In May 2011, Raj Rajaratnam, founder of the Galleon Group hedge fund, was found guilty on fourteen counts of insider trading. After having initially postponed the sentencing decision, US District Judge Richard Howell sentenced Rajaratnam to 11 years in prison on October 13th. This constitutes the longest prison sentence ever imposed in an insider trading case, though well short of the prosecutions requested 20 to 24 year sentence.
During the trial, Rajaratnam and other Galleon traders were convicted of securities fraud and conspiracy under 15 USC §78j(b) and 17 CFR §240.10b-5, allowing them to make tens of millions in profits trading on publicly unavailable information. The Justice Department and the Securities and Exchange Commission successfully used wiretap recordings to prove that Rajaratnam had received inside tips about public companies.
The defendants based their arguments on the so-called “mosaic theory”, according to which Galleon’s investment decisions were made by combining publicly available information, coming from sources such as company announcements, newspaper argument and analysts’ reports. In this way, Rajaratnam could have gotten an information advantage over other investors without having committed fraud. The jury, however, did not accept this theory and ruled that Rajaratnam had also sought and used confidential information to conduct illegal trading.
Mr. Rajaratnam’s sentencing has sparked a debate about the severity of the punishment for insider trading crimes when no clear victim can be designated. The prosecution stressed the need for adequate deterrence: “Other corporate executives, CEOs of financial institutions, and heads of hedge funds will almost certainly look to the sentence imposed on Rajaratnam for the message as to how seriously courts will punish offenders for insider trading.” The underlying rationale seems to be that society as a whole benefits from healthy, trustworthy capital markets.
Mr. Rajaratnam’s lawyers on the other hand argued that he “cannot be compared to insider trading defendants in some of the other recent cases, such as lawyers who stole client information regarding corporate deals and traded on it.” According to the defense, the Federal Sentencing Guidelines used by the prosecution for calculating fraud loss were unsuitable in this case where there is no real or intended loss to a victim, and where “the amount of gain does not … bear any relationship to the underlying culpable conduct”
Indeed, we were not dealing with ‘Madoff, the sequel’. Contrary to some other forms of white-collar crime, Mr. Rajaratnam claimed that his actions did not directly affect identifiable individuals. But is there really such thing as a victimless crime? Apparently not when it came to Galleon trader Zvi Goffer, who was sentenced to ten years in prison on September 21st nor Mr. Rajaratnam himself.
Berkeley Business Law Professor Eric Talley notes that “so far, white-collar criminals have not had the best luck in convincing courts to ignore – even though they are voluntary – the Sentencing Guidelines.” According to Professor Talley, “the thing that’s very hard about this particular case is that the type of insider trading Galleon was involved with is right on the edge of legality. The real question is probably going to be about how much the judges will accept the invitation to treat the federal guidelines as voluntary, and to discount things that were reckless but not clearly willful.”
Of course, Mr. Rajaratnam will not go quietly into that good night. Lawyers for Rajaratnam are currently preparing for an appeal based on the government’s failure to fulfill the requirements of the Wiretap Act.
Good job Juno 🙂 Make us Belgians Proud over there!
I’m just curious to ask you about what should be an argument of Raj Rajaratnam if you’re his attorney what should do and what shouldn’t do from the perspective of lawyer and business person?
vice versa, if you’re the prosecutor what should do and what shouldn’t do?
Those are indeed very interesting questions, and although it is hard to give you a clear-cut answer for all of them, I will try to give you my thoughts nonetheless.
The role of the prosecutor seems fairly straightforward: they will have to gather all the evidence to prove that defendant was aware of “material non-public information” at the time it did a certain security transaction.
Defendants could try to rebut this by alleging that the information was not “material”, i.e. did not play an important role in the investment decision.
Next, defendants could rebut the “non-public” element, which is what Rajaratnam’s attorneys (unsuccessfully) attempted by arguing that the information came from a combination of public sources.
Defendants could also argue that even though they were in possession of “material non-public information”, they did not make use of this information. However, many courts do not accept not accept this non-use defense.
In reality, it will be important for a lawyer not only to rebut the SEC’s allegations, but also to give an alternative story as to why it was rational for your client to make the investment. An interesting article about the defense in Rajaratnam’s can be found here: http://finance.fortune.cnn.com/2011/03/10/insider-trading-defense-its-just-a-bunch-of-lies/
Finally, Rule 10b5-1(c) also provides some affirmative defenses, for example when the trader has already entered into a binding contract to purchase or sell the securities before he/she became aware of the non-public information, or when he/she has instructed another person to sell or purchase the security on his/her account before becoming aware of the information. (As a consequence, if a person delegates to someone else the authority to handle all his trading, this would fall under the affirmative defense)
The role of the prosecutor seems fairly straightforward: they will have to gather all the evidence to prove that defendant was aware of “material non-public information” at the time it did a certain security transaction.
Defendants could try to rebut this by alleging that the information was not “material”, i.e. did not play an important role in the investment decision.
Next, defendants could rebut the “non-public” element, which is what Rajaratnam’s attorneys (unsuccessfully) attempted by arguing that the information came from a combination of public sources.
Defendants could also argue that even though they were in possession of “material non-public information”, they did not make use of this information. However, many courts do not accept not accept this non-use defense.