NEW YORK — The lawyer for a wealthy investment manager accused in the biggest insider-trading scandal ever to hit the hedge-fund world engaged in a combative verbal battle Tuesday with a top government witness, trying to cast his client’s one-time friend as a man facing a long prison term who is desperate to win his freedom.
Former financial consultant Anil Kumar grew increasingly impatient and defensive with attorney John Dowd as he explained his encounters with Galleon Group founder Raj Rajaratnam, a one-time billionaire whose family of hedge funds was forced to shut down after his October 2009 arrest.
Under earlier questioning from a prosecutor over three days, Kumar said Rajaratnam paid hundreds of thousands of dollars into overseas accounts in return for inside information.
The two men met at the University of Pennsylvania’s Wharton School in the early 1980s. Kumar is testifying under a plea agreement that can win him leniency if he answers questions honestly. He has admitted feeding inside information to Rajaratnam.
The testy exchanges between Kumar and Dowd came on the same day that the government played an audiotape of a phone call in which a former Goldman Sachs board member could be heard telling Rajaratnam that Goldman was discussing whether it was wise to acquire a bank such as Wachovia Bank or an insurance company like American International Group.
The government had said it would introduce evidence at trial that Rajaratnam was aided by his relationship with the ex-board member, who is not criminally charged.
But it was the exchanges between Dowd and Kumar that highlighted the day, with both men engaging in lengthy verbal sparring.
“You provided services to Mr. Rajaratnam?” Dowd asked Kumar, who worked for McKinsey Co. for more than 23 years before his 2009 arrest.
“Illegal services,” Kumar responded.
“Nevertheless services, correct?” Dowd asked.
“Yes,” Kumar said. He paused before again adding: “illegal services.”
Repeatedly, Dowd tried to restrict what Kumar said by warning that he had asked a yes-or-no question and it should be answered accordingly.
It was the first sample jurors got to Dowd’s manner of questioning after he delivered an opening statement last week that took twice as long as the initial description of the evidence in the case presented by Assistant U.S. Attorney Jonathan Streeter.
Dowd, best known for preparing a report that led Pete Rose to accept a lifetime ban from baseball in 1989, opened his cross examination of Kumar by talking about securities-fraud charges Kumar pleaded guilty to a year ago that could bring a prison term of up to 25 years.
“You might not go to jail at all, correct?” Dowd asked, dismissively.
“Yes,” Kumar responded.
“It’s important to make Mr. Streeter happy, correct?” Dowd asked.
“Wrong,” Kumar immediately answered.
“And his goal is to convict Mr. Rajaratnam, correct?” the defense lawyer continued.
“Wrong,” came the reply again.
Kumar is considered key to the government case against the 53-year-old Rajaratnam, who was charged along with more than two dozen other hedge-fund employees and workers for public companies.
The government has said Rajaratnam’s illegal profits may have topped $50 million while Dowd has maintained that Rajaratnam only made trades based on information that was already public. After his arrest, Kumar quickly cooperated, which gave Dowd another line of attack that he did not pass up.
“When you got caught, you pinned it all on Raj didn’t you, ’cause that’s what you needed to do to stay out of jail?” Dowd asked.
And that Level Global, which used to manage $4 billion, is closing.Â
But when you add it all up with the additional news from Pensions and Investments today that FrontPoint was hit with an additional $500 million in redemptions in the first quarter, the insider trading scandal has cost hedge funds a stunning ~$9 billion.
From PI:
Multistrategy hedge fund manager FrontPoint Partners, touched by a separate insider-trading investigation, received redemption requests for an additional $500 million for the first quarter, confirmed a source who asked not to be identified.
And that’s just three of the many hedge funds that have been tied to the investigation.Â
You know who else was constantly paranoid about wiretaps? The Wire’s Russell “Stringer” Bell. For good reason.
The Fed’s insider trading investigation is giving the already cagey hedge fund industry more reason to be paranoid lately.
Hedge fund managers are paying security firms to check their offices and homes for bugs and listening devices, according to the FT. The suspicious bunch want to know whether or not the government is listening in on their conversations.
The paranoia was set in by the Fed’s insider trading investigation that’s charged dozens of hedge fund employees and expert network employees for their involvement in receiving and sharing non-public information about companies like Apple, Dell, AMD and Marvell.
The hedge fund industry is very opaque and one of the least regulated areas of the financial industry. So it comes as little surprise that fund managers are paying money to find out if anyone is listening in on their super-secret trading activity.
But doesn’t the mere act of hiring experts to sweep your home and office for wiretaps implicate a bit of guilt? That’s not to say every firm that’s paid for a sweep of their office is the next RajRajaratnam but if you’ve got nothing to hide, why all the fuss?
Before the privacy police get on my case, I want to clarify that I agree with the principle behind average citizens wanting to know whether or not the government is watching and listening. However, I don’t think the hedge fund industry should be placed on the same level.
Besides, as a computer forensics expert tells the FT, it’s highly unlikely that most hedge funds are being tapped anyway.  Edward Stroz of Stroz Friedberg tells his clients to think twice before requesting the sweeps. He asks them: “What led you to think this? Is it really worth the effort, or are you thinking back to some movie you saw?”
