The Great Debate

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.

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.

Sometimes legal fishing expeditions pay off.

A year ago, a Connecticut hedge fund sued UBS, contending that it knowingly sold toxic mortgage-backed securities to institutional investors but never disclosed that information.

At the time, the accusation by the fund, Pursuit Partners, seemed intriguing. But because the complaint lacked any sign that it had the beef to back up its potentially explosive claim, the litigation all but fell off the radar screen.

Now, it appears the hedge fund managers were onto something, thanks to a Connecticut state judge's decision to allow Pursuit's lawyers to get limited access to some of UBS' internal emails.