Federal Sentencing Guidelines for Insider Trading

Federal Sentencing Guidelines for Insider Trading: Why Raj Rajaratnam Got 11 Years

Raj Rajaratnam built the Galleon Group into one of the largest hedge fund management firms in the world, overseeing $7 billion at its peak. On October 13, 2011, he received an 11-year prison sentence – the longest ever imposed for insider trading in U.S. history. The sentence wasn’t just about the money. It was about what prosecutors called a “systemic” pattern of corruption that infiltrated some of the most prestigious companies on Wall Street. The FBI used wiretaps for the first time in an insider trading case. They recorded Rajaratnam receiving tips from corporate insiders, discussing how to disguise trades, and orchestrating a scheme that generated over $60 million in illegal profits. He was found guilty on all 14 counts.

Here’s what makes insider trading sentencing so unusual. Unlike most fraud crimes where sentences are based on the loss to victims, insider trading sentences are based on the gain to the defendant. The reason is simple and disturbing: the victims of insider trading are essentially impossible to identify. When you trade on material nonpublic information, you’re taking money from the anonymous mass of investors on the other side of your trades. Nobody knows who they are. So the sentencing guidelines use your profit – what you gained – as the measure of harm. The more you made, the more time you serve.

The maximum sentence for insider trading is 20 years per count, with fines up to $5 million for individuals. But here’s the reality: median sentences have tripled over the past three decades. In the 1990s, the median insider trading sentence was less than one year. By the early 2000s, it was 18 months. Today, it’s closer to three years. The same maximum penalty, dramatically different enforcement. Prosecutors got more aggressive. Judges got less lenient. And new technology – from wiretaps to sophisticated data analytics – made catching insider traders far more effective. If you’re facing these charges in 2025, you’re facing a very different system than existed twenty years ago.

How Raj Rajaratnam Got 11 Years – The Longest Sentence in History

Heres the thing about the Rajaratnam case that changed everything. The FBI used wiretaps. Before this case, wiretaps were tools for drug dealers and mob bosses. Nobody thought youd use them against hedge fund managers trading stocks. But prosecutors went to court, got authorization, and recorded thousands of phone calls. When the jury heard Rajaratnam on tape – receiving tips, discussing timing, talking about how to avoid detection – the case was essentially over.

The evidence was devastating. Rajaratnam had sources inside Goldman Sachs, Intel, IBM, McKinsey, and other blue-chip companies. One of his sources was Rajat Gupta – a member of the Goldman Sachs board of directors and former worldwide managing director of McKinsey & Company. Gupta would call Rajaratnam within minutes of learning material nonpublic information in board meetings. Rajaratnam would trade immediatly. The profits flowed to Galleon.

On May 11, 2011, a jury found Rajaratnam guilty on all 14 counts – 9 counts of securities fraud and 5 counts of conspiracy. Five months later, Judge Richard Holwell sentenced him to 11 years in federal prison, plus a $10 million fine and forfeiture of $53.8 million. The SEC piled on with a record $92.8 million penalty – the largest ever imposed on an individual.

Heres what drove the sentence to historic levels. It wasnt just the amount – though $60 million is substantial. It was the scope. Twenty-five other defendants were implicated. Twenty-one pleaded guilty. Corporate insiders at the highest levels of American business were feeding confidential information to a hedge fund. The scheme was calculated, systematic, and ongoing for years. Judge Holwell called it “one of the most egregious cases of insider trading” ever prosecuted. The sentence reflected that.

Rajaratnam served seven and a half years and was released in 2019. He later published a memoir criticizing the prosecution. But the damage was done – not just to him, but to everyone who followed. His case established that prosecutors would use every tool available to pursue insider trading. Wiretaps were now standard.

Why Gain, Not Loss, Determines Your Sentence

OK so heres were insider trading sentencing diverges from every other fraud crime. Most fraud sentences are based on “loss” – how much money victims lost becuase of your scheme. The higher the loss, the higher your offense level, the longer your sentence. But insider trading uses “gain” instead.

The reason is that insider trading victims are impossible to identify. When you buy stock based on inside information, someone else sold you that stock. Who? An anonymous investor on the other side of an exchange transaction. They sold to you at a price that didnt reflect the nonpublic information you knew. They lost money they should of made (or made less then they would of if youd never traded). But theres no way to identify them. Millions of shares trade every day. Your counterparty could be anyone.

So the sentencing guidelines under §2B1.4 use your gain as a proxy for harm. If your illegal profit exceeded $5,000, your offense level increases according to the loss table in §2B1.1. The more you made, the higher your sentence. A $100,000 gain adds 6 offense levels. A $1 million gain adds 12 levels. A $10 million gain adds 20 levels.

