How to stop the Whac-a-Mole of insider trading
Preet Bharara’s work rooting out insider trading is good news for U.S. investors, as long as you’re not one of the 240 people being investigated. But until governments tackle insider trading on a global basis, it’s like playing Whac-A-Mole. If your business model includes insider trading, you can pop up in Hong Kong or London almost as easily as Tokyo and Shanghai without much fear of prosecution.
That number — 240 people — is shocking. Prosecutors already have 57 convictions or guilty pleas since Raj Rajaratnam was arrested in October 2009, dozens more than during the Wall Street scandals of the 1980s. Bharara told the New York City Bar Association that insider trading on Wall Street was rampant. Rengan Rajaratnam, Raj’s brother, encapsulated the culture cynically but perfectly. Optimistic about his efforts to recruit a McKinsey consultant to their gang, he said to Raj, “Scumbag. Everybody is a scumbag.”
Alan Greenspan once famously said that the “market” would sort out financial fraudsters — regulators weren’t needed. Now we know the market actually includes quite a number of fraudsters who don’t seem to mind doing business with one another at all.
How did it get this bad?
We have been studying insider trading in Hong Kong for the past year. In reviewing enforcement of insider trading laws in major markets over the past 30 years, two factors stand out: the leniency shown crooks during the U.S. scandals of the 1980s and the effective tolerance of insider trading by governments everywhere else.
Twenty-five years ago last month, Rudy Giuliani and his team introduced the perp walk to Wall Street, handcuffing a Kidder Peabody arb in front of his colleagues and marching him out of the building. As one of the arb’s colleagues said, “if it was attention they wanted, they got it.” It was a good show, part of what’s needed for deterrence, but when it all ended six years later, most of the bad guys got off easy. Michael Milken was indicted on 98 felony counts and faced 755 years in jail. He pleaded guilty to six, was sentenced to 10 years, and was out in two. (Update: Milken was indicted on insider trading charges, but was not convicted and did not plead guilty to them.) His 1987 salary of $550 million didn’t quite cover his $600 million fine and restitution payments (Editor’s note: the original version of this column indicated that the fine Milken paid was $600 million; in fact, it was a $200 million fine and $400 million returned to investors). Ivan Boesky pleaded guilty to a single felony, paid a $100 million fine, and spent 21 months in a minimum security prison camp in California. Martin Siegel was out in two months. The most popular sentence handed down seemed to be a year and a day and federal guidelines at the time allowed parole after serving one-third of a sentence.
One can only wonder how many of this generation’s cheaters would have avoided the pain they’ve caused their loved ones if a tougher insider trading message had been sent 20 years ago.
But at least U.S. authorities were doing something about it.
In 1990, insider trading was illegal in only 34 countries. Today it’s illegal in most countries with stock markets. Lawmakers get it.
But having laws isn’t the same as enforcing them. The UK and Hong Kong have both stepped up enforcement recently, but they’re the exceptions, and even their efforts seem sparse, with occasional prison terms and no ability to use tools like the wiretaps that have proved so effective in the U.S. London prosecutors won a 40-month prison term last year against investment banker Christian Littlewood, who, along with his wife and her friend, traded — and raised red flags — ahead of takeover announcements for eight years. That’s a long cycle time and investigators needed years of connect-the-dots to make their case. January’s £7.2 million fine against David Einhorn and his firm, Greenlight Capital, bagged the FSA (Financial Services Authority) some big game — a stated goal for years — but one might wonder if it’s now safe for the rest of the big game to go back to the watering hole.
In Hong Kong, the jailing of Beijing princeling Du Jun in 2009 for seven years sent a Raj-like message, but there haven’t been many more since. He made nine trades ahead of a 2007 transaction done by his own client, Citic Resources. He was turned in to the SFC (Securities and Futures Commission) by Morgan Stanley, his employer, but only after he ignored repeated warnings to stop trading and was fired. He fled to the mainland for a year before returning, foolishly, to pick up some personal belongings. In short, he was a lucky catch.
Japan is a basket case, where few are prosecuted, no one goes to jail, and fines, often just thousands of dollars, can leave inside traders with much of their gains. One of us wrote in the Financial Times when the Olympus scandal broke last year about Japan’s notorious failures in dealing with white-collar scandals. Insider trading is no different.
China’s markets are so bad that they have reflected a disconnect from its high-growth real economy since 2008 — Shanghai trades today at about 40 percent of its 2008 peak — leading regulators to step up their rhetoric about curbing market abuses. But with more than 150 million retail investors tired of markets that have grown up abusing them, regulators have their work cut out.
Those entrusted to allocate society’s savings to their best use get paid well to maximize the benefits those savings can return to society. They have a fiduciary and moral obligation to be honest. If they have to cheat to be successful, they’re in the wrong line.
Insider trading is the graffiti and broken windows of financial neighborhoods worldwide. Stepped up enforcement in the U.S. is good, but until the crime is tackled globally, white collar gangs — and that’s what they are — can easily move to where their odds are better. Twenty-five years ago that required resourcefulness. Today they can do it without leaving their desk, no matter where it is.
Like they say in poker, if you don’t know who the mark at the table is, it’s you. If financial industry professionals can exploit inside information with impunity, the public stops playing, as in China. The economic and social ramifications of that are not encouraging in today’s world of growing inequality. With Main Street seething at finance industry corruption, broader, more effective enforcement of insider trading laws should be pushed, and cheered, by honest financiers everywhere.