By Grant McCool

NEW YORK (Reuters) - Securities regulators mustwait for access to thousands of secretly recorded conversationsin the Galleon hedge fund insider trading case until thelegality of the wiretaps is decided in a parallel criminalprobe, a U.S. appeals court said Wednesday.

The 2nd U.S. Circuit Court of Appeals in New York agreedwith arguments by Galleon founder Raj Rajaratnam and principalco-defendant Danielle Chiesi that a lower court's broad orderwould needlessly disclose private conversations to the U.S.Securities and Exchange Commission.

"While the district court was correct that the SEC had alegitimate right of access to the wiretap materials, it couldnot properly balance that interest against the privacyinterests at stake while the legality of the wiretaps was stillunresolved," the written opinion by the three-judge panel saidin part.

Rajaratnam and Chiesi, a former trader at New Castle Fundsin New York, were arrested on Oct. 16 last year on criminalcharges of conspiracy and securities fraud. They face as manyas 20 years in prison if convicted at trial.

Both have denied any wrongdoing in a case that U.S.prosecutors describe as the biggest probe of allegations ofinsider trading at hedge funds in the United States.

Prosecutors say the case marks the first wiretaps used in awidespread probe of insider trading on Wall Street. In all, 21people were criminally or civilly charged. Twelve have pleadedguilty and eight not guilty and one is at large.

The next significant event in the criminal matter isscheduled for Oct. 4, when a judge is to preside over arelatively uncommon evidentiary hearing on the defendants'challenges as to how the court-ordered wiretaps were obtained.

The eventual ruling by U.S. District Judge Richard Holwellon the legality or illegality of the wiretaps will besignificant to the evidence at the trial scheduled for January.The civil trial is scheduled for February.

Wednesday's opinion said the judge presiding over the SECcivil case, U.S. District Judge Jed Rakoff, should have waitedfor a ruling on the legality of the wiretaps, and should havelimited disclosure to relevant conversations. It said Rakofferred in ordering the disclosure of conversations involvinghundreds of parties.

"We are pleased with the 2nd Circuit ruling today that theCommission has a legitimate right to obtain relevant, legallyintercepted wiretap materials from defendants prior to theirdisclosure in criminal proceedings," SEC spokesman John Nestersaid in a statement.

A statement by Rajaratnam's team of lawyers noted the courthad granted an appeal of the "order directing the wholesaledisclosure of wiretapped conversations to the SEC and otherdefendants in the SEC case."

Chiesi's lawyer, Alan Kaufman, said in an emailed statementthat "we are gratified that the Second Circuit appreciated thegravity of the privacy issues at stake, and therefore reversedthe disclosure order."

Rajaratnam and Chiesi had argued that disclosure of thewiretaps to the SEC was prohibited by a statute known as TitleIII of the Omnibus Crime Control and Safe Streets Act of 1968.

The cases are USA v Raj Rajaratnam et al, U.S. DistrictCourt for the Southern District of New York, No. 09-01184, andSEC v Galleon Management LP et al No. 09-08811. (Reporting by Grant McCool; editing by John Wallace and GeraldE. McCormick)