S and CLWR will combine their spectrum assets and land outside financing. However, it is difficult to forecast the timing of such a deal given the complexities of such an arrangement and the size and number of parties involved.458
The JV makes a lot of sense, but most likely nothing will be announced before CTIA, although they would like to announce it before or at CTIA. It didn’t get done last summer because it was a “battle of egos.” Negotiations are in full swing but not sure if concludes by CTIA.459
Surveyed a group of analysts who publish on CLWR, mixed bag on what expectations are for timing of a potential deal with S and investors... Happens next week - 2; Don’t know - 3; Will take more time - 3.
ML - thinks WSJ article makes sense, legit opportunity, seems feasible for next week given its been a long time coming and WSJ says Hesse is pushing for it. Not sure if it happens in next few days but thinks w/in a few weeks def see something.
JPM - has no idea if deal gets done for CTIA (worried this deal has gotten put off many times and risk owning into CTIA if no announcement). Don’t bank on the timing but thinks article is real.
Pali - doesn’t think it happens for CTIA.... WSJ article was not intended to say it gets done, just that S wanted to get it done by 4/1. Never say never on timing, but doubtful.
BS thinks could get done by next week, he says wait and probably a good short on both CLWR/S at that point.
Stanford - thinks article was dead on, timing thinks Hesse wants to announce something at CTIA could see some sort of
457 See Instant Message from Galleon analyst, March 26, 2008 at 7:35am (emphasis added). 458 See Email from J.P. Morgan to Galleon containing J.P. Morgan analyst report, March 26, 2008 at 10:04am (emphasis added). 459 See Email from Rengan Rajaratnam to Raj Rajaratnam regarding calls with JNK consultant and infrastructure consultant, March 27, 2008 at 2:06pm (emphasis added).
149 announcement before final agreement is determined (did this last summer letter of intent)...
WACH... timing is a tough call cited articles but didn’t sound like he had a clue said gut would be tough to put together in time for CTIA.
Stifel - sounds credible, doesn’t think it happens in time for CTIA...
CSFB Cable analyst - doesn’t cover it,... he met with TWC, doesn’t get the sense of near term deal/investment as written in the WSJ.460
[ThinkEquity Partners] thinks INTC needs to have this ready soon because chips are ready now and CPE ready in June. If there is no announcement next week there is downside in the stock.461
CLWR’s CEO and CFO have cancelled all meetings while at CTIA so we are instead meeting with CTO. No reason was given but we assume it has something to do with ongoing negotiations with Sprint.462
484. On March 25, 2008, The Wall Street Journal reported that the Clearwire/Sprint joint venture would receive a cash infusion of $3 billion. One analyst thought the level of funding could even be as high as $5 billion to $10 billion.
Comcast Corp. and Time Warner Cable Inc., the two largest U.S. cable providers, are discussing providing funding for a new wireless company run by Sprint Nextel Corp. and Clearwire Corp.... Comcast would put up as much as $1 billion and Time Warner $500 million.... Bright House Networks, the sixth-largest cable operator, may contribute as much as $200 million to the venture...463
Today’s Wall Street Journal (WSJ) indicates that Clearwire and Sprint are about to clinch a deal to combine their WiMax network assets and spectrum with $3B in fresh funding from Intel, Google,
460 See Email from Galleon analyst, March 27, 2008 at 6:33pm (emphasis added). 461 See Email from Galleon analyst, March 27, 2008 at 8:39pm. 462 See Email from Pali Capital to Galleon, March 31, 2008 at 11:41am (emphasis added). 463 See “Comcast, Time Warner Discuss Funding Wireless Company, WSJ Says,” Bloomberg News, March 25, 2008 at 9:19pm (emphasis added).
