If Rajat Gupta Is An Inside Trader Maybe You Are, Too

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So Rajat K. Gupta, the ex boss of McKinsey & Co. and a former Goldman Sachs board member, was arrested today, and charged with being a friend of hedge fund bigshot Raj Rajaratnam. Well, that’s not how the indictment read exactly. Officially, the allegations are conspiracy to commit securities fraud, plus five counts of securities fraud. Gupta faces up to 20 years in prison on each fraud charge. More specifically, the allegations are that Gupta leaked to Rajaratnam— the head hedgie of Galleon Management, who is now facing 11 years in the slammer for insider trading— information concerning Berkshire Hathaway’s $5 billion investment in Goldman Sachs before it was announced on September 23, 2008. He’s also charged with tipping off Rajaratnam on Goldman Sachs’s financial results for both the second and fourth quarters of 2008 and P&G’s earnings for the quarter ending December 2008.

What did Gupta gain from this? Nothing. Nothing but grief, anyway. As Gupta’s lawyer Gary Naftalis points out, “he did not trade in any securities, did not tip Mr. Rajaratnam so he could trade, and did not share in any profits as part of any quid pro quo.” The feds say that’s baloney, that Gupta profited because he was invested in Galleon’s funds. (Yeah, says Naftalis, and lost $10 million doing so.) The feds also say that his info allowed Galleon to avoid a $23 million loss on Goldman’s stock while Galleon’s traders generated profits of “over $570,000” on P&G. Wow, that much for a multibillion dollar trading operation. You call that a tip?

 Which is going to lead to questions, as it did in the Rajaratnam case, of what constitutes insider trading? If you’re chatting with your buddy who works for Apple and she tells you she likes what she sees, does that make you a criminal for piling into the stock? Conversely, if your buddy happens to be in charge of a hedge fund, and you work for Apple and you tell him what you’ve been up to and he piles into the stock, are you a criminal?  If the FBI is listening in, maybe. Insider trading has always been a moving target, but U.S. attorney Preet Bharara has nailed more than 50 people during an investigation that began with one case. It’s classic, start –with- the- small- fish and move up law enforcement, but it is also raising some issues about overcriminalization. One of the broader legal issues, says Heritage Foundation legal scholar Paul J. Larkin, Jr, a former Justice Department attorney, “is that you take one discrete type of conduct and make it a crime under multiple statutes. It’s a serious question that we are only starting to debate.”

There is a school of thought, often tied to the University of Chicago, which says that all information, inside or not, is beneficial to the market. So let it be. Others argue that insider trading is an abuse of privilege that should remain illegal. But now that the heavy artillery of U.S. Attorney’s office has been brought to bear, the potential outcomes of these cases have changed to an extraordinary degree. Gupta could do hard time for blabbing to a buddy. Will that prospect, and Bharara’s  breakthrough access to wire tapping, make insider trading go away? Of course not. But if a guy like Gupta loses, you can expect the Street to lean very heavily on its pals in Washington to redefine the law. Because if this is a crime, then there are likely more criminals than not on Wall Street. But you were thinking that anyway.