The Dark Underbelly of Finance, by Luigi Zingales, Commentary, Project Syndicate: If you thought that America’s financial sector had gotten enough of bad publicity, think again. The insider-trading trial of Raj Rajaratnam, a billionaire hedge-fund manager, has now begun. It is likely to provide an especially lurid exposé of the corrupt underbelly of the financial world.
Rajaratnam’s trial is remarkable... First, it is one of the few insider-trading cases ever to be brought against a professional hedge-fund manager. ... This time, we are talking about the very heart of corporate America. ...
It is so difficult to imagine that successful executives would jeopardize their careers and reputations in this way that many of us probably hope that the accusations turn out to be without merit. But recent academic research – by Lauren Cohen, Andrea Frazzini, and Christopher Malloy – shows that it is not far-fetched that university friends like Kumar, Goel, and Rajaratnam would get together to share confidential information. ...
However, even though finance has a "corrupt underbelly" and "it is not far-fetched" that this would happen:
After ten weeks of a trial like this, it will be easy for the public to conclude that all hedge funds are crooked, and that the system is rigged against the outsiders. Fortunately, this is not the case. While there are certainly some rotten apples in the hedge-fund industry, the majority of traders behave properly, and their legitimate research contributes to making the market more efficient.
Corruption does not always involve breaking the rules. Sometimes the rules themselves are corrupt, and that is the bigger worry for me. (He suggests that hedge funds "publicly report all past trades that are at least two years old" to show they are honest brokers, but that's not going to happen unless they are forced to do so.)