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December 20, 2021 Reading Time: 11 minutes

Years ago, and while at a dinner in New York City, the subject of “insider trading” came up. A woman who had formerly worked in Royal Dutch Shell’s headquarters had an interesting anecdote to convey about trading on material non-public information (MNPI). She’d worked in accounting for Shell, and as such was privy to its quarterly earnings before investors were.

Her story was that she, along with several other employees, would make small inter-office wagers every quarter on what the stock-market’s reaction would be to the numbers. The guesses were all over the place, and usually wrong.

About this story, it will be said up front that the markets and economy would be much more vibrant if they got rid of undefinable “insider trading” laws altogether. The more informed the markets are, the much better. What a backwards, confused world we live in that something so additive to market and economic health is so demonized.

Furthermore, it’s obvious that the prosecutors and pundits who look askance at “insider trading” haven’t a clue how difficult it is to know what to do with information, even if it’s of the MNPI variety. Getting right to the point, it’s no easy feat to divine the future direction of markets when armed with information that others lack. See Shell. After that, see the varied reactions to any bit of news. Perception is rarely uniform.

All of this and much more came to mind while reading Raj Rajaratnam’s excellent and essential new book, Uneven Justice: The Plot to Sink Galleon. Rajaratnam was the founder of the wildly successful technology hedge fund Galleon that was needlessly destroyed by zealous prosecutors, and Uneven Justice is his “attempt to shed light on the corrupt few” in government “who act with impunity and destroy lives and families to further their career ambitions.” If you read Rajaratnam’s book, prepare to be enraged. From the very first page.

Indeed, in October of 2009 Rajaratnam “was arrested and charged with insider trading.” On its face, the arrest was offensive. See above. Investors like Rajaratnam are what Canadian economist Reuven Brenner refers to as “price givers.” They’re the rare, intrepid souls willing to take big risks, and in doing so, their courageous trading renders equity markets far more informed. Rajaratnam was handcuffed for his intrepid ways. Don’t worry, it gets worse.

As he writes, “The prosecutors alleged 0.01 percent of all my trades between 2005 and 2009 were illegal.” Of course “illegal” on the matter of “insider trading” is intensely hard to define. As Jonathan Streeter, the lead prosecutor in Rajaratnam’s case later acknowledged about “insider trading” laws, “There is incredible confusion on what is illegal.” No matter there. At least for prosecutors. Incredible confusion is their friend. Never forget that they want to live well too.

“Insider trading” cases are their path from toil as government attorneys into private law practice of the partnership variety. Harpoon a whale with laws that can’t be defined, then go into private practice demonizing the same laws that paved your way into private practice to begin with. What’s incomprehensible is your ticket out of government work.  As former SEC commissioner Mary Schapiro put it about “insider trading,” the “beauty of insider trading laws is the flexibility in interpreting them.”

So there you have it. Ambitious prosecutors earning government salaries are desperate to get into much higher-paying, private practice work. They throw undefinable rules at well-heeled Wall Street types desperate to avoid ruin, and possibly prison. Careers are made by attacking the price givers with what is legally malleable. Let’s be honest about what “insider trading” laws are: a relief act for public and private sector attorneys.

Which brings us back to Rajaratnam. A microscopic fraction of his total trades are alleged to have been made with MPNI. About those trades, please keep in mind that Galleon “had lost over $30 million” on them. Except that reason is of no consequence on matters such as these. Preet Bharara couldn’t be U.S. attorney for the southern district of New York forever. Private sector money needed to be made. A handcuffed billionaire like Rajaratnam would be his whale. Don’t worry, it gets even worse.

On a Friday morning in October of 2009 FBI agent Kang knocked on Rajaratnam’s door and told him he was under arrest. Keep in mind that Rajaratnam’s parents lived next door. His “two younger children were hiding under the blankets.” There was no telling what they thought, or the fear they felt. Sorry, but the story gets worse. After cuffing Rajaratnam as though this brilliant technologist was a common criminal, Kang told him to “Take a good look at your son because you’re not going to see him for twenty years.” Rajaratnam’s bail was $100 million. Bernie Madoff’s was $10 million….If you’re not a libertarian after reading Rajaratnam’s account of nobodies in government trying to be somebodies, you need your head examined. What happened is nauseating.

