Rajaratnam, Rule 10b-5 and the Common Law

Raj Rajaratnam was originally scheduled to be sentenced this week.  The government was asking for an extraordinary sentence of between 19 and 24 years.  We have posted the sentencing memos submitted by both the government and Rajaratnam.  Resolution will have to wait until mid-October.  The trial judge postponed the sentencing until Oct. 13.

There has been commentary already about the fact that sentences in white collar cases cases have grown in length.  Peter Lattman's article at the Deal Book does a nice job on this.  As he notes:

• Today, prison terms measured in decades are common for white-collar criminals. In 2005, Bernard J. Ebbers, the former chief executive of WorldCom, was sentenced to 25 years in prison for a huge accounting fraud. Earlier this year, Lee B. Farkas, a former mortgage company executive, received a 30-year term for his role in a fraud that the government says caused $2.9 billion in losses. On Monday, a federal judge in Miami sentenced Marianella Valera, a former mental health company executive, to 35 years in prison for her role in a $205 million fraud at American Therapeutic; a 50-year sentence was earlier imposed on her co-defendant, Lawrence Duran.

From a broader perspective, Rajaratnam's sentencing illustrates something most American lawyers rarely think about. 

The US uses the common law rather than the civil law system of justice.  The common law system is built around judge made law, whether law created ab initio or judicial interpretation of statutes.  While all systems use judges and all judges must interpret, they have far less breadth in civil law countries.  Thus, in many civil law countries, judges do not come from private practice but are selected based upon tests taken after law school.  It reflects the role of judges where technical knowledge is more important than private experience. 

Insider trading is an example of the common law approach that ought to startle even common law lawyers.  While its true that insider trading is loosely based on a rule (rule 10b-5) which is in turn loosely based on a statute (Section 10(b)), the reality is that almost every important element of the requirement has been devised by a court.  This includes a private right of action which the administrative father of the rule indicated he never contemplated.  With respect to insider trading, courts have added a complicated gloss that looks at such things as duty, benefit, and temporary insider status.  Try to find any of that language in the statute or the rule.

But beyond the judicial nature of the requirement are the consequences.  Courts make up the law but defendants, such as Rajaratnam, can go to jail for this judge made law.  Moreover, as the government is proposing, they can go to jail for decades.  There is an element of flexibility in the common law system but also unpredictability.  As Raj Rajaratnam will see, it is a system with judge made law and judge made sentences.