Revisiting insider trading and if it is outdated


A generic photo of what can pass off as a high-powered stock trader

As the trial of Rajat Gupta, a prominent businessman and former managing director of McKinsey and Company on the charges of conspiracy and securities fraud winds down in New York, it might be useful to repeat two posts I wrote on May 13 and October 15 last year.

Here is what I wrote:

October 15, 2011

The sentencing of Raj Rajaratnam (the billionaire co-founder of the hedge fund Galleon Group) to 11 years begs the question whether insider trading is an outdated, victimless crime. The question is particularly relevant in the information age where the lines between insider trading and legal trading have been indistinguishably blurred.

When you consider that the whole business of stock trading is based on a sordid mixture of verifiable and unverifiable tips and intelligence, I am not entirely sure how egregious insider trading is. Let me qualify my view by saying I have never traded in life because I have never had the money to trade and, more importantly, I regard the business of trading to be a generally useless pursuit.

Whether insider trading is a victimless crime is a question that has occupied a lot of serious academic minds for quite sometime. Whether it is an outdated crime is something that I have added. There is so much information floating around in cyberspace that one can make a reasonable case that a fairly smart trader can distil it into highly lucrative intelligence even while unconsciously violating the provisions of the law against insider trading. This glut of information is a direct consequence of the information technology revolution which is now in its very advanced stages.

Of course, in Rajaratnam’s case the prosecutors have argued that he squeezed every ounce of insider intelligence out of his rolodex in order to make huge profits. They have also argued that since he had inside information he had a clearly established unfair advantage over ordinary investors with no such access. One result of this was that ordinary investors would have most likely paid much more on the stocks than Rajaratnam, who had the ability to buy low and sell high because he got in early on the strength of his inside information.

That’s a fair point but at the same time it is debatable how many ordinary investors who had a similar opportunity of cashing in on inside information the way Rajaratnam did would have actually shunned it on moral and legal grounds. I understand that in the end the Rajaratnam case is about enforcing the law as it exists on the statute books. Prosecutors have a constitutional obligation, not to mention a moral one, to prosecute to the fullest extent of that law. However, my contention is whether such a law makes sense any longer when the ways in which it can be wittingly and unwittingly violated or circumvented have grown manifold because of the IT revolution.

In the strictest legal and moral sense stock markets and stock traders the world over do occasionally operate outside those tight definitions. If it is only a question of not being found out ever or for the longest period possible, then I am afraid the whole edifice of the rule of law collapses.

Mine may be a cynical view of the world of finance in general and stock trading in particular but those who inhabit that world have not done a stellar job disabusing doubters of their doubts about the fundamental integrity of the profession.

I have mixed feelings about the whole business of stock trading. It has never appeared to me to be a particularly constructive line of work. While it does require a degree of smarts to monitor complex market trends and pick out winners from them, it primarily remains a hollow vocation. It is also peculiarly self-serving.


May 13, 2011

The conviction of hedge fund billionaire Raj Rajaratnam for insider trading has taken me back to the Bombay of the mid 1980s and early 1990s. Having been born and grown up in Ahmedabad I was already primed to understand the stock market culture. “Ketla banshey (How much would I make?)” was the only benchmark that stock traders kept in mind while buying or selling any stock.

For close to five years I worked out of newspaper offices situated, by some quirk of fate, on and around Dalal Street (India’s Wall Street). The offices of the Free Press Journal, the first newspaper I worked for, was some 1000 feet away from the Bombay Stock Exchange.  It was close enough to smell the greed. To think that you could smell it above the lead-rich printing ink tells you how powerful the greed ought to have been.

It is my sense that stock brokers of any size are generally open to insider tips notwithstanding their illegality. It is also my sense that they genuinely believe that there is nothing particularly immoral or illegal about information even if it comes from inside. They treat it as part of their tradecraft. When you point out that insider trading is illegal under the law of the land, their reaction could be summed as “So?” Many stock brokers consider insider trading as a legitimate device and do not regard it as violative of anything.

When I read about the so-called “mosaic theory defense” by Rajaratnam’s attorneys I was reminded of what a broker once told me. Mosaic theory means that brokers depend on a mosaic of intelligence and analyses gathered from a variety of sources to effect their trades. The basic argument being that insider tips are merely one minor part of that mosaic. At the height of the 1992 stock market scandal presided over by the late broker Harshad Mehta, a broker (not Mehta) told me, “I would even find out what the chaprasis (peons) of the company that is going public are saying. I need to know everything.”

The difference in the Rajaratnam case is that instead of chaprasis he cultivated their bosses. It is a question of levels.


About chutiumsulfate

South Asians can infer from my name what I am. View all posts by chutiumsulfate

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