October 17, 2011 11:12AM

Insider Trading and the Rajaratnam Case

Alexander R. Cohen of the Business Rights Center at the Atlas Society is sharply critical of the 11‐​year sentence given Raj Rajaratnam for alleged insider trading. Cohen notes:

And as long as the sentence is—and it is much longer than is typical in insider‐​trading cases—it’s less than half the maximum the government wanted, 24.5 years. Looking at that number, Rajaratnam’s lawyers offered, as points of comparison, the average sentences for other crimes in 2010:

For sexual abuse, 109 months—nearly two years less than Rajaratnam got.

For arson, 79 months—more than four years less.

For manslaughter, 73 months. That’s right: People who killed people got sentences more than four years shorter than Rajaratnam’s. (They did get longer sentences than his if their crimes rose to the level of murder—though even the average sentence for murder was less than the 24.5 years the government wanted to impose on Rajaratnam.) [emphasis added]

I do wonder how the U.S. attorney would explain those respective sentences. The prosecutor did face a challenge in explaining just how Rajaratnam had harmed people. Cohen isn’t impressed with his answer:

But even the prosecutors admitted that it was hard to identify victims or measure their losses directly. So they argued that the stock‐​market is a zero‐​sum game, and that however much profit Rajaratnam made, he took from someone else.

This is nonsense.

First of all, the stock market is not a zero‐​sum game. If a stock becomes more valuable, perhaps because the issuing company became more productive, it does not somehow take away money from everyone who doesn’t own that stock. It means they’ll have to pay more if they want to buy it—but (unless they’ve sold short) they do not have to buy it. It’s true that people who don’t own a stock when it goes up are missing an opportunity, but missing an opportunity is not the same thing as losing money.

Second, the previous owners of stocks Rajaratnam bought on inside information never owned the profits they would have made had they kept the stock. They only had the right to those profits if they chose to keep the stock long enough for its price to go up, then sell it before it went down. They chose not to keep it. Therefore, they never had the right to the money that Rajaratnam made.

Cato’s Doug Bandow argued in Barron’s at the beginning of the Rajaratnam case that insider trading shouldn’t be a crime. And way back in 1985 Henry G. Manne, one of the pioneering scholars in the field of insider trading, argued that “the economic, moral and legal arguments are very strong against the SEC’s stand on insider trading” in the Cato Journal.