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Is SEC Setting us up?
Out of 26 Odd People Under Trial in The Galleon case, Gupta is in The Few Facing Civil Instead of Criminal Proceedings. Is The SEC setting The Stage for an Escape Route?
Issue Date - 23/06/2011
The verdict is finally out, loud & clear. Good guys have won yet another round (apparently)! The nailing of Galleon Group hedge fund (managing over $7 billion before closing in October 2009) tycoon Raj Rajaratnam has been brandished around by SEC in an attempt to project the view that the US legal setup is still not a set-up in US when it comes to chasten influential financial-world figures. One has to accept to SEC’s credit, the Galleon case is the biggest blow against insider trading in a generation as the trial involved some of the most high-profile executives on the Wall Street. But hold on to your beer barrels, we just might have been had by the SEC.

First the empirical evidence. No doubt, there have been cases in the past where people have been caught for their crimes, but almost all of them (except a few; see chart) surprisingly escaped unscathed. Even the government has tried to curb cases and incidences of insider trading by putting in place laws like SOX (the Sarbanes-Oxley Act of 2002), but much in vain. According to data compiled by Bloomberg, while there were just 70 hedge funds managing $39 billion in 1990, the number had grown to a whopping 2,600 (managing $1.7 trillion) by the end of 2010. And so, one may presume, the cases of insider trading.

However, this time, thanks to the diligent prosecutors and FBI agents involved in the case that Rajaratnam, a Sri Lanka born US citizen, was finally found guilty of conspiracy and securities fraud on all 14 counts, and now awaits sentencing on July 29, 2011, which is most likely to put him behind bars for the next decade or so (or even more!). Rajaratnam is said to have made over $60 million by illegally trading on secret tips from bankers, consultants, traders, directors, and former employees of some big companies, including Goldman Sachs (GS) and McKinsey. Apart from Rajaratnam, there are more than 40 people who are now facing insider trading charges stemming from a nationwide investigation that has roots going back to 1998.

But now that Rajratnam is down, what awaits Rajat Gupta?
As one would know, the United States Securities and Exchange Commission (SEC), on March 1, 2011, accused Gupta of illegally tipping Rajaratnam with insider information about Goldman Sachs and Procter & Gamble while serving on the boards of both companies. For instance, in October 2008, Gupta apparently attended a Board meeting of Goldman Sachs where it was revealed that Berkshire Hathway, owned by the legendary investor Warren Buffett, would invest $5 billion in the company to bail it out of trouble. SEC has evidence that Gupta passed on this information to Rajaratnam, who in turn made a killing. In fact, wiretaps of phone conversations between Gupta and Rajaratnam released by prosecutors during Rajaratnam’s trial clearly show that Gupta discussed the details of Goldman Sachs board meetings with Rajaratnam, including the company’s plan to buy some other financial firms like Wachovia and AIG.

However, interestingly too, Gupta has not been charged criminally. Instead, SEC chose to file civil insider trading charges against Gupta (out of 26 people under trial, Gupta is one of the few facing civil proceedings which are scheduled to start on August 22, 2011), which, if proved, could cost him a few million dollars and nothing else. 23 or so accused have already pleaded guilty. Not Gupta though. So, does it mean Gupta will escape unscathed? Also, does it mean that discussing details of a secret boardroom meeting with friends and family (who, in turn, use it to make profits) does not come under the purview of insider trading? If that’s the case, what about punishments that have been meted out to defendants in the past, just for tipping their former colleagues and friends? For instance, while Robert Moffat, the former Sr. VP of IBM was sentenced to six months in prison in 2010 for tipping Danielle Chiesi (a former New Castle employee) about a forthcoming IBM deal with Advanced Micro Devices, Ali Hariri, former VP of chipmaker Atheros Communications, received an 18-month sentence in November 2010 for tipping a former Galleon employee. Joseph Contorinis, a former hedge fund manager, too received a six-year sentence in December 2010 for providing tips on impending mergers (in particular the 2006 buyout of Albertsons Inc.) to family and friends.

Yes, the SEC has been famously inconsistent in getting comparable sentences across the board, but has managed to put a showcase lot behind bars – for example, while Hafiz Naseem, a former Credit Suisse Group Investment Banker, was put behind bars for 10 years after he was found guilty of sharing details about pending corporate deals with friends in February 2008, Randi Collotta, a former Morgan Stanley lawyer, received a sentence of 60 days in prison for providing tips to her husband about impending merger deals.

Ergo, if all of them could be sent behind bars just for providing the so-called tips to their friends and family, then why isn’t Gupta, like his counterparts and predecessors, facing criminal charges? Or is it that Rajat Gupta has finally decided to turn, well, an approver himself? While all that may not be yet the case though, not many realize that Gupta in fact had himself sued the SEC in March 2011 claiming that the SEC was deliberately disallowing a jury trial for Gupta and instead – by retroactively using the newest Dodd-Frank financial reform law – forcing Gupta to face a court that is a part of SEC itself, than a jury-led federal court; and this, reportedly, is something that doesn’t happen usually.

While SEC’s move appears malignantly strange, in a quid pro quo, James Mercer, a Goldman Sachs investor, on June 7, 2011, sued Rajat Gupta for recovering the profits made by Galleon. What is interesting is not the suit per se; but the fact that Mercer claims that he was forced to file the suit after his repeated requests to Goldman Sachs to sue Rajat Gupta went unheeded.

Clearly, there is much more to this case than the eye can see – with players like Goldman Sachs, Rajat Gupta and SEC itself behaving extremely uniquely, one can only suspect the intent of the prosecuting authority and be amazed at its responses. Thought leaders like Sumit Ganguly, the US-based Professor of Political Science at Indiana University in Bloomington, tell B&E, “The culture of deregulation that was spawned since the days of the Ronald Administration created an environment within which this form of freewheeling behaviour [corporate greed] became possible.” Corollary, the Rajat Gupta case decision will prove to the world whether the situation is improving or degrading. We’ll keep a watch. Hope the SEC does too...

Manish K. Pandey           

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