Insider Trading Scandal Shows the Audacity of Greed
Mortimer B. Zuckerman

Time to get tougher on insider trading

The jury's conviction of the Galleon Group's Raj Rajaratnam on all 14 charges could be the turning point in the ever-recurring public and private debates on insider trading. The argument that it benefits the whole economy by forcing asset prices to adjust to reality looks a lot less appealing in the light of the courtroom exposures. What we see is a network of conspiracy to get rich quick more pervasive than previously imagined. The sheer volume of obscure figures in the financial world with access to lucrative tips and an inclination to sell them was astonishing: not the audacity of hope, but the audacity of greed.

Rajaratnam, considered a Wall Street billionaire success story, could not find it in himself to stop trading off significant non-public information in more than a dozen companies. His approach was one of "getting the number," that is, exploiting insider information before it became public to trade ahead of public announcements on earnings, forecasts, mergers, and spinoffs. As one of the trial witnesses put it: "Research is sort of doing your homework ahead of time. Getting the number is more like cheating on the test."

His competitors had long admired what seemed to be a deep set of contacts that he had cultivated inside Silicon Valley executive suites and on Wall Street trading floors. But they enabled him to build a vast network of information based on betrayals of corporate trust by people he seduced. As the prosecutor put it: "Cheating became part of his business model."

A blow has also been dealt to a second argument that insider trading should not be penalized -- that it is impossible to police. Secret recordings by the federal government, beginning in 2008, reveal the mechanisms of fraud as Rajaratnam and other insiders swapped information, discussed recruiting other corporate insiders to provide information, and plotted ways to avoid detection in unsparing detail.

As for wiretapping, most commonly used before to convict mobsters, it is defensible here, too. The prosecutor put it well: It is "not being heavy-handed, it is being even-handed," for these people were adopting "the methods of common criminals."

The tapes included a discussion of ways to throw off a normal insider-trading investigation, proving that the defendant knew that what he was doing was not only wrong but illegal, in a world in which fortunes could be made betting on the short-term stock moves triggered by events such as surprises in quarterly earnings. Rajaratnam convicted himself with his own words caught on the tapes.

Now, many financial institutions, hedge funds, prime brokerages, and research-driven investors will have to rethink their practices. People want to know that the markets are operating fairly and that the police are capable of catching the bad guys. They have long believed that Wall Street is rigged against the average investor, while bankers and brokers enrich themselves at their expense. The results will mandate reforms. Traders should be obligated to maintain reliable time stamps providing information about who trades and when, for without this it would be almost impossible to build an insider-trading case in many of the different markets in the world of finance.

Everybody knows the main financial groups and the big hedge funds have a huge comparative advantage over the average investor through relationships in the corporate world that provide them with valuable insights about companies, trends, and potential market-moving events. They have the resources to hire consultants to dig up more information. They can hire expert-network companies, which connect large investors with outside experts, and pay them handsome fees for non-public information on stocks whose share prices can quickly turn on tidbits about forthcoming products or financial performance. Given that the supply chain is now predominantly global in nature, the marketing or the dissemination of such material information is beyond the reach and control of U.S. regulators. An employee of one expert-network company was arrested last year and accused of having a group of Asia-based employees of North American technology companies who could provide such information to clients.

Every reputable company and advisory service, including investment banks, must be horrified by these revelations and will seek to make sure it does not happen to them by revising the rules for their director and compliance standards to avoid the breakdowns revealed in this trial. The cracks in governance are big and intolerable. We may even see greater interest in a revived proposal to lay down trading rules for non-public information collected by congressmen.

Insider trading is not research.

The playing field may never be truly level on Wall Street, but the government is now in a position to patrol more aggressively the gray line between financial research and financial crimes. The courts will be more willing and able to make wiretaps available to the Securities and Exchange Commission. Concern that federal agents are listening should be an effective deterrent and reinforce the idea that people need to be very careful about how they deal with information that has financial value. As the prosecutor put it in the press conference announcing the original arrest: "Greed sometimes is not good."

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