Tuesday, December 29, 2009

Issues raised by the indictment of Raj Rajaratnam



















Today the Wall Street Journal ran an article entitled "The Man Who Wired Silicon Valley" full of colorful details from the career of former tech analyst and hedge fund manager Raj Rajaratnam, who has been accused and indicted by the SEC for profiting in the markets from insider information.

The Journal article's accompanying interactive graphic calls Rajaratnam's alleged web of Silicon Valley contacts "a far-reaching and complex scheme," but the story itself for the most part does not detail any actual criminal activity -- mainly it gives glimpses of Rajaratnam's history of aggressively asking for information at companies, along with descriptions of parties where "wealthy investors and executives swirled" around luxurious pools, "smoked cigars and hobnobbed with beautiful women" -- as if these scenes somehow indicate that all the wealth came from illegal or underhanded activity.

The one activity actually detailed in the report that may have been unethical, or even illegal, involved an employee of Intel* faxing prices and orders to Rajaratnam.

Let's be clear: at Taylor Frigon we do not condone trading on "material, non-public information" (which is illegal), nor do we condone the use of deceit or trickery in gaining information. We also do not personally practice an investment strategy based on short-term events such as the quarterly earnings performance that have become such a circus on Wall Street. We have explained many times that our strategy is built around the long-term ownership of good businesses, through many market cycles and short-term events.

However, we also believe that there is a tendency among many -- including some at the federal government -- to think that trying to find out everything you can about a business in which you are going to invest large amounts of capital should somehow be illegal. It may turn out that Mr. Rajaratnam did indeed cross a line between digging for information and doing something that the SEC defines as illegal, but the existence of such a line and where it is drawn are important philosophical questions.

There is a strain of thought which seems to believe that all investors should somehow be "equal" and that those who do no research should have just as much opportunity to make money as those who burn the midnight oil digging into the business details of a company and analyzing its future prospects. This misguided view seems to want to turn investing into nothing more than a roulette wheel, where everyone has an equal chance at winning and nobody has any more intelligence than anyone else.

We believe that this type of thinking is dangerous in that it undermines the important function of allocating capital to the best businesses. Investors should understand this misguided sentiment and be alert for it, and discuss these issues with their friends and families.
* The principals of Taylor Frigon Capital Management do not own securities issued by Intel (INTC).

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