I wonder how many hedge fund managers are catching up re-runs of HBO’s The Wire. How many of them are sitting around living a scene similar to this one? Perhaps minus the part about ripping payphones out of the walls. But maybe not.
Throughout the U.S. government’s ongoing insider trading investigation, much of the outrage has centered on rich and powerful investors using improperly-obtained information to gain an edge on the mom-and-pop investor. Tuesday’s SEC charges against former Goldman Sachs board member Rajat Gupta, which allege the director shared non-public information with hedge fund manager Raj Rajnaratnam, just adds to the perception that the financial markets are not a level playing field.
Mark Rifkin, a partner at law firm Wolf Haldenstein Adler Freeman Herz specializing in securities and shareholder rights litigation, said Tuesday’s charges against Gupta “reinforced the suspicion that big-money guys are in better position to profit, but not because they are smarter or better investors.”
Gupta stepped down from the board at Goldman last spring, around the same time the Wall Street Journal reported the former McKinsey executive was linked to the insider trading investigation into Galleon.
Perhaps the worst part of the actions, which Gupta is denying through his lawyer, is the betrayal of trust that comes when an outside director – who is voted onto a board with the explicit mandate to protect shareholders and keep management accountable – uses his position to profiteer, or help his friends profiteer, says Rifkin.
SEC Division of Enforcement Director Robert Khuzami said “Gupta was honored with the highest trust of leading public companies, and he betrayed that trust by disclosing their most sensitive and valuable secrets. Directors who violate the sanctity of board room confidences for private gain will be held to account for their illegal actions.”
“It’s a breakdown in the system, says Rifkin. And what happens, he wonders, the next time Blankfein has to share sensitive information with his board ahead of its public release?
“The bigger issue is whether it is one rogue director or if it represents something about the culture,” says Rifkin. “Gupta was on the governance committee! Talk about the fox in the henhouse.”
Goldman Sachs declined to comment on the charges against Gupta Wednesday. The director is also alleged to have passed Rajnaratnam pre-release earnings figures from Procter Gamble, where he was also on the board. The consumer products maker confirmed that Gupta stepped down from its board Tuesday. American Airlines parent AMR, where Gupta is also a director, declined to comment on the matter, as did Buffett’s Berkshire Hathaway.
The SEC’s allegations are totally baseless. Mr. Gupta’s 40-year record of ethical conduct, integrity, and commitment to guarding his clients’ confidences is beyond reproach. Mr. Gupta has done nothing wrong and is confident that these unfounded allegations will be rejected by any fair and impartial fact finder. There is no allegation that Mr. Gupta traded in any of these securities or shared in any profits as part of any quid pro quo. In fact, Mr. Gupta had lost his entire $10 million investment in the GB Voyager Fund managed by Rajaratnam at the time of these events, negating any motive to deviate from a lifetime of honesty and integrity.
No Big 4 audit firms or their partners have been named in the insider trading scandal surrounding the now-defunct hedge fund Galleon Management. But the SEC has accused one of the most prominent businessmen ever implicated in such crimes, Rajat Gupta, a former McKinsey Company Global Managing Director.
Monadnock Research: Gupta is alleged to have tipped Galleon’s Rajaratnam, a friend and business associate, providing him with confidential information learned during board calls and in other aspects of his duties on the Goldman and PG boards. Gupta reportedly made calls to Rajaratnam “within seconds” of leaving board sessions where market-moving information was discussed.
The complaint alleges that Rajaratnam then either used the inside information on Goldman and PG to execute trades on behalf of some of Galleon’s hedge funds, or shared it with others at Galleon, who then traded on it ahead of public disclosure. The SEC claims the insider trading scheme generated more than $18 million in a combination of illicit profits and loss avoidance.
Gupta, as a McKinsey veteran, embodied the “trusted advisor” consulting ethos and personified the McKinsey “advisor to CEOs” business strategy and brand. The firm’s value to its clients and its effectiveness as an advisor requires knowing their secrets and holding them close to the vest.
If the charges against Gupta prove true, it could be a mortal threat to the firm. Even if there’s no evidence that confidentiality was breached while Gupta was at the firm, being led by a man who would later leak insider information would be devastating. If Gupta is shown to have engaged in similar actions while he was at McKinsey, that could be the end for the Firm.
“At that point, I think we go the way of Arthur Anderson,” another former McKinsey consultant said, referring to the once-prestigious accounting company brought down by its connections to Enron.
Loose Lips, Reuters BreakingViews, Robert Cyran and Rob Cox, March 3, 2011
According to McKinsey, “Our clients should never doubt that we will treat any information they give us with absolute discretion.” The allegations against Gupta make it hard for clients not to wonder.
In my opinion, extrapolating Gupta’s behavior to McKinsey as a whole is a stretch. I’m no McKinsey apologist but one man, even a former Global Managing Director, does not make the firm.
On the contrary. The firm made him and he’s the one whose currency is now worth less.
