Making a mountain out of the insider trading molehill

Larry Ribstein —  27 April 2011

Jon Macey insightfully wrote in the WSJ that the Galleon case illustrates the need to distinguish “trading on the basis of information that was legitimately ferreted out from trading on the basis of information that has been wrongfully obtained through fraud or theft.”

Macey notes that the SEC’s refusal to clarify the distinction between the mountain of trading on non-public information from the molehill of stolen information (which could include the information about Clearwire Rajaratnam paid Rajiv Goel for in violation of the latter’s duty to Intel) fosters an ambiguity that “increases the SEC’s power and allows government lawyers to pick and choose among prosecution targets.” He concludes that “the government should be compelled to provide clear guidance as to what constitutes illegal insider trading and what constitutes legitimate, albeit aggressive, research.”

That’s true for all insider trading cases, but especially true for criminal cases.  Business people will stay a long way from conduct that has any chance of being characterized as criminal.  Indeed, that deterrence is why we use powerful criminal sanctions.  But the avoided trading, including the industrious digging that characterized much of Rajaratnam’s activities. could bring valuable information into the market that enhances its efficiency.  Moreover, empowering prosecutors with vague laws invites a host of abuses in cases against corporate agents that sully our criminal justice system.

The SEC might argue that clarifying the scope of illegal insider trading could limit its ability to catch the really bad trading based on theft or fraud.  The government needs to sweep broadly in order to bore down into the facts that reveal serious misconduct.  But even if this is true, we need to balance the benefits of catching a few more theft cases against the costs of compromising market efficiency and encouraging prosecutorial abuse. 

In balancing costs and benefits, we should keep in mind that illegal insider trading is basically just another type of agency cost, like any fiduciary breach.  This sort of conduct is generally handled by firms’ contracts and discipline, as I noted recently regarding David Sokol’s trades and discussed at more length in my Federalism and Insider Trading, 6 Supreme Court Economic Review, 123 (1998).  Intel has ample incentive to punish Goel if he’s profited from personal use of information that is essentially a corporate asset.  And if the managers disregard shareholders’ interests in failing to impose discipline, the shareholders can sue derivatively as has been done in the Sokol case.

It’s no wonder that the SEC would want the public to see Rajatnaram sitting in the dock day after day to show that the SEC is protecting public markets.  But this spectacle is not a substitute for the work the SEC should be doing in guarding against future Madoffs.

Larry Ribstein


Professor of Law, University of Illinois College of Law

5 responses to Making a mountain out of the insider trading molehill


    I could not agree more, Mr. Ribstein. See especially the dozens of other insider trading cases that have followed Galleon. Some of those are downright Orwellian, such as most of the “expert network” cases as well as cases like those of Noah Freeman and Donald Longueuil, two young portfolio managers formerly at SAC Capital.

    Just as older, wiser journalists knowingly smile at cub reporters who think they have a scoop but really don’t, more experienced money managers smile knowingly at the likes of Noah Freeman and Donald Longueuil, who breathlessly believe they have access to valuable inside information but in reality can’t turn a profit as traders. Both were both fired by SAC Capital for poor performance.

    Ironically, the very reason that Freeman and Longueil’s “inside” information was useless is precisely because our markets are so efficient. Who cares if you have one more opinion from one more “insider” (and they all claim to be “insiders”) about what revenues were last quarter? Apple bought huge numbers of Iphone batteries? What a revelation.

    Market efficiency, like democracy, is a noisy, messy process, full of opinions, characters and delusions. Trying to control that process (to strive for a theoretical construct such as “equal access” for example) is like trying to control the press. It can be done, but then you won’t have a functioning democracy– or markets that investors believe in and that allocate capital efficiently by accurately pricing securities.

    north fork investor 27 April 2011 at 5:40 am

    I note that Macey gave no examples of governmental accusations of Raj of “simply talking to people and then trading” as illegal inside trading. If that was the mountain then why not provide a few. I think it mischaracterizes the case as a molehill of illegal activities.

    I disagree that the SEC takes the view that trading on the basis of any informational advantage is illegal and again I note Macey points at no particular party or cases that demonstrate that.

    By the way in relationship to Raj why are Macey and you even talking about the SEC. This is DOJ after all. They authorized the wiretaps.

    Finally I would argue that we need to balance the costs of a little prosecutorial abuse (there is no reduction in market efficiency) in reducing the inequities associated with trading on misappropriated insider information. One thing we have learned from the very recent arrests of three persons responsible for misappropriating information from several law firms over decades, is that illegal insider trading is difficult to detect and the evidence to prosecute is difficult to obtain. Thus no matter how many headlines are generated by big name cases, it is tempting for some to cheat.

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