Rajaratnam stands convicted. What, exactly, did he do wrong?
Holman Jenkins, writing in today’s WSJ, appropriately mocks the notion driving the Rajaratnam prosecution that insider trading “law’s purpose is to protect the public from informed stock prices.” As Jenkins notes:
There is no level playing field. Nor does there need to be one for the stock market to be an acceptable place for the public to park its savings. The efficient-markets hypothesis may not be in the best of odors these days, but its signature piece of advice is as good as ever: Stock trading is a mug’s game. Use an index fund.
On the other hand, Jenkins says, the Rajaratnam trial is properly based on the corruption by which Rajaratnam’s acquired his information:
In the noses of any sane jury, the whiff of criminality arising from these actions would have been stronger than any forlorn assertion that investors generally were harmed by Rajaratnam’s trading.
That may be true. But it’s still the case that the seasoning of non-harm to investors with a “whiff of criminality” does not turn this bland prosecution into tasty public policy.
The wrongs that gave rise to these prosecutions were solely to the companies that owned the stolen information. What makes this illegal insider trading, complete with Draconian criminal penalties, is that the misappropriation became the basis of stock trading, which as Jenkins says does not harm the market whether it’s based on criminality or not. Unlike conventional securities fraud, the market is not deceived. If anything it is enlightened by trading that helps make stock prices more accurate.
The only deception, according to the Supreme Court in U.S. v. O’Hagan, is by the information thief to the information owner. The federal government gets to prosecute these actions only because of a Rube Goldberg contraption by which deceiving your employer in New York into thinking you’re keeping information confidential is magically converted into fraud on a day-trader in Omaha who benefits by trading the security without realizing that its price reflects the stolen information. And of course most of us in the market aren’t affected at all because instead of foolishly day-trading we’re buying and holding index funds.
Jenkins says the jury properly dismissed the defense’s theory that the defendant’s trades were motivated by a mosaic of legitimate information rather than by the illegal bits. But the mosaic theory is no nuttier than the rest of this jury-rigged legal theory. Again, Rajaratnam committed a federal crime only because the theft of information is a kind of deception, which in turn is what makes the trading illegal under present securities law. If you steal information but don’t trade it’s not a federal crime. If you trade on legitimately acquired non-public information it’s not a crime. Why, then, should it be crime if you steal information but trade on other information?
And while we’re at it, what about the other questions raised by this wacky theory and discussed in my Federalism and Insider Trading, 6 Sup. Ct. Econ. Rev. 123 (1998): 1. What kind of deception is necessary? 2. What if the information owner consented to use of its information? 3. What kind of breach of duty amounts to actionable misappropriation to justify an insider trading charge? 4. If the information owner is not harmed, does it matter if the information traded on was material to investors? 5. If the information owner is harmed, does it matter if the information was immaterial to investors? 6. What does materiality mean in this context? 7. How much knowledge of all the elements of wrongdoing must the defendant have?
Let us not forget that these are criminal charges which could send Rajaratnam to jail for a very long time. Shouldn’t we be a little clearer on exactly what he was doing wrong? The Supreme Court ultimately may think so.