Richard J. Holwell, a Manhattan federal judge, will give his answer to that question when he sentences Rajaratnam on Sept. 27. A lengthy sentence would go a long way toward validating not just the federal prosecutors who brought the case but also the Securities and Exchange Commission, which first investigated the hedge fund. Before and since the Rajaratnam trial, the S.E.C. has brought numerous cases, part of a campaign to root out insider trading and, in theory, make markets fairer for the average investor. In recent weeks alone, the S.E.C. filed complaints against traders who ran the gamut from celebrity to ordinary. It settled charges with Doug DeCinces, a former Baltimore Orioles third baseman who bought stock in Advanced Medical Optics after learning from a tipster that the company was about to be taken over; it reached an agreement with Hugh Hefner’s son-in-law, who blatantly ignored written warnings against trading in the stock of Playboy, where his wife was the chief executive; and it settled with a Denver businessman, who tipped his son, an investor, about a pending acquisition.
No one knows how much cheating of this kind occurs, but regulators have developed good tools for spotting it. Every time there is market-moving news, like a merger or an earnings report, computers at Finra, a regulatory body, scan millions of buy and sell orders, looking for suspicious trades, like a big stock purchase in advance of a takeover. Finra refers some 250 trades a year to the S.E.C. for a closer look. Getting a stock-market tip has always been a sort of all-American fantasy, and despite the risk of detection, the desire for an edge seems irresistible. “People are greedy,” says Robert Khuzami, the S.E.C.’s director of enforcement. “They think they won’t get caught.” Even those who should know better: Donald L. Johnson, an official at Nasdaq, was entrusted with confidential information from listed companies, and he used his privileged knowledge to trade in advance of news of drug trials and other results. Johnson dimly supposed that by trading in an account listed in his wife’s name, his behavior would go undetected. He was sentenced to three and a half years.
Not all cases are so black and white. The law on insider trading, which has developed over the years from judicial rulings and is not specifically found in a statute, is ambiguous enough to allow for a range of interpretations. And at a time when the government is accused of going easy on white-collar crime, Khuzami has pursued an aggressive approach, pushing the boundary of what is deemed illegal. Strengthening the S.E.C.’s long-running effort, Khuzami has focused, particularly, on the hedge fund industry, which for reasons related to its competitiveness, capital and connections, he sees as especially prone to insider trading. Wall Street has taken notice. For one thing, the Rajaratnam case, which was prosecuted by the United States attorney for the Southern District of New York, led to dozens of criminal convictions. Perhaps more important, the bread-and-butter civil actions brought by the S.E.C. is putting pressure on traders to refrain from using information that is even borderline illegal.
The dollar amounts involved in such cases tend to be small, which has led critics to question whether the S.E.C. shouldn’t be spending more of its resources on larger offenses like mortgage fraud. But in truth, insider trading is just the sort of activity the S.E.C. was created to combat. Not so very long ago, the public had a sense that the agency was watching out for small investors and keeping markets safe. Then in 2008 came a pair of cataclysmic failures: virtually the entire investment-banking industry, which the S.E.C. regulated, either failed or sought a bailout; then, having ignored explicit warnings about Madoff, the agency was further humiliated by the revelation that he’d been running a Ponzi scheme.
Some have criticized the emphasis on insider trading cases as a kind of quick fix to the S.E.C.’s battered image. “Nonsense,” says Khuzami, who joined the agency two months after the Madoff fiasco. But image actually is important; it’s part of providing an effective deterrent. To an unusual degree, respect for insider trading laws depends on the visibility of enforcement. In a survey of 2,500 traders taken in 2007, more than half said they would take advantage of an illegal tip if they were assured they wouldn’t be caught. Without S.E.C. enforcement, Wall Street would degenerate into a cesspool of conspiratorial tipping — as it was before the agency existed. If you think that doesn’t matter, ask yourself if you’d be comfortable investing in, say, Oracle, if Larry Ellison, its lavishly compensated C.E.O., were free to buy and sell the stock, and to clue in his friends, every time Oracle’s sales took an unexpected but not yet public twist. By bringing cases and challenging hedge funds, the S.E.C. aims, at very least, to remind investors that insider trading isn’t simply financial naughtiness — it’s a crime.
Roger Lowenstein (elrogl@gmail.com), an outside director of the Sequoia Fund, is a contributing writer and the author of “The End of Wall Street.”
Editor: Vera Titunik (v.titunik-MagGroup@nytimes.com)
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