150 and Sprint’s Pivot partners Comcast, Time Warner Cable, and Brighthouse, with a focus on completing the arrangements such that Sprint could announce the agreement at CTIA next week.... We anticipate an aggregate level of new funding at $5B-10B, rather than the reported $3B.464
think eq note last night saying could see 5-10bn in funding vs WSJ article ~3bn... seems a bit of a stretch.465
We [J.P. Morgan] assume Sprint and strategic investors could take equity in CLWR at $14 - $18/share...466
485. Although no deal was announced at CTIA, Sprint’s CEO did confirm on April 2,
2008 that they were “still in talks” with Clearwire.467 Throughout April, analysts continued to speculate on the timing of an announcement:
[Bear Stearns] expect deal in next 2 weeks.468
CLWR - [Raymond James analyst]... could hear more news when S reports - date bouncing around between 4/30 and 5/12...469
S/CLWR must act fast.... The urgency for S/CLWR to act fast is greater than we thought. HSPA upgrades that will come out well before LTA could erode the WiMax first mover advantage if network deployment is delayed.470
CLWR cancelled their meeting that Rollins [Citigroup] had planned tomorrow...471
464 See Email from ThinkEquity Partners to Galleon containing ThinkEquity Partners analyst report, March 27, 2008 at 9:40am (emphasis added). 465 See Instant Message from Galleon analyst, March 27, 2008 at 8:30am (emphasis added). 466 See Email from J.P. Morgan to Galleon containing J.P. Morgan analyst report, March 27, 2008 at 10:30pm. 467 See Email from StreetAccount to Galleon, April 2, 2008 at 12:47pm (emphasis added). 468 See Email from Bear Stearns to Galleon, April 3, 2008 at 8:51pm (emphasis added). 469 See Email from Galleon analyst, April 14, 2008 at 4:57pm. 470 See Email from J.P. Morgan to Galleon containing J.P. Morgan analyst report, April 14, 2008 at 6:16am (emphasis added). 471 See Email from Citigroup to Galleon, April 15, 2008 at 9:24am (emphasis added).
151 Clearwire-CLWR volatility at 108; renewed takeover speculation circulating; CLWR is recently trading up 39c to $14.10 on renewed takeover chatter.472
(Barron’s Online) reported Clearwire Higher As Takeover Rumors Crop Up.473
Talks still going on, expects deal – positive, notes cable/INTC dragging feet on funding, INTC not happy WiMAX launches delayed...474
Sources expect a revived Sprint / Clearwire JV to be announced as early as next week.... While details are still fuzzy, sources were adamant that CLWR management would be running the JV, with its Chairman Craig McCaw taking an active role. We also hear that additional funding will be provided by Intel (INTC), Best Buy (BBY) and Google (GOOG), whose involvement has been rumored previously.475
JNK call today is positive for S and CLWR on intent for deal to happen, but negative on timing doesn’t think in time for 5/12 S earnings.... Action [Galleon analyst]: Going to trim some CLWR here until getting more clarity on timing.476
A Cowen analyst said Tuesday that he expects Sprint Nextel Corp. to strike a major deal soon, and upgraded the cell phone service provider’s shares to “Outperform” from “Market Perform.”477
486. On April 29, 2008, Galleon trader, Ian Horowitz, indicated to Galleon’s portfolio managers that he was “...not adding [Clearwire] here, but continuing to own for the potential
WiMax deal in future.”478
472 See “Clearwire-CLWR Volatility at 108; Renewed Takeover Speculation Circulating,” Bloomberg News, April 22, 2008 at 10:48am (emphasis added). 473 See “Clearwire Corporation - Company News,” NewsTrak Daily, April 24, 2008 (emphasis added). 474 See Email from Galleon analyst to Galleon portfolio managers, April 23, 2008 at 3:44pm (emphasis added). 475 See Email from Detwiler to Galleon, April 25, 2008 at 1:37pm (emphasis added). 476 See Email from Galleon analyst to Galleon portfolio managers, April 30, 2008 at 11:49am (emphasis added). 477 See “Ahead of the Bell: Sprint Upgraded on Possible Deals,” AP Newswires, May 6, 2008 at 9:12am (emphasis added).
152 487. On April 30, 2008, a Galleon analyst sold 50,000 shares of Clearwire in his paper
portfolio based on “...incremental data point JNK today saying deal will get done, risk is on timing, trimming here.”479
488. On May 6, 2008, an analyst at Cowen “expected” Sprint to “strike a major deal
soon, and upgraded the cell phone service provider’s shares to ‘Outperform’ from ‘Market
Perform.’”480
489. Also on May 6, 2008 (the day before Clearwire announced the joint venture), The
Wall Street Journal reported the Clearwire/Sprint joint venture would be valued at more than $12 billion:
The carrier [Sprint] is closing in on a deal to create a joint venture with Craig McCaw’s Clearwire Corp. that would build a nationwide high-speed wireless network using WiMax.... The venture, which would be backed by more than $3 billion in equity financing from leading cable providers and tech giants including Intel Corp. and Google Inc., would be valued at more than $12 billion, people familiar with the situation said.481
