Moody's Scandal: The Firm Has Leaked Inside LBO Information

As if Moody's needed any more black marks against it, going through the Galleon indictment indicates that Raj Rajaratnam used, among many other tricks, a leak at Moody's to provide him with information on the Hilton Hotel LBO in which Galleon ended up making $4 million, and throwing a $10,000 kickback to the Moody's leaker. This is not one isolated incident: one can extrapolate that this kind of behavior was prevalent at Moody's (and probably at the other legacy rating agency) throughout the LBO boom. Just how many hedge fund managers made a killing by being stupid enough to buy stocks, or, a little smarter, to buy CDS or steepeners in the 2006-2007 period courtesy of Moody's leaks? Perhaps it is time to go through the phone records of every single Moody's analyst in that two year time period.

We quote from the filing:

Based on documents provided by Moody's, I have learned that in 2007, an Associate Analyst employed at Moody's (the "Moody's Analyst") was involved in Moody's rating of Hilton...The Moody's analyst owed duties of trust and confidence not to disclose for personal gain material, non-public information regarding Moody's and its clients.

Based on documents provided by Hilton and Moody's, I have learned that on or about July 2, 2007, at approximately 2:20 pm, certain executives of Hilton placed a phone call to a Vice President and Senior Analyst at Moody's who served as Moody's Lead Analyst for the rating of Hilton. During the call, which lasted approximately seven minutes, the Hilton executives informed Moody's that Hilton would be acquired by the Blackstone Group LP, and that Hilton would likely announce the acquisition sometime before July 4, 2007 (the "Hilton Inside Information")

Based on my conversations with the CW [Cooperating Witness], I have learned that on or about July 2, 2007, the Moody's Analyst told the CW that Hilton was going to be taken private the following day at a price substantially above its publicly traded stock price. [And a deal that Blackstone is kicking itself in the ass now for completing].

I have reviewed phone records from a telecommunications company for a cell phone used by the Moody's analyst at all times relevant to this Complaint (the "Moody's Cell Phone"). Consistent with what the CW told me, these phone records show that on or about July 2, 2007, at approximately 3:06 p.m., a telephone call was made from the Moody's Cell Phone to the CW's home phone, lasting approximately one minute. A second such call was made at approximately 3:10 p.m., lasting approximately two minutes. A third such call was made at approximately 3:14 p.m., lasting approximately one minute.

Based on conversations with the CW, I leaned that on or about July 2, 2007, the CW provided Hilton Inside Information to Raj Rajaratnam, the defendant. Specifically, the CW informed Rajaratnam that Hilton was going to be taken private and that it was a "sure thing." The CW informed Rajaratnam that the source of the Hilton Inside Information was very good. The CW further informed me that Rajartnam understood that the CW was providing him with Inside Information.

Based on my review of account records for the Galleon Technology Funds, I have learned that on July 3, 2007, Raj Rajaratnam, the defendant, caused the Galleon Technology Funds to purchase 400,000 shares of Hilton stock at an average price of approximately $35.13 per share.

Based on my review of public records and news reports, I have learned that on July 3, 2007, following the close of the market, Hilton announced that it had agreed to be acquired by Blackstone for $20.1 billion in cash , and that Blackstone had agreed to buy all outstanding shares of Hilton for $47.50 per share, representing a premium of approximately $10 per share. [Can you say Blackstone did the greatest market top ticking exercise ever?]

Based on my review of account records for the Galleon Technology Funds I learned that on July 5, 2007 and July 16, 2007, Rajaratnam caused the Galleon Technology Funds to sell all 400,000 shares of Hilton stock, collectively, at prices ranging from $45.25 to $45.63 per share, for a profit of approximately $4 million.

Based on conversations with the CW, I learned that following the announcement that Blackstone would acquire Hilton, the CW arranged to pay the Moody's Analyst $10,000 in exchange for the Hilton Inside Information.

We present the Moody's report from July 5, 2007, authored by Margaret Holloway and John Rogers, SVP's in Moody's Corporate Group.



