On 22 September 2008, as world stock markets lurched from crisis to crisis and seasick investors fled the market, Goldman Sachs chief executive
Lloyd Blankfein thought he had found a way to calm the waters. In a conference call to his trusted directors, he revealed that Warren Buffett, the world's richest and most respected investor, was preparing to make a $5bn investment in the bank. The vote of confidence from "The Sage of Omaha" was a major coup. The events that followed will be the subject of the biggest insider dealing trial in decades, which starts in New York this week, and could see Blankfein taking the stand as a government witness. It is a case that the US authorities have pursued with wiretaps, dawn raids and a determination to prove to a still nervous investing public that they will stop at nothing to stamp out insider trading. But, warn experts, insider dealing is hard to prove and even harder to stop. According to US prosecutors the man at the centre of the trial, Raj Rajaratnam, billionaire founder of the Galleon hedge fund, ran a network of informants who illegally supplied him with price-sensitive information. Last week the Securities and Exchange Commission (SEC) charged Rajat Gupta, one of America's most prominent businessmen and a former Goldman director, with supplying Rajaratnam with the inside tip on Buffett.
The SEC alleges Gupta told Rajaratnam the Buffett news within minutes of Blankfein's call. Rajaratnam immediately arranged for Galleon funds to buy more than 175,000 Goldman shares. When the news was announced the next day Rajaratnam sold the holdings, making a profit of more than $900,000 (£553,000). Gupta denies any wrongdoing. The deal is just one of a series to be highlighted at Rajaratnam's trial, which is expected to run for months. The authorities allege he made profits of more than $20.6m trading on illegal tips about firms including chip maker AMD, Goldman, Google and Hilton Hotels. Since Rajaratnam's arrest more than 30 other people have been rounded up by the FBI and the probe has expanded to other hedge funds, banks, technology companies and so-called expert networking firms that are supposed to supply investors with legal inside information on firms and industries. According to the prosecution, Rajaratnam encouraged his network of informants to cross the line between illegal and legal information time and again. Preet Bharara, the attorney leading the case, says he is not alone. Bharara has called insider trading "rampant" and is pursuing other cases. So far 19 people have pleaded guilty in the Galleon case, but not Rajaratnam, who pleads innocence while facing up to 20 years in jail if found guilty. His lawyers dismiss the charges, saying the government has overstepped the mark not only in terms of the law but in the extreme methods it has used to pursue it. At least 500 people were wiretapped in the Galleon case and thousands more are probably being monitored now as the US chases other hedge funds and investors, sparking concerns from privacy groups. Out on bail on a $100m bond, Rajaratnam has assembled a team that will test the limits of the government case. His court team will be lead by the formidable John Dowd, head of Akin Gump Strauss Hauer & Feld's criminal litigation group, and a man who counts senator John McCain among his former clients. Dowd will be part of an 11-lawyer team in court and has been granted permission to set up a high-speed internet link so that transcripts of testimony can be sent immediately to another set of lawyers outside the courtroom. As battle looms they appear to face an uphill struggle. In a landmark ruling last November, Judge Richard Holwell ruled that prosecutors could use thousands of hours of secretly taped conversations between Rajaratnam and his associates. And many of Rajaratnam's former friends and colleagues have turned against him, most notably former beauty queen turned trader Danielle Chiesi, who had been due to stand trial with the hedge fund king. In January she admitted she conspired to use non-public information to make trades for her former employer, Bear Stearns' New Castle Funds. Her decision followed the wiretaps ruling and was in marked contrast to her earlier claims that: "There is not even a chance we will do one day in jail. We didn't do anything wrong."
But, say legal experts, these are early days and for all the government's bravado, getting convictions in insider dealing cases is not so easy. "The government has some seemingly damning emails but we've seen in prior cases that sometimes emails seem more deadly than they are when seen in context," says professor Larry Ribstein, associate dean for research at the University of Illinois College of Law. "This is a very borderline case that is going to depend on the specific evidence brought to trial." Neither are jurors necessarily well disposed to witnesses who have cut deals to save their own skins. "There's always a risk with trials like this that, for all the evidence, you can't prove that the person acted illegally," says James Cox, law professor at Duke University. But in this case the government seems to have built quite a weight of evidence and if the last high-profile insider dealing trial is anything to go by, the jury may buy it. Sam Waksal of drugs firm ImClone received a seven-year jail sentence in 2003 for insider dealing. The scandal reached its peak a year later when kitchen and interior decor mogul Martha Stewart was jailed for covering up her involvement in the affair. That trial too followed massive (and far larger) financial scandals, and the jury was unforgiving. "The evidence in that case was highly circumstantial and she went to jail," says Cox. But even if the government is successful, insider dealing is likely to continue. An influential study of insider trading by Arthur Keown and John Pinkerton published in 1981 in the Journal of Finance concluded that about 40-50% of the price gain experienced by the targets of takeovers occurs before the actual takeover announcement. "The results confirm statistically what most traders already know," they concluded. "Impending merger announcements are poorly held secrets and trading on this non-public information abounds." Ribstein argues that a lot of insider prosecutions are a waste of time and money. "Even assuming all the defendants are guilty as charged, this is not the conduct that seriously harmed the marketplace. It's not even close to Madoff-style conduct," he says.
But Cox says insider dealing does harm investor confidence. "It gives the impression that the markets are unfair," he says. And the government is determined to make investors feel safe again. So, just like the crackdowns after the 1980s boom and bust and the millennial crash, here comes another epochal insider dealing case. Whatever the outcome, says Charles Elson, chair of corporate governance centre at University of Delaware, there is something in human nature that makes trading on inside information irresistible for some: "How long will there be bank robberies? As long as there are banks."