There is room for doubt about whether trades that Raj Rajaratnam made in the stock of Google really count as prohibited insider trading.
But the Second Circuit, which will be overseeing the case against Rajaratnam, has adopted an expansive view of insider trading that will make it difficult for the defence to prevail.
According to the SEC civil complaint, a person identified as “Tipper A” received information in 2007 that Google’s earnings would fall short of expectations. This information came from an unnamed employee of Market Street Partners, a San Francisco investor-relations firm that was presumably handling the release of Google’s quarterly results. The SEC says that Tipper A then provided the information to Rajaratnam and that Galleon executed trades designed to profit on a decline in Google stock. The trade resulted in a $9 million profit.
The courts have in the past found that people who work at outside firms, such as law firms or printing houses, that are doing business with a publicly traded company can count as “insiders” when their firm gets material, non-public information. So the unnamed employee potentially counts as a “tipper” under insider trading rules. Passing that information on to someone who trades could violate insider trading laws. It’s not a far stretch to say that passing that information on to someone who in turn passes it on to someone who trades also violates the rules, especially if everyone involved expected the information to move in this way.
One element of insider trading law, however, requires that the tipper expects something in return for the tip. Innocently letting information out, such as accidentally leaving a document in a taxi, wouldn’t result in an insider trading violation. And that’s true even if the person who finds the document subsequently trades based on its information.
Interestingly, the SEC complaint says that the informant at Market Street demanded $100,000 to $150,000 a quarter to keep supplying Tipper A with information, but Tipper A refused and the informant stopped providing tips. So the key question is whether or not the rules prohibit trading on information that was delivered with a demand for a reward even if the person getting the tip refused to supply the reward.
In some sense, the refusal to pay off the guy at Market Street seems to exonerate Tipper A and Rajaratnam. Tipper A did not act to further this fraudulent transaction by paying the bribe demanded.
Unfortunately for Rajaratnam, it may not matter if the Market Street employee was actually paid off. In earlier cases decided by the Second Circuit, it was enough that the person supplying the inside information just expected to benefit.
In a case called SEC v. Warde, the Second Circuit held that a tipper did not in fact have to receive a tangible benefit to be liable for insider trading. In Warde, the defendant, Thomas Warde, was a “good friend” of Edward Downe, a director of Kidde, Inc. While the company was negotiating its sale, Downe and Warde purchased warrants on the company’s stock. When the company was sold, the stock went up and both men profited from the warrants.
Warde was found liable for insider trading based on the theory of “tippee” liability. That is, the court said he was guilty of insider trading because he had traded based on his friend’s tips. He appealed, arguing that his “tipper,” Downe, had not received a “benefit” for delivering the tips.
The court shot down Warde’s argument the Downe had received no “benefit.” It held that the close friendship between the tipper and the tippee demonstrated that tipper’s action was “intended to benefit” himself.
In the trade involving Google, the Market Street employee clearly intended to benefit himself by delivering the information. It’s likely that the person known as Tipper who then passed the information on at Rajaratnam also expected to benefit, even if that benefit was limited to just having a closer relatiionship with Rajaratnam. This means that Rajaratnam could very well be found to be a “tipee” under insider trading rules.
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