Richard Holwell: Why Raj Rajaratnam Got 11 Years in Prison
January 7, 2014, 9:40 pm ET
Richard Holwell is a former federal judge for the Southern District of New York. In 2011, Holwell gave Raj Rajaratnam, the former chief of the Galleon Group hedge fund, the longest prison sentence on record for insider trading. This is the edited transcript of an interview conducted on Sept. 23, 2013.
We’re looking here at a situation that I think is puzzling to a lot of people. We’ve seen a rise of hedge funds over the last 20, 25 years. We’ve seen this rise of insider trading. People wonder to what degree is insider trading really central to the model of hedge funds.
I don’t think it’s central to the model of hedge funds. I think you might conclude that hedge funds, because they are a new entity, they were largely unregulated and invested in highly leveraged, riskier investments than you would generally [see], that the ground was ready for misbehavior, if you will, and a culture, a subculture really, developed. Obviously most hedge funds are well run and honestly run, but I think there was a little more room for things to go awry on the hedge funds industry.
For a long time, hedge funds as a class were outperforming the market, some of them by incredible margins, which leads people to conclude that over time nobody is ever able to do that reliably, so something must have been really afoul at the hedge funds.
I don’t think you would conclude that by looking, for example, at Galleon and Raj Rajaratnam. The amount of trades that were suspect and proven at the criminal trial was really a minuscule aspect of Galleon’s $7 billion -a-year operations.
So it really was I think a question of cream on top, and I think that’s probably largely true in the hedge fund area.
Don’t forget, hedge funds can invest in ways that banks and investment banks ordinarily weren’t allowed to invest in terms of the high leverage that they could achieve and the fact that they could lock in investors’ funds for a period of time so you couldn’t pull your money out. So it did create a situation where higher-than-average returns were feasible.
When you say that only a small portion of the trades that were going on, as far as you could tell, at Galleon were suspect –
Oh, yes. Now, you can’t tell from a criminal case how widespread criminality is. You can only tell if the 23 trades or situations the government attacked in the Rajaratnam case resulted in either illegal profits earned or losses avoided of $50 or $60 million. That’s a lot of money, but it’s small in comparison to the $7 billion in assets that are under investment.
But from where you sat, did it seem like the tip of an iceberg or simply exceptional, aberrational behavior?
It appeared to be not the normal way the business was operated. There were surely a lot of honest people at Galleon who were not touched by, in any way, the scandal that the CEO and a few others were involved in. There are a fair number of honest people there.
A lot of the business was straightforward doing what other hedge funds and investors do. Of course, as we know, the jury concluded that Mr. Rajaratnam was on the wrong side of the law there.
So the idea that hedge funds are particularly rife with insider trading — you reject that?
I think there was an opportunity there for misdeeds because of the way that the hedge fund industry developed. I don’t think that there is any reason that the hedge fund as an industry can’t be run and isn’t largely run on an aboveboard, honest basis.
Hedge funds rely on informational edge for rapid turnover, active trading, speculation. Once the Regulation FD [Fair Disclosure] came into place, it became harder, as I understand it, for these fund managers to get an informational edge. At around that time, you see the rise of these expert networks. What role did those play? …
I thought that the expert networks were a serious structural flaw in the marketplace, because the opportunity is just too great for leaking inside information.
You have an organization that is putting a portfolio manager in touch with recently retired members of Intel, or recently in the [SAC Capital Advisors fund manager Mathew] Martoma case that we’ll talk about probably a little bit later, with doctors who were researching medicines and doing drug testing. The opportunity, as I say, was significant for malfeasance. And I think if I were running the marketplace, I probably would make these types of networks illegal.
So what led to their rise?
It was like any business; it was an evolutionary situation. You are constantly out as a portfolio manager trying to get another piece of information, and this developed.
More edge — exactly right. You can do it legally, or you could do it illegally.
Do you think that the people that operate in the business are aware that they’re breaking the law or simply aggressively pursuing information and simply inside an industry where they don’t really see the line between aggressive research and criminality?
