A Galleon style ship, stranded in the desert at Burning Man
Raj Rajaratnam was one of the richest Sri Lankans in the world. Not that he had much to do with Sri Lanka. I remember someone talking in hushed tones about a meeting with a big time donor (in the context of some relief work). Turned out that was Raj. I think he gave some money back. That’s all I ever heard of him. Until he got arrested. The last big time Sri Lankan I heard of was Sanjay Kumar, the Computer Associates CEO who got sentenced to 12 years for fraud. There are plenty of Sri Lankan expats that make good, and a few that make really really bad.
Raj was recently found guilty of insider trading. It’s a compelling story with him buying out McKinsey Directors and getting information from beauty queen honeypots. If he’d stuck to the Sri Lankan stock market it probably wouldn’t be a big deal as everything runs on insider trading, known here as trading.
I know of a guy who spends a shitload entertaining brokers just to get them to pump and dump stocks together. Even the government is getting into it, buying stocks in companies that it regulates. But I guess you can’t do that abroad.
Except you can. Except insider trading is almost natural. What Raj did was research on one hand, and then personal contacts on another. For every merger or buyout there are 10 lawyers and 20 consultants working on paperwork or due diligence. Not to mention their bosses. So the information exists well before it ‘should’. Using informal flow of information it seems that you can make a lot of money. Which is also illegal.
I’m actually trying to figure out why Insider Trading is so bad. It seems to be the way most business is done, through word of mouth. There actually seems to be quite a debate here.
On one hand, insider trading is broadly perceived as corrupt or unfair. But so is short selling. Or the stock market in general. Then there is Gordon Gecko. However, the more empirical argument is that “illegal insider trading is believed to raise the cost of capital for securities issuers, thus decreasing overall economic growth.” To that end I skimmed a Duke study which says, “we find that the cost of equity in a country (after controlling for risk factors, a liquidity factor, and other shareholder rights) is reduced by about 5% if insider trading laws are enforced.”
OK. On the other hand, there’s the argument that says let information flow and it will set prices more accurately than trying to control it. As Milton Friedman said, “you want more insider dealing, not less. You want to give people most likely to have knowledge about deficiencies of the company an incentive to make the public aware of that.”
I also read this from Ajay Shah, an Indian finance/economics guy.
Let us imagine two island–countries with different policy regimes. On island A, insider trading is swiftly detected and severaly punished, hence it is essentially absent. On island B, insider trading is rampant. If insider trading were an unambiguous evil, then island B should clearly have inferior market efficiency. Is that the likely outcome? How would price formation on the two islands differ?
On island B, insiders would play a major role in price discovery. Individual and institutional speculators would find it very difficult to compete, and they would settle into passive strategies like owning index funds. On island A, in the absence of insider trading, market inefficiencies would flourish, which would attract significant resources into research and speculation by both individuals and institutions. Markets would become quite efficient on island A too, but the price discovery would be dominated by retail and institional speculators who stand outside listed companies and subject them to intense scrutiny.
To me, I think an island where people buy index funds is probably better, since most people shouldn’t be picking stocks at all and are just getting ripped off by firms taking advantage of their ignorance.
Honestly, I’m not sure whether insider trading is bad or not. Compared with the egregious crimes that people got away with in the US financial crisis, and get away with still, I’m not sure that insider trading is even up there. Sanjay Kumar, for example, actually committed fraud.
But anyways, uh, Raj Rajaratnam is in jail.