The end of a prominent winning streak inspires trivia questions. Which team stopped the U.C.L.A. men’s basketball team at 88 wins in a row? Notre Dame. Which baseball team put an end to Joe DiMaggio’s 56-game hitting streak? The Cleveland Indians.
With his acquittal on Tuesday, Rengan Rajaratnam is now the answer to this trivia question: Who was the first defendant – of the 86 charged with insider trading so far – to avoid conviction since the Justice Department began its crackdown with the arrest of Rengan’s older brother, Raj Rajaratnam, in October 2009?
The end of the string of successful prosecutions resulted largely from a lack of evidence that the younger Mr. Rajaratnam knew of a benefit provided to the source of the inside information. The prosecution shrank to a single conspiracy count after Judge Naomi Reice Buchwald of Federal District Court in Manhattan threw out charges for trading in the wireless network company Clearwire because there was nothing to show Mr. Rajaratnam was aware of what the tipper received from his older brother.
Criminal prosecutions are far more important than sporting events, and beyond the effects on the individual defendants the cases can affect how the government can pursue other investigations. The prosecution of Mr. Rajaratnam shows how a change in the interpretation of a law can make it much more difficult to prove a violation.
The United States Court of Appeals for the Second Circuit in Manhattan signaled during an oral argument in April that proving the tippee’s knowledge of the benefit given to a tipper might be an important means to limit the reach of insider trading.
Judge Buchwald applied that understanding of the legal requirements for a conviction to keep the government from relying on its principal evidence, the Clearwire trading, to prove Mr. Rajaratnam’s guilt. Without it, the likelihood of a conviction was substantially reduced, and future cases against “remote tippees” — those who do not deal directly with the source of the inside information – will be more difficult to pursue.
An interesting question is what happens next to Mr. Rajaratnam. The verdict means there will be no further criminal proceedings, but the Securities and Exchange Commission filed civil insider trading charges against him last year. That case has been suspended until the resolution of the criminal prosecution.
The civil lawsuit cites trading in five different stocks by Mr. Rajaratnam based on information provided by his older brother: Polycom, Hilton Hotels, Akamai Technologies, Advanced Micro Devices and Clearwire. The complaint is rather terse, however, simply stating that Mr. Rajaratnam received the information and traded on it without identifying any benefit passed on to the sources.
If the court adopts the same approach to proving insider trading in the civil suit as was applied in the criminal case, then the S.E.C. will have to show Mr. Rajaratnam was aware of the benefits received by the tippers. Those tippers include names made famous in his older brother’s case, among them Roomy Khan, Danielle Chiesi and Deep Shah.
Even with the lower burden of proof in a civil case, the S.E.C. will still need evidence to establish Mr. Rajaratnam’s knowledge about how his brother gathered the information and what he provided in exchange to his sources.
One advantage the S.E.C. has over the Justice Department is the authority under civil discovery rules to require Mr. Rajaratnam to testify in the case. If he refuses by invoking the Fifth Amendment privilege against self-incrimination, that can be considered evidence against him, allowing the jury to draw what is called an “adverse inference.” The idea is that if a party to a lawsuit refuses to furnish information, then it can mean the information was harmful to that party’s case.
An even more intriguing source of information might be Mr. Rajaratnam’s older brother, who is serving an 11-year prison sentence for his insider trading convictions. Although there is a good chance he would refuse to testify by asserting the privilege against self-incrimination, the law may allow a similar adverse inference against younger Mr. Rajaratnam based on his brother’s refusal to provide evidence.
Normally, the conduct of someone who is not involved in litigation cannot be used against one of the parties. In LiButti v. United States, however, the Second Circuit found that a father’s invocation of the Fifth Amendment – in a tax case against his daughter that involved the ownership of a race horse – could be considered by the court in deciding who was the actual owner.
The appeals court said that there were four factors to be considered in deciding whether a nonparty’s assertion of the Fifth Amendment could be considered as evidence: the nature of the relationship, the degree of control one person had over the other, whether the witness refusing to provide information had an interest in the outcome of the case and whether the witness “was a key figure in the litigation.”
The older brother is certainly a crucial figure in Mr. Rajaratnam’s case because he was the conduit of the information from the tippers. The wiretaps used in the criminal prosecution show the two men discussing the prospects of the companies they traded, and to the extent the government must show Mr. Rajaratnam’s awareness of the benefits his older brother provided to the tippers, there is no better source than these two men.
In the criminal trial, the defense argued that Mr. Rajaratnam did not have a healthy relationship with his older brother, claiming he was badly treated. In the LiButti opinion, the appeals court said the nature of the relationship was the most significant factor, and “the closer the bond, whether by reason of blood, friendship or business, the less likely the nonparty witness would be to render testimony in order to damage the relationship.” The relationship between the Rajaratnam brothers seesawed over the years, DealBook reported, with the older brother protective but sometimes irritated with his sibling’s foibles.
If the S.E.C. decides to pursue its complaint aggressively, then there is a good chance that Mr. Rajaratnam and his older brother will be the focal point of the effort to gather evidence of the benefits provided to the tippers, information that was not available to the Justice Department in the criminal prosecution. That approach may well push Rengan Rajaratnam to settle the charges to avoid the risk of being found liable based on his brother’s decision whether to testify in the case.