I think that the lines are pretty clear. If you’re an academician, you can spend hours a day debating the refinements of insider trading law. But if you’re out working in the financial markets, you know when the information you’re receiving crosses the line. I don’t think it’s very difficult.
And if you look at all of the cases that have been brought by Preet Bharara and [the] U.S. Attorney’s Office, all of them are straightforward, no sophistication to it, straightforward insider trading.
What about the idea that this is basically a victimless crime?
That is a misnomer. I think what you could say about it is that the victims are unidentifiable. There surely are victims.
There are people who, had they known that a company’s earnings were going to go up the next day, wouldn’t be selling their shares. So there are individuals who are directly injured by insider trading.
The biggest injury, however, goes to the integrity of the marketplace. The marketplace depends on the integrity of the participants, and when you inject fraud into it, then it’s not operating clearly and cleanly. Then the whole marketplace suffers.
We’ve seen the use of wiretaps come into practice here in a big way. You sat at the center of that as a development. … Why is [it] that prior to that, there was very little use of wiretaps?
There’s a little history here. Wiretapping was in fact outlawed by the federal government in the 1930s, and any evidence derived from wiretapping was inadmissible in any court. That was basically a view held at the time, that the Fourth Amendment right to be free from searches and seizures was all-important.
“The marketplace depends on the integrity of the participants, and when you inject fraud into it, then it’s not operating clearly and cleanly. Then the whole marketplace suffers.”
That changed in the 1960s as the Justice Department continued to do battle with organized crime, and that gave rise to the Wiretap Act in 1968, which for the first time permitted federal authorities to wiretap people.
But very interestingly, at the time the law was passed, senators from both sides of the aisle said, yes, we’re giving the Justice Department this authority, but we want you to use it sparingly because it’s quite dangerous. And they limited the use of wiretap to certain, so-called predicate offenses, such as mail fraud or wire fraud or kidnapping.
But then over the years, successive congresses would increase the basket of predicate crimes that one could wiretap for.
Predicate crimes — how do you define that?
A predicate crime would just be a crime defined by the statute as one for which a prosecutor could get a wiretap. For example, wiretapping is still prohibited for prosecution of insider trading, and you can’t go to a federal judge and say, “Judge, we’re investigating insider trading, and we want a wiretap.” It’s not permitted under the law.
But as you can guess, every insider trading scandal is in effect mail fraud or wire fraud, because people pick up the telephone and transfer inside information. So you’re allowed to go in to a court and get a wiretap to investigate wire fraud, and the fruits of that might be a prosecution for insider trading. …
… Put us where you were when this issue came before your court in the Rajaratnam case, the issue of whether or not to allow for the admissibility of wiretap evidence.
Those issues come up typically by a motion to suppress the wiretap, made by a defendant in any criminal case. If it’s an armed robbery, the defendant moves to suppress the gun on the grounds that it was illegally seized. It’s the same situation. In an insider trading case, the defendant moves to suppress the wiretaps on the grounds that the wiretap order was improperly granted.
So Rajaratnam’s attorneys moved to suppress the wiretap evidence against him?
That’s correct. And in order to justify a wiretap, the prosecutor has to persuade the issuing judge. In this case, it was Judge [Gerard] Lynch that [agreed] the wiretap was necessary. That’s what the statute requires.
That is, you have to persuade the issuing judge that the traditional means of prosecutor’s investigations — use of a grand jury, interviewing witnesses, turning witnesses, revealing documents — would be unsuccessful in detecting the crime, and therefore a wiretap, which of course brings with it a risk of invasion of privacy, is proper because it’s the only likely means to uncover criminality. That’s the issue.
So the prosecutor in this case had gone before the court and said, “We need a wiretap because we’ve exhausted every other means, and we’re not going to get this guy, but we suspect he’s involved in insider trading, but we need a wiretap to prove it.”
That’s exactly what their argument was. And when I reviewed the affidavits that had been submitted to Judge Lynch, it was my view that the government had not told the complete story to Judge Lynch and that at the time they made their request for a wiretap, the SEC [Securities and Exchange Commission] had been investigating Rajaratnam for almost 10 years and had gotten produced to it over 4 million documents from Galleon, had deposed many individuals at Galleon, including Rengan Rajaratnam.