Notable here is that upon being taken “downtown” as it were, Rajaratnam answered question after question sans attorney. Why wouldn’t he have? In his words, “my innocence was obvious.” Of greater interest to this reader and reviewer would be a video of Kang interrogating Rajaratnam. Can you imagine? Can you imagine someone possessing a small fraction of Rajaratnam’s intelligence presuming to interrogate him? About market matters? The arrogance of government is astounding, and needs to be exposed. It seemingly never occurred to Kang that his badgering of Rajaratnam, and his efforts to essentially trap him with “tough” questions, would be the equivalent of a 7th grade flag football coach attempting to stump Bill Belichick on the intricacies of defensive alignments.

Except that what always vandalized basic reason actually became even dumber. In his nationally televised press conference announcing the arrest of Rajaratnam, Bharara proclaimed that “Greed is sometimes not good.” Bharara’s lack of self-awareness is amazing. That’s the case because among other things, he’s the greedy one. Rajaratnam made his money the hard way. If anyone doubts this, please do some basic due diligence about the success rate of hedge funds. “Hedge fund billionaire” is a clichéd term not because these individuals are common, but precisely because they’re so incredibly uncommon. If billions were easily earned by portfolio managers, we’d all be portfolio managers. The reality is that people with Rajaratnam’s talent bring new meaning to the word rare.

To earn billions as a portfolio manager you have to be much more than good. Think about it. There are two sides to every trade; as in every buy or sell you’re completing has a counterparty who thinks the opposite of what you do. The markets are crowded with extraordinarily bright people who have different views about what’s ahead, at which point it’s wildly courageous to put money to work. And that’s if you merely want to tread water. On a good day. To earn billions is to put money to work in brave fashion. It’s to enter into trades that, on the face of it, don’t necessarily make sense. Put simply, billionaire hedge fund managers get that way by making trades that could just as easily sink them, or that more often than not do sink them. Markets are way too efficient for billions or even millions to be earned easily. What Rajaratnam accomplished before having his business destroyed by the likes of Kang and Bharara was gargantuan.

Compare this yet again to Bharara; he of the obnoxious, childish, and trite Wall Street (the movie) reference, “Greed is sometimes not good.” Was Bharara so delusional as to believe what he was saying? He uttered those words fully cognizant that a victorious case against Rajaratnam would be his path to seven-figure earnings outside government. In short, Bharara’s endgame all along was the high life too, only he took a much easier route: he would use the vagaries of securities laws and the destruction of businesses and reputations as his path to wealth. Rajaratnam’s desire for achievement created wealth. By definition. Without investment, there is no economic growth. Period. Bharara would destroy wealth and reputations in order to attain riches. Ok, so who’s the greedy one? In Rajaratnam’s words, Bharara et al “had no problem making the transition from denouncing apparent ‘greed’ in the financial markets to defending that same greed” in the private sector. For this, Bharara was lionized by a lefty, market-skeptical press. This included a Time magazine cover story. No doubt Bharara has the latter framed. Let’s be honest. Blood money.

About Rajaratnam, it’s very apparent from reading Uneven Justice that he’s a very serious person. How could he not be? Anyone can get lucky with a trade or some trades, but luck eventually runs out. In Rajaratnam’s case the Wharton MBA was president of technology investment bank Needham & Co. by the age of 35, and upon departure from Needham to start Galleon, George Needham wrote in a memo to company employees that “Raj is the finest research analyst I’ve ever known. His grasp of stocks and the market remain without peer.”

This is important as Rajaratnam builds a case that he never should have had to build in the first place. But since there will always be ambitious prosecutors eager to make money the easy way, it’s useful to note that “Every trade in the eight stocks of the original indictment was supported by detailed written analyses by competent Galleon analysts.” Well, of course. Only in the imaginations of those who would never be entrusted with billions (let alone millions) can traders blithely put capital to work without a reason for doing so. Successful hedge funds back their trades with endless research and serious thought. As Rajaratnam puts it, there’s a “stereotype of traders that has been celebrated and caricatured in popular culture.” Which is the point. The stereotype is nonsense. “The Wall Street greed and high intensity, the unprincipled trader, are a trope and a stock character in movies and television.” Kang and Bharara imagined a Wall Street that never existed, and actually believed someone like Rajaratnam could compile the brilliant fortune he did based on bluster, bets, and the occasional “tip” not available to the average bear. If only success were as easy as people like Bharara imagine it to be. Except in his eyes, it is easy: bludgeon the actually successful with vague laws, hold lots of press conferences while doing so, then cash in. Bharara planned his success. He would wrongly bring down others in order to lift himself up.

In Rajaratnam’s case, his achievements were the result of being right in a field where it’s exceedingly difficult to be right. If anyone doubts this, they need only contemplate the proliferation of index funds. “Portfolio manager” is in many ways a dying profession as a consequence of markets being so smart, and fully priced.

Important about the above is that markets are efficiently priced precisely because courageous people like Rajaratnam are studying companies endlessly, and then putting wealth to work based on frequently contrarian hunches developed based on painstaking work. Rob Arnott once told me that “I work all day to make markets efficient.” So does Rajaratnam, or did Rajaratnam. He’s the hero in this story, or he should be.

Thanks to people like him constantly trading based on the serious research of companies, the small investor has much less to worry about. About this, Ken Fisher arguably puts it best: “the markets will do your worrying for you.” And it’s the Rajaratnams of the world doing your worrying. Diligently studying companies, their investing creates a much clearer picture for the smaller investors who follow them into the market.

If you doubt any of the previous paragraph, please think about the times you’ve put money to work. Were you sweating? Losing sleep? In Rajaratnam’s case starting Galleon (eventually a 180 employee, $7 billion manager) brought with it “gut-wrenching anxiety.” Of course it did. You see, his investors weren’t paying him to shadow the market; rather they were paying him to navigate uncharted waters. Hence all the thought that went into every trade. The “seen” is the very few very successful hedge funds. The “unseen” is the exponentially greater number of funds that close, or are forced to shut down due to a lack of performance.

Rajaratnam’s seeming error was success. Had he been a run-of-the-mill portfolio manager, there’s no way he would have caught the eye of Bharara. Don’t you get it, there’s little private sector upside to harpooning nobodies. Particularly in 2009, and with memories of 2008 still fresh, Bharara had to find a whale. The problem was that Galleon had a clean track record. No matter. Quoting Rajaratnam quoting Alan Dershowitz, “prosecutors can easily succumb to the temptation of first picking the man and then searching the law books or putting investigators to work to pin some offense on him.” Which is what Bharara did.

To help his case, he found past employees of Galleon or those distantly associated with Rajaratnam and Galleon to testify against Rajaratnam. Some will ask what would it matter if he were innocent, but such a question ignores what prosecutors can do with young, frequently junior individuals. They can terrify them. One former Galleon employee (Adam Smith) with two young boys was hit with a variation of “Take a good look at your son because you’re not going to see him for twenty years.” Smith had formerly made plain that all of Galleon’s trading was on the up-and-up, but facing the possibility of not seeing his kids, he changed his tune. So did others like Roomy Khan and Ali Far. Fearful of prosecutors with theoretically endless resources, they turned on Rajaratnam and Galleon too. It didn’t matter that “witnesses” like Khan and Far were “inconsequential to any decision” made at Galleon of the trading variety. Since they had ties to Rajaratnam, they were used to build their case. As for the prosecution’s star witness in Anil Kumar, he “offered damning testimony under oath in my case only to recant the very same sworn testimony three years later during the trial of my brother.”

