Yeah, the Dow’s back above 10,000 today, but some traders might not even be paying attention. They might be home “sick” or taking apart their phones to see if they’re tapped.

The arrest of billionaire hedge-fund manager Raj Rajaratnam on insider trading charges must have the hedge fund world on edge. The SEC built its case using wiretaps and software that culls through millions of high-speed trades. Rajaratnam is accused, along with others, of making $20 million by obtaining information about public companies (like Google and IBM) in illegal ways. From the Marketplace Morning Report:

Jeremy Hobson: The SEC’s director of enforcement said Rajaratnam was no master of the universe. He was a master of the Rolodex — calling contacts at companies and getting information before trading.

But that’s not uncommon in the world of hedge funds — says Fordham University Securities Law Professor Steve Thel.

Steve Thel: All hedge funds that do fundamental analysis are reaching out and trying to get all the information they can. Here it looks like these defendants used that information not in a legitimate way, but in an illegitimate way to buy a particular stock. But all hedge funds are pushing very close to that line.

So where’s the line? Well, it was drawn by the SEC after the tech bubble burst. The Wall Street Journal has more on Rajaratnam’s hedge fund Galleon:

Galleon made its name investing in tech stocks in the 1990s. In that era, analysts and favored clients got early looks at analyst reports, tips about corporate earnings and allocations of hot initial public offerings. That world ended after the tech bubble burst in 2000 and new rules — dubbed Regulation Fair Disclosure — barred companies from disclosing information selectively.

Getting exclusive information remained a crucial part of Galleon’s investment strategy, and the firm aggressively pursued rumors and used sources to gain it. Pressure was intense on traders and analysts to get information, especially about coming corporate earnings.

“Get an edge or you’re gone,” said a former trader. “Galleon is looking for that little bit of extra edge. That’s what the firm is about.”

I wonder how many hedge funds exist where that’s not what it’s all about. Information is constantly flying around Wall Street. But what constitutes inside information? And how do you prove it? From Bloomberg:

Investigators have struggled to build cases against large institutional investors such as hedge-fund managers, who often deflect regulatory queries about suspiciously timed bets, arguing they’re statistical flukes amid millions of trades. The case against Rajaratnam, built on recorded conversations within a web of alleged conspirators, offers a glimpse of how U.S. investigators are using more aggressive tactics to cut through the blizzard of trading and trace the flow of information.

Clusterstock’s Henry Blodget and John Carney talk about the fine line between insider trading and legal knowledge: