Hedge fund conviction: Why Wall Street should worry

Hedge fund founder Raj Rajaratnam was convicted on all 14 counts. His trial sets precedents for how other insider-trading cases will be carried out beyond the hedge fund universe.

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    Galleon hedge fund founder Raj Rajaratnam departs Manhattan Federal Court in New York May 11, 2011. Mr. Rajaratnam was found guilty on all 14 counts in a dramatic case that vindicated the government's aggressive use of phone taps to prosecute Wall Street figures.
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By Cadie Thompson, CNBC.com Producer

Even if Wall Streeters support the verdict in the Raj Rajaratnam case, they still have reason to be a concerned about what exactly that verdict means.

With Rajaratnam convicted on all 14 federal charges, five counts of conspiracy and nine counts of insider trading, a precedent has now been set for how insider trading will be pursued by law enforcement agencies and tried in a court of law.

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And basically, federal law enforcement officials have been given the green light to treat suspected violators of securities laws like murderous mobsters.

With Rajaratnam, the prosecutors found the almost perfect defendant.

He appears to have very blatantly and regularly used insider information to make trades. But great defendants can make for bad law.

"The government has acted unfairly. I'm going to play the role of defense counsel here. I feel pretty strongly about this. They have brought to many counts. You know, if you bring enough counts, 14 counts, you bring 30 counts, you bring 50 counts...a judge should of amended that, a judge should of changed that indictment," Jack Burkman, of Burkman Associates, told CNBC before the verdict was reached. "It's very unfair when a judge allows all of these counts to be brought. You have to limit an indictment to give fairness to the defendant. I just think they have gone too far here."

Another unique facet of the Rajaratnam case that may stir fear among Wall Streeters is that audio tapes of tapped conversations were allowed as evidence.

The defense argued that there was no precedent for undercover recordings in a case similar to Rajaratnam's case. It is a new prosecution tactic in a case of this sort that will no doubt continue to play a role in future insider cases.

Rajaratnam was convicted of securities fraud and conspiracy to commit securities fraud. But wiretaps are not permitted by law for securities fraud cases. The federal prosecutors got permission to use wiretaps to pursue different charges altogether—charges of wire fraud.

Wire fraud is one of the underlying charges that lead to racketeering convictions. And racketeering was a law invented to make it easier for feds to pursue mobsters.

A loophole in the law allows prosecutors to get a wiretap in pursuit of one set of charges, and then prosecute on an entirely different set of charges. This loophole will no doubt be at the center of Rajaratnam's appeal.

Besides a definite change in prosecution tactics for future insider trading cases, there is also the concern of the possibility of new regulations evolving from the Raj case.

The government's victory in the Rajaratnam could add momentum for more insider trading prosecutions that could ultimately lead to more regulation.

"We have to be very careful about drawing broad conclusions...about rushing to the conclusion that, 'well, this (insider trading) is everywhere, this somehow justifies Congress coming in and changing the law or going with more regulation with the Treasury or the SEC,'" said Burkman.

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