Raj Rajaratnam: The Good, the Bad, the Ugly

Raj Rajaratnam: The Good, the Bad, the Ugly

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It seems that justice was served this week, when a year and a half after his initial arrest, billionaire hedge fund manager Raj Rajaratnam was found guilty of nine counts of securities fraud and five counts of conspiracy to commit securities fraud.  Rajaratnam could face up to 19 ½ years in prison when he is sentenced on July 29.  His lawyer plans to appeal the decision, so Rajaratnam will have to wait to learn his ultimate fate.  But the ordeal has implications for others.

The Good
Often times, the average investor feels like Wall Street is an insiders’ game where the rich get richer and seem to do so above the law.  This was the frustration verbalized by Chris Ferguson, the director of Inside Job, when he received his Oscar for Best Documentary Feature earlier this year.

It would have been a disaster had the jury returned not guilty verdicts, especially after the public heard taped phone calls of Rajaratnam obtaining material nonpublic information.  The confidence of average investors would have been shattered if they saw that the rich and well-connected have a major information advantage that’s legal.  Furthermore, a not-guilty verdict would have completely undermined the government’s ability to prosecute wealthy Wall Streeters.

The Bad
Just as bacteria evolve into more antibiotic-resistant strains, so do criminals.  The Wall Street players illegally trading on inside information are learning from the mistakes of the convicted.  The prosecution’s case in Rajaratnam’s trial relied heavily on the use of wiretaps from 2003 to 2009.  After Rajaratnam, Eliot Spitzer and his texts with a prostitute, and five seasons of HBO’s critically acclaimed series The Wire, most inside traders should know not to engage in such egregious behavior on their BlackBerries.  Future insider trading cases will likely be much smaller in scale or involve violations that occurred years ago.

The Ugly
What if Raj Rajaratnam sincerely believed he was playing bythe rules, at least according to what’s known as mosaic theory? It is possible to trade on non-public information, as long as it isn’t considered material.  However, when dealing with nonpublic information, an analyst has to use his or her judgment to differentiate between material and nonmaterial information.   Unfortunately, it’s not always a black and white issue.  If anything, the real winners will be the securities lawyers, who will be getting phone calls from their hedge fund clients seeking increasing amounts of advice regarding mosaic theory.

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