On Thursday 13 October, Raj Rajaratnam, the founder of the Galleon hedge fund, received a record sentence in the US of 11 years in prison for insider dealing. US prosecutors had sought a sentence of 25 years. Rajaratnam was also fined $10m and ordered to pay restitution of $50m.
This conviction followed no less than 14 other high profile insider dealing convictions connected to Galleon, carrying an average prison sentence of just under three years. The convictions were secured with heavy reliance upon evidence obtained by wire taps – the use of which in the US was both unprecedented and controversial. It begs the question; can we expect this type of case, with correspondingly heavy prison sentences, in the UK?
The US courts have held misuse of inside information by company directors to be fraud at common law since the early 1900s. The current day US insider dealing offences have their genesis in the Securities Act 1933 and the Securities Exchange Act 1934. In the last decade the US authorities have further stepped up enforcement efforts and sentencing levels for insider dealing cases which have culminated in the series of Galleon convictions.
US sentencing guidelines are based on the amount of gain made by the defendant. Rajaratnam’s defence counsel had contended that his personal gain from trading on inside information was limited to $7m. The prosecution position, which was largely accepted by the court, was that the gain was at least $50m and may have been as much as $70m. The US sentencing guidelines imply a sentence of a minimum of six years on the defence case and a minimum of 19 years on the prosecution case. In the event, US District Court Judge R Holwell sentenced Rajaratnam to 11 years because he had been diagnosed with advanced diabetes with the prospect of requiring a kidney transplant.
The co-chair of the American Bar Association has openly questioned the efficacy of sentencing guidelines where first-time offenders for financial fraud face significantly more severe sanctions than individuals who commit violent crimes. There is however, no evidence that the trend in favour of ever more aggressive enforcement action against insider dealing is about to abate.
The judgment in Rajaratnam echoes popular sentiment. Judge Holwell described Rajaratnam’s actions as, “an assault on the free markets that are fundamental to our nation” and that his crimes “reflect the virus in our business culture that needs to be eradicated.”
The adoption of measures against insider dealing in the UK has trailed behind that of the US. Insider dealing only became a criminal offence in the UK in 1980 (Part V Companies Act 1980 – consolidated in the Companies Securities (Insider Dealing) Act 1985). The insider dealing offence is now found in the Criminal Justice Act 1993. The civil offence of insider dealing is found in the market abuse provisions of Part VIII of the Financial Services and Markets Act 2000.
The Financial Services Authority (“FSA”) Head of Enforcement, Margaret Cole, noted in October 2007 that, “What we do not yet have, however, is the experience of bringing cases that the SEC has built up since its foundation in 1934. We are seeking to speed up our progress by learning from our older cousins but, in comparative terms, we are a relatively “young” regulator and it will be some time before there is an established body of case law for us to draw on.”
At that time the FSA had not prosecuted any insider dealing cases but, it has now secured convictions against ten individuals (most recently C Littlewood, 3 years 4 months, A Littlewood, 1 yr –suspended for 2 years – H Omar Sa’aid, 2 years) and has a dozen pending prosecutions. The sentences may not compare with those at the higher end of the scale imposed in the Galleon cases, but then the gains made by those convicted in the UK to date have been considerably less.
The FSA enforcement policy is nonetheless informed by the policy of effective deterrence. Margaret Cole described this in 2007 as, “ensuring both that people fear being caught – which our ever improving surveillance and intelligence techniques focus on – and that they fear the consequences of being caught – we have signalled our intention to impose larger financial penalties through our administrative process but we also see the risk of criminal convictions and custodial sentences playing a real part in that.”.
In the last four years enforcement policy against insider dealing has hardened significantly with a clear emphasis on seeking custodial sentences. That does not mean however that the position in the UK will shortly approximate that in the US. While the FSA may now have plea bargaining powers, a useful tool in pursuing insider dealing convictions, it does not have wire tap powers. Moreover, the UK approach to sentencing for white collar crimes and financial frauds is different than that in the US.
The UK Sentencing Guidelines for fraud set by the Sentencing Guidelines Council suggest a sentencing range of between two and seven years for financial frauds where gains exceed £500,000. Margaret Cole has explicitly characterised insider dealing as “a financial crime – [which] may not attract the immediate moral outrage of a violent crime against a person but it is, in our view, and that of the UK Government, a serious white collar crime with potential sentences of up to seven years imprisonment”. It is of course a matter of speculation, but had Rajaratnam been convicted in the UK, his custodial sentence might well have been somewhat less than seven years having regard to his mitigating health condition.
The debate was lost some time ago about whether insider dealing should be a crime at all. Insider dealing is often referred to as “a victimless crime” and has been said to produce social benefits with the promotion of market efficiency by leading free market economists such as Milton Friedman. However, the debate as to what represents a proportionate and just response to the crime of insider dealing remains very much alive.
The trend in the US appears to be towards ever more severe custodial sentences for financial fraud in general and insider dealing in particular. Certainly the FSA has recently strengthened its enforcement approach against insider dealing and custodial sentences have been secured. On the other hand, neither established UK sentencing guidelines for financial fraud, nor stated FSA enforcement policy, contemplate custodial sentences as severe as those imposed in the US Galleon cases.
Robert Falkner is a financial services litigation partner at Reed Smith.