Raj Rajaratnam went to jail for insider trading but much bigger players escape scrutiny for the same practice.
By Les Leopold
Raj Rajaratnam sits slightly slumped and rumpled in his chair next to his tallish, white-haired, high-priced defense attorney. The man next to me in the overflowing courtroom gallery says, “It sure looks like he had a restless night.”
He will have many more.
The Raj, as he likes to be called, is a barrel-shaped 54-year-old man with a very round face and a dark complexion. He’s nearly six feet tall and well over 200 pounds. He also is, or at least was, a big man in finance.
Forbes reported that in 2009, when Raj headed the Galleon hedge fund, he was the 236th richest person in America, with an estimated net worth (total assets minus liabilities) of $1.8 billion. That’s more than 23,000 times the median U.S. family's net worth (which was $77,300 in 2010, down from $126,400 in 2007.)
The Raj shows no facial or emotional affect at all as the bow-tied Judge Richard Holwell carefully reads out the sentence — 11 years in federal prison in Butner, North Carolina, the current home of Bernie Madoff. The Raj must also cough up $10 million in fines and forfeit $53.8 million in ill-gotten gains. With good behavior, he gets out in nine years. The money is chump change.
From Icon To Sacrificial Lamb
You wonder what the Raj must be thinking as the judge accuses him of befouling our financial markets, scaring away investors, and putting jobs in danger. Only a few short years ago, the Raj was worshipped as a great American hero, an icon of finance, and a philanthropist who cared deeply about helping those less fortunate. He was precisely what every business school graduate wanted to become. His billions were proof positive of his genius and of his value to society.
Back then, his aggressiveness to secure “privileged” information was more a badge of financial acumen —the kind of take-no-prisoners behavior that investors expected of the very best hedge-fund chieftains. He was an important face (albeit a brown one, originally from Sri Lanka) of the new American capitalism —a capitalism built on an ever-widening role for high finance. He was our future.
When our future nearly succumbed to financial follies, however, sacrificial lambs were needed to appease the populist gods.
The rotund Raj looked good on the spit. How easy it is to turn this financier from the epitome of capitalism into a scoundrel. His crime of insider trading, according to the judge, is nothing less than an “assault on the free markets that are a fundamental element of our democratic society.” The judge continues:
“This is not to say that the defendant’s insider trading is the cause of the economic dislocations that our society now faces. That would be too easy an answer. But his crimes and the scope of his crimes reflect a virus in our business culture that needs to be eradicated.”
The disease is so endemic to hedge funds, Judge Holwell opines, that the stiff sentence, the longest ever given for this offense, is needed to “deter other fund managers, traders, and brokers from engaging in insider trading.”
Cheating a Major Source of Hedge Fund Profits
The federal trial of Raj Rajaratnam exposed what the government claims is a ubiquitous hedge-fund practice. The prosecution successfully argued that the Raj had accumulated ill-gotten gains of more than $70 million by cashing in on tips from informants whom he’d paid under the table. If this game really is widespread among hedge funds, as both the prosecution and the judge believe is proven beyond a shadow of doubt, then cheating indeed may be a major source of hedge-fund “alpha” profits.
Understanding how widespread lying, cheating, stealing, and general corner cutting are is important to figuring out how millions can be made. After all, hedge funds are supposed to be good for America, pushing markets and investments in the direction of innovation and efficiency.
If hedge funds are mostly just capitalizing on investments already moving in the right direction or even raking in profits from pushing markets in the wrong direction, well, it certainly makes the path to millions a lot simpler. You don’t have to understand what no one else understands. You just have to be willing to do what no one else is willing to do.
Let us all learn from the Raj’s sad example.
His network united various international financial elites, many of whom just happened to be of Asian descent. They met while attending elite universities and business schools in England and the United States. Yet, had the Raj and his associates been part of the (white) American old boy network, they might have parlayed valuable insider information without fear of reprisal.
Wall Street’s Old Boy Network
Here’s how the old boy network plays the game.
Think back to July 2008. Bear Sterns had already collapsed, home prices were falling fast, and the stock market had the jitters. With foreclosures hitting record levels, hedge-fund sharks turned their attention to Fannie and Freddie, which were sure to experience enormous financial difficulties.
Hank Paulson, the former head of Goldman Sachs and then serving as Bush’s Treasury Secretary, had a mess on his hands. He needed to find a way to stabilize Fannie and Freddie and keep the predators at bay.
He decided on a two-part public strategy. First, he asked Congress for authority to buy equity in the firms, which usually signals a move toward nationalization. He also set about to audit their books, in order to assure investors that all was well. Yet, he told both Congress and the press that he had no intention of taking over the ailing firms. “If you have a Bazooka, and people know you have it, you’re not likely to take it out,” he said, according to Bloomberg News.
Paulson’s public pronouncements heartened investors. For if Paulson nationalized Fannie and Freddie, shareholder value would plummet to nothing. Yet, if Paulson bolstered the firms and kept them in private hands, share prices would recover, which is precisely what happened after Paulson spoke publicly in mid-July.
Hank Paulson Tips Off Wall Street on Fannie & Freddie
Just a few days later, however, Paulson took a quiet little sojourn up to New York City to have lunch with some of the boys — his old comrades at Goldman Sachs who now ran hedge funds. “Around the conference room table were a dozen or so hedge fund managers and other Wall Street executives — at least five of them alumni of Goldman Sachs,” reported Bloomberg News.
There, Paulson made it crystal clear that the government would soon seize Fannie and Freddie. And just in case his former employees at Goldman Sachs were too dimwitted to figure out what that meant, he explained “that under this scenario, the common stock of the two government-sponsored enterprises ... would be effectively wiped out. So too would be the various classes of preferred stock.”
Hmm. You tell the public all is well, and the stock goes up. But you tell your hedge-fund cronies that you’re about to wipe out the stock! Think you could make money with that information?
Short-Selling Fannie & Freddie
Well, someone did. No one knows for sure who was at the meeting and whether they used the secret Paulson information to short the firms. Yet, on the day of the meeting, short-selling of Fannie and Freddie stock reached record highs and then went even higher during the next few days.
A little more than a month later, Paulson took out his bazooka and fired away, nationalizing both Fannie and Freddie, which crashed the stock and made millions upon millions for the short sellers.
All of it was legal, or mostly so. You can’t nail Paulson, because he didn’t make any investments based on his information, and it’s hard to prove that he lied to Congress. You can’t really nail those who used the information for fun and profit, because you don't know who was there, and it’s not clear that using the information violates any law.
So step back and compare the Paulson and Raj Mafiosi. If you’re the Raj and you’re plying corporate boardrooms for hot tips, you can land in jail, if you’re caught. But if you get the info from your friends who are appointed to top economic positions in government, well, you’re both in the clear and in the money.
You want to cheat? Then, as always, it pays to have friends in high places and to look like you can play the part.
Step 7: Don’t Say Anything Remotely Truthful
Step 6: Rig Your Bets
Step 5: Betting Is For Chumps
Step 4: Use Other People's Money
Step 3: Rip off Entire Countries Because That's Where The Money Is
Step 2: Take, Don't Make
Step 1: How To Make A Million Dollars An Hour In Twelve Easy Steps