It’s understandable that, in the heat of this moment, some might naïvely compare the consequences of the criminal indictment of an audit firm with civil charges against an individual, albeit one who trades on his association with a prestigious professional services firm.
Being an insider with a fiduciary duty sure is risky, as heavyweight Rajat Gupta is now finding out amidst serious SEC charges. So is having board members, as Goldman Sachs and Procter and Gamble are now worrying. Of great concern to each are the reputational risks and attendant costs that this might impose on them.
One thing this story gets slightly wrong is the fiduciary duty of a director. Directors have a duty only to the corporation. That might change some directors’ views of where their bread is buttered. Did Gupta think that if he spread the love around enough, everyone would be happy?
Monadnock Research’s Mark O’Connor cites an interview with Gupta in May 2001 by Wharton Professor Jitendra Singh. [i] In it, Gupta gives some advice to those just starting their careers:
Gupta: …The second piece of advice I’d give is that I think it is vitally important to make other people successful. If you have a mindset of always trying to make other people successful, they will in turn make you more successful that you ever dreamed-of. So, I really believe that it’s not about getting ahead at the expense of others, it is getting ahead because lots and lots of people are helping you achieve it.
When the Big 4 audit firms are hit with insider trading scandals – and there have been some whoppers recently – they manage reputational risk in two ways:
They ignore reports in the media, giving either no comment or minimal comments that distance them from the accused.
They do everything possible to repair relationships with clients, including paying them off.
A Deloitte active-duty Vice Chairman, Thomas Flanagan, was accused and settled with the SEC this past summer over insider trading charges related to several Fortune 500 companies. Auditors have a public duty to shareholders and a legal obligation under federal securities laws to maintain engagement confidentiality, in addition to their contractual obligation to do so. And yet the Flanagan story captured only momentary media attention and no one claimed Deloitte was going down as a result.
The SEC gave Deloitte credit for software, manuals, and controls that may have been designed effectively, but those controls surely did not, in the Flanagan case and the hundreds of other examples of non-compliance cited by the PCAOB, operate effectively. Deloitte did not discover Flanagan’s sins. According to the Financial Times, FINRA discovered the abnormalities in activity via normal market monitoring activities during Walgreen’s acquisition of Option Care.
Deloitte’s audit clients – Walgreens, Best Buy, Sears Holdings and others – received calls from the SEC. Then the SEC and the clients called Deloitte. Deloitte forced Flanagan to “retire” and then sued him to assuage their clients.  Deloitte’s claim against Flanagan cited potential costs in reimbursing clients for their investigations.
Deloitte did reimburse some clients: $456 thousand to Sears, $79 thousand to Best Buy, for example. Deloitte’s audit clients, of course, made the quick, universal decision that their auditor was still independent. Those companies would have otherwise experienced the ignominy of admitting that a non-independent audit firm had attested to prior-filed financial statements. Those companies would have been vulnerable to lawsuits, may have had to pay for a new audit for the affected years, and would have had to change auditors in a hurry – a messy and expensive proposition for a large public company.
There are disclosures in almost all the proxies. They look like they were all written by the same lawyer.
Following these investigations, DT and our management advised the Audit Committee that no evidence was discovered that indicated that the former advisory partner had any substantive responsibility for or role in the conduct of the audit. DT delivered a letter to the audit committee stating that, despite the trades in our securities by their former advisory partner and the resulting violation of the SEC’s independence rules, the former advisory partner had not exercised any influence over the conduct of the audit or its conclusions with respect to the audit or accounting consultations, that the objectivity of the persons responsible for the actual conduct of the audit had not been affected by the former advisory partner’s actions, and that DT’s independence was not impaired…
Closer to the kind of work McKinsey’s Gupta did for clients, we have another senior Deloitte partner accused of insider trading, Arnold McClellan. He advised private equity firms about the tax implications of proposed acquisitions. The level of trust – and consequences of a betrayal of that trust – in MA advisory is akin to the level of trust expected of a company director. Interestingly, the two cases have a company in common – Kronos.
The McClellan case is pending but, in spite of being the second one for Deloitte in such a short time and with allegations of tipping others for profit that covered the same time period as the Flanagan case, Deloitte is still kicking consulting ass and taking names, including for the federal government.
Statement of Gary Naftalis, Counsel for Rajat Gupta
These allegations first made by the SEC are totally baseless. Mr. Gupta’s 40-year record of ethical conduct, integrity, and commitment to guarding his clients’ confidences is beyond reproach. Mr. Gupta has done nothing wrong and is confident that these unfounded allegations will be rejected by any fair and impartial fact finder.  There is no allegation that Mr. Gupta traded in any of these securities or shared in any profits as part of any quid pro quo. In fact, Mr. Gupta had lost his entire $10 million investment in the GB Voyager Fund managed by Rajaratnam at the time of these events, negating any motive to deviate from a lifetime of honesty and integrity.
[i] McKinsey’s Managing Director Rajat Gupta on leading a knowledge-based global consulting organization; Volume 15 No. 2.
The insider trading scandal ended up costing three hedge funds, Diamondback, FrontPoint, and Level Global, a combined $9 billion.
