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.