Wall Street Chill: Raj Verdict to Hit Volume, Close Funds & Research Firms

The landmark guilty verdict against Raj Rajaratnam on 14 counts of insider trading sent a chill down Wall Street, causing hedge funds to rethink their use of so-called expert analyst networks and also ponder the impact of the historic decision on the implementation of the Dodd-Frank regulatory bill.

Raj Rajaratnam, confronted by media as he leaves the Daniel Patrick Moynihan United States Court House at 500 Pearl Street after being found guilty of 14 charges against him on May 11, 2011 in New York City. After eleven days of deliberation a jury convicted Rajaratnam with all 14 counts of securities fraud and conspiracy.
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Raj Rajaratnam, confronted by media as he leaves the Daniel Patrick Moynihan United States Court House at 500 Pearl Street after being found guilty of 14 charges against him on May 11, 2011 in New York City. After eleven days of deliberation a jury convicted Rajaratnam with all 14 counts of securities fraud and conspiracy.

The biggest and most successful insider trading case in decades may put a freeze on already anemic trading activity and cause many giant hedge funds with billionaire operators to rethink their future in the business, regardless of their moral scruples, traders said.

“It’s very negative for exchanges,” said Dave Lutz, managing director of trading at Stifel Nicolaus. “Major players of liquidity will be removed from the market, causing volumes on exchanges to plunge further.”

Some traders said the wait for the Rajaratnam verdict, the separate probe into expert-networking firms and the ongoing haggling over the Dodd-Frank fine print was already hitting trading activity. Volume for stocks in the S&P 500 is averaging about 3 billion shares a day this month, close to half the volume of last May.

Rajaratnam was found guilty of getting insider information about companies from insiders within those firms. An ongoing probe right now is wading into the gray area that lies between Rajaratnam’s blatant grab and industry information gathered by research firms from professionals that work in that industry. This is what so-called export networks do.

For example, these firms would survey doctors on the chances of the FDA approval of a drug, but the doctors don’t work for the company in question and are not on the FDA panel. But sometimes the line gets murky.

“A number of firms have disassociated themselves with expert networks, deciding it’s not worth the risk of crossing the line,” said one former head of research at a major Wall Street firm who asked to remain anonymous. “If company X has 50 retail stores and the expert network (or the fund manager) calls each of the 50 asking about sales, is this an abuse? This is the gray area.”

While all the focus was on Rajaratnam, an account manager at Taiwan Semiconductor pleaded guilty Wednesday in Manhattan federal court to sharing nonpublic information on Taiwan Semi to clients of an expert-networking firm called Primary Global Research.

“To the degree that catalyst-driven hedge funds use expert access to crystallize their thoughts on a given trade, reducing the use of these networks must reduce both the number of trade ideas and the conviction behind them,” said one strategist after the Raj verdict. “Now that they have their answer, watch trading volumes in the coming weeks – especially in sectors where these conversations really help, such as Tech, Health Care and Retail. They may well decline until traders and investors find the next way to get an edge.”

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Trader disclosure: On May 11, 2011, the following stocks and commodities mentioned or intended to be mentioned on CNBC’s "Fast Money" were owned by the "Fast Money" traders; Pete Najarian owns (PFE); Pete Najarian owns (MRK); Pete Najarian owns (AAPL); Pete Najarian owns (TCK); Pete Najarian owns (AKAM); Pete Najarian owns (C); Pete Najarian owns (HPQ); Pete Najarian owns (TEVA); Pete Najarian owns (MS); Pete Najarian owns (RSX); Pete Najarian owns (GE); Pete Najarian owns (MSFT); Pete Najarian owns (YHOO); Pete Najarian owns (VLO); Pete Najarian owns (TER); Pete Najarian is long (RIMM) calls; Pete Najarian is long (AVL) calls; Pete Najarian is long (NTAP) calls; Pete Najarian is long (XLF) calls; Pete Najarian is long (PMCS) calls; Pete Najarian is long (CVS) calls; Pete Najarian is long (XL) calls; Pete Najarian is long (BSX) calls; Pete Najarian is long (HBC) calls; Pete Najarian is long (EWZ) calls; Pete Najarian is long (XLI) calls; Pete Najarian is long (FCX) calls; Finerman owns (M); Finerman owns (CMI); Finerman owns (LEA); Finerman owns (MSFT); Finerman is short SPY; Finerman is short (MDY); Finerman is short (IWM); Finerman is Long S&P 500 Puts; Finerman is Long Russell 2000 Puts; Terranova owns (VRTS); Terranova owns (AAPL); Terranova owns (JPM); Terranova owns (V); Terranova owns (BX); Terranova owns (UPL); Terranova owns (BAX); Terranova owns (PFE); Terranova owns (PEP); Terranova owns (MCD); Terranova owns (TM); Terranova owns (DIS); Terranova owns (BJ); Terranova owns (APA); Terranova owns (OXY); Terranova owns (XOM); Adami owns (AGU); Adami owns (C); Adami owns (GS); Adami owns (MSFT); Adami owns (NUE); Adami owns (BTU)

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