Stephen Foley: The FSA must be given more weapons to root out insider-dealing networks

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The Independent Online

Outlook If Raj Rajaratnam had returned to the UK after business school in Pennsylvania and set up his hedge fund, Galleon, in the City of London instead of in the US, would the British authorities have been able to put him in the dock on charges of insider trading? The answer, sadly, is certainly not.

The UK's Financial Services Authority (FSA), which will keep responsibility for insider-trading prosecutions even after it is split into three by the Coalition, will be watching Mr Rajaratnam's trial with more than a twinge of envy.

Some of the reasons the UK lags behind the US in its approach to insider trading stem from differences between the criminal justice systems of the two countries. US prosecutors are political creatures who often use success in high-profile cases as a springboard to higher office, something which puts some drive behind the process.

Preet Bharara, the US attorney who will open the case against Mr Rajaratnam when jury selection is completed, is following in the footsteps of Eliot Spitzer and Rudy Giuliani before him.

The US authorities also have the ability to use wiretapping evidence, which will be a central feature of the Galleon case, and a system of plea bargaining that makes it easier to persuade lower-level members of a criminal conspiracy to co-operate, effectively encircling the real mastermind. No one would want to import the occasionally brutish and politically charged US system to the UK, but it does mean that the FSA and its successor, the Financial Conduct Authority, must work harder and be handed extra tools if we want to flush out the most sophisticated insider traders.

The FSA's own analysis identifies unusual share-price moves before almost one in three major takeover announcements. Even if you eliminate the majority of those as being caused by press leaks or market speculation, you are still left with the depressing conclusion that only a fraction of insider dealers are being caught.

The FSA has made progress. Under Margaret Cole, the FSA's enforcement division has claimed more resources and shifted from pursuing civil penalties to criminal charges, but the authority admits it is still learning on the job.

It has won prison terms for offenders in 10 relatively straightforward cases against individuals, and is about to embark on the prosecution, this autumn, of an alleged insider-dealing ring. Even that case, though, which involves the leak of information from the printing presses of UBS and JPMorgan Cazenove, looks uncomplicated when compared with Mr Rajaratnam's.

Galleon used a large network of sources, many of them company insiders, in its aggressive pursuit of any information that would give it an edge over other traders. Many hedge funds on both sides of the Pond do so. Proving that these insiders and these traders have stepped over the line into the exchange of confidential, price-sensitive information is going to be tough in the Galleon case, let alone in the UK without wiretapped evidence of what was said.

It is also, as Ms Cole has been pointing out, costly, since telephone records, documents and trading computers must all be painstakingly examined for clues. We must be vigilant that enforcement at the new Financial Conduct Authority is not short-changed when its structure and budgets are finalised. Now would also be a good time to re-examine the definition of "material non-public information", which is the legislative standard for an illegal insider tip.

Information divulged by insiders may not be likely to lead to an immediate share-price spike, but that doesn't mean corporate executives or bankers are not breaching a fiduciary duty and engaging in a conspiracy against other investors by passing it on. The UK should nip in the bud the development of the kinds of paid "expert networks" used by Mr Rajaratnam and other US hedge funds to get access to corporate insiders.

And finally, how about a bit more deterrence? The current top prison sentence available for insider trading is seven years, compared with twice that in fraud cases. But insider dealing is a fraud on the rest of the investing public, on the people that buy from insiders who already know of a looming profit warning, or that sell to traders who already know a takeover is on the cards. There is still a lot of spring cleaning to be done in the City of London.