How insider trading becomes endemic

By Felix Salmon
June 22, 2011
George Packer's massive, 11,000-word article on Raj Rajaratnam, his prosecutor Preet Bharara, and financial prosecutions. Highly recommended. But there was one line in particular which jumped out at me:


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This week’s New Yorker has George Packer’s massive, 11,000-word article on Raj Rajaratnam, his prosecutor Preet Bharara, and financial prosecutions. Highly recommended. But there was one line in particular which jumped out at me:

If there are examples of people whom Rajaratnam unsuccessfully tried to corrupt, they have not surfaced in the voluminous public record on Galleon.

I asked Packer what he meant by this. Is it simply a narrow statement about “the voluminous public record on Galleon”? Is it possible that Rajaratnam never met someone he couldn’t corrupt? Or is it something in the middle, maybe that Rajaratnam had an extremely good nose for the kind of people who could be corrupted?

I wanted to know just how malign Packer considers Raj to be. If you or I had been approached by Raj in full flower, would he have corrupted us, too? I have an image of Raj as someone a bit like Javier Bardem in No Country for Old Men, only instead of killing the people who come across his path he just turns them into insider traders.

Packer replied:

From my work on this story, I’m certain there are people Raj tried to corrupt and couldn’t. And perhaps it’s not surprising that their names didn’t show up in the record, since we’re talking about a criminal investigation. It’s just striking that so many names of the corruptible do show up, how casually they show up, how easy it was for Raj to turn most of them. Also striking that not a single counter-instance happens to stumble into the record, with all the documents I’ve seen and wiretaps I’ve heard. You’d think that at least one example would appear. (And, to answer one of your questions, I’d to think that if you or I floated through this world, we’d have been that example.) And finally, it’s striking how many people who weren’t actively involved in the crimes must have known about them but apparently never raised a red flag, and certainly never went to regulators or other authorities. There’s a kind of code of silence on Wall Street that reminds me of omerta in the mob and the blue wall with the police, which obviously makes it all the harder for prosecutors to take on the vast scope of these crimes. Preet Bharara was cautious about what he would say to me, but one thing he did say was that insider trading is “everywhere you look.”

This is depressing, and rings true. I’m no expert on insider trading, but it does seem to me that prosecutions tend to come proactively as a result of deep investigations, rather than reactively as a result of companies or employees turning violators over to the authorities. Galleon employed about 70 analysts, fund managers and traders when Raj was arrested, as well as support staff; it’s reasonable to assume there were at least as many ex-employees too. It’s silly to believe that they were mostly ignorant of what Raj was looking for — and yet none of them said anything.

The key here, I think is the same slippery slope of complicity that I’ve written about before. Start with a job offer, and an office culture. And then slowly raise the money and the pressure, and bring as many people as you can inside the fold. Long before they do something illegal, they’re tainted, and won’t give up their colleagues.

I also wonder: hedge funds are famous for the barrage of interviews and personality tests that they put prospective employees through. Are some of those tests ferreting out precisely the sort of people who are the most corruptible? After all, corruption is a close relative of greed, which hedge funds are unabashed about prizing.

And remember too that all of Wall Street, even down to the level of individual investors, trafficks in exclusive information. Think of all those expensive newsletters offering an edge in the market, or the various subscription websites and boring conferences which promise to give people hugely valuable investment advice.

It’s a given, on Wall Street, that information can be prized and valuable. One time-tested way of making it big on Wall Street is to find information which others don’t have and then act on it: look at Muddy Waters for a prime example. Everybody’s looking for the information edge — and the point at which exclusive information crosses over into being inside information is maybe not always obvious from the point of view of an ambitious analyst. If I’m sitting on the Acela and overhear two businessmen talking about an upcoming deal, I can act on that knowledge perfectly legally. And the main problem with analysts’ information isn’t that it’s illegal, but rather just that it’s worthless.

All of which says to me that there’s a lot more insider trading going on than the number of prosecutions would imply, and that it’s going to be extremely difficult to crack down on. The very architecture of Wall Street is designed to encourage it, with only a thin layer of compliance people doing their best to warn people sternly about what they can’t do. They — along with prosecutors — are likely to remain mostly ineffectual, so long as everyone else continues to push for an edge wherever they can find one.

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