On October 13, 2011, a US district court sentenced Mr. Raj Rajaratnam, general partner of Galleon Management L.P., to eleven years in federal prison as part of the biggest insider trading enforcement action in years. The stiff sentence for Raj Rajaratnam highlights a trend of increasingly longer prison sentences for insider trading.
In fact, the median sentence for insider trading has almost tripled over the last two decades. Remember the notorious Ivan Boesky case back in 1980’s? His sentence was a mere 41 months in prison vs. 132 months for Raj Rajaratnam.
The main statutory authority for insider trading is section 10(b) of the Securities Exchange Act of 1934, which proscribes the employment of "any manipulative or deceptive device or contrivance" in "connection with the purchase or sale of any security." The government has often presented these cases as the ones involving perpetrators that are privileged individuals who succumbed to the vice of greed or some other character flaw. And it’s easy for a jury to see it the same way.
A moralistic contempt for this flaw feeds into the increasing criminalization of this act. Wall Street is full of crooks and fat cats; a narrative trumpeted by both political parties, is adding fuel to the fire. The statutory penalties for illegal insider trading are almost as severe as first-degree murder, yet insiders make tens of thousands of lucrative transactions every year. What is the explanation for this paradox? In fact, the increase in penalties over time has done little to slow down insider trading. In fact, based on the penalties, long prison sentences and publicity surrounding these cases, one has to wonder why any one would go near these trades?
In most insider trading cases, the information is usually leaked from an employee at the issuer company to an outside investor. Are the companies doing enough to warn their employees? I think compliance programs are often focused on individuals who are closest to complete financial information, i.e., corporate executives, finance and investor relations’ professionals. However, there are employees who are far removed from this direct financial information who can take their partial information and translate that into a powerful insider trading input. From my own personal experience, this could be an individual in marketing, testing, packaging and shipping, to name a few. Are the employees in all these departments receiving the same sort of compliance coverage as the ones in the frontline of finance? Probably not.
Two cases came to light within the last two weeks alone. The first one reported on June 6, 2016. Michael Maciocio, a former Pfizer employee, leaked M&A targets to his buddy David Hobson. Mr. Maciocio was not involved in the M&A discussions directly. He was a master-manufacturing planner. In that role, he was usually tasked to assist in determining whether the pharma company will be able to manufacture the new products in house. Typically, Mr. Maciocio was not provided the name of the target acquisition. However, he used this partial piece of information and researched the rest to uncover the identity of the target company.
In fact at times, Mr. Hobson, his buddy at Oppenheimer, aided him in this task. This reminded me of my own role in 1999, when I used the top customer list at Intel, and translated that into a mock upcoming income statement. The second case was reported June 8 th 2016 that a junior employee, Andrei Postrado working in KPMG real estate and construction tax department in Toronto, engaged in insider trading of takeover target companies. He was not part of the team working on the proposed deals, but was able to access documents in the tax department’s computer system to uncover the identity of target companies. He traded himself and passed this information to his father, Fernando Postrado.
These cases do not cast any doubt on the firms such as Pfizer, Intel or KPMG commitment to conduct with integrity and be compliant with insider trading law. These highlight two things:
- Temptation and greed can be a powerful impetus to propel an employee in completing the mosaic for insider trading, something I know intimately from my own behaviors in the past.
- There may be lacunae in the compliance with insider trading within corporate America.
I believe corporate America is very committed to conducting themselves with the highest integrity and respect and be in compliance with the laws. A lot of effort is expended upon training for the personnel in senior- management, finance and investor-relations. In fact most of these personnel are usually restricted to rule 10b5-1 programs and the breach of the insider trading rules usually does not happen in these departments.
It is not just senior management, finance professionals and investor- relations employees that need to be trained on the rules and the boundaries of securities law. Instead, may be, a wider net needs to be cast. Whether it is a part of new hire training or some other form of mandatory training, most all employees need to be aware of the definition and prohibition of sharing company confidential information. This training could have a two-pronged approach: Emphasize and reinforce the ethical conduct of the employees. Offer a primer on the securities law and provide stark reminders on the criminality of a breach in conduct.
Sharing or passing of the financial data to outsiders might seem innocuous, but it is a criminal act that can lead to prosecution resulting in ignominy, fines, and incarceration. Much broader and mandatory repeat training programs on the definition and the prohibition of insider trading and underscoring the ethical conduct of the employees might be able to slow down this breach. Such programs might not deter the deliberate perpetrators, but the borderline offenders might be stopped.