Heres what makes this complicated. Courts disagree about how to calculate “gain.” There are three competing methodologies used across different circuit courts:

1. Net profit approach – Your actual realized profit from the trades
2. Notional profit/market absorption approach – A theoretical calculation of what you gained from the information advantage
3. Event studies approach – Statistical analysis of how the information affected stock price

Depending on which court sentences you, the same conduct could result in vastly different “gain” calculations – and vastly different sentences. Only two circuit courts have definitively resolved this question. The potential result is that the difference between methodologies could mean the difference between freedom and years in prison.

The Martha Stewart Lesson – Prison for Lying, Not Trading

Martha Stewart went to federal prison in 2004. Everyone thinks she went to prison for insider trading. Shes the most famous insider trading defendant in history. But heres the truth: Martha Stewart was aquitted of the securities fraud charges related to insider trading. She went to prison for lying about it.

Think about what this means. Stewart sold ImClone stock in December 2001 after her broker tipped her that the CEO was selling. Prosecutors charged her with securities fraud based on insider trading. The jury found her not guilty of those charges. But in the course of the investigation, Stewart made false statements to federal agents. She lied about why she sold the stock. Those lies became seperate federal crimes – false statements under 18 USC 1001 and obstruction of justice.

She was sentenced to five months in prison and five months of home confinement. A relatively light sentence. But the damage to her reputation was catastrophic. The conviction – not the underlying allegation – destroyed her public image for years.

The Martha Stewart case is a template that repeats constantly in insider trading prosecutions. Prosecutors may not be able to prove the trading violation. The elements are technical. The evidence may be circumstantial. But if you talk to investigators – if you try to explain, if you shade the truth, if you misremember details – you create opportunities for obstruction and false statement charges. Many defendants ultimatly go to prison not for trading but for what they said about trading.

This is why criminal defense attorneys tell clients facing insider trading allegations to stay silent. Not becuase there guilty. Becuase talking, even truthfuly, creates risks that silence dosent. Every word you say to investigators is a potential felony waiting to happen.

When Your 10b5-1 ‘Safe Harbor’ Becomes Criminal Evidence

Rule 10b5-1 trading plans were designed to protect corporate insiders from insider trading allegations. The idea is simple: you create a plan in advance specifying when and how you’ll sell stock, you follow the plan, and your trades are presumed legitimate even if you later acquire material nonpublic information. It’s an affirmative defense. A “safe harbor.” Executives have relied on these plans for decades.

In 2024, that safe harbor became a trap. Terren Peizer, the chairman and largest shareholder of Ontrak, was convicted of securities fraud based exclusively on his use of 10b5-1 trading plans. The DOJ argued – and a jury agreed – that Peizer adopted and modified his trading plans while in possession of MNPI about the company’s deteriorating finances. The plans werent protection. They were evidence of premeditation.

Heres what the DOJ’s Principal Deputy Assistant Attorney General said after the verdict: “This was our first insider trading prosecution based exclusively on the use of a trading plan, but it will not be our last.”

Think about what this means. The mechanism designed to protect you from prosecution can now be used to prosecute you. If prosecutors beleive you adopted or modified your 10b5-1 plan while possessing material nonpublic information, the plan itself becomes evidence of intent. Your “safe harbor” becomes proof of your scheme.

The Peizer case signals a new era in insider trading enforcement. Executives can no longer assume that having a trading plan provides protection. The question isnt wheather you had a plan. The question is what you knew when you created it.

The Wiretap Revolution in Insider Trading Cases

Before Rajaratnam, insider trading cases relied on circumstantial evidence. Suspicious trading patterns. Questionable timing. Relationships between traders and insiders. Prosecutors had to build inferential cases showing that the defendant must have had inside information based on the evidence surrounding there trades.

Wiretaps changed everything. The FBI obtained court authorization to record Rajaratnam’s phone calls. For months, agents listened as he recieved tips, discussed information sources, and coordinated trades. The recordings were played for the jury. There was no inference required. The jury heard Rajaratnam committing the crime in real time.

Since Rajaratnam, wiretaps have become standard in significant insider trading investigations. If your under investigation for serious insider trading, you should assume your communications may be monitored. Phone calls. Text messages. Even encrypted apps – prosecutors have found ways to access these through cooperation with service providers, device seizures, and cooperating witnesses who record conversations.

Heres the uncomfortable truth. The same technology developed to catch drug traffickers and terrorists is now deployed against white-collar defendants. Prosecutors got comfortable with wiretaps in Rajaratnam. They saw how effective they were. They kept using them. Every major insider trading investigation since has potentially involved surveillance.

