After eight weeks of trial, and another 12 days of deliberations, the jury in the insider-trading case against Raj Rajaratnam, co-founder of the Galleon Group hedge fund, finally returned its verdict: guilty on all 14 counts. There are two lessons in this conviction, neither of which are the ones prosecutors hoped to send.
First, although the case will generate publicity and chest-beating about insider trading, it will ultimately provide a "road map" for anyone looking to profit by trading on insider tips. Second, and even more troubling for regulators, the case illustrates how the government's approach to insider trading is illogical and bad policy.
The prosecutions won't end there. Dozens of informants related to Galleon have pleaded guilty and are co-operating with the government. All of this seems scary. It is enough to make a hedge fund manager afraid to use the phone.
But over the slightly longer term, smart traders will examine the facts used against Mr. Rajaratnam, calculate the probability of getting caught and conclude that now is the time for an insider-trading feast. If you do the maths, given the amount of insider trading, the chances of doing prison time are roughly the same as getting bitten by a great white shark while surfing off the coast of my home town, San Diego.
There are rare shark attacks and many people become very afraid after them, just as some traders are now fearful after this high-profile conviction. However, that fear is irrational, based on the salience of an unusual event.
Of course, plenty of people will obey the law because it is the right thing to do, even if they would be better off transgressing. But Wall Street is known for applying probabilities to its risks, including the risk of liability. Bankers advocate aggressive tax structures and liberally interpret accounting rules. Insider trading is no different.
Moreover, and this is the second, deeper problem for regulators, it isn't clear from this case what insider trading even is. Many business people do not understand why Mr Rajaratnam committed crimes related to Intel's acquisition, yet it was apparently legal for David Sokol to buy Lubrizol shares just before it was acquired by his company, Berkshire Hathaway. There is no clear dividing line.
There are muddy questions of "materiality". And insider-trading law strangely requires someone (not necessarily the person who bought shares) to have breached a fiduciary duty to the source of the information. The U.S. Supreme Court has called this convoluted requirement a judicial oak that grew from a legislative acorn. The focus on breach of duty makes the law maddeningly vague, and the links between trader and breacher can be attenuated. It is no surprise that Mr Rajaratnam's jury took 12 days.
Prosecutors might hope vagueness will deter, but instead it erodes respect for the law. Anyone who examines the evidence against Mr Rajaratnam will see how he could have generated bad facts to avoid prosecution. First, don't say anything that might be recorded. If you talk on the phone, be cryptic. Don't buy hundreds of thousands of shares. Don't make tens of millions of dollars of profits. Don't buy immediately after you are tipped. Don't trade in common shares. Instead, buy over-the-counter derivatives, swaps, options, or contracts for differences.
Most important, keep a contemporaneous record of reasons to buy other than the tip. It isn't enough to hire an expert after the fact, to tell a jury that analysts were recommending the stock. You need to have those analyst reports and articles in a file, with contemporaneous e-mails reacting to them.
If Mr. Rajaratnam had heeded these lessons, and traded in smaller numbers, he would have made less money. But he probably wouldn't have been caught or indicted. He almost certainly wouldn't have been convicted. As the saying goes, pigs get fat but hogs get slaughtered. Here come the insider-trading pigs.
The writer is professor of law at the University of San Diego