Insider Trading and The Individual Investor

The trial of Raj Rajaratnam on multiple counts of insider trading started this month and has rekindled debates as to how much insider trading permeates hedge funds and Wall Street in general. This case is not the first instance nor will it be the last instance of insider trading but it highlights the issues that ordinary investors continue to have in trying to compete with large hedge funds who in their pursuit of profit often straddle the thin line between the legal and illegal. To give you a better understanding of this case, here is some background information on the Galleon Group scandal. Raj Rajaratnam founded the Galleon Group, which at its peak had close to seven billion in assets under management, in 1992. The Galleon Group was founded with a focus on the tech sector under Needham and Company and went independent in 1997 under Raj's direction and since its original inception it has been among the most successful hedge funds on the market. Since its 1992 inception till the indictment, Galleon Group has realized returns of 2879.43%, seemingly pumping out 20-25% annual returns without a problem, including an amazing 93% return in 1999. Despite such outrageous returns, the Galleon Group did not draw much outside scrutiny. While the hedge fund and Mr. Rajaratnam had multiple issues with the SEC, it did not draw intense scrutiny, as this was considered standard within the hedge fund industry. Trotting the line between legal and illegal was almost a requirement if a hedge fund wanted to prove it is serious about maximizing annual returns. The legal case alleges that a portion of these returns were the result of Raj Rajaratnam trading on insider information provided to him by his various contacts within the tech industry. To date in this case, the government has charged 26 people and 19 people have plead guilty to the charges. While the case has just started and Raj Rajaratnam has not been convicted of anything to date, that insider trading exists has been proven in the past and by those who have already plead guilty in this case. While this is just an individual instance of trading it does speak to trends that exist in the industry at large. In a hypercompetitive industry where investors have a ‘what have you done for me lately' attitude with investment vehicles, it has become increasingly important for hedge funds to realize high short-term gains. As short-term results are highly volatile, hedge funds have began to put a premium on acquiring information that will give them an edge so that they can achieve reliable high short term results. Gordon Gecko, in the movie “Wall Street” put it best when he said, “the most valuable commodity I know of is information.” As Robert Khuzami, director of enforcement at the Securities and Exchange Commission (SEC) said “Raj Rajaratnam is not a master of the universe, but rather a master of the Rolodex.” This is where the legal line is often crossed, since this information that these hedge funds acquire is often not available to individual investors putting individuals at a significant disadvantage in the market. The basic idea sold to self investors is that if you do your homework on the market and invest wisely you have as good a chance to beat the market as the professionals; but how can someone justify this thinking knowing that the big dogs have all the publicly available information plus information that an ordinary investor cannot hope to attain. It creates a situation where the average investor is playing on a tilted field and outside of luck it is seemingly impossible to outperform Wall Street. I have been investing by myself for a number of years; I never doubted that I had a chance to or would beat the market. While I knew that insider information existed within the industry, till this case I never realized the extent of insider trading and as a result I really started thinking whether I have any chance of beating the professionals by self-investing. It seems like a hopeless enterprise to try and outperform people who have access to more and better information than me. Since this case I have been wondering as to whether my portfolio's outperformance of the market and most hedge funds is due to dumb luck. From this assumption I have started contemplating whether its time to close out my account and move my portfolio over to the newest hot portfolio manager. This case is a prime example that should cause investors to analyze their portfolio performance and goals and reevaluate whether to continue to invest by themselves or give up control of their investments to professionals.