Insider Trading for the Rest of Us

Raj Rajaratnam, the putative head of the alleged insider trading ring at the Galleon Fund, may not have a firm grip on his moral compass. But he clearly knows one thing about stock picking -- namely, that the only way to win consistently is to have information the market doesn't.

Rajaratnam's problem, of course, is how he got his information. In addition to the analysts and money managers at his hedge fund, Rajaratnam maintained a network of informants inside companies and on Wall Street trading desks who were paid to deliver hot tips. The SEC and the U.S. district attorney say that some of those tips included material, non-public information that the informants had a duty to keep confidential. If so, and if Rajaratnam knew that when he traded, he's in trouble.

But note: There's nothing wrong with keeping a network of paid informants in itself. Lots of hedge funds do.

If you trade stocks, that ought to give you pause. You already knew that when you buy a stock you're up against professionals backed by platoons of analysts on Bloomberg terminals. Now you learn that some of your competition also maintains paid networks of insiders turning over market-moving tips, legal or otherwise. And the rest of us have...Jim Cramer?

Want to profit from the Galleon insider trading case? Then take the hint: It's a waste of time trying to beat the pros at the stock picking game. They outgun you, and they don't always play fair. Far better to join them, by investing in low-cost index funds or ETFs, like Vanguard Total Stock Market Index (VTSMX) , as my colleagues Larry Swedroe, Allan Roth and Nathan Hale repeatedly urge you to do. (As do the likes of Peter Lynch and Warren Buffett.) That way, you're buying the whole market at the market price, which incorporates the collective judgment of all the Rajaratnams, Warren Buffetts and Peter Lynchs who have their money in the market. History suggests you'll beat most pros after fees in the long run. Call it insider trading for the rest of us. Without the perp walk.

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Comments

[lvg]

A number of recent articles and op eds have tried to characterize these "paid networks of insiders turning over market-moving tips, legal or otherwise" as nothing more than a friendly social network -- like the kind you or I maintain on Facebook. And the Rajaratnam case does raise interesting questions about the role social information networks play in moving markets. For more, http://bit.ly/2n1pq1