America has long been the most active policeman in this area, and the one that inflicts the toughest penalties (see table). In fiscal year 2010 the SEC brought 53 cases against 138 individuals and entities, a jump of more than 40% on the year before. The regulators are also employing tools typically used to fight drugs and gang violence: investigators used wiretaps for the first time in the Galleon case.
Other countries, particularly those with big stockmarkets, are getting tougher, too. “Seventy percent of all equity trading in the world takes place in London, New York and Hong Kong,” says Mark Steward, director of enforcement at Hong Kong’s Securities and Futures Commission (SFC). “It’s not surprising to see all three jurisdictions take the same thing seriously.” In February the Financial Services Authority (FSA), Britain’s financial regulator, celebrated when Christian Littlewood, an investment banker charged with insider trading, was sentenced to 40 months in jail, the longest sentence yet handed out.
Developing countries are under pressure to make their markets more welcoming to foreign investment as well. Maria Helena Santana, who heads the CVM, Brazil’s securities regulator, says that “after having investors consider our legislation and regulatory environment not safe enough or strong enough”, the CVM had to “gain credibility”. Fighting insider trading has become “the single most important task we have”. Earlier this year Russia made insider trading a criminal offence for the first time.
But the variations between jurisdictions remain striking. Many countries do not pursue insider-trading convictions, or if they do, only impose financial penalties. Earlier this year Brazil brought its first successful criminal prosecution for insider trading against two former executives of Sadia, a food producer, who were fined and sentenced to 17 and 21 months in jail. Instead, they have been allowed to spend that time doing community service.
Winning a conviction in the first place is hard enough. Insider trading is tough to prove, and it can take years to gather enough evidence to bring charges. Detection is also getting harder. Investors are able to trade more quickly and in greater volumes than ever before. According to Frank Partnoy of the University of San Diego: “Before you were trying to find a needle in a haystack [but] at least you could see the needle gleaming. Now you have to find a needle in a million haystacks.”
That has required regulators to upgrade their surveillance systems, which sort through trading records to find suspicious patterns around corporate events such as takeovers or earnings reports. In August the FSA launched its new system, called “Zen”. The SEC wants a new system that will allow it to see the equity and derivatives markets in real time, but this could carry a price tag of more than $1 billion.
Bad apples are also getting smarter about how they trade on inside information—putting through both buy and sell orders, for example, to cover their tracks, and trading in instruments other than shares. The SEC brought its first case involving exchange-traded funds only last month, and its first case involving credit-default swaps in 2009 (it lost). Regulators hope that as more derivatives trade on exchanges, it will be easier to spot suspicious trading patterns across asset classes.
Having access to client IDs for trades is another priority for securities regulators, says Belinda Gibson of the Australian Securities and Investments Commission. At the moment regulators can only see the broker who executed the trade, which makes it easier for dodgy trades to go undetected. Companies are also becoming more vigilant, as their employees have been implicated in insider-trading cases.
A crackdown on insider trading is generally good for markets. Crooked transactions corrode confidence, which hurts firms and investors alike. According to a 2002 study by two economists at Indiana University, enforcing insider-trading laws reduced the cost of equity in the countries they looked at because investors did not demand a premium for the risk of trading with a crooked counterparty.
But not everyone welcomes regulators’ swagger. Some hedge-fund managers give warning that a crackdown will do more harm than good for investment research. They say they’re not speaking to company executives they are legally entitled to for fear of coming under fire. Others say they don’t put details into e-mails or instant messages because things might be taken out of context if they were ever to end up in court. Whether exposing insider trading alarms investors more than comforts them is another question. Seeing Mr Rajaratnam’s face everywhere may just fuel fears that there are more of his type out there—peddling information, getting a better deal and making the real money. Before the news became public the broker sold the stock for his wife and clients. His punishment was a $3,000 fine and suspension for 20 days from the New York Stock Exchange. According to industry lore, the case was good for business. Clients after a broker with an edge lined up to hire him.
The costs now are rather higher. In May a jury found Raj Rajaratnam, the former boss of Galleon, a now-defunct hedge fund, guilty of 14 counts of insider trading and conspiracy. The Galleon case has ensnared people at big-name firms outside finance, including McKinsey & Company, IBM and Intel. But Mr Rajaratnam is the biggest fish netted so far in a two-year drive by American regulators to catch crooked traders. Mr Rajaratnam was awaiting sentencing as The Economist went to press; prosecutors were hoping to see him spend more than 20 years in prison.
Economist
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