America’s insider-trading trials have a heavy purpose

June 19, 2012

Since Raj Rajaratnam was arrested in late 2009, federal agents have swept up more than 60 hedge fund employees, consultants, and corporate managers in the largest insider-trading crackdown in history. Most of those arrested are now in or on their way to prison for sentences generally measured in years.

The sweep already dwarfs the cathartic closure to the 1980s, when a couple dozen high-profile convictions and guilty pleas were won. But it looks like prosecutors still have plenty of work to do. In February, U.S. Attorney Preet Bharara disclosed that 240 more investigations are ongoing, and it’s likely that prosecutors will file charges against half of the people being investigated. If the mostly short prison sentences of the 1990s – many less than a year – provided a deterrent, it didn’t last long.

But not everyone thinks criminal prosecution of insider trading is the way to go. The Rajat Gupta trial has brought the insider-trading apologists, not to mention Gupta’s friends, out in force. Columnists in both Slate and Forbes argue that the government should have pursued its case against Gupta with civil charges instead. Either they are new to the case or they somehow overlooked the fact that it was Gupta who sued the government to upgrade his case from civil to criminal proceedings. He wanted his day in front of a jury, and he got it.

Breakingviews columnist Reynolds Holding’s provocative piece “Rajat Gupta goes down but insider trading may not” argues that the vagaries behind Gupta’s conviction might fail to deter would-be inside traders because it’s not obvious when they cross the line. He also argues that a better approach may be pursuing a greater number of lesser, easier-to-prove charges with smaller penalties, in part because the government doesn’t have the resources to do many Gupta-like cases.

Rajaratnam, the former CEO of the Galleon Group hedge fund, was convicted on 14 counts of insider trading and conspiracy last year and is now serving 11 years in prison. A former Cravath and Skadden lawyer, Matthew Kluger, and his trading partner, Garrett Bauer, were sentenced to 12 and 9 years, respectively  in a Newark federal court earlier this month.

The trend in capital markets worldwide is clear: stronger enforcement and harsher penalties for insider trading. Now the UK and Hong Kong are cracking down too, albeit without the gift of wiretaps, doling out long prison sentences and large fines, and Europe is heading in that same direction. Among the world’s largest markets, even Japan and China claim they are trying – imposing an occasional fine.

Still, insider trading plays a significant role in some hedge funds’ business models in the U.S., which until about five years ago was the only country in the world  to actively prosecute the act. Where the punishment for insider trading is a battery of fines and banishment from boardrooms, getting caught just becomes a cost of doing business.

Like corporations searching for the most favorable tax centers when making decisions about where to build plants and establish offices, inside traders can do the same with insider-trading laws. Easing up on enforcement and punishment while other countries are going in the opposite direction moves the U.S. in the direction of an insider-trading haven.

In cases like Tiger Asia in Hong Kong and First New York Securities in Japan, New York traders are being pursued by Asian authorities for insider trading in their markets. Tiger Asia has denied the allegations against it. If authorities in the U.S. relax just as their counterparts elsewhere are getting more serious, these scenarios could work in the opposite direction. The U.S. may become the playground for the world’s unsavory trading business.

U.S. regulators have crooked hedge fund managers sleeping with one eye open now. The indications are that prosecutors are pressing on and will finish the job. With the sentences being meted out, it is likely that the deterrence from this generation’s crackdown will last a lot longer than last time. That’s a good thing for honest investors everywhere. Sixty cases down, and 120 to go.

PHOTO: Rajat Gupta, a former Goldman Sachs and Procter & Gamble board member, arrives at Manhattan Federal Court in New York, June 4, 2012. REUTERS/Andrew Burton

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