PREVIEW-UPDATE 1-Courtroom showdown in sweeping US trading probe

* Galleon’s Rajaratnam faces barrage of tapes, witnesses

* Seasoned defense team may spring trial surprises

* Battle over allegations of tips, $45 million in profits

* Biggest insider trading probe of hedge funds -government
(Updates with audio tapes to be played of conversations
between Rajaratnam and former Goldman Sachs director in
paragraphs 5 & 17-19, first witnesses in paragraph 14)

By Grant McCool

NEW YORK, March 4 (Reuters) – A sweeping insider trading
case that shook the hedge fund world is finally set for trial,
with onetime billionaire Raj Rajaratnam fighting to stay out of
prison in a courtroom drama over corporate secrets, tapped
telephones and friends-turned-government witnesses.

Jury selection in the case against the Galleon Group
founder in New York starts on Tuesday. The trial, expected to
last up to two months, comes as U.S. authorities push on with
other probes into stock trading in the $1.9 trillion hedge fund
industry based on leaked company earnings and deals.

Rajaratnam is accused of making $45 million in illicit
profits through tips from former friends and associates at the
highest levels of Corporate America. Once named the richest
person born in Sri Lanka, the 53-year-old U.S. citizen has
vowed to clear his name at trial. Galleon managed $7 billion at
its peak. (For a Factbox click: [ID:nN03153848])

“All signs are pointing to a battle royal,” said Chicago
securities attorney Andrew Stoltmann, who is not involved in
the case. “Just by being a hedge fund manager he is a gambler
by trade. The mentality is a little bit different than what we
see with other defendants.”

At a hearing on Friday, prosecutors said they would play
audio tapes of conversations between Rajaratnam and a former
Goldman Sachs director, Rajat Gupta, as evidence to the jury
that they conspired in 2008 to share confidential Goldman
information and that Rajaratnam traded on it. [ID:nN04214521]

Rajaratnam, arrested in October 2009 and free on bail,
faces up to 25 years in prison if convicted of conspiracy and
securities fraud in Manhattan federal court.

The government’s wide-scale use of phone taps sets it apart
from past insider trading cases, which are notoriously
difficult to prove. In announcing the case, prosecutors called
it the biggest ever probe of insider trading at hedge funds,
sending a warning to money managers that the government might
be covertly listening to them.

The prosecutions are reminiscent of the blockbuster insider
trading cases of the 1980s, when speculator Ivan Boesky pleaded
guilty and cooperated with authorities. That led to criminal
charges against Drexel Burnham Lambert, which was destroyed in
the scandal, and Michael Milken, its former junk bond chief.

KEY RULING

While Rajaratnam lost a key ruling that will allow jurors
to hear audiotapes of his telephone conversations secretly
recorded by the FBI, his lawyers argue the tapes prove nothing.
The tapes could be an issue for appeal if he is found guilty
because there is “at least some lack of clarity in the statute
about whether it authorized wiretaps here” (for insider
trading), said Manhattan Institute think tank legal policy
director James Copland.

Part of defense trial strategy is to tell the jury that the
government has significantly expanded the bounds of what
insider trading means, court papers show. Rajaratnam’s
representatives have said repeatedly that “he intends to
establish his innocence at trial before a jury of his fellow
citizens.”

The prosecution team must convince the jury that their
evidence proves Rajaratnam knew that between 2003 and March
2009, he was trading on confidential information given to him
by people who had a fiduciary duty not to disclose it.

“Just because there is a wiretap it does not mean this
evidence is going to be absolutely conclusive” for the jury,
said New York attorney Nathaniel Burney of Burney Law Firm LLC
in New York, who is not involved in the case. “There is a lot
of room for skillful advocacy. The tapes could be
misinterpreted or misunderstood.”

The allegations extend far beyond Rajaratnam. Besides him,
25 former traders, executives and lawyers have been charged
with being part of two overlapping insider trading networks.
Nineteen have pleaded guilty, and some of those defendants are
expected to testify against him at the trial.

Prosecutors told Judge Richard Holwell at Friday’s hearing
that former McKinsey & Co executive Anil Kumar and FBI Special
Agent Diane Wehner would be the first government witnesses.
Kumar pleaded guilty to sharing client secrets and receiving $2
million in payments from his friend Rajaratnam.

A graduate of the prestigious Wharton business school at
the University of Pennsylvania, Rajaratnam had a deep network
of acquaintances including people at Goldman Sachs Group, Intel
Corp and McKinsey & Co.

Prosecutors said it was some of those contacts who spilled
secrets that helped him gain an unfair edge over other traders,
gleaning stock tips that helped Galleon prosper.

One friend, former Goldman director and McKinsey head
Gupta, conspired with Rajaratnam, assistant U.S. Attorney
Jonathan Streeter said in court on Friday. Gupta has denied
accusations by securities regulators of disclosing Goldman
secrets. He is not charged in the criminal case.

In the courtroom elevator on Friday, chief defense lawyer
John Dowd, using the back of his right hand, patted Rajaratnam
on the chest, and said: “He’s a good man.”

Dowd declined to comment on the allegations about Gupta.

The trial is the biggest in the financial industry since
two former Bear Stearns fund managers were accused of
misleading investors over mortgage-linked securities as the
housing market collapsed in 2007. The two were acquitted.

An acquittal of Rajaratnam would be another embarrassment
for the government, which has given the case high priority.

Rajaratnam will go to trial in the same courthouse in lower
Manhattan where Bernard Madoff pleaded guilty two years ago to
a multibillion-dollar swindle. It was also where celebrity
homemaker Martha Stewart stood trial in 2004 in another stock
tipping case.

The government has released excerpts of the tapes and could
present as many as 173 intercepted mobile phone audio
recordings to the jury. The full extent of the evidence from
the calls and text messages is not known, so there may yet be
surprises at trial.

Another unknown is whether or not Rajaratnam will testify
in his own defense.

“If the defense is ‘I didn’t know the information given to
me was material nonpublic information’ the only way that story
comes into the trial is through him,” said Evan Stewart, a
partner at law firm Zuckerman Spaeder who is not involved in
the case.

Jim McCarthy, a spokesman for the defense, declined to
comment on the possibility of Rajaratnam taking the witness
stand.

The case is USA v Raj Rajaratnam, U.S. District Court for
the Southern District of New York, No. 09-01184.
(Reporting by Grant McCool; Editing by Gary Hill and Richard
Chang)