Rajaratnam’s Trades
490. After the alleged receipt of inside information on February 8, 2008, Mr.
Rajaratnam purchased 1.1 million shares of Clearwire between February 8, 2008 and May 6,
2008. These purchases were made over seven separate trading days and consisted of ten
478 See Email from Galleon trader to Galleon portfolio managers, April 29, 2008 at 8:11am. 479 See Email from Galleon analyst to Galleon portfolio managers, April 30, 2008 at 11:51am. 480 See “Ahead of the Bell: Sprint Upgraded on Possible Deals,” AP Newswires, May 6, 2008 at 9:12am (emphasis added). 481 See “Sprint Mulls Shedding Nextel Unit – Weighing Spinoff or Sale, Carrier Could Unwind 2005 Merger,” The Wall Street Journal, May 6, 2008 (emphasis added).
153 transactions that ranged from 25,000 shares to 325,000 shares each. The total cost of this investment was $16.8 million.482
Joint Venture Announcement
491. On May 7, 2008, before the market opened, Clearwire and Sprint announced they were combining their next-generation wireless broadband businesses to form a new wireless communications company. This new company would focus on expediting the deployment of the first nationwide mobile WiMAX network. As part of the combination, Intel, Google, Comcast,
Time Warner Cable and Bright House Networks had agrreed to invesst $3.2 billion into the new company.483
492. On May 7, 2008, Clearwire’s common stock price decreased 1.5% to close at
$16.22 per share. The excess return is not statistically siignificant at the 95% confidence level
(see Exhibit 13).
Conclusion
493. In summary, my review of the mix of information in the market clearly indicates that the supposedly “material non-public” information was in fact publicly-available and acttively speculated upon by analysts and the financial press. Such publicly-available information includes:
i) Constant status updates of the widely anticipaatted Clearwire/Sprint joint venture;
ii) On December 27, 2007, implications and market signals regarding status of negotiations after the resignation of Intel Caapital executive from Clearwire’s board of directors; suggestion of “imminent investment” by Intel Capital into Clearwire;
482 Source: Galleon OMS Database; Complaint, ¶¶109-112. 483 See “Sprint and Clearwire to Combine WiMAX Businesses, Creating a New Mobile Broadband Company,” Business Wire, May 7, 2008 at 6:00am.
154 iii) On January 29, 2008, Clearwire’s stock price “soared” 23% after The Wall Street Journal reported that Sprint and Clearwire were “in talks” and that Intel Capital and others would provide “funding;”
iv) Chatter in February 2008 that Inteel Capital would make a $2 billion investment in Clearwire joint venture;
v) Direct confirmation from executives at both Clearwire (March 4, 2008) and Sprint (April 2, 2008) that parties were in active negotiations;
vi) On March 25, 2008, Clearwire provided its executives with “golden parachutes;”
vii) Beginning as early as March 25, 2008, the joint venture was expected to receive approximately a $3 billion cash infusion from strategic investors such as Intel Capital, Google, Comcast, Time Warner Cable, Brighthouse and others;
viii) Checks indicated that part of funddiing had been “finalized” and others were in “final negotiations;”
ix) In late March 2008, Sprint CEO was “pressing” all parties to finalize negotiations;
x) In late March and mid-April 2008, Clearwire executives were cancelling meetings with Wall Street analysts; and
xi) Rumors that “deal is near,” “confiident” in deal, “about to clinch deal,” “closing in on a deal” and “JV to be announced as early as next week.”
494. Based on the substantial level of discussion by Wall Street analysts and the financial press about the Clearwire/Sprint joint venture, in my opinion, all of this commentary and analysis was publicly-available before the Clearwire/Sprint joint venture announcement on
May 7, 2008.
495. Based on the market reaction to Clearwire’s joint venture announcement (-1%), I conclude that Clearwire’s market price prior to the disclosure already accurately incorporated all of the positive expectations by Wall Street analysts, as well as any information contained in the alleged tips. I reach this conclusion after observing that: (i) the direction of Clearwire’s stock
155 price movement on May 7, 2008 was directionally inconsistent with the SEC’s allegation and (ii) such price movement was not economically material.
