HEDGE FUND MANAGER SETTLES WITH SEC AND USAO

Lawrence Goldfarb, the manager of a successful hedge fund, and the fund he managed, settled charges with the SEC and the U.S. Attorney’s Office stemming from his diversion of over $12 million from a side pocket investment of the fund. Investors knew that the assets had been placed in the side pocket but were not told that the investment was profitable. SEC v. Goldfarb, CV-11-0938 (N.D. CA. Filed March 1, 2011); U.S v. Goldfarb, CR 110099 (N.D. CA. Filed March 1, 2011).

Mr. Goldfarb has been the manager of Baystar Management, LLC since 2001. Baystar is the investment adviser to a private investment fund, Baystar Capital II, L.P. In 2004 the fund held assets of about $100 million. In 2003 fund made an $8.4 million investment in Island Fund Investment, a limited liability company which invests in real estate. Mr. Goldfarb put the investment in a side pocket, a device intended to hold what are viewed as illiquid investments. Typically these investments are only redeemed upon disposition of the assets in the side pocket. When the redemption occurs the proceeds are to be distributed among share holders on a pro rata basis.

Fund investors were aware that the Island Fund investment was being held in a side pocket. Repeatedly over a period of years they asked Mr. Goldfarb about the investment which, under the fund rules was valued at cost. In each instance the investors were told that the investment remained in the side pocket. Indeed, Mr. Goldfarb even furnished investors with statements showing the no gains had been realized on the investment.

In fact the investment began to generate revenue the year after it was purchased. Mr. Goldfarb did not disclose this fact to fund investors. Rather, beginning in 2007 he diverted revenue from the investment to other investments and his personal use. Portions of the funds were put in a separate real estate fund. Other portions were diverted private companies. Portions of the proceeds were deposited into the bank account of one of Mr. Goldfarb’s related entities which he used to pay for unauthorized personal expenses. Overall about $12 million was diverted. None of these transactions were authorized by the fund’s offering documents. The SEC’s compliant against Mr. Goldfarb and Baystar Capital alleges violations of Advisers Act Sections 206(1), (2) and (4).

To settle with the SEC Mr. Goldfarb consented to the entry of a permanent injunction prohibiting future violations of the sections cited in the complaint. He also agreed to pay disgorgement of $12,112,416 along with prejudgment interest and to pay a civil penalty of $130,000. In addition Mr. Goldfarb agreed to be barred from associating with any investment adviser or broker, with a right to reapply in five years, and to be barred from participating in any offering of penny stock.

In a related criminal proceeding Mr. Goldfarb and Baystar were charged in a one count information alleging wire fraud. To resolve this action the defendants entered into a deferred prosecution agreement with a term of three years. Under the terms of that agreement Mr. Goldfarb is to make restitution in accord with the terms of his settlement with the Commission. He will also be barred from the securities business for three years.

THE LATEST GALLEON CASE: ILLEGAL TIPS FROM A GOLDMAN DIRECTOR

On the eve of the criminal insider trading trial of Raja Rajaratnam the SEC unveiled the latest chapter in the investigation into the founder of Galleon Management LLC: he had been illegally tipped by a former Goldman Sachs and current Proctor and Gamble board member. In an Order for Proceedings the SEC’s Division of Enforcement alleges four tips by Rajart Gupta to Mr. Rajaratnam. Three concerned Goldman Sachs. One concerned Proctor and Gamble. Each alleged tip is apparently inferred from detail drawn from telephone, trading and other records. In two instances Mr. Rajaratnam is alleged to have confirmed to a co-conspirator that he had inside information. All of the tips resulted in profitable trades or losses avoided. Those totaled about $18 million according to the Enforcement Division. In the Matter of Rajart K. Gupta, Adm. Proc. File No. 3-14279 (Filed March 1, 2011).

Mr. Gupta was a member of the Goldman Sachs board of directors from late 2006 through May 2010. During that time he served on several committees including the Audit and Corporate Governance Committees. He joined the board of P&G in 2007. As a member of that board he has also has served on various committees including the Audit Committee.

Messrs. Gupta and Rajaranam are friends and business associates. Mr. Gupta is the founder and chairman of New Silk Route Partners LLC, an investment firm. That firm was previously known as Taj Capital Partners. It was started by Messrs. Gupta and Rajaratnam and others in 2006. Mr. Gupta is also alleged to have had a variety of lucrative business interests with Mr. Rajaratnam, including an investment in one of the Galleon funds.

The Order is built on four alleged tips:

The Berkshire investment: The first tip involved the $5 billion investment in Goldman Sachs made by Berkshire Hathaway as the market crisis was unfolding. The arrangement was announced on September 23, 2008. According to the Order, on September 21, 2008 a special Sunday Goldman board meeting was held. Mr. Gupta dialed in on the telephone. During the meeting the board approved the investment bank becoming a bank holding company and was updated on various strategic alternatives. The next morning the Order alleges that it is “very likely” based on various records that Raja Rajaratnam and Mr. Gupta spoke on the phone

On September 23 the two men spoke on the telephone for 14 minutes. One minute into the call Galleon purchased 40,000 shares of Goldman Sachs. Later that day the board approved the Berkshire Hathaway deal. Three minutes after Mr. Gupta signed off of the telephone call from the board meeting he placed a call to Raja Rajaratnam who then purchased 175,000 Goldman shares just prior to the close of the market. Later Mr. Rajaratnam told a co-conspirator he had information about the investment. The position was liquidated at a profit of about $900,000 after the public announcement.

Goldman’s 4Q08 results: The second centers on the $2.1 billion loss publicly announced by Goldman on December 17, 2008, the only period loss since the company became public. The Order alleges that on October 23, 2008 the Respondent dialed into a Goldman meeting. At the time the board was advised about the financial condition of the company. A loss was projected. Twenty three seconds after signing off the call, Mr. Gupta telephoned Mr. Rajaratnam. The call lasted 13 minutes. At the opening of the market on October 24 Galleon sold Goldman shares. When the quarterly results were announced the share price tumbled. Galleon avoided a loss of over $3 million according to the Division of Enforcement’s allegations.

Goldman’s 2Q08 results: Goldman announced quarterly results on June 17, 2008. The firm performed better than had been expected despite the turbulent markets. About one week prior to the announcement the Chairman of the firm telephoned the Respondent. The date and time of the call are not specified. During the evening of June 10 Mr. Gupta and Mr. Rajaratnam had a series of short calls which culminated in one lasting 18 minutes. The next morning Mr. Rajaratnam called the Respondent prior to the opening of the markets. Just after the opening Galleon purchased 5,500 call options for Goldman shares. Additional shares were also acquired. After the results were announced the position was sold at a profit of $13.6 million.

P&G Quarter December 2008: The final tip is alleged to have involved P&G quarterly results. Those results were announced on January 30, 2009. The day before the release the audit committee reviewed it. The Respondent was on the call. The organic results would be less that previously predicted. Following the call Mr. Gupta telephoned Mr. Rajaratnam according to the Order. Subsequently, Galleon sold 180,000 P&G shares short. That position was closed following the release of the results by the company at a profit of $570,000.

The Order alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The action is proceeding to litigation. The administrative and cease and desist proceeding will determine what remedies, if any, are appropriate including disgorgement and a civil penalty.