It was my view that that information should have been more clearly provided to Judge Lynch in order to permit him to make a decision as to whether it was necessary under the statute to authorize a wiretap to get the information against him.
So that was an error on the part of Bharara’s attorneys?
That was my view of it, and that was how I ruled. However, the fact that the prosecutor has made a misstep, even a serious one, doesn’t necessarily mean that you suppress the evidence.
So you thought it was a sloppy application?
I thought it was at best a sloppy application. … I thought it was a reckless application.
You’ve used that word “reckless” a lot.
It is the standard one looks at in reviewing wiretap applications and/or wiretap orders, so I concluded it was reckless.
On the other hand, I declined to suppress the evidence and let the wiretaps be introduced into evidence at trial, because I looked at the evidence that wasn’t given to Judge Lynch and concluded that had I been sitting in his seat and had gotten all of the information, nonetheless, I would have authorized the wiretaps as the only truly effective way to investigate the extent of the insider trading conspiracy.
So there was a lot at stake here for the prosecution?
Yes. The case turned in many important respects on the wiretap decision.
And sitting through that three-day hearing and then sitting by yourself and making this call, you knew that it was going to be a turning point in the prosecution?
So how tough was that for you?
It is difficult. I think any judge who says otherwise [is] probably fibbing. It’s hard when you’re in the fishbowl of a highly publicized trial to make some decisions, and you have to reinforce yourself. You have a case that’s on the cover of the New York Post every day.
It would have been a certainly a serious event for a court to have thrown out the wiretaps and suppress them, because in that situation, Rajaratnam may well have walked away from the indictment, because most of the evidence was wiretap evidence. But any judge has to be prepared to do that in the appropriate situation.
How close did you come to throwing out the evidence?
I was irritated with how the government had proceeded. I thought that they had not proceeded properly. But it was not really a close decision as to whether I should suppress the wiretaps or not. It was quite clear that looking at all the information that the SEC had received and given to the U.S. Attorney’s Office that there was no way — because of the fact that insider trading usually takes place over the telephone — that the scope of the conspiracy, which turned out to be quite substantial, would ever have come to light absent a wiretap.
… If you compare wiretaps today and what has resulted from the use of wiretaps and insider trading to the prosecutions 20 years ago of Ivan Boesky or Michael Milken, those prosecutions resulted in one or two famous indictments. We don’t know whether or not there was a large web of insider trading going on at the time, but one might suspect that it was broader than the government ever realized because it didn’t use wiretaps.
And in this case, the wiretaps revealed that there was a large web?
It revealed 30 or 40 individuals who have been indicted and prosecuted to date, all connected in one way or another to Galleon and Mr. Rajaratnam.
And to SAC [Capital Advisors] and its satellite funds?
As we know, SAC has been indicted, and there were SAC employees, portfolio managers who had dealings with Rajaratnam.
And some who worked with Rajaratnam as well as having worked with Steve Cohen [of SAC].
Some had moved to Galleon from SAC.
This is what gives rise to the notion that people ask, just how pervasive is this, and what does it tell us about ethics on Wall Street?
I think that again — and this is just impressionistic, right? — most of us are honest, and most of us do things that aren’t against the law in the business world. So I didn’t come away from all of these cases with a feeling that the illegality was pervasive.
Most of us are not offered $10, $20 or, you know, $50 million to cheat.
True enough. I don’t think somebody like a Rajaratnam necessarily does it to make the extra dollar. After all, he was a billionaire.
… But what about all those portfolio managers that are working in a highly pressured environment where a lot of money is at stake for them? They haven’t necessarily made those big bucks yet. They’re not billionaires, and they’re tempted by tens of millions of dollars on the table. They’re human.
That’s true, but most humans don’t break the law. You go to any profession. … If you’re a doctor, you can cheat on your Medicare applications. If you’re a lawyer, you get access to inside information all the time. If you wanted to call up your brother, you can make an awful lot of money working at one of the big law firms in New York because you’re constantly given inside information. If you’re in the Merger & Acquisition [Services] department of IBM, every day you have access to information that could make you or your friends or relatives fantastically wealthy, and people generally don’t do it.
