Rajaratnam Indictment: Wall Street Wrongdoing Remains Pervasive

One of the reasons hedge funds have commanded their stratospheric fees is the widely held belief that the people overseeing them are decidedly more brilliant than run-of-the mill institutional or individual investors. But it has become increasingly clear in recent years that many of the supposedly legendary investor titans aren’t quite as smart as they purported to be. Turns out, many have figured out a way to rig the system and see everyone else’s proverbial cards before playing their own.

To a layman, this is known as cheating. On Wall Street, it’s called insider trading.

Trust me on this, the arrest of hedge fund mogul Raj Rajaratnam for allegedly netting $20 million trading on non-public information is just the tip of the iceberg. Other major hedge funds also have been implicated in insider trading allegations and suspicions have surfaced about some very prominent Wall Street executives. It’s well known that if you are a big trading macher on Wall Street, you gain access and insight that just isn’t available to even mid-sized institutional investors. You get Wall Street’s equivalent of the Glengarry Glen Ross real estate leads: the Goldman Sachs weekly “huddle.”

There is sometimes a very fine line between market “color” and “inside information,” and based on the allegations against Rajaratnam and his indicted cohorts, on the surface there appears little doubt that the government has a very compelling case of criminal wrongdoing. Indeed, the wiretap evidence reveals that some of Rajaratnam’s co-conspirators were clearly aware they were breaking the law; one of them openly feared she would end up like "Martha f….g Stewart.”

The U.S. Attorney’s Office is to be commended for bringing this case, and let’s hope that if the accused get convicted, they get put away for considerably longer than the measly 22 months of incarceration meted out to legendary insider trader Ivan Boesky.

Unfortunately, the U.S. Attorney’s office has finite resources and therefore must focus its efforts solely on bringing Rajaratnam and his co-conspirators to justice. What’s needed is a far-reaching Congressional investigation examining how hedge funds garner their information. Even if you take Goldman Sachs at its word that its weekly “huddle” is merely an exchange of market “color” for the firm’s best customers, the fact remains that hedge funds generating the highest volume of trading commissions invariably get access to the best analysis and insight. It would be interesting to know if Rajaratnam, or someone from his firm, participated in Goldman’s weekly “huddle”. If that proves to be the case, then Rajaratnam’s supposedly $20 million of ill-gotten gains likely helped him achieve tens of millions more in “legitimate” profits.

The current laissez-faire treatment of hedge funds by Congress and regulators is reminiscent of what led to the Wall Street Crash of 1929. All sorts of fraudulent acts were committed by the unregulated banking industry and it wasn’t until Ferdinand Pecora and his famous Pecora Commission exposed the rampant, ongoing fraud that laws were reformed and the SEC itself was created.

Later, in his memoirs, Mr. Pecora wrote about the lack of disclosure that led to the crash: “Had there been full disclosure of what was being done in furtherance of these schemes, they could not long have survived the fierce light of publicity and criticism. Legal chicanery and pitch darkness were the banker’s stoutest allies.”

We need a modern day equivalent of the Pecora Commission. The indictment of Raj Rajaratnam badly underscores the fact that wrongdoing on Wall Street today is likely far more pervasive than ever before.

Comments

[Alan Young:]

Reportedly, Rajaratnam was arrested ahead of schedule because he was getting ready to leave the country. The FBI loves to do big dramatic sweeps where they nab 20 people at a time. Now the other sharks are on warning.

Any investor who STILL thinks that they are getting their money's worth with a 2/20 fee schedule deserves what they get.

Oct 20 09:53 PM

[BRUCE E. W.:]

Wait.....Does this mean that Rajaratnam won't get his BONUS incentives this year? Maybe we should rethink this? That just doesn't seem fair!

Oct 21 02:58 PM

[Graham and ...:]

We're in this mess because we've had too little disclosure for too long. But it's not too late to fix it.

Oct 21 07:34 PM

[anarchist:]

Oooh my, but more Government oversight would be Socialism!

Oct 22 10:35 AM

[stark naked:]

Does Gurthie's conversations with GS constitute insider trading!

Oct 22 11:31 AM

[Steak:]

The Fed and Treasury need the Primary Dealers and the TBTFs that deal heavily in derivatives. In 1929 Wall Street was its own entity, today it works hand in hand with the government. That is why any scenario short of a full blown economic collapse will not bring us Pecora 2. Why would the government ever expose its business partners as criminals?

Oct 22 12:28 PM

[Jim P. Smith:]

How can we have an effective, trustworthy market when there will never be equal access to it?

Oct 22 01:08 PM

[talld:]

Unluckily for Rajaratnam he is not to big to bust like AIG and the "insurance" they peddled with almost no reserve fund. IMO those folks deserve a much longer sentence than Rajaratnam.

