According to government prosecutors, Raj Rajaratnam, co-founder of the hedge fund Galleon Group, made millions of dollars in illegal profits by trading on tips about companies like Intel Corp., Goldman Sachs and Clearwire Corp. But the Supreme Court has long made it clear that getting tips from sources inside companies and trading on those tips is not necessarily illegal.
Some of the government's accusations in U.S. v. Rajaratnam appear well-grounded in the law. For example, on Feb. 8, 2010, former Intel executive Rajiv Goel pleaded guilty to leaking information to Mr. Rajaratnam about Clearwire that he learned at Intel. The government alleges that Mr. Rajaratnam made about $579,000 trading on this information, and that he "paid" for the tips by placing profitable trades for Mr. Goel's benefit in a private brokerage account. Paying for confidential corporate information is and should be illegal because it is improper to bribe an executive to betray his duty of confidence to his employer.
However, some of the government's other allegations accuse Mr. Rajaratnam of simply talking to people and then trading. But if the information did not come from an insider, or if it was being relayed for a legitimate corporate purpose such as to set the record straight about the company, then it is not illegal.
The prosecution of Mr. Rajaratnam is not an isolated fight but rather part of an ongoing doctrinal war pitting the rather extreme views of the Securities and Exchange Commission against the carefully considered law of insider trading articulated by the Supreme Court. The SEC does not draw a distinction between trading on the basis of legitimate albeit unorthodox research and illegal trading on the basis of improperly acquired proprietary information. But it should.