What is it that justifies the record-breaking US$92.8 million fine slapped on Raj Rajaratnam by the U.S. Securities and Exchange Commission?
I don’t particularly doubt the fairness of the fine. But it’s still useful to ask what reasons lie behind specific instances of punishment, particularly when those punishments are as notable as this one.
It’s worth noting that Rajaratnam is also going to jail, as a result of a separate criminal proceeding related to the same wrongdoing. But let’s focus just on the monetary judgement issued as a result of the SEC’s civil case. There are at least four possible justifications for punishment by means of a fine.
1) Deterrence. Sometimes we punish in order to make the offender less likely to re-offend, or to set an example for others who might otherwise have been tempted to commit similar crimes.
2) Restoration. Sometimes a financial penalty can be used to “make whole” the parties harmed by the wrongdoer. This, of course, would require that (some of) the fine actually be given to those who lost out due to Rajaratnam’s hijinks. As far as I know, that’s not going to happen. But then, there’s a sense in which society as a whole loses out when someone violates market norms as aggressively as Rajaratnam did. So maybe American society is the ‘victim,’ here, and is being compensated through its representative, the SEC.
3) Retribution. The fine may just amount to imposing pain on a roughly eye-for-an-eye basis. From this kind of point of view, the goal isn’t to achieve any particular outcomes (like, say, deterring wrongdoing) but rather just to ‘get even’ with the wrongdoer. Retribution is rooted in some pretty primitive (and, frankly, ugly) emotions, but it certainly has its appeal and plenty of defenders.
4) Denunciation. Closely related to retribution, denunciation is essentially the act of saying “No!” in response to crime. From this point of view, a big fine is a way of saying, loud and clear, that the kind of behaviour in which Rajaratnam engaged is simply not OK in our society.
What does the SEC say?:
“The penalty imposed today reflects the historic proportions of Raj Rajaratnam’s illegal conduct and its impact on the integrity of our markets,” said Robert Khuzami, Director of the SEC’s Division of Enforcement.
OK, that helps. But let’s get it from the horse’s mouth. In the words of Judge Jed S. Rakoff:
“S.E.C. civil penalties, most especially in a case involving such lucrative misconduct as insider trading, are designed, most importantly, to make such unlawful trading a money-losing proposition not just for this defendant, but for all who would consider it.” He added that it was a warning that, if caught, “you are going to pay severely in monetary terms.”
So there you have it. The rationale behind the historic fine is deterrence. The fine was a warning to others. Of course, the fact that deterrence was the goal doesn’t mean that the fine is actually going to deter anything, or that the outsized fine is going to be more effective in that regard than a more modest fine would have been. Does anyone seriously think that a $92.8 million fine is going to work where a $50 million fine would not have?
But anyway, the problem here is liable to be the same as that faced in trying to deter street crime, which is that no one expects to get caught. That’s likely to be doubly true of a man like Rajaratnam. After all, he was a Wall Street titan, a self-made billionaire. He was—to steal a phrase from Enron’s Jeff Skilling—the ‘smartest guy in the room.’ How could a man like that even imagine being caught by the mere mortals at the SEC and FBI? The result is that deterrence may well be futile.
So what we really need is for our markets and regulatory agencies to be designed with the full expectation that, every once in a while there’s going to be a Raj Rajaratnam. We need institutions to put safeguards in place, precisely to deal with the inevitable lapses both of conscience and in our belief in our own fallibility.