This dosent mean every investigation includes wiretaps. The standard for obtaining authorization is high – prosecutors must show probable cause and demonstrate that other investigative methods have been exhausted or would be unlikely to succeed. But if your trading patterns flagged the SEC’s algorithms, if there cooperating witnesses, if the amounts are significant – wiretaps are on the table.

Red Flags That Make Your Case Go Criminal

Most SEC insider trading investigations never become criminal prosecutions. The SEC handles them civilly – fines, disgorgement, industry bars – but no prison. So what determines wheather your case stays civil or goes criminal? Prosecutors look for specific factors.

Heres what heightens the risk of criminal referral:

Computer hacking to access MNPI. If you obtained inside information through unauthorized access to computer systems, your case is going criminal. This isnt just trading on a tip – its theft of information.

Encrypted communications or burner phones. Using encrypted messaging apps, prepaid phones, or other methods to avoid detection signals consciousness of guilt. Prosecutors see this as evidence you knew what you were doing was illegal.

Offshore or opaque brokerage accounts. Trading through accounts designed to hide your identity – foreign accounts, nominees, shell companies – suggests sophisticated concealment. This aggravates everything.

Code words in communications. If your calling stock tips “weather reports” or using other coded language to discuss trades, prosecutors will argue you were deliberately hiding your conduct.

Scale of profits. The DOJ has limited resources. They prioritize cases with significant impact – cases that will serve as deterrents. Six-figure and seven-figure profits get more attention then smaller amounts.

Pattern of conduct. A single trade might stay civil. A systematic pattern of insider trading over years will almost certainy go criminal. Repeated conduct shows willfulness and eliminates claims of innocent mistake.

If multiple red flags apply to your situation, assume criminal prosecution is coming. Plan accordingly.

The Sentencing Math for Insider Trading

Let me show you how insider trading sentences are actualy calculated. This math determines wheather your doing 18 months or 8 years.

Insider trading uses Sentencing Guideline § 2B1.4. The base offense level is 8. But this is almost never were defendants end up, becuase gain enhancements add levels quickly.

If your gain exceeded $5,000, you add offense levels from the loss table in § 2B1.1:

• More then $6,500 adds 2 levels
• More then $15,000 adds 4 levels
• More then $40,000 adds 6 levels
• More then $95,000 adds 8 levels
• More then $250,000 adds 10 levels
• More then $550,000 adds 12 levels
• More then $1.5 million adds 14 levels

A defendant who made $500,000 in illegal profits starts at base level 8, adds 12 levels for gain, and reaches offense level 20. At Criminal History Category I, thats a guidelines range of 33-41 months.

But wait – additional enhancements apply:

Organized scheme enhancement. If your offense involved an “organized scheme to engage in insider trading” – calculated, systematic, repeated efforts – theres a minimum offense level of 14. This ensures even smaller gains result in some prison time.

Sophisticated means. If you used sophisticated methods to conceal your trading or avoid detection, add 2 levels.

Abuse of position of trust. If you were a corporate officer, director, or held another position of trust, add 2 levels.

Obstruction of justice. If you destroyed evidence, lied to investigators, or otherwise obstructed, add 2 levels.

Raj Rajaratnam’s $60 million in illegal profits, combined with his leadership role, sophisticated concealment, and the organized nature of his scheme, pushed his offense level into the stratosphere – resulting in the 11-year sentence that made history.

What To Do If Your Facing Insider Trading Allegations

If your facing insider trading allegations – wheather from the SEC, the DOJ, or both – heres what you need to do immediatly.

Stop trading. Any additional trades while your under investigation can add counts, demonstrate pattern, and destroy any argument of innocent mistake. Freeze everything.

Assume criminal exposure exists. About 27% of SEC securities cases go criminal. You dont know if your in that percentage until its to late. Treat every interaction as if it could become part of a criminal prosecution.

Get specialized counsel immediatly. Insider trading defense requires attorneys who understand both SEC enforcement and DOJ prosecution, securities law and criminal procedure. This is a specialized practice area. General criminal defense attorneys may not know the specific dynamics.

Preserve evidence properly. Destroying communications, trading records, or other evidence is obstruction of justice – a seperate federal crime that can add years to your sentence. Whatever you have, preserve it.

Understand the parallel investigation trap. The SEC collects evidence using civil subpoena power. That evidence flows to DOJ through Access Requests. Your cooperation with the civil investigation can build the criminal case against you. Navigate this carefully with counsel.

Calculate your exposure. Have your attorney calculate your likely guidelines range under different gain calculations. What methodology will prosecutors use? What enhancements might apply? You cant make informed decisions without understanding the math.

The median insider trading sentence has tripled over 30 years. Wiretaps are now standard. “Safe harbor” trading plans can be prosecuted. Prosecutors are more aggressive, technology is more sophisticated, and sentences are longer then ever. Understanding how this system works is essential to surviving it.