496. Based on this evidence, I conclude that a well-informed, professional investor
(such as a hedge fund manager) that engages in legal information gathering and related arbitrage trading in the shares of Clearwire would have been aware of the mix of information in the market that I have discussed above. Further, a hedge fund manager employed at Galleon would additionally be aware of Galleon’s internal research on Clearwire.
497. Based upon the mix of information available in the marketplace and within
Galleon prior to the Clearwire/Sprint joint venture announcement on May 7, 2008, in my opinion, it would be reasonable for such an investor to purchase Clearwire’s common stock, just as Mr. Rajaratnam had done. In my opinion, this publicly-available information provided ample justification to take an arbitrage position in Clearwire ahead of its announcement.
498. Moreover, based on my understanding of the information the SEC is alleging was conveyed in the tip, it is my opinion that the information allegedly tipped to Mr. Rajaratnam was not private information, but rather was substantially similar to information that was already included in the mix of publicly available information. Furthermore, it is my opinion that the announcement was not economically material.
xvii. eBay – Workforce Reduction
499. The SEC alleges that:
On or about Thursday, October 2, 2008, Kumar learned through another McKinsey client, an eBay subsidiary, that eBay was planning to announce a major work force reduction on the following Monday, October 6, 2008, and that such information was confidential.484
484 See Complaint, ¶154.
156 On or around October 3, 2008, Kumar tipped Rajaratnam to this material nonpublic information.485
500. Below, I examine the mix of information available in the marketplace and within
Galleon about eBay’s work force reduction prior to eBay’s announcement on October 6, 2008.
Mix of Information
501. On September 5, 2008 (one month before the SEC contends Mr. Rajaratnam
received inside information), a Galleon analyst attended an eBay investor conference.486 Based on comments made by eBay’s CFO about their 16,000 employees, the Galleon analyst commented to Galleon’s portfolio managers that eBay was “...not ruling out moving parts of the bus[iness] offshore-leaving door open to downsize.”487
502. On September 9, 2008, Stanford Group initiated coverage on eBay with a hold
recommendation and expressed concern that the company’s “...growth rate has slowed
meaningfully and the global economic slowdown may further hinder growth.”488
503. On September 11, 2008 (three weeks before the SEC contends Mr. Rajaratnam
received inside information), an analyst at Wedge Partners sent an instant message to Galleon
regarding a forthcoming “significant layoff” at eBay:
Our checks continue to suggest that eBay’s business is deteriorating. We believe the company is seeing core metrics decline and is readying a significant layoff that will hit numerous groups inside the company.489
485 See Complaint, ¶154. 486 See “EBay Meeting Teleconference,” Bloomberg News, September 5, 2008 at 1:58pm. 487 See Email within Galleon, September 5, 2008 at 1:13pm (emphasis added). 488 See “EBAY: eBay Initiated with a Hold at Stanford,” Bloomberg News, September 9, 2008 at 8:59am. 489 See Instant Message from Wedge Partners to Galleon, September 11, 2008 at 3:19pm (emphasis added).
157 504. On September 12, 2008, Wedge Partners email to Galleon a note that:
We are getting a lot of feedback and interest in our EBAY note from yesterday.... [F]undamentals are deteriorating and fixing that deterioration and turning things around will involve a significant re-sizing of the business...490
505. On September 15, 2008, Barron’s reported that “more trouble is brewing for eBay
– and its employees”:
...investment-research firm Wedge Partners wrote late last week that the company’s business is “deteriorating” and that the company is readying layoffs that could affect 10% of the company’s 15,000 employees.491
506. The Wedge Partners report and Barron’s article were both reported on in the
financial press.492
507. I note that eBay’s stock price had no statistically significant stock price reactions
to the news of pending layoffs on either Thursday, September 11 (when Wedge Partners released
its report); Friday, September 12; or Monday, September 15 (when the financial press discussed
the prospect of layoffs).
508. On September 17, 2008, Merrill Lynch cut its price target for eBay from $30 to
$27 per share.493
509. On September 25, 2008, Citigroup emailed an analyst report to Galleon
commenting about the takeaways from their Internet/eCommerce trends call:
490 See Email to Galleon, September 12, 2008 at 12:08pm (emphasis added). 491 See “Low Bid: Why eBay Shares Trade Near Their Five-Year Low,” Barron’s, September 15, 2008 (emphasis added). 492 See “Ebay May Cut 1,500 Jobs - Barron’s,” Reuters News, September 14, 2008 at 9:14am; “eBay May Cut 1,500 Jobs; U.S. Online Auctioneer eBay Inc May Cut 1,500 Jobs, According to an Article in Barron’s Weekly, Citing a Report Published Last Week by Investment-Research Firm Wedge Partners,” PC Magazine, September 15, 2008. 493 See “Merrill Lynch & Co., Inc.,” JagNotes.com, September 17, 2008 at 9:05am.
