More than a wrist slap needed for insider traders

Just last week, the Securities and Exchange Commission that it has sent subpoenas to hedge funds and other financial firms as it probes possible insider trading prior to the downgrading of the U.S. government’s credit rating by Standard & Poor’s.

Also last week, federal prosecutors said that they are moving closer to bringing criminal charges against Rajat Gupta, a former director at The Goldman Sachs Group Inc., who allegedly leaked inside information about the firm at the height of the financial crisis.

It seems that insider trading once again is all the rage.

For its part, the government has requested that Mr. Rajaratnam receive a sentence ranging from 19 years and seven months to 24 years and five months.

I can only hope that Judge Richard J. Holwell of the U.S. District Court for the Southern District of New York issues the maximum sentence.

It would be the longest prison term ever for an insider-trading crime, and it would deliver a strong message to others that the consequence of insider trading is a lengthy stay behind bars.

Of course, lawyers who represent Mr. Rajaratnam, the co-founder of Galleon Group LLC, have lashed out against the proposed sentencing. One lawyer called it “grotesquely severe” and argued that the “advisory guidelines severely overstate the seriousness of the instant offenses.”

He went on to say: “Insider trading does not cause the kinds of measurable losses to identifiable victims that conventional fraud causes [do].”

As for Mr. Rajaratnam, he still doesn’t think he did anything wrong. Interviewed by court probation officers after his conviction, he said: “I am not aware of anyone who lost money as a result of my actions presented to the jury.”

I guess that Mr. Rajaratnam and his lawyers think that insider trading is a victimless crime.

Nothing could be further from the truth. Insider trading cheats all investors. Every owner of shares manipulated by insider trading is a victim.

In addition to direct investors, the victims of insider trading are the thousands, if not millions, of 401(k) plan participants, mutual fund shareholders and bank trust customers who received lower prices for their shares because a few cheaters had inside information.

Very simply, trading on knowledge of a major corporate event — a merger, acquisition, financial filing or significant management change — before that information is released to the public is wrong. It is also illegal.

Inside traders know that what they are doing violates the law; they just don’t care. For these people, cheating is part of their business model, and it can be extremely profitable.

Beyond profiting on information that others don’t have, inside traders harm everyone by undermining trust in financial markets. If more people become suspicious of markets because they come to think that the game is rigged, they will shy away from investment opportunities, which will damage the nation’s capital-raising mechanism.

Mr. Holwell has a chance to make a statement that would go a long way toward restoring trust in America’s financial markets.

It is my hope that he dishes out a long prison sentence and that the decision serves as a model for other judges when they are presented with similar cases. Investors and shareholders deserve justice when they have been lied to, misled and cheated.

Jim Pavia is the editor of InvestmentNews.

Related Topics: Just Thinking