Raj Gets Nailed. The Ratings Agencies Beat the Rap

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So the Feds got their big fish. The takedown of Raj Rajaratnam for insider trading is going to give U.S. Attorney Preet Bharara plenty of momentum in using an old prosecutorial weapon to go after a new set of miscreants. Rajaratnam was fried by his own words, obtained by the kind of wiretap that the prosecutors use to go after Mafiosi, drug lords and other denizens of the underworld. Rajaratnam could be heard gaming the system, getting inside dope on Goldman Sachs from board member Rajat Gupta. “I heard yesterday from somebody who’s on the board of Goldman Sachs that they are going to lose $2 per share. The Street has them making $2.50.” Knowing that information isn’t illegal—and Gupta has not been criminally charged for giving Rajaratnam the scoop—but trading on it is the issue here.

All over Wall Street and in the high floor headquarters of hedge funds in Manhattan and waterside offices in Greenwich, Connecticut, the compliance officers and attorneys are poring over trading records, emails and phone logs looking for red flags. Relationships with “expert networks” that broker information between corporate insiders and traders, are being severed, although it all may be too late. 

It’s always been easy for prosecutors to get  wiretaps on mobsters. Low level criminals are generally willing to give up somebody to save their hides, and that first cooperator starts the ball rolling. It’s the prosecutor’s ability to flip witnesses sequentially that builds cases.  That’s the huge difference in the Rajaratnam case. Bharara first got a court order for a wiretap in March of 2008 and the case has been building since then. Cooperating witnesses provided evidence against him. It’s that wiretap that Rajaratnam’s attorneys will be targeting in their appeal—whether it met the proper legal standard. But that standard, says one criminal defense attorney that I know, “has been getting looser and looser.” That’s not Bharara’s problem; it’s Rajaratnam’s. His lawyer, John Dowd, said his client would appeal. “We’ll see you in the second circuit,” said Dowd.

That would be the Second Circuit Court of Appeals, which sits in lower Manhattan, where Rajaratnam’s trial took place. Lost in all the attention about the insider trading case was one decided by the very same Second Circuit in favor of Moody’s, Standard & Poor’s (owned by McGraw Hill) and Fitch Ratings. The court ruled that the three companies could not be held liable for collapse in value of a group of mortgage bonds, which they rated triple A in many cases, backed by mortgages issued by Lehman Brothers and by IndyMac. Lehman’s failure set the financial meltdown into overdrive; IndyMac handed out tons of Alt A, no doc mortgages— liar loans— before it failed. The Second Circuit ruled that the ratings agencies, despite rubber stamping this subprime garbage with a triple A, were merely issuing opinions, which are protected by the First Amendment. Case closed.

Rajaratnam’s behavior, however illegal, was relatively isolated and victimless. My 401k didn’t take a beating because Raj was insider trading. The market was gamed and conned but not harmed. The ratings agencies, on the other hand, contributed to the meltdown of our economy. The plaintiffs in the ratings agency case included the retirement fund of police and fire fighters in Detroit. The cops were robbed here and the perps are walking.  The law is funny that way. In Manhattan, U.S. Attorney Bharara used a new weapon available to him, and like every good prosecutor he is going to push it until he runs out of targets or a higher court reverses. He’s charged 47 people and got 36 convictions or guilty pleas. If you work in a hedge fund, you may want to think twice about answering the phone—cooperating witnesses will do just about anything to avoid a jail term, including implicating friends and associates. If you work for a ratings agency, be assured that your criminal incompetence is fully backed by law.

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