Why Is This Trial Happening?

The insider trading trial of Raj Rajaratnam has confused me in the same way that it has confused my colleague Andrew Ross Sorkin, who writes in his column today that he would not want to be Mr. Rajaratnam’s lawyer.

My confusion: What is the defense’s case?

We’ve heard about the “matrix” method of investing, which supposedly involves stitching together all kinds of information to reach a decision on whether to buy a stock. That sounds a lot like what they recommended when I was studying at Columbia Business School 30 years ago.

And we’ve heard suggestions that Mr. Rajaratnam might be able to prove he had very good non-inside information that led to him buying the stock. I’m sure he did. It is a rare case when there are not persuasive reasons to buy any stock at the current market price. After all, someone did buy it. And there must be reasons someone found persuasive to sell it at that price. Otherwise there would have been no trade.

The trouble is that the insider trading law, at least as I understand it, does not make allowance for other information.

Consider this hypothetical: A chief executive has been arguing publicly for months that his company’s stock is undervalued, and he has purchased shares. And, we will say, he did so without any material inside information.

Now the company gets a takeover offer at a substantial premium to market price. Can he legally buy more shares before the offer is disclosed? You know the answer.

There are three defenses I can think of to an insider trading charge, once it is proved that the trader had inside information.

One is that the information was not material. The defense seems to be trying for that, but it strikes me as a long shot. There is no way that Warren E. Buffett’s backing of Goldman was not material at the time a Goldman director is said to have leaked the information.

The second is that no confidence was violated. I would have a defense for buying Goldman stock if I had learned about Mr. Buffett’s plans because a copy of his agreement with the bank blew out of a limo window while I was walking down the street. I have no obligation to Goldman or Berkshire Hathaway, Mr. Buffett’s company, and no one who had such an obligation provided the information to me.

In this case, however, the Goldman director clearly had such an obligation.

The third defense is that the source of the tip had no expectation of benefit from providing the tip. That is a very tough defense to mount. A web of business relationships provides numerous reasons to expect some benefit, whether or not one was explicitly agreed to.

Andrew concludes:

Why Mr. Rajaratnam decided to fight the case, with so many witnesses in taped conversation with him, is a mystery.

I am left thinking he must have decided that he had nothing to lose and that if his lawyers could persuade just one juror, it would be worth going to trial. But I’m still glad I’m not his lawyer.

I too have pondered the question, and have some different answers.

The real question is, Why not fight the case? What would he gain from a plea deal? I doubt it would have produced a significantly lighter sentence than he will get if convicted. A conviction can be appealed, and he could have a shot at staying free while the appeal proceeds. If so, he has bought some time. Finally, he has plenty of money to pay for the defense without damaging his family.

If I were a lawyer, I would gladly handle this case. Winning the case, while unlikely, would enhance my reputation immeasurably. Given the overwhelming evidence, that reputation would not be hurt by a loss. Either way, I would make a lot of money.

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