By Artur Davis
Had hedge fund billionaire Raj Rajaratnam managed to deadlock his jury, or had his defense team maneuvered to a muddled verdict of the kind that baseball’s Barry Bonds received on perjury and obstruction charges, there would have been a lot of hand-wringing in legal and editorial circles. There would have been intense second-guessing of the prosecution’s extravagant expenditure of time and resources and of the decision to engage this matter as a full-pronged criminal probe rather than as a civil enforcement action that would have been bent on shutting down the Galleon Group fund rather than sending individuals to prison.
Now that the Galleon jury has spoken and done so emphatically, with a guilty verdict on all 14 counts of securities fraud and conspiracy, there will be a tendency to veer in the opposite direction and project the case as a signal development in insider trading law. That would be a reach and would miss that at its core, the charging and convicting of Rajaratnam is a straightforward application of insider trading principles. It signals a toughness in the pursuit of illegal trading, but not much as legal theory that is new or untested.
The recent investigation into expert networks, and the broader Galleon investigation, do not involve cutting-edge claims of the kind in the celebrated Martha Stewart probe a few years ago. In that case, while the eventual charges involved allegations that Stewart lied to investigators and covered up her actions, the SEC gave serious consideration to a scenario that insider trading cases almost never touch: the use of information that did not come from a known confidential source, by an individual who owed no duty, fiduciary or otherwise, to the company whose shares were traded. Had Stewart been successfully charged under this theory, Wall Street would have been unsettled for good reason.
The verdict in U.S. v. Rajaratnam also sheds little light on the much-discussed mosaic defense that was offered in this trial. The jury was not persuaded by the defense claim that Rajaratnam assembled a slew of public details about the market, what the investment industry calls a mosaic, and that in no single instance was a trade actually based on illegal inside information. This was a very fact-intensive theory that never had a high likelihood of absolving Rajaratnam of more than a few of the counts at his trial. It was undermined from its inception by voluminous wiretap evidence of the defendant boasting about his inside tips and coaching some of his associates about how to avoid getting caught.
The fact is that the Second Circuit, which includes the Southern District, where Rajaratnam was convicted and where much of the hedge fund industry resides, has a relatively weak legal standard for establishing insider trading liability. A trader who comes into “knowing possession” of illegal inside information is essentially foreclosed from trading and is deemed liable of a securities violation if he goes ahead and trades any stock connected to that information. It is a pretty unforgiving standard, and some other circuits have criticized it as too draconian. However, despite an aggressive defense that struck early and often with pretrial motions, Rajaratnam’s lawyers did not challenge the current state of the law in this jurisdiction and perhaps denied themselves the one appellate issue that might have attracted the Supreme Court’s attention.
There is one fundamentally new feature of this trial and Galleon’s collapse. For the first time, prosecutors used electronic wiretaps as an investigative tool in an insider trading case. Typically, wiretapping has been reserved for cases involving organized crime, narcotics smuggling or old-fashioned political corruption. Its deployment here suggests a new swagger in the federal government’s attitude toward illicit trading on Wall Street. That wiretapping worked so well means that the FBI will use it again and that other unconventional techniques, like sting operations and confidential informants, will not be far behind.
The aggression against illegal trading does not, in my opinion, foretell a campaign to criminalize the bad institutional judgments that almost collapsed the capital markets in 2008, and probably offers no hints about the Department of Justice’s approach to the political and legal thicket around mortgage foreclosures. It would be much more difficult to prove a criminal state of mind in those matters. So perhaps the Rajaratnam case is less a groundbreaker and more a fairly conventional tale of human frailty and ambition gone awry: tragic for a first-generation immigrant who became one of the wealthiest men in America, but not so meaningful for the rest of the investing public. AR
Artur Davis, a former prosecutor and four-term congressman from Alabama, is a partner at SNR Denton in Washington, D.C.