Tuesday, May 17, 2011

You Gotta Keep Insider Traders Way Down in the Hole

By Mike Dorf

Last week's conviction of Raj Rajaratnam for insider trading may herald an expansion of the use of wiretaps as a tool in the policing of Wall Street.  Accordingly, it's worth asking how Wall Street practices might change in response.  Practices on a different street--the corner where drug dealers ply their trade--may provide one useful point of comparison.

I'm not the first person to draw this parallel.  As reported in a Forbes magazine blog post in February, it appears that hedge fund managers have already become paranoid about wiretaps and bugs, hiring security firms to check their homes and offices.  Based on my extensive experience watching the HBO show The Wire and mob films and tv shows, I expect that this will only be the beginning of the change in behavior.

Consider the discipline of the Barksdale crew on The Wire.  When the series opens, even before they realize that they are the subject of electronic surveillance, they do not use their own telephones to conduct business.  Instead, they use a code for pagers and talk only on pay telephones.  After a bust tips off crew chiefs Avon Barksdale and Stringer Bell that the police are onto them, Bell instructs his dealers not to use the payphones in their immediate territory (and orders the phone cords ripped out just for good measure).

What's striking about the recorded evidence against Rajaratnam is how oblivious and careless he was.  For example, in one extraordinarily damning recording, after providing a client with inside information about a company, Rajaratnam instructs the client how to respond to an email that Rajaratnam will then send making it look as though the trade is based on general market analysis.  Avon and Stringer never would have said anything like this on any telephone line. Indeed, I doubt that they would have even said it aloud to anyone.  After all, even a trusted lieutenant could some day turn on you--and you just never know who could be informing or wearing a wire.

Suppose the government aggressively pursues insider trading cases going forward.  One consequence might be the development of codes.  Street dealers have developed elaborate systems in which the big players never touch the drugs or even much of the money, leaving the most incriminating transactions to under-age gang members.  To be sure, they must occasionally talk with their customers and suppliers about things like price, although even there, it can be done largely in code.  We can imagine future Rajaratnams developing the same methods.

But here's the rub: As Wall Street crooks start taking measures to avoid detection that resemble measures taken by drug dealers, they may start to behave like drug dealers in other respects.  Much of the violence associated with the drug trade stems from the conflict between rival gangs.  But not all of it.  A good deal of violence occurs between people who were formerly working together.  If you are engaged in an illegal activity and worried that a business partner, supplier, or customer is double-crossing you, you can't call the police for fear of incriminating yourself.  Thus, you resort to violent self-help.

Bottom Line: Aggressive prosecution of insider trading and other criminal activity on Wall Street could lead to a diminution of that activity, but it could also have the unintended consequence of turning some white-collar criminals into killers.


Neil H. Buchanan said...

It is amazing how brazen some CEO's can be. In the early 80's, the CEO of one airline called the CEO of another airline, and laid out a plan for price collusion. The other CEO said, "We can’t talk about pricing!" The first CEO was unfazed: "We can talk about any f*cking thing we want to talk about." I wish I knew whether he did time. I doubt it.

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Doug said...

I guess it depends on how deep the criminality runs. One would expect that all drug dealers are criminals (by definition) but that the percentage of those willing to commit criminal behaviour on wall street is much more limited and the thinking more of a - well this time only and I won't get caught - since a string of insider trading will show up on market monitoring reports. More aggressive prosecution will also change the risk/reward tradeoff which is significant as most people on wall street already have a good salary outside of criminal income (unlike drug dealers).