So there is a problem here, but I wouldn’t indict an entire industry for the sins of a relatively small percentage. It doesn’t mean that doesn’t have to be eradicated, and government is attempting to do that, but I don’t think it’s a basis for throwing stones at all investment bankers.
The truth is, isn’t it, that we don’t really know?
I think that’s a fair statement. We don’t know. We only know what we see.
And until these investigations go through a long process, we won’t really know how many people were cheating and had their hand in the cookie jar?
And only that will be with respect to the targets that the government has focused on. So it’s very difficult to draw deep conclusions other than that there’s a problem here. The behavior of an unknown number of people on Wall Street has to be changed, and the government is making a concerted effort to do it.
You’ve described the prosecution of inside trading as low-hanging fruit for the government.
I say that because, as I said previously, the insider trading here is plain as the hand before your face. It’s not sophisticated. It’s illegal. The people who are doing it know it’s illegal. And once you discover it, it’s quite easy to prove.
Certainly that’s established by the fact that there hasn’t been a single defendant in any of the insider trader cases brought in the past couple years who have come back with a not-guilty verdict. So once the government discovers it and goes after you, your goose tends to be cooked.
There are other areas of the financial markets that are far more complex. The government, of course, has been criticized for not going after that aspect of the financial marketplace that has created synthetic obligations like CDOs [collateralized debt obligations] and RMDs [required minimum distributions], securities that resulted in the Great Recession of 2008. But I understand the difficulties the prosecutors have in pursuing that type of behavior as a violation of the criminal law.
So you can kind of see these insider traders as the sort of dumb bunnies of the financial world?
Well, what they’re doing is really unsophisticated. It’s simply cheating, right? You’re just getting information and using it. … Insider trading is a plain vanilla crime.
If you’re structuring a synthetic obligation where you know that the assets that are securing it are bad, going in, that’s much harder to prove. They are very complicated. A lot of people don’t even know how they work and what the risks are from them.
And don’t forget the typical prosecutor is somebody who is [a] 28- or 29-year-old lawyer who’s going to work for the Department of Justice for four or five or six years and then move on. The industry has created some of these transactions. The expertise runs quite deep, so it’s difficult for a prosecutor to get their arms around these types of transactions. Not so with insider trading.
… When it came time for you to decide on what Rajaratnam would face in terms of time, when it came time to sentence him, what was on your mind? What was at stake as you saw it?
The single most difficult job a judge has is putting a number and sentencing somebody to jail for a certain number of years, because there is of course a little bit of playing God in doing so.
But what you’re representing is the conscience of the community, so you look at the individual, all right? You try to take the measure of the man. You look at the crimes that he or she committed and consider how serious they are. You also consider — and that was an element in this case — the extent to which the crime they’ve committed is a significant problem in the culture, in our society.
And sentencing him to 11 years, what does that tell us about what you decided?
That was, and maybe still is, the longest sentence that a defendant convicted of insider trading has been given. It’s about a third of what the government was asking for under the sentencing guidelines and about 11 years more than Mr. Rajaratnam’s counsel was suggesting, so it tells you it’s a serious crime.
It tells you, however, that in my view at least, while it was a serious crime, it was different from running a Ponzi scheme. There are differences between crimes, and while a [Bernie] Madoff may well deserve life in prison because he’s just stealing money directly out of the people’s pockets, insider trading has a different quality to it. So you take that into account.
You balance all of those things together and you look at what other judges have done. You look at the sentencing guidelines. You wake up in the morning and say, “This is a fair sentence.”
When you took a look at the man, when you took the measure of the man, in your words, what did you see?
A very smart man. A man who actually had spent a lot of his time working on socially respectable and important projects, helping people who were cyclone victims in Sri Lanka and giving away a considerable amount of wealth; but also, in my view, a person who suffered hubris, who thought that he could live outside the law and for whom winning was more important than anything.
Does charitable giving actually reduce someone’s sentence?