I have written software which partially identifies what the biggest traders in the market are doing. It appears to me there are a number of questionable activities going on. If you are curious, take a look the graphs I have posted on the instantblog. There are literally millions of unique graphs that could be created each day.

I wish I had your knowledge to go with my software(g).

Oct 22 05:12 PM

[rdd:]

Apparently the Goldman Sachws board met with Hank Paulson during the crisis where he provided information to them on the government's thinking and strategy.

If they then traded on any of this information, should they all be indicted for insider trading?

Oct 22 06:30 PM

[Tom Armistead:]

It is well known that options activity picks up ahead of many mergers and acquisitions, or other news events. Academics have done studies that proved and quantified huge amounts of insider trading.

The SEC, the FBi or the NY Attny General could catch as many perpetrators as they want to at any time by following the trail of options trades when the activity is suspicious.

Very likely they are only bringing in a selection of individuals who have good P/R value. Rajaratnam donated money to charities that may have been fronts for Tamil Tigers, sounds sort of like terrorism, and was fined in 2005 for sham trades in connection with short-selling ahead of capital raises. He probably fit the profile of a good p/r case.

I really don't understand how an academic can get access to data that proves crimes with no problem, but the SEC when attempting to track the naked CDS, short and distort types who ruled during the reign of terror up to and after the fall of the house of Lehman just couldn't get any info, even with subpoenas. Nobody was under any obligation to keep any records, it seemed, or to disclose anything to the SEC, who had no authority.

I don't need another Martha Stewart or a Mark Cuban or really a Raj Rajaratnam. I want CDS manipulators, the guys that brought down the system, very nearly put the country in a Depression. Rajaratnam is foreign born and not really very photogenic, why can't we get some impeccably groomed Ivy League types, smooth as silk, steal more money with a computer than ten lawyers with briefcases or 100 street criminals with machine guns.

Oct 22 06:49 PM

[marketstudent:]

Unfortunately, the cheating isn't limited to Wall Street. The same loose lending practices that led to the derivatives fiasco continue to be encouraged/mandated by government regulators. Our financial system continues to be brittle and another major downturn should be expected unless this is fixed soon. Government regulators attempt to place all the blame on Wall Street, but without their enablement/pressure, the bad lending practices wouldn't have occurred. Do-good-ism is inevitably betrayed by the law of unintended consequences.

We need to bring back Glass-Steagall.

Oct 22 09:30 PM

[talld:]

MarketStudent: IMO the reason the market is headed for a crash is because risk is no longer considered risky. I believe that perception of risk is cyclical in nature, and right now we are at an extreme, where no matter what the risk is, a whole bunch of people will take it.

Consider no-doc loans. The only thing that could even be worse than no-docs loans in silliness is possibly Nigerian No-docs. Risk pays almost nothing and therefore the entire market has become a market of speculation strategies.

When the average Joe no longer fears risk is when the entire market will go. I think we are most of the way there. Look how many stocks do not pay a dividend, even though they are NOT growth stocks.

Risk pays almost nothing, because people do not think it is possible to lose. I have heard many people talk about when the market will recover, as if it is just a fact. The argument for them seems to be how long until it recovers, not IF it will recover.

There is no real belief in risk. They are not risking their money, they are risking having to wait for it longer than they thought. Maybe by a year or even five.

Where are the people who still think there is a risk in the market? Where are those who are talking about "If" the market will recovery. There are some, like yourself, but there should be a lot more. The lack of almost anyone who fears risk will cause every stupid risk there is (Ie, no doc loans) to get play, such as AEG did, until finally it all crashes.

Oct 23 12:53 AM

[Moon Kil Woong:]

Agreed, this is just the tip of the iceberg. Bad practices, no transparency and rules, and a lack of enforcment of the few rules that are there are a market fact making the concept of a fair, equal, and unbiased market exactly that, just a concept.

I remember when I was covering the big brokerage conferences and everyone asked Ultratech Stepper's CEO if he was buying a new car this year. After digging into the facts a number of hedge funds used the question as a informal way of knowing if the business and earnings were on the up and up or going to cycle down. There is no way the general public can get this type of coverage and almost no way to enforce such coded tip offs.

What are you going to post in your analyst report. The "CEO feel confident enough to buy a new hotrod"? This is the type of gunk hedge funds squander their premiums on. Whether on not it's worth it or legal or not is up to you.

Oct 26 01:34 AM

[Michael Clark:]

Tip of the iceberg, indeed!

Boys will be boys! Everybody cheats, so why don't we! Here's a little something for you -- all you have to do is look the other way! Nobody gets hurt!

Immorality sinks the ship! Cheating, stealing, lying become the standard operating procedure!

Yes, and when a democracy cheats, steals and lies to its citizens, then it stops being a democracy. It becomes...state capitalism.

Oct 26 01:49 AM