We would like to inquire of the regulators just how much leakage by Ms. Holloway and Mr. Rogers (if they are in fact those contacted by Hilton), and broadly within Moody's might have occurred in the span of a few short hours from the point Hilton disclosed on a very limited basis it would be LBO'ed, to subsequently this information making its way to the Associate Analyst and from there to the entire investing world?

This is actually a rather serious issue, as Moody's was traditionally notified in advance of every LBO in the 2006-2007 period, and that begs the question: just how much leakage of insider deals has Moody's been responsible for?

Going back to the actual trade, what likely occurred is that Raj and his accomplices further leaked the information in order to dilute their tracks, and as a result, numerous other hedge funds (both equity and credit) lapped up Hilton's stock and CDS on the holiday shortened July 3 Tuesday. The leakage was so blatant it prompted Dealscape to pen this article on July 5, 2007:

Blackstone Group LP’s announcement of its $26 billion buyout of Hilton Hotels Corp. at 6 p.m. on the eve of a major summer holiday may have been made earlier than the two parties wanted.

Trading volume of Hilton shares more than doubled before the deal was announced, soaring from a daily average of 3.36 million to 7.47 million in Tuesday’s half-day session that ended at 1 p.m. EDT. The last time Hilton’s stock was in such demand was June 1, the day after it paid its dividend. With the word evidently out about Hilton, Blackstone sat back and watched the 40% premium it would have paid Monday shrink to 32% by Tuesday’s close, as the stock had one of its best days this year, gaining 6.4% to close at $36.05.

With the number of bankers, lawyers, advisers, board members and management involved in the recent megabuyouts growing, it has become more difficult than ever to keep the lid on an impending deal. But with private equity firms drawing ever more attention from politicians, the press and ultimately the public, the last thing they need is a rash of Securities and Exchange Commission investigations into how they do deals. —George White

As disclosed, Galleon accounted for a mere 400,000 of this 7.5 million shares (4 million above average). This means that numerous other funds were also tipped off, likely by Galleon itself in order to not focus too much attention on itself. Also, as we have pointed out on numerous occasions, Galleon apparently was sufficiently stupid not to trade on this information via CDS. The first chart below shows the price/volume of HLT from July 2 to July 5.

One critical question here is how did the conversation between Galleon's head trader and whoever their key equity sales coverage was:

Galleon: "Yo [Joe] can you pick me up 400,000 shares of HLT. VWAP. Stat: gotta get me some golf time in today, it's July 4th tomorrow after all and the Hamptons beckons."

[Joe]: "Sure Galleon. But why? That's a huge block. Should I know something about this?"

Galleon: "Donchu worry about that. Wink wink. Call me cell [Joe]. Let's discuss over pops."

And likelewise for all the other funds who all of a sudden had a huge appetite for HLT.

Yet where the real money was made was not stock, but CDS. The chart below shows the dramatic move in HLT 5 year CDS from the day before the transaction to the day after.

The 5 year CDS contract jumped from 120 bps to over 220 bps: a 100 bps change. On a $100 million CDS trade, this is a juicy $4.5 million profit. Apply a 20x leveraged TRS notional courtesy of Goldman Sachs and you have a $100 million return in 24 hours. Also, another way, to have played this preannouncement would be with a 3s5s steepener, which was also a popular way to play insider trading preannouncements with CDS.

May we suggest that the SEC carefully analyze any and all stock and CDS trades (both 3 and 5 maturities) in HLT, and than back into who may have been speaking to a trading desk shared with Galleon, or alternatively, who was directly speaking to Galleon.

Either way, Zero Hedge is confident that Galleon's implosion will be the reason for comparable such insider trading charges being filed at many other major linked hedge funds, which did not differ in how they procured information (illegally) or how they traded on it. We also expect an aggressive retaliation against expert networks where this kind of illegal information exchange is a daily occurrence.

We continue going through the Galleon indictment and will present any additional findings.


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