It doesn’t reduce it in any quid pro quo manner, but it’s a factor that anybody looks at in deciding. What you’re looking at is the measure of a man’s life, not just of the particular crime he or she committed. …
I wanted to talk a little bit about SAC Capital. The government alleged that SAC Capital was “a veritable magnet of market cheaters,” and they then decided to indict the company, not the founder and architect and president, [Steven Cohen], the man who ran the company. Does that make sense?
It makes sense on one level, and that is the practical level, that you have to assume by looking at the indictment that the government did not believe it had the goods on the owner of SAC, that they did not think they could get a conviction on Mr. Cohen’s actions. If they thought they could, they would.
But you’ve got a company where the government had already tried and convicted people inside the company for criminal behavior, right?
Not a few but several.
And more trials on the way.
So if I form a company and I have 1,000 employees, but I have a couple of units of that company that are engaged in criminal behavior, even if the company’s indicted, I don’t really face any consequences for setting that up?
Or in the criminal law, in order to be guilty and for the government to be able to convict you, you have to show criminal intent, a bad will or a bad motive. So you have to show more than recklessness or negligence or gross negligence. You have to show a willing intent to violate the criminal laws.
Now, in this situation, the government is faced with an individual who structured SAC to give the various funds that SAC runs a lot of independence, so it’s not obvious that the government can reach through the misdeeds of any fund manager and get to the CEO.
But by charging the company, or indicting the company as a criminal enterprise, it’s not saying in that charge that there were a couple of rogue operators in that company. It’s saying that the company was a criminal enterprise.
They don’t need to show that the company was a criminal enterprise in order to indict the company.
I see. But what are they saying when they say it’s a “veritable magnet of market cheaters”? It seems like the guy who put together that company ought to be responsible in some way for setting up a company that is a magnet for market cheaters.
I wouldn’t disagree with you. The fact remains that the government has to believe it can convince 12 jurors to bring back a guilty verdict, and in order to bring back that guilty verdict, the jury’s going to listen to the judge, and the judge is going to say, “In order to convict the CEO of this crime, you’ll have to show that he intended for the company to engage in insider trading.”
Because Steven Cohen can go to court and his lawyer can say: “Well, these were unfortunate rogue operations inside the company. They weren’t the doing or the design or the intent of Steven Cohen.”
That [would] be the expected defense if the government went after Mr. Cohen.
Then why not simply indict the people inside the company that cheated rather than indict the company?
That’s a question of prosecutorial discretion. … Whenever an officer of a company commits a crime, if he does so not as a rogue operator but in his capacity as an officer of a crime, if I’m the vice president of sales and I engage in price-fixing on behalf of my company, the government can indict me, and it can also indict the company, because the vice president of sales is an agent for the company.
And so the company is indicted because one of its agents violated the law. A company is only an assemblage of its agents, so you can always indict the company when you indict a senior office of the company.
The government generally doesn’t do that because they know it could wind up in the company going out of business and all of the employees being sacked.
And of course in the recent past we’ve had that experience with Arthur Andersen. Thousands and thousands of people are out of a job because the government decided that the entity should be indicted as well as the individual partners who engaged in misdeeds.
… We’re talking somehow some sort of gross weighing of fairness here. But to the individual who loses his job, it’s his job.
Yes. But I think you put your finger on the decision by the prosecutor here. The prosecutor here has decided they want to put SAC out of business.
Simple as that?
Simple as that.
Will they succeed?
That depends on whether they get a guilty verdict or not. … [Editor's Note: After this interview was conducted, SAC Capital agreed to plead guilty to insider trading violations and pay a record $1.2 billion penalty. The government also forced SAC to close its business of managing money for outside investors.]
… The SEC has filed a civil action based on the idea that Cohen failed to supervise correctly or properly. I don’t know all the legal terms, but that’s my understanding, right?
Yeah, that’s correct.
I think what you’re saying is that the criminal prosecutors don’t have that ability to charge Cohen in this case with failure to supervise?
That’s correct. There are two problems that the prosecutor faces. One is the issue of proving criminal intent by the individual that you have indicted, a guilty mind. The second problem is that the standard in a criminal trial is so much higher: beyond a reasonable doubt. When you’re sitting in a jury box and you hear the judge telling you that you must find guilty beyond a reasonable doubt, that is quite a standard, and jurors really will take that seriously.
