Opinion: The Fall of Raj Rajaratnum and the Ways of Wall Street

Behind every great fortune there lies a crime

—Honore de Balzac
Passage in Le Pere Goriot (aka Father Goriot)
very loosely translated*

Honore de Balzac is credited with the saying in the above quote and, although I don't feel is accurate in a country like America, I do think it applies very well to the period Balzac was living in (18th and 19th centuries) and to modern day developing and undeveloped countries with non-existent or corrupt legal systems.

I never even heard of Raj Rajaratnum before the scandal broke late last week. I never even knew a Sri Lankan Tamil was a billionaire—he's the same ethnic group as me grr :(—let alone some major Wall Street player in technology investing. Although it's too early to say for sure, and I'm reserving judgement until the courts rule, it does appear that Rajaratnum was involved in a major insider trading ring. Law enforcement used techniques typically used to bring down organized criminals, including extensive wiretaps. Assuming the wiretaps weren't fabricated, they indicate that Rajaratnum and others involved in the scheme knew what they were doing. The New York Times reported the following last week:

Recorded conversations between Mr. Rajaratnam and Ms. Chiesi appear to show they were aware their information was far beyond what the market knew. “If the two of us weren’t close to the company as we are, would you be long the stock?” Ms. Chiesi asked Mr. Rajaratnam on Aug. 26, 2008, referring to A.M.D. “No. I wouldn’t be,” he responded. She added that she would not have touched the company with a “10-foot pole.”

The two also showed concern about the consequences of their schemes being discovered. On Aug. 27, Ms. Chiesi told an unnamed co-conspirator: “I’m dead if this leaks. I really am and my career is over.”

Ironically, Danielle Chiesi worries about her career when she should have been worrying more about prison. Career is the least important aspect of anyone's life. High performers don't realize it but other things, like family or freedom, are far more important.

Although the insider trading charges amount to a profit of $20 million, one wonders if the billion in wealth—Rajaratnum claimed his wealth was somewhere around $200m in court, perhaps due to the stock market collapse last year—was earned through nefarious ways.

The fact that law enforcement is willing to use stronger techniques for white-collar crime should improve transparency in investing. Another question is whether Raj Rajaratnum was doing something unique or whether his techniques are more wide-spread on Wall Street. Writing for The New York Times, Alex Berenson wonders the same thing (text bolded by me):

The most precious commodity on Wall Street is information, and savvy players will do almost anything for it.

Raj Rajaratnam, the billionaire hedge fund manager who was arrested Friday on accusations of insider trading.

Some investment funds canvass doctors to scout out blockbuster drugs. Others pay meteorologists to forecast weather that will affect the price of oil and wheat. And still others hire corporate executives to provide an inside view of companies and industries.

But now some of Wall Street’s biggest hedge funds are watching nervously as prosecutors say that Raj Rajaratnam, a billionaire fund manager, went too far in this relentless quest for a trading edge.

...

A close reading of the two criminal complaints filed so far, and an associated civil complaint filed by the Securities and Exchange Commission, suggests a web in which hedge fund managers, analysts, corporate executives, and consultants and other people outside Wall Street traded tips — sometimes for money, sometimes for other tips, and sometimes for little more than the promise of unspecified future favors.

...

At other times, Mr. Rajaratnam received information from an unnamed witness who is cooperating with the government investigation. But the complaint does not state whether Mr. Rajaratnam knew the ultimate sources of the information he received from the witness. Nor does it allege that Mr. Rajaratnam paid the witness for the information.

Still, the existence of a cooperating witness — along with the fact that prosecutors wiretapped some of Mr. Rajaratnam’s conversations — gives them a great advantage in the case, said David S. Ruder, a law professor at Northwestern University and a former chairman of the S.E.C. The conversations may help show that Mr. Rajaratnam knew the information was valuable and that he should not be trading on it, Mr. Ruder said.

“It gets you around the mens rea, or state of mind question,” he said. “If you know it’s coming from an insider, or if you have strong reason to believe it’s coming from an insider, you’re in trouble.”

There are very few lessons for most readers of this blog, whom, like myself, are small investors and don't work on the Street. We don't even have a rolodex ;) However, some readers may work in on the Street and face competitive pressures so this case should be a good lesson for all of you. In particular, pay attention to the bolded last paragraph in the quote, where the law professor says that you are culpable if you know information is coming from an insider—even if you suspect it's an insider, run away.


On a positive note for most readers of this blog, if you are a long-term investor or a fundamental or macro investor, you won't be vulnerable to insider trading. The so-called "insider tips" are next to useless in the grand scheme of things, and will appear as tiny little bumps on a long-term chart. The only thing that is going to make you successful, if following these strategies, is correct evaluation of long-term trends or business fundamentals.


FOOT NOTE:

(* The actual passage is supposedly, ""Le secret des grandes fortunes sans cause apparente est un crime oubli , parce qu' il a t proprement fait." In English, that translates as: "The secret of a great success for which you are at a loss to account is a crime that has never been found out, because it was properly executed." [source here])