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The Return of Rudy G

The WSJ has breathlessly reported:

Federal authorities, capping a three-year investigation, are preparing insider-trading charges that could ensnare consultants, investment bankers, hedge-fund and mutual-fund traders, and analysts across the nation, according to people familiar with the matter.

The criminal and civil probes, which authorities say could eclipse the impact on the financial industry of any previous such investigation, are examining whether multiple insider-trading rings reaped illegal profits totaling tens of millions of dollars, the people say. Some charges could be brought before year-end, they say.

The investigations, if they bear fruit, have the potential to expose a culture of pervasive insider trading in U.S. financial markets, including new ways nonpublic information is passed to traders through experts tied to specific industries or companies, federal authorities say.

Peter Lattman’s NYT story provides some perspective, noting that Justice and the SEC “have taken an increasingly aggressive — and public — stance in pursuing insider trading” and that the prosecutor in the latest case (as in the Galleon case), Manhattan U.S. attorney Preet Bharara, is among those taking the “hardest line.”

The NYT article quotes recent Bharara statements that insider traders “are already among the most advantaged, privileged and wealthy insiders in modern finance” for whom “material nonpublic information is akin to a performance-enhancing drug that provides the illegal ‘edge’ to outpace their rivals and make even more money” and reminding us of “the lengths to which corrupt insiders will go to misuse confidential information for their own personal gain.” Lattman notes that

Mr. Bharara’s sharp rhetoric is evocative of the insider-trading scandal during the 1980s when Rudolph W. Giuliani, then the United States attorney in Manhattan, prosecuted Wall Street executives using laws that had rarely been enforced. (Exactly 20 years ago Sunday, a federal judge sentenced the financier Michael Milken to 10 years in prison for securities violations relating to the insider-trading scandal.)

And, says Lattman, the United States attorney’s office has adopted “increasingly aggressive techniques” to match its “sharp rhetoric,” including wiretaps like those used on organized crime figures and drug traffickers.

It’s fitting that Lattman summons the memory of Giuliani’s patented perp walks of the 1980s, which Rudy G rode to a mayoralty and presidential campaign, as well as riches as a lobbyist and lawyer. Some years later, in soberer times, a former federal prosecutor wrote in the NLJ:

In 1987, at the height of then-U.S. Attorney Rudolph Giuliani’s insider trading war, he had three Wall Street investment bankers handcuffed and arrested at their desks. When one demanded an immediate trial, Giuliani had the case dismissed (without prejudice) to avoid a speedy trial violation, since the government wasn’t ready for trial. Much later, two pleaded guilty to relatively minor charges. The third case was never pursued, but a reputation was ruined. This abusive exercise of the arrest power is still remembered.

The three traders were Timothy Tabor, Richard Wigton, and Robert Freeman. The scene was evoked in the film of the same year, Oliver Stone’s Wall Street. One wonders if Bharara is gearing up for a similar high-profile media event, with a similar financial and political payoff.

Rudolph Giuliani
Rudolph Giuliani

All of this theater can’t hide the dubious public policy underlying these prosecutions. Insider trading is, at worst, a breach of fiduciary duty which, like other such breaches, can be dealt with under state law. There’s only the thinnest basis for getting the federal government involved — that insider trading might increase trading spreads and therefore might reduce trading by outsiders. But sensible outsiders don’t do a lot of trading.

Even if there’s a case for a federal law against insider trading, criminalizing this conduct and unleashing aggressive publicity-seeking prosecutors to enforce the criminal laws is particularly dubious. The vast majority of trading on non-public information does a lot of good by making stock prices more accurate and, occasionally, exposing fraud. (Sometimes it seems legal insider trading does more to inform the markets than does the SEC — remember Madoff?).

The line between legal and illegal insider trading is shadowy at best. Branding anybody who crosses the line as a hardened criminal subject to a potentially huge jail sentence or at least career-ending prosecution could shut down or at least discourage legitimate firms that deal in non-public information, including the expert services that Bharara’s investigation is supposedly targeting. Bharara may succeed in cleaning the markets of a lot of good information along with a few criminals (actually, no criminals if this crime wave is like the one targeted by Giuliani).

Finally, there’s the journalistic aspects of all this. One can be forgiven for sniffing an implicit deal here between Bharara’s office and the WSJ. The WSJ got a prized story, to which it devoted four top reporters (according to the byline). In return it reported the story exactly the way Bharara’s office wanted the public to see it — as “expos[ing] a culture of pervasive insider trading in U.S. financial markets,” rather than as a costly lark by a publicity-seeking prosecutor. This smells a little like the way the traders in “Wall Street” used a newspaper called the “Wall Street Chronicle” to leak non-public information (Blue Horseshoe loves Preet Bharara).

Professor Larry E. Ribstein is the Mildred Van Voorhis Jones Chair in Law and the associate dean for Research, University of Illinois College of Law.

This story originally appeared on the blog Truth on the Market. It has been republished with the author's permission.

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