It is a very serious situation they’ll find themselves in, and they’ll apply that test rigorously. If you go to the SEC, the SEC brings a civil action, and there the standard is just more probable or not. So you have a scale, and it tips even a little way in one direction, the SEC has established its case.
But there is such a thing as criminal negligence?
There is such a thing as criminal negligence. But you can’t violate the insider trading laws. You can’t commit fraud negligently.
But my failure to supervise my company, my creation, isn’t that somehow parallel to the idea of criminal negligence?
It would be more extreme than that. It would be a willful blindness that you would have to show.
So we now are facing this trial of Mathew Martoma for the infamous Elan and Wyeth trades, and there are no wiretaps here?
No wiretaps here, and so the government is put back in the position that it was before the Rajaratnam case, where all of their insider trading was proved by circumstantial evidence. And their record in that situation is pretty good.
So wiretaps are a great boon to the prosecutor and a great threat to wrongdoers in the marketplace, but in fact they’re not essential to prosecution of an individual in any given case.
Now I’m confused, because I thought that when you made that decision to allow the wiretaps as evidence that that was a deal breaker. …
Had there been no wiretaps in the Rajaratnam case, it’s surely not clear from the information they did have before the wiretaps that they would have indicted Mr. Rajaratnam or successfully prosecuted him. The wiretaps were critical.
But there are situations, and in the Martoma case obviously, even though there are no wiretaps, it sounds as if they’re going to have the tipper, the doctor who gave Mr. Martoma, allegedly, information about the results of drug tests.
But Martoma can say, “Look, I’d had two other employees, portfolio managers, criticizing our position, the company’s position in Elan and Wyeth, so there were other factors that led me to believe that this was a trade I’d better get out of.”
That will certainly be his defense or one of his defenses.
So it’s circumstantial?
On the other hand, the jury is going to see the correlation between telephone calls with the good doctor and trades at SAC and whatever other evidence the government has which we don’t know of, and they’ll make their own decision.
So in that case, it’s very much going to be up to a jury and their judgment. Very hard one to call, I would imagine.
Until you see all the evidence at trial, it’s very difficult to call. I will tell you that the evidence that the government usually puts in in these cases, which is a schedule of telephone calls and market trades, can be very, very convincing circumstantial evidence.
This is the kind of new template, if you will, for presenting these kinds of cases, the use of very sophisticated technology that gathers and organizes through computer software, puts together all these different events, sees connections.
This is a new development in the business.
Yes, and the government of course examines major trading activity, has computer programs that will weed out questionable trades, and then the SEC will start pursuing it.
Who knows where this all goes? — will what you call a “virus in our business” be eradicated?
That’s a more difficult question to answer. I think the answer is probably yes, but maybe only over time.
“Had there been no wiretaps in the Rajaratnam case, it’s surely not clear from the information they did have before the wiretaps that they would have indicted Mr. Rajaratnam or successfully prosecuted him. The wiretaps were critical.”
The closest analogy I can think of is if you go back maybe 30 years, the government became concerned that price-fixing was endemic in business America, and they aggressively pursued price-fixing in the electrical industry, in the paper industry, in the steel industry.
They brought indictments. They sent people to jail, albeit only for a year or two in those days. My read on it is that was a very effective move by the government and that price-fixing no longer is the serious concern that it once was.
Here it’s going to be a little more difficult. If you’re, again, the vice president of sales, you know you shouldn’t be having lunch with your counterpart at your competitor. But a portfolio manager’s job is always to be ferreting out the different parts of the mosaic of information that goes into creating the market price of stock.
You’ll always … [be] in an area of temptation, if you will. So it will be more difficult, and there will be more temptation. It will be a harder process.
[Is there] a problem, in your view, on Wall Street?
There is a problem. I think that most people who have looked at the insider trading scandal would agree that there is a problem. There’s disagreement as to how broad the problem is or how narrow the problem is and whether the problem is solvable. …
Since the ’60s, when wiretaps to prosecute wire fraud were allowed, there was very little use of them in financial crime cases. Why? Is that a failure of imagination?
