Insider Trading and the Trial of Raj Rajaratnam: Implications and Predictions (Part 1)

For almost two months, the trial of Raj Rajaratnam has flooded the newspapers and airways.  The indictment involved 14 counts and implicated companies from Goldman and Google to AMD and Hilton.  There were alleged tips from officials at Morgan Stanley, Goldman Sachs and McKinsey.  After rigorous closings (they can be found here), the case has officially gone to the jury.  While anything can happen, it is likely that it will take a few days for the jurors to slog through the multiple counts of the indictment.

From all appearances, Rajaratnam's lawyer, John Dowd, did about as good of a job as was possible given the circumstances.  But the reality is that he was dealt a weak hand. The case involves allegations of insider trading in somewhere around ten different companies.  To win, Dowd will have had to convince the jury that Rajaratnam did not engage in insider trading with respect to all of them. While he is likely to get an acquittal on some of the counts, the government, to be declared victor, needs a conviction on only one. 

Victory for Dowd requires what amounts to a trifecta.  He must overcome credibility, coincidence, and confessions.

Credibility.  Dowd has to convince the jury that the three main witnesses for the government, Kumar, Smith and Goel, are not credible.  As Dowd noted in his closing: "The government has not proven its case and you cannot convict unless you believe the word of Anil Kumar, Rajiv Goel, and Adam Smith. If you don't believe these three men, you must acquit."  Transcript, at 5343. 

All of them are vulnerable.  They have pled guilty to criminal charges and are awaiting sentencing.  See Id.  ("None of them has been sentenced yet. And the prosecutors decide whether the government is going to help them at sentencing or not.").  They are motivated to help the government in return for leniency.  Moreover, there are other vulnerabilities.  Dowd in his closing hammered away with the most force at Kumar.  Nonetheless, to win, the jury will have to believe that all three are essentially untrustworthy. 

Coincidence.  Irrespective of the testimony of the three witnesses, there are instances of trading patterns that look suspicious.  Thus, for example, Rajaratnam bought shares in Goldman shortly after receiving a phone call from Rajat Gupta, a director at Goldman.  Gupta had just attended a board meeting where a possible investment by Warren Buffett was discussed.  As Reed Brodsky stated for the government in his closing:

• On September 23, 2008, you know Mr. Gupta was on the Goldman Sachs board from 3:13 p.m. to
  3:54 p.m. . . . And here you have Buffett investing in Goldman Sachs stock. And that occurs from 3:13 to 3:54, the Goldman board approves of the deal, and that's at 3:54, right before the end of the trading day. Right then and there, 16 seconds later, who does Mr. Gupta call? Mr. Rajaratnam. That's not a coincidence. And what happens next? Two minutes later Mr. Rajaratnam buys Goldman Sachs stock. Now, he puts in an order to buy 350,000 shares of stock worth $43 million at that time, 3:58 p.m.

Transcript, at 5247.  There was no tape of the phone conversation introduced at trial and Gupta did not testify.  So the contents are speculative, although there was a recorded conversation produced at trial that has Rajaratnam telling one of his traders the next day that "I got a call at 3:58 saying something good might happen to Goldman."

Nonetheless, the confluence of the board meeting, the phone conversation, and the trading activity, are a result of a coincidence or the transmittal of material non-public information.  The jury will have to believe it was coincidence in order to aquit (or, less likely, that Gupta did not benefit).

Confession. Then there are the confessions.  These are the wiretapped conversations, probably the most insurmountable hurdle for the defense.  Some are ambiguous (the one between Gupta and Rajaratnam about Goldman's considering a commercial bank).  But others are not.  The conversation between Kumar and Rajaratnam about the investment by the Abu Dhabi Sovereign Wealth Fund in AMD is hard to explain away (the tape is here).  In it, Kumar describes the certainty of the deal (there was a handshake), the amount to be invested ($6-8 billion) and the date the transaction will be announced (a week after labor day). 

While the market may have been speculating about the investment, speculation by definition involves a degree of conjecture.  The information received by Rajaratnam had no real element of speculation.  It was a set of hard facts.  Nonetheless, even if the market had only been speculating, it is true that there could be no insider trading if the share prices already reflected the information (it would in those circumstances be immaterial).

To win, jurors will have to believe that the speculation in the market effectively informed investors to the same degree as the hard facts.  Moreover, they will have to believe it about more than one conversation.  The tape between Rajaratnam and Goel about Goel's investment in PeopleSupport likewise contained a number of specifics. 

On any given point, credibility, coincidence or confession, Dowd may win.  But Rajaratnam's freedom depends upon the jury agreeing with all of them.  This seems unlikely.