UPDATE 3-Rajaratnam invests in fund run by trial witness

* Cross-examination of defense witness reveals investments

* NY jury hears Rajaratnam side of insider trading case

* Nothing offered in exchange for testimony -witness (Updates with Rajaratnam defense lawyer statement on testimony)

By Grant McCool and Basil Katz

NEW YORK, April 14 (Reuters) - Hedge fund founder Raj Rajaratnam and his family invested $25 million in a $35 million fund managed by an executive called to testify in Rajaratnam's insider trading trial defense, the jury heard on Thursday.

The acknowledgment in testimony by Rajaratnam's one-time Galleon Group chief operating officer, Rick Schutte, appeared to take the defense by surprise, providing one of the more dramatic moments so far in the Manhattan federal court trial.

Schutte stood to earn an annual fee of $500,000 for managing the Rajaratnam money, federal prosecutor Reed Brodsky noted in a cross-examination intended to undermine the credibility of a key defense witness in the biggest Wall Street insider trading case in decades.

Schutte acknowledged on the witness stand that Rajaratnam was one of the investors in his fund, Spottail Capital Advisers LLC, which he founded last July and has $35 million under management.

"He is the biggest investor?" Brodsky asked, to which Schutte responded: "That is fair to say."

A defense lawyer, Michael Starr, who did not bring up the investments in his questioning of Schutte, later tried to show there were no improper inferences to be drawn.

He asked Schutte whether Rajaratnam had ever offered him anything in exchange for testifying at the trial.

"Absolutely not," Schutte said.

After the jury had been dismissed for the day, Rajaratnam spokesman Jim McCarthy said in a statement: "We were well aware and regard those facts as totally routine and ordinary."

Sri Lankan-born Rajaratnam, 53, is the central figure in what prosecutors have described as the biggest probe of insider trading at hedge funds on record. Rajaratnam's trial on charges of conspiracy and securities fraud is in its sixth week and will run to the last week in April.

He could be imprisoned for up to 20 years if convicted.

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Galleon Group case graphic r.reuters.com/jyk48r

Rajaratnam ran tight ship at Galleon [ID:nN11290810]

Prosecution slowly beat same drum [ID:nN06254548]

Scrushy acquittal: Lessons for Rajaratnam [ID:nN24177653]

FBI agent tallies Rajaratnam trades [ID:nN05141368]

Q+A-The case against Rajaratnam [ID:nN0798137]

FACTBOX [ID:nN03153848]

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Schutte and other defense witnesses were introduced to the jury this week to underpin Rajaratnam's argument that his trades were guided by a vast collection of company analysis and published reports, not highly-placed corporate insiders as the government contends. He said Galleon was a tightly run organization that sifted through volumes of research. [ID:nN11290810]

The government charges Rajaratnam with making an illicit $63.8 million in dozens of stocks, mostly technology companies, between 2003 and March 2009.

The jury heard five weeks of government evidence, including dozens of FBI phone taps, and former friends who testified against the hedge fund founder.

In the cross-examination of Schutte, the prosecutor pointed out that Rajaratnam invested $10 million in Spottail last September and his family invested an additional $15 million on Jan. 4.

"Eight weeks before the start of this trial Raj Rajaratnam's family put $15 million into the Spottail fund," Brodsky said.

"That is correct," Schutte testified.

The executive was also paid at least $2 million as a consultant to wind down the Galleon Group after Rajaratnam's October 2009 arrest, the jury heard. The prosecutor also got Schutte to acknowledge on the witness stand that he spoke to Rajaratnam on the phone on March 18, ten days after the trial began.

The defense also called their expert witness on Thursday.

University of Rochester Simon School of Business professor Gregg Jarrell, a former U.S. Securities and Exchange Commission chief economist and a frequent trial expert witness, displayed for the jury a dizzying set of calculations meant to put Rajaratnam's suspected trades in the broader context of business at Galleon.

Between 2005 and 2009, Rajaratnam himself traded in up to 602 different company stocks each year in 36,000 total trades valued at over $172 billion.

"That's a lot of trading," Jarrell said under questioning by defense attorney Terence Lynam. "It's mind boggling."

The case is USA v Raj Rajaratnam et al, U.S. District Court for the Southern District of New York, No. 09-01184. (Editing by Dave Zimmerman, Phil Berlowitz and Bernard Orr)