It’s generally true that wiretaps, for the first 30 years or so, were used for what you’d call blue-collar crime as opposed to white-collar crime, generally crime tinged by violence, kidnapping, murder, drug dealing
Organized crime but not financial frauds. And there are a couple of reasons for that. One is that, by and large, financial frauds are pretty hard to wiretap. Insider trading is an exception there, but most financial frauds are complex transactions that take place over time, and you really can’t effectively ferret out the criminality through a wiretap. …
So why then is it a failure of imagination when there were many referrals going on from regulatory agencies to the SEC. Why did that not spark a use of the wiretaps?
Probably two phenomena. First of all, for better or for worse, white-collar crime has generally been viewed as less serious than blue-collar crime because of the lack of the element of violence. So prosecutors generally will dig harder with respect to crimes of violence.
The second factor is that in a use of wiretaps, there’s a balancing that’s going on, and the balancing is between society’s need to ferret out illegal activity and the citizens’ interest in maintaining privacy. And the prosecutors consider those issues.
A wiretap is a very dangerous weapon in the hands of the government and has to be used with great caution, and the pendulum actually has swung away from that concern of individual rights and liberties. And that has happened probably as a result of the explosion of information.
If you talk to anybody under 30 today, I don’t think they expect their Internet communications to be confidential, really. Everybody knows that everything that they send out on their Blackberry or iPhone is there forever, and if somebody really wants to find it, they’re going to find it.
So to a certain extent, the prosecutors have been following the swing of the pendulum away from concerns with individual liberties toward more aggressive prosecution through the use of wiretaps because we’ve been prepared to go along with it.
Let’s say I’m running a construction company. I have a crane on my site, and I know that this thing is breaking down and there’s been a lot of problems with it. But for one reason or another, I continue to ask my team to keep operating that crane, and then one day it falls over and kills a couple of guys. It seems to me, in the case of SAC Capital, you have a lot of referrals coming in. They know very well that there are problems inside their company, and they know that a lot of people’s livelihoods depend on them acting as fiduciaries on behalf of their clientele. Are we failing to make the link between the kind of criminal negligence that would apply to a construction operator and a guy who’s running a hedge fund?
In a large sense we are. But the prosecutor, of course, has to live with the law as he or she finds it. And insider trading is a creature largely court-made, law by the federal courts, and it has evolved over time.
It isn’t a highly refined tool. It’s gray around the edge, and it would take, really, an act by the Legislature, some statute to give it more teeth if you want to use it in a situation such as what you were talking about, of making the CEO criminally responsible, if you will, under a kind of criminal negligence standard.
The courts haven’t gotten there. You have to keep in mind, of course, that insider trading is an evolving crime. It wasn’t a crime under the federal law before 1934. Indeed, it was generally a perk for officers in the Roaring ’20s to be able to trade with knowledge that their company was about to issue an earnings forecast.
It became illegal in 1934 but under a very vague statute. The courts have continued to expand its coverage, but that’s a slow evolution, an evolution by accretion of decision by decision.
You say the courts and the prosecutors really haven’t caught up. So I can run a shoddy operation if I’m running a construction company and be criminally liable, but if I run a shoddy operation in finance, I may get away with it?
The company will be shut down. If they prove their case against SAC, SAC will be history. Galleon was shut down on the day that Rajaratnam was indicted.
I won’t do any time?
You won’t do any time under the current case law as it exists.
If I’m Steven Cohen, I’ve got $8 or $9 billion already in my bank account.
The government is going after that, of course. They’re seeking forfeiture, both the SEC and the Department of Justice, so it’s unclear how much of that he’ll have left.
But the point is well taken. I think the answer, however, would be Congress taking action here as opposed to the slow evolution of our court systems.
In order to hold the CEOs of hedge funds or banks liable for running shoddy operations or dangerous operations, you’d have to have an act of Congress to write new law?
Certainly if you want to impose a criminal negligence standard. That’s beyond the scope of the law that we presently have.
And we’re looking for more deterrence here, I assume?
Yes. We’re looking for more deterrence to change bad behavior.
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