The arrest in New York of Raj Rajaratnam, the billionaire founder of the Galleon Group, for securities fraud and insider trading has opened a rare window into the secretive universe of hedge funds, which relatively escaped public censure during the global financial crisis compared to investment banks and insurance companies.
But for some critics, what they saw as the opaqueness of hedge funds? winning strategies like short selling and derivatives was a red rag to the bull and these funds drew sharp criticism as shielding super-elite wealthy investors who piled on excessive debt and forged a financial bubble. Continental European politicians were especially raring to rein in hedge funds, but the latter had backers within the US government.
The G-20 summit in London in April 2009 reflected a compromise position among the major world powers, whereby only ?systemically important hedge funds? were to be brought under state oversight. Moreover, the attention was diverted to ?advisors? of hedge funds who cross a certain threshold of assets rather than the firms themselves, a distinction that was labelled a victory for the American delegation in London.
The latest G-20 summit in Pittsburgh reiterated lip service to disclosure and accountability of hedge funds with the proviso that funds only ?above a certain size? should be obliged to report to supervisors.
The buzz among hedge fund managers was that non-intrusive requirements to register themselves and disclose details if they exceeded an undefined asset threshold were quite acceptable since such actions were routine anyway. Coveted practices and trade secrets through which hedge funds made their billions were not, after all, being prised open.
Some managers were confident that they could restrict fund sizes below transparency thresholds and continue with business as usual by diversifying into multiple numbers of entities that circumvent the rulebooks. The general feeling on Wall Street and in the City of London was that as the worst of the economic slump was being declared over, even the bare minimum handcuffs on hedge funds instituted by the G-20 would come unlocked.
But the charging of Rajaratnam along with executives from IBM, McKinsey, Intel and Moody?s as cogs of the largest hedge fund insider trading ring ever will shock the greedy and the complacent. The language and tactics used by public prosecutors and law enforcers in pinning down Rajaratnam and his co-conspirators was aggressive and single-minded. A New York attorney called it a ?wake-up call for Wall Street? and equated the investigative methods for busting Galleon to those employed in tracking down the mafia and drug cartels.
In 1992, Pulitzer prize-winning author James Stewart wrote a bestseller, Den of Thieves, recounting the insider trading scandals of the Ronald Reagan era. It chronicled the colourful and conspiratorial world of fraudulent stock traders such as Michael Milken and Ivan Boesky, forefathers of the Rajaratnams of today.
A key lesson of Stewart?s expos? was that arrogance and a politically-induced sense of invulnerability during the 1980s had encouraged Wall Street?s elites to prey upon illegally-secured information about mergers, takeovers, quarterly earnings etc and then execute strategic purchases or sales of shares for a killing in stock markets.
Insider trading, which hogged the limelight as a systemic problem during the Great Depression and was one of the deformities that triggered regulation of financial markets in 1934, is a violation of the idea that stock markets should function on the basis of publicly available information to all the players.
It offers undue advantages to greasers of palms like Rajaratnam, who could induce his collaborators within corporations to tip him beforehand about acquisitions and other company secrets. The very concept of the marketplace as a level playing field is put into serious doubt if insider trading becomes rampant.
Rajaratnam was a creation of an era in American history when prosecution of white-collar criminals had fallen by a whopping 27% between the years 2000 and 2007. With scant fear of being nabbed, hedge fund managers like Rajaratnam could go on the offensive and secure all kinds of private data and place the best bets on selected shares in the nick of time. There was freedom to cheat and amass wealth in this nominally ?free market? system.
The Obama administration has shown spine and spunk by unmasking Galleon and warning that more proactive policing is on the anvil. Whether the net will be cast wider to the entire hedge fund industry in the US remains to be seen, but the arrests of Rajaratnam and his inner circle of powerful contacts is a bold step in calling for rule of law in the jungle in which stock markets exist.
The sheen around hedge fund managers as magicians with a sixth sense about share prices and their movements is also in for a beating following Galleon?s round-up. The comment by the enforcement chief of the US
Securities and Exchange Commission that Rajaratnam was ?not the astute student of company fundamentals or marketplace trends that he is widely thought to be but rather a master of the Rolodex? is egg on the face for a section of the financial sector that paraded its intelligence and financial acumen.
Insider trading is now as old as the hills. Technologically superior forms of inveigling private information such as ?high frequency trading? are today said to be generating larger volumes of ill-begotten profits than classic ?den of thieves? could obtain through personally intimate circles. Will the Obama prosecution bandwagon take on the more sophisticated computerised methods that render ?free markets? unfree? The answer will have a bearing on the larger question of how capitalism is viewed popularly, especially after the great crash of 2008.
?The author is associate professor of world politics at the OP Jindal Global University