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Raj's Sentence Is Too Long

Thursday, 13 Oct 2011 | 5:04 PM ET
Raj Rajaratnam
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Raj Rajaratnam

The idea that the sentence handed down Thursday to fallen-hedge fund billionaire Raj Rajaratnam resembles anything like the proper administration of justice depends on a very common factual error.

The error: Investors are victimized by insider traders.

Rajaratnam received the longest prison sentence ever for insider trading. But unlike those convicted of any other kind of fraud, Rajaratnam’s sentence is not at all linked to the harm he inflicted on his victims.

The reason why Rajaratnam’s sentence isn’t linked to any victims is because no one has found any victims. They just don’t exist.

Even the judge in the case couldn’t identify a victim. Instead, he called insider trading an “assault on the free market.”

Many people think investors on the other side of Rajaratnam’s trades are harmed, people who sold stock when Rajaratnam was buying but lacked the informational advantage he had illicitly obtained.

But are they really harmed? Of course not. No investor was ever induced by Rajaratnam to sell a stock. Stock market transactions take place impersonally, without regard to who is on the other side of a trade.

Saying that investors wouldn’t have sold if they had Rajaratnam’s information doesn’t make the sellers victims of Rajaratnam’s trading. Even if Rajaratnam hadn’t bought the stock, they still would have sold while being in a position of relative ignorance compared to him.

Let’s do a quick thought experiment.

1. Raj gets early word that Intel is going to report great earnings. He doesn’t trade at all. You sell your shares at $23.39. Did his possession of inside information harm you?

2. Raj gets early word that Intel is going to report great earnings. He buys shares for $23.39 at the exact same moment you sell them for that price. Has his buying now suddenly transformed his knowledge into something that harms you?

3. Raj has a hunch based on no inside information that Intel is going to report great earnings. He buys shares for $23.39 at the exact same moment you sell them for that price. His hunch turns out to be right. Are you better off because you sold to a guy with a hunch than a guy with inside information?

Quite obviously the answer to all three questions is no. Whether he buys or not is irrelevant. Whether his buying is motivated by knowledge or a hunch is irrelevant.

What’s really harmed you is that there was a fact about the world — Intel’s sales were going great — that you didn’t know about. You might have a complaint against Intel for withholding this information from you. But securities laws allow Intel to withhold information investors would think is valuable and important for certain periods of time. Companies don’t have to reveal things immediately.

You’d have a better case for the actual inflicting of harm if a company were intentionally concealing information so that insiders could trade on the information while outsiders traded on ignorance. But no one alleges the companies Raj was convicted of trading were in cahoots with him.

Eleven years for a crime without a victim. Does that seem like justice?

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