Oops, they missed it again: SEC had chance to nab Rajaratnam in 1998

sec-had-chance-to-nab-rajaratnam-in-1998The Wall Street Journal has done a public service by getting its hands on court records in the case of Galleon Holdings founder Raj Rajaratnam, who is currently walking around on $100 million bail. He's no Bernie Madoff, who stole $60 billion from his investors in a Ponzi scheme. Rajaratnam allegedly paid for inside information and traded on it -- a far more subtle form of stealing.

But in the cases of both Madoff and Rajaratnam, the Securities and Exchange Commission knew about their alleged nefarious acts for at least a decade before charging them. Bruce Watson posted on Madoff's long history of evading the SEC's weak efforts to stop him. And the Journal's reporting on how Intel (INTC) caught its employee, Roomy Khan, calling and faxing sales reports into Rajaratnam is revealing.

Going back to 1996, Intel claims it suspected that an Intel insider was leaking sales data to Rajaratnam. One reason is that in 1997, an anonymous source said that Khan told another Intel employee that she had access to important data on chip sales, and "that if you sell this information, you can get real money for it."

So Intel began analyzing who was calling Rajaratnam and discovered that Khan enjoyed calling and faxing him. Then Intel installed a camera to film her at the fax machine -- catching her on March 6,1998, faxing first quarter 1998 chip pricing and volume statistics to Rajaratnam.

Those statistics take much of the guess work out of forecasting quarterly sales because all you have to do is multiply the price and quantity figures to get a precise calculation of the sales numbers. Trading on that information becomes quite simple -- if analysts expect sales to top your number, you short the stock, and if they expect sales below your number, you buy.

For some reason, that film was not enough evidence to arrest Rajaratnam. The Journal reported that in 2002, government prosecutors wrote: "After an exhaustive analysis of the labyrinth of accounts associated with Galleon, however, the SEC/FBI has not been able to show that any Galleon trade resulted from Rajaratnam's possession of the information stolen for him by Kahn [sic] from Intel."

The good news is that in exchange for a light sentence -- Khan spent six months in home detention -- she agreed to record conversations with Rajaratnam which appear to have contributed sufficient evidence to indict him.

This situation raises many questions: Why was it so difficult for the SEC to bring Rajaratnam to justice after obtaining that videotape? How much did Rajaratnam's alleged insider trading cost investors? Who else beside Rajaratnam has been trading on insider information? What kind of punishment for Rajaratnam and what sort of regulatory enforcement structure would it take to end insider trading for good?

I hope SEC Chairwoman Mary Schapiro has some good answers.

Peter Cohan is a management consultant, Babson professor and author of nine books, includingCapital Rising (due in June 2010). Follow him on Twitter. He has no financial interest in the securities mentioned.

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