By: Christopher Santopolo
The SEC has hardened its stance on insider trading in recent years. Within the past two years, Preet Bharara, the United States Attorney in Manhattan, has brought charges of insider trading crimes against 54 people. 50 of these individuals have either pled guilty or been convicted at trial, three are pending trial and the fourth is a fugitive. Those convictions include the two longest prison sentences ever for insider trading charges. Zvi Goffer, a former trader at hedge fund giant Galleon, received 10 years in prison while his former boss, Raj Rajaratnam, was sentenced to 11 years in prison as well as a $10 million fine and an order to forfeit $53.8 million earned due to insider trading. These sentences may be overshadowed in April of next year, when Rajat Gupta will face trial for conspiracy to commit securities fraud and five counts of securities fraud, charges that carry a potential sentence of 105 years in prison.
Insider trading cases are very difficult to pursue, as most evidence is easily deflected as circumstantial or coincidental. It is easy to see when a trader makes a favorable transaction before information is made public, but hard to prove that the trade was made based on inside information. In many instances, it takes prosecutors years to gather enough evidence to bring charges. Due to this high degree of difficulty, investigators are starting to use tools more commonly used to fight drug trafficking and gang violence. For example, the government used wire taps for the first time in an insider trading case when investigating Mr. Rajaratnam. The SEC is also seeking a new surveying system which will show equity and derivatives markets in real time and sort through trading records to find suspicious patterns around corporate events.
As surveillance of trades and enforcement of insider trading laws become stronger, those who participate in insider trading are becoming smarter about how they accomplish their trades. For example, some insider traders are trading in instruments other than simple shares, such as exchange-traded funds and credit-default swaps. The government is hoping that more derivatives will trade on exchanges in the future, which will make it easier to notice suspicious trading patters across different asset classes.
This concentrated effort against insider trading is good for markets. The biggest problem with insider trading is its negative impact on investor confidence, which hurts both companies and investors. Judge Holwell, who sentenced Mr. Rajaratnam, said that “[i]nsider trading is an assault on the free markets” and that the crimes “reflect a virus in our business culture that needs to be eradicated.”
Some disagree with this sentiment, however, and suggest that allowing insider trading to be legal would have more benefits than costs. People have suggested that fraud may be brought to light sooner if insider trading were legal. James Altucher, a managing director at Formula Capital,, thinks that Enron’s extensive fraud would have been outed sooner if not for insider trading laws: “Enron is an example where tens of thousands of investors got burned because they were piling into the stocks during the later stages of its fraud. If insiders were selling we would’ve seen a much swifter move down, and probably fraud exposed.” Others proponents of repealing insider trading laws have argued that the employees and executives of a company would presumably be the ones to trade on knowledge not known to the public, and banning insider trading is to disallow the information from those who know the company best from entering the market.
Throwing away the insider trading laws currently in place, however, would be a mistake. Those who participate in high scale insider trading are very sophisticated investors, so it is difficult to believe that those in charge of a company like Enron would not come up with some other way to hide their fraud. Legalizing insider trading would create outrage among those who would not be privy to such inside information. People in this country are already displeased with what they believe to be a system which benefits only the very wealthy. Repealing laws meant to help even the playing field when it comes to investing would certainly not be acceptable to most Americans.