158 Sellers seem to be continuing to migrate their sales away from eBay’s platform...
...we came away [from the call] incrementally more negative on EBAY... If eBay rollout of new pricing structure, 30-day listing format, is not going smoothly, and if the search algorithm changes are really disadvantaging some of the larger sellers, a turnaround at eBay is unlikely to occur in Q3, and risk that Q4 GMV [gross merchandise volume] growth remains muted could keep stock under pressure near term.494
510. Commenting on the Citigroup report, a Galleon analyst told Galleon’s portfolio managers that “ebay [was] looking bad” and that he “will look to short... ebay at 24-25.”495
511. The Citigroup analyst report was reported on in the financial press.496
512. On September 27, 2008 (six days before the SEC contends Mr. Rajaratnam received inside information), Bloomberg News reported eBay was planning to layoff 10% of its workforce:
EBay Inc.... plans to cut 10 percent of its 15,000-strong global workforce... [with] most of the layoffs at management level, while customer service departments will be spared... citing a cost-savings plan to be published shortly.497
513. Again, the stock price reaction was not statistically significant.498
514. On September 30, 2008, Goldman Sachs cut its price target from $30 to $26 per share and lowered its earnings estimates.499 Merrill Lynch said their “channel checks remain troubling.”500
494 See Email from Citigroup to Galleon containing Citigroup analyst report, September 25, 2008 at 7:02pm (emphasis added). 495 See Email within Galleon, September 25, 2008 at 7:30pm (emphasis added). 496 See “Analysts See Problems Ahead for eBay and Amazon,” AP Newswires, September 26, 2008 at 8:53am. 497 See “EBay Planning as Many as 1,500 Job Cuts Worldwide, Focus Says,” Bloomberg News, September 27, 2008 at 12:08pm. 498 See “Dow Dives 777 Points, Biggest Single Day Fall Ever, as House Rejects Financial Bailout Package,” AP Newswires, September 29, 2008 at 7:59pm.
159 515. On October 2, 2008, Morgan Stanley downgraded eBay from “overweight” to
“equal-weight” saying “trends deteriorated more than expected.” The analyst also lowered
earnings estimates and indicated that the market’s estimate “remains too high.”501
516. On October 2, 2008, Galleon sold 83,000 shares of eBay after a Galleon analyst
expressed concern that eBay’s stock could decline further:
shd we just cut our losses on ebay… was playing for major headcount reduction…. might get it but stock cld be at 15 yeah, just blow it out, was stupid502
517. On October 3, 2008 (the same day Mr. Rajaratnam allegedly received the inside
tip, but before Mr. Rajaratnam traded in eBay’s shares), TechCrunch reported that eBay would begin laying off 10% of its workforce on Monday:
Last month reports started to emerge that eBay was poised to cut 1,500 jobs, or 10% of its workforce globally, according to an article in Barron’s weekly. It cited a report published by investment-research firm Wedge Partners.
My sources tell me the process will start on Monday next week [October 6, 2008] and that the lay-offs will take in staff at PayPal, but not Skype, the eBay-owned property.... An official eBay spokesperson told me today: “We don’t comment on rumours.”503
518. Again, the stock price reaction was not statistically significant.
499 See Email from Goldman Sachs to Galleon containing Goldman Sachs analyst report, September 30, 2008 at 7:41am; “Goldman Sachs Cuts Its Price Target on eBay (EBAY) to $26,” StreetInsider.com, September 30, 2008. 500 See Email from Merrill Lynch to Galleon containing Merrill Lynch analyst report, September 30, 2008 at 5:18pm. 501 See Email from Morgan Stanley to Galleon containing Morgan Stanley analyst report; “EBay Cut to ‘Equal-Weight’ at Morgan Stanley on Profit Outlook,” Bloomberg News, October 2, 2008 at 6:30am. 502 See Instant Message within Galleon, October 2, 2008 at 9:43am. 503 See “As eBay Preps for Layoffs, Startup Investment Crashes – It’s Going to Be a Cold Winter People,” TechCrunch, October 3, 2008 at approximately 12:35pm EDT (4:35pm UTC).