The sad news is that the story just keeps getting worse. In order to weakly tie Rajaratnam to their less-than-credible witnesses, they quite literally wiretapped Galleon’s phones as though it was some kind of criminal organization. As the Judge (Holwell) presiding over the case later admitted, “It’s difficult to overstate how damaging wiretap evidence can be to a jury. Playing a recording in front of a jury of you calling your mother to ask what you’re going to have for Sunday dinner sounds criminal.” All this in a country founded on deep skepticism about politicians….

Did the book have weaknesses? No doubt a few. For one, it seems an editor didn’t closely scrub Rajaratnam’s recollections. This meant a misspelling here and there, the mention of “business columnist Mike Taibbi” even though his name is Matt, former SEC commissioner Mary Schapiro is spelled as Shapiro, and the mention of Colombo (the Sri Lankan city where Rajaratnam grew up) as a “teardrop-shaped island” was found on pages 29 and 31.

But arguably the biggest weakness for me was Rajaratnam’s lament starting on the book’s second page that “not one major banker was held accountable for the 2008 global meltdown.” The critique here is that no banker should have been held accountable. Banks and investment banks are ephemeral collections of individuals. At least in the old days, Goldman Sachs would always show its new employees a deal tombstone from the 1950s full of investment banks that no longer exist. Which was the point. The business is difficult, and there’s no rule saying Goldman should always exist. So be careful. Applied to 2008, various financial institutions erred. This wasn’t nor should it be a crime. Furthermore, the meltdown wasn’t caused by failure as it was. The obvious cause was government intervention in the failure. Politicians decided that markets lacking any kind of ideology, and that quite simply ARE, were no longer functioning properly. Which was an impossibility. Markets just function. That’s it. They’re information personified. The “crisis’ in 2008 was the intervention in financial-institution failure, not the failure itself. As a technology investor, Rajaratnam knows this well. Silicon Valley isn’t the richest region in the world because all of its businesses succeed; rather it prospers precisely because the vast majority fail.

Errant bankers shouldn’t have faced jail time in 2008, and Rajaratnam most certainly shouldn’t have faced prison time in 2011. But he did. A Judge with his fingers on the scales of justice limited Rajaratnam’s defense, allowed the prosecutors to play wiretapped calls taken completely out of context, plus the mere instruction of jurors took several hours. Rajaratnam was found guilty on 14 counts of “insider trading,” only to be sentenced to 11 years in prison. He served 7 ½. How very shameful that he was on trial in the first place, and how very unfortunate for the economy and markets that this price giver extraordinaire was sidelined.

And this isn’t because even Bharara ultimately admitted (once in the private sector, of course) that a near total lack of certainty about what “insider trading” is has left “market participants without sufficient guidance on how to comport themselves.” This should not be about behavior. What it should be about is that the markets are better and safer for the proverbial “little guy” the more that they are informed. Although witless prosecutors could never pin Rajaratnam for what is undefinable as is (“insider trading”), the simple truth is that we need much more of what can’t be defined. Really, how odd it is that company employees are not allowed to trade company shares. Per George Gilder, rules like this essentially “blind” the markets. Why on earth are their rules against those potentially possessing the most knowledge of a company from informing the markets through trading, and why do traders risk prison for actively searching for information not broadly known? Why is a vague law set up to penalize market sleuths?

There’s no good explanation for these questions. Worse, there’s no understanding among lawyers and pundits that there are two sides to every trade, and as such, anyone viewed as trading with actual market-moving knowledge unique to them would soon enough lack counterparties. Markets are the ultimate regulator. By their very name.

In Rajaratnam’s case he’s up front that “I, like every other hedge fund portfolio manager, did not turn away information.” What’s sad is that something so basic requires saying. It’s the job of courageous hedge fund managers to digest good and bad information so that we don’t have to. For doing right Raj Rajaratnam spent time in prison. He should never have been charged. Please read this essential book to see why, and please tell friends about it. The lunacy surrounding markets and information must stop.

Reprinted from Forbes

John Tamny

John-Tamny

John Tamny, research fellow of AIER, is editor of RealClearMarkets.

His book on current ideological trends is: They Are Both Wrong (AIER, 2019)

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