Insider Trading: What’s Fair and What’s Foul?

[WSJ_law_blog]

Insider trading remains one of the more confounding crimes to understand. What sort of information is fair game for savvy investors and what sort is illegal?

A few articles today offer an insider-trading tutorial in light of the seeming implosion of Galleon Group, the giant New York hedge fund whose founder Raj Rajaratnam was arrested Friday for allegedly trading on nonpublic information involving some major companies.

Before we hit the law books, let’s quickly get caught up on the news.

Galleon already has started hemorrhaging clients, with investors seeking to withdraw about $1.3 billion of the $3.7 billion in assets under management, WSJ reports.

Rajaratnam told about 130 employees yesterday at Galleon’s Manhattan offices that he did nothing wrong and would be “busy” defending criminal charges filed against him. “I’m counting on you to take care of our investors,” he said, according to an attendee.

So back to the main question: When does aggressive information gathering cross the line into insider trading?

First off, it’s a thin line between, according to a New York Times explainer piece today. Prosecutors will need to show that Rajaratnam had a sufficiently culpable state of mind. Northwestern law professor David Ruder tells NYT that prosecutors may be aided by the fact that cooperators wore wires, capturing conversations that may establish Rajaratnam knew the information he gathered was valuable and that he should not trade on it.

A WSJ article today further underscores that prosecutors will need to establish that Rajaratnam had a duty not to trade on insider information; in order words, it’s not enough to show merely that a defendant traded on nonpublic information.

“Just saying, we want better information, even we want information no one else has, there’s absolutely nothing illegal about that,” former prosecutor Christopher Clark tells WSJ.

All hedge funds registered with the SEC, such as Galleon, have codes of conduct under which employees pledge not to trade based on inside information. That is one basis for charging a hedge-fund employee with insider trading.

He knows that this was wrong.