The Gupta Verdict And The Future Of Insider Trading Policy

The war on insider trading hit another milestone this week with the conviction on insider trading charges of Rajat Gupta, former Goldman Sachs director. Unlike others who have been convicted or pleaded guilty in the recent string of insider trading cases, Mr. Gupta is from the upper echelons of the corporate world where directors and senior executives are routinely privy to the secrets of Wall Street and the inner workings of corporate America. He is perhaps the most prominent member of this exclusive club to be put on trial and convicted for insider trading. The message from this case is clear – anyone who trades on inside information will be prosecuted.

Perhaps more important than Mr. Gupta’s position, is the nature of the case. Coming into the Gupta trial, the Manhattan U.S. Attorney’s Office, aided by the SEC, had an unbroken record of convictions or guilty pleas a series of insider trading cases. Those cases however were built on mountains of FBI wire taps which secretly recorded defendants such as convicted hedge fund mogul Raja Rajaratnam discussing inside information about pending mergers or upcoming earnings announcements.

The case against Mr. Gupta had none of that. There were no tapes of him actually telling anyone anything. There were no tapes of Mr. Gupta discussing inside information he learned at a board meeting. There were no tapes of Mr. Gupta talking to Mr. Rajaratnam. Rather, this time the U.S. Attorney’s office built its case the old fashioned way in the manner of a classic SEC insider trading action – on bits and pieces of evidence carefully woven together into a tapestry of illegal conduct. Board meetings were followed by phone calls by Mr. Gupta ending with securities trades by his long time friend and business associate at Galleon. While there were no cash profits for the already wealthy Mr. Gupta, there were plenty for his friend and the reward of a close personal relationship for a man who had worked hard to climb into the privileged inner circle.

Proving insider trading cases is notoriously difficult. Meeting the high standard demanded in a criminal case using only circumstantial evidence against a defendant with a sterling reputation such as Mr. Gupta is a significant accomplishment. There should be little doubt that the verdict in the Gupta case will propel the war on insider trading forward.

The impact of the verdict is likely to extend beyond the U.S. Attorney’s Office and also bolster the SEC’s insider trading program. After all, it is the Commission which is often on the advanced edge of the insider trading wars. It is the Commission which typically proves its charges with circumstantial evidence while the U.S. Attorney’s Office relies on the defendant’s own words captured on tape. If circumstantial evidence can be used to prove the guilt of Mr. Gupta in a criminal case, it will surely suffice in a civil SEC enforcement action where the proof requirement is significantly less.

The verdict may also embolden the Commission’s push on the contours of what constitutes insider trading. While criminal cases such as Gupta and Rajaratnam garner huge headlines, those actions are based on passing tips about information that is clearly material and non-public, that is, inside information. The SEC however, as the front edge of the war on insider trading, has been focusing on more difficult cases that may well redefine what actually is insider trading. These include actions such as:

• SEC v. Cuban, the much discussed case against Mark Cuban which focuses on when a person has a duty to refrain from trading;

• SEC v. Dorozhko, the so-called “computer hacker” case, that centered on what constitutes deception, a key element;

• SEC v. Tedder, SEC v. Steffes and SEC v. Carroll, a series of cases that may redefine the mosaic theory since the charges were brought against corporate employees who learned what might typically be viewed as small bits of information while on the job and later traded; and

• SEC v. Knight, which concerned in part corporate insider trading policies since the employee defendant traded prior to a black out period and with the knowledge of the company.

The common thread through all of these cases is that an individual obtained information others in the market place did not have and then traded. While insider trading policy has always sought to create a fair playing field, its goal in not a level one. Parity of information is not required. Yet these cases move in that direction. If the Gupta verdict emboldens an already aggressive SEC, the drive toward a parity of information may accelerate. That would represent a significant policy shift which could ultimately undercut the efficiency of the markets by deterring the constant quest by traders for bits of information, a process which is essential to the price discovery mechanism of the markets.