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05/18/2011

Commentary: The King’s Ransom


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This week, Galleon hedge fund manager Raj (“King”) Rajaratnam was found guilty on all 14 counts of insider trading. The wiretap evidence incriminating “the King,” including (incredibly) tips from inside the Goldman Sachs boardroom by the former head of McKinsey, was overwhelming and created the specter of a gangster trial. The defense’s strategy suggesting it was all “public information” was insulting to common sense, even more so to market professionals, and was clearly unpersuasive to the jury.

But I am interested to explore questions beyond guilt or innocence, questions far more pertinent to the institutional framework of capitalism itself, at this critical historical juncture when Wall Street and the entire practice of finance is effectively on trial. In particular, how should the Simon School of Business Administration at the University of Rochester respond to finance professor Gregg Jarrell’s role as expert witness for the defense in this historic insider trading case, in which Jarrell reportedly earned $1 million for his troubles? And why has there been no media attention drawn to this question?

I understand “innocent until proven guilty” and the ideal that our legal system provides all accused a fair trial. But the good intentions to protect individuals against an all-powerful (and abusive at times) State have been corrupted by the legal armies and clever consultants available to powerful corporations and billionaires. “Fair trial” in a democracy should not equate to the “best defense money can buy.” The burden such battles place on the State and the taxpayers is clearly not in the public interest, but a solution to this problem eludes me.

However, the decision to be complicit in this system is one that individuals, firms, and institutions are free to make for themselves. I have always been troubled by lawyers who represent criminals they know are guilty when there is enough money involved. But in fairness to lawyers, even guilty defendants need expert counsel to negotiate fair settlements when facing aggressive prosecuting attorneys in a legal system rife with stories of abuse.

The one I struggle with is the Simon Business School’s finance professor Gregg Jarrell’s willingness to support the defense’s case by conducting event studies1 that seek to validate the defense’s position that the inside information Rajaratnam traded on was not “inside” after all, but already in the public domain. In my opinion, the analytical complexity of these event studies was a disingenuous smokescreen for the basic questions of the case, raising serious ethical questions for the Simon School of Business worse than those raised for the economics profession in the Academy Award–winning documentary Inside Job.

Professor Jarrell’s $1 million engagement—which cynically supports Rajaratnam’s defense in the most far-reaching insider trading case in recent history, one that has already seen 20 significant guilty pleas, with Wall Street rightfully discredited—is wrong. By association, Jarrell’s engagement has demeaned the University of Rochester’s reputation.

I did a little homework on Professor Jarrell and discovered he is no slouch, having set the record at the University of Chicago for shortest time to earn a PhD. He was also chief economist at the SEC during the Reagan years in what appears to be an ideological appointment early in the deregulation movement.

Although he may have rushed through the halls of the University of Chicago, he did pay attention, once saying, “Most regulations hurt more people than they help.” There is a school of thought that says there is no such thing as “inside information,” and argues that government should take a laissez-faire approach to market surveillance. Perhaps this helps explain why Professor Jarrell describes himself as “frequently serving as an expert witness on … criminal inside trading cases,” no doubt using his event studies as a tool to obfuscate black-and-white criminal behavior such as that recorded by multiple wiretaps in the Galleon case.

The University of Rochester’s Simon Business School website boasts its “History of Remarkable Achievement” since its founding in 1958, declaring in part:

As a result of pioneering work by Meckling and Michael C. Jensen, one of the talented young faculty members he recruited, and groundbreaking work by other faculty members, the School became known for making enormous contributions in the critical areas of finance, accounting and organizational theory. The faculty’s contributions, in turn, helped shape the research agenda of a generation of business scholars around the globe, influencing teaching in graduate business programs and forever changing how many companies and executives in this country and abroad conduct business.

It would appear that Professor Jarrell’s event studies are intended to be part of the “faculty contributions forever changing how executives in this country and abroad conduct business.”

I wonder if this is the brand of free market capitalism William E. Simon, former Secretary of the Treasury, had in mind when he put his name on the University of Rochester’s business school back in 1986. No doubt Mr. Simon, Milton Friedman, and Ronald Reagan all understood that markets are not free when they are not fair.

Maybe speed is not a virtue when it comes to a Finance PhD.

–John Fullerton is the founder and president of the Capital Institute. He is also the principal of Level 3 Capital Advisors, LLC, an investment firm focused on high impact sustainable private investments. 


Addendum: I received the following response from Rajiv Dewan, Dean for Faculty and Research at the Simon Graduate School of Business, when I forwarded this blog piece to University of Rochester President Joel Seligman and Mark Zupan, dean of the graduate business school:

Dear Mr. Fullerton,

I am responding to the email you sent to President Seligman and Dean Zupan regarding the Rajaratnam trial.

The Simon Graduate School of Business at the University of Rochester has played a key role in furthering the science of management through development and testing of theories of management, including use of advanced econometric techniques to analyze issues in management of firms and in markets. Our world renowned faculty are often sought out as expert witnesses. We respect the right of our faculty privately to engage in their community and offer their expertise for examination of critical issues in our community.

Sincerely,

Rajiv Dewan


1. Event studies are statistical studies intended to show how stock prices respond to specific events, in contrast with normal market conditions.


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