160 Rajaratnam’s Trades
519. In the twelve months before October 3, 2008 (when Mr. Rajaratnam allegedly
received inside information), Mr. Rajaratnam bought and sold 1.6 million shares of eBay with a
total transaction value of $44.0 million. As recently as September 4, 2008 (four weeks before
Mr. Rajaratnam was allegedly tipped), Mr. Rajaratnam shorted 150,000 shares of eBay for $3.7
million.504
520. After the alleged receipt of inside information, Mr. Rajaratnam sold short an
additional 200,000 shares of eBay on October 3, 2008. This short sale consisted of two
transactions of 100,000 shares each. The total investment value of these short sales was $3.9
million.505
Workforce Reduction Announcement
521. On October 6, 2008, before the market opened, eBay made four major
announcements: (i) acquiring online payments business Bill Me Later for $945 million; (ii)
acquiring Denmark’s leading online classifieds website for $390 million; (iii) reducing global
workforce by approximately 10%, affecting about 1,000 employees and several hundred temporary workers; and (iv) updated third quarter guidance with expectations to hit the low end
of its previously issued revenue guidance and exceed its earnings guidance.506
522. On October 6, 2008, eBay’s common stock price decreased 5.5% to close at
$17.89 per share. The excess return is not statistically significant at the 95% confidence level
(see Exhibit 14). The 5.5% decline is not significant because the market (i.e., the Nasdaq
504 Source: Galleon OMS Database. 505 Source: Galleon OMS Database; United States of America v. Raj Rajaratnam per GX 24. 506 See “eBay Inc. Buys Leading Payments and Classifieds Businesses, Streamlines Existing Organization to Improve Growth,” Business Wire, October 6, 2008 at 7:45am.
161 Composite Index) was down 4.3% as well, resulting in a net-of-market return of only -1.4% (see
Exhibit 14). The 4.3% drop in the market reflected the fear in the marketplace when “[s]tocks
nosed dived at the [opening] bell as aftershocks from the U.S. credit crunch reverberated around
the world and touched off a global equities sell-off amid fears that a global recession is
nearing.”507
523. During eBay’s conference call with analysts to discuss the recently announced
developments, management briefly mentioned the workforce reduction. eBay’s CEO
specifically noted the workforce reduction would produce annualized savings of approximately
$150 million beginning in 2009. Curiously, not a single analyst on the call asked any question of
the workforce reduction. Instead, the eleven analysts that asked more than 40 questions during
the call were focused exclusively on the two acquisitions that were announced.508
524. After the eBay announcement and the completion of the eBay conference call,
analyst commentary included:
Standard & Poor’s – They are spending $1.3 billion for a company in Europe seen as the next stage in the global meltdown, and another that focuses on consumer purchases, which people are not very optimistic about. I don’t know that this is the time for these kinds of acquisitions.... [A]fter this transaction, they suddenly seem to have a less profitable business, they are going to have a lot less cash to spend and people wonder what this deal says about its exposure to the credit markets.509
507 See “Stocks Dive as Credit Fears Go Global, Sparking Rising Recession Fears,” MidnightTrader, October 6, 2008 at 9:52am. 508 See “EBay M&A/Other Teleconference,” Bloomberg News, October 6, 2008 at 9:44am. 509 See “Investors Fear EBay Deal Increases Exposure To Volatile Mkts,” Dow Jones News Service,” October 6, 2008 at 2:55pm.
162 Stifel Nicolaus – ...timing was unfortunate, in our opinion, in terms of the market’s willingness to digest a deal that included “credit” as a talking point.510
Deutsche Bank – While acquisition, HC [headcount] reduction and in-line 3Q may be the good news, we think the bad news remains that fundamentals are weakening in the core business.... We like the BillMeNow story/concept and strategic fit, but not when there’s a credit crisis, consumer spending decline and plenty of issues to address/fix in the core business.511
JPMorgan – We believe the cuts could help position eBay to more efficiently weather the current challenging economic environment.512
Sanford C. Bernstein & Co. Analyst Jeffrey Lindsay called the cuts “long overdue” but said they might not be enough as EBay struggles to compete against Amazon.com Inc. and other online rivals.513
Jefferies & Co. – We view the ensuing near-term dilution as an incremental negative but expect the long-term impact to be positive...514
Banc of America – While the acquisitions fit with management’s strategic goals, both are dilutive and we expect them to weigh on shares near term.515
510 See “EBay to Lay Off Workers While Making Acquisitions; Shares Fall to Six-Year Low After Online Auctioneer Warns on Revenue,” MarketWatch, October 6, 2008 at 4:36pm. 511 See “Deutsche Bank Reiterates a ‘Sell’ on eBay (EBAY), Bill Me Now: Right Idea, Wrong Timing,” StreetInsider.com, October 7, 2008 (emphasis added). 512 See “eBay Poised to Pare Staff By 10% Amid Slowing Growth; 1,600 Jobs To Be Slashed in Reductions Aimed at Creating ‘Nimbler’ Company,” Seattle Post-Intelligencer, October 7, 2008. 513 See “The Financial Crisis; Internet; EBay to Cut 10% of Workforce, Buys 3 Firms,” Los Angeles Times, October 7, 2008 (emphasis added). 514 See “RESEARCH ALERT-Analysts Cut eBay Price Target,” Reuters News, October 7, 2008 at 8:56am (emphasis added). 515 See “RESEARCH ALERT-Analysts Cut eBay Price Target,” Reuters News, October 7, 2008 at 8:56am.
163 Conclusion
525. In summary, my review of the mix of information in the market shows that Wall
Street had a negative view of eBay’s prospects and clearlly indicates that the supposedly
“material non-public” information was in fact publicly-aavailable and actively discussed by an analyst and the financial press. This publicly-available innformation includes:
i) In September and the first days of October 2008, several Wall Street analysts cut their price targets and/or ratings and noted: a) eBay’s business was “deteriorating,” b) “incrementally more negative on EBAY,” c) “channel checks remain troubling,” d) “trends deteriorated more than expected;”
ii) On September 11, 2008, an analyst at Wedge PPartners advised Galleon that “significant layoffs” at eBay were forthcoming;
iii) On September 15, 2008, Barron’ss, Reuters News and PC Magazine reported that eBay was “readying layoffs that could affect 10% of the company’s 15,000 employees;”
iv) On September 27, 2008, Bloomberg News reported that eBay’s plan to cut 10% of its workforce would “be published shortly;”
v) On October 3, 2008 (the same day Mr. Rajaraattnam allegedly received the inside tip, but before Mr. Rajaratnam traded in eBay’s shares), TechCrunch reported that eBay woould begin laying off 10% of its workforce on Monday, October 6, 2008; and
vi) eBay’s stock price had no statisticcally significant stock price reaction to any of the news of pending layofffss.
526. Additionally, a Galleon analyst recommended to Galleon’s portfolio managers that they “short” eBay, which Mr. Rajaratnam did.
527. Based on the substantial level of discussion by Wall Street analysts and the financial press about layoffs at eBay, in my opinion, all of this commentary and analysis was publicly-available beefore eBay’s announcement on October 6, 2008.
528. Based on the market reaction to eBay’s announcement of multiple items (-1%), I conclude that eBay’s market price prior to the disclosure and prior to Mr. Rajaratnam’s
164 transactions already accurately incorporated the expectations by Wall Street analysts, as well as any information contained in the alleged tips. I reach this conclusion after observing that eBay’s stock price movement on October 6, 2008 was not economically material.
529. Based on this evidence, I conclude that a well-informed, professional investor
(such as a hedge fund manager) that engages in legal information gathering and related arbitrage trading in the shares of eBay would have been aware of the mix of information in the market that
I have discussed above. Further, a hedge fund manager employed at Galleon would additionally be aware of Galleon’s internal research on eBay.
530. Based upon the mix of information available in the marketplace and within
Galleon prior to eBay’s announcement on October 6, 2008, in my opinion, it would be reasonable for such an investor to transact in eBay’s common stock, just as Mr. Rajaratnam had done. In my opinion, this publicly-available information provided ample justification to take an arbitrage position in eBay in anticipation of its announcement.
531. Moreover, based on my understanding of the information the SEC is alleging was conveyed in the tip, it is my opinion that the information allegedly tipped to Mr. Rajaratnam was not private information, but rather was substantially similar to information that was already included in the mix of publicly available information. Furthermore, it is my opinion that the announcement was not economically material.
165