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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.”
The SEC charges against Gupta allege that he passed information to Rajnaratnam regarding Goldman Sachs earnings and a $5 billion investment from Warren Buffett’s Berkshire Hathaway, moments after CEO Lloyd Blankfein discussed the details with the board. Rajnaratnam’s Galleon Group then quickly made trades in the bank’s shares to produce some $17 million in ill-gotten gains, regulators claim. (See “SEC Accuses Former Goldman Sachs Director Of Insider Trading.”)
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.
Click here for the SEC’s charges against Gupta.
The full statement from Gupta’s attorney:
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.
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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.
Several media commentators have openly wondered whether the accusations against Gupta and earlier accusations in the same scandal against McKinsey senior partner and Gupta protégé Anil Kumar, strike a deadly blow to McKinsey.
Will Rajat Gupta Destroy McKinsey? John Carney, NetNet, March 2, 2011
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.
Reuters’ Westlaw Business has a detailed story about the reputational risk to both inside traders’ firms and the companies they target.
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.
In fact, the SEC never even charged Deloitte. How does an audit firm Vice Chairman “dupe” his fellow partners and professional colleagues more than three hundred times, as Deloitte’s lawsuit against Flanagan alleged?
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.
Ernst Young has also survived the embarrassment of one of their partners going to jail for inside trading. Even worse, the firm was mentioned in the same news stories as cheater site AshleyMadison.com. But Ernst Young is still working for the federal government and several Fortune 500 clients as an auditor, in spite of also being accused of complicity in the fraud that resulted in Lehman Brothers’ failure.
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.
Greed was the clear motivation for the most serious case of insider trading to appear before a British court.
After all, Christian Littlewood, an investment banker who made his way up the ranks to director at Dresdner Kleinwort, had already been earning £400,000 (S$820,000) a year. And yet he still used information gleaned from the office to make £590,000 in profit from illegal insider trading.
He made his Singaporean wife Angie, 39, to use her maiden name, Lew Siew Yoon, to buy the shares in her name to avoid detection. She teamed up with her Singaporean friend, Helmy Omar Sa’aid, in using her husband’s price-sensitive tip-offs to trade 2.15 million pounds worth of shares.
All three pleaded guilty to eight counts of insider trading for the scam that they had been doing for eight years – from 2000 to 2008 – at different London Stock Exchange and AIM listed shares.
According to a Straits Times report, the court found that Littlewood would spy on his colleague’s computers and eavesdropped to gather information which he would pass to his wife and Sa’id. They would then buy shares in firms that were subject to takeover bids. Once the share prices went up after news of the takeover came up, the two would then sell their shares, making a tidy profit.
Christian Littlewood, the most senior banker caught while still working by the Financial Services Authority, now faces three years and four months in jail.
His wife, Angie, was given a 12-month jail sentence, suspended for two years. She will be electronically tagged for the first three months of her suspended sentence and will be under curfew at her home between 8am and 7pm.
The judge said she was under her husband’s influence was already suffering from “moderate depression and possible alcoholism”, and was a good mother to her three young children, aged three, five, and eight, according to a Reuters report. At least one of them has a serious medical condition.
“In my judgment, you did as you were told to do by your husband,” he said.
Sa’id received a two-year sentence, and will be deported to Singapore. He had already spent almost one year in jail since being extradited from the Comoros Islands in the Indian Ocean last March.Â
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The Securities and Exchange Commission was formally charged six men in an insider trading case.
The group includes Anthony Longoria, a former manager at AMD, as well as Daniel DeVore, a manager at Dell as well as Marvell consultant Winifred Jiau, Flextronics executive Walter Shimoon and two employees of investment research firm Primary Global.
Longoria, Shimoon as well as the primary Global employees were arrested in an FBI sting back in December. The original accusation involved passing on confidential product information in exchange for money to Primary Global. These new SEC charges apparently stem from new findings from an ongoing investigation as the organization alleges that Longoria, DeVore, Jiau and shimoon “obtained material, non-public confidential information about quarterly earnings and performance data and shared that information with hedge funds and other clients of PGR who traded on the inside information.” According to the SEC, the illegally provided information resulted in profits in the amount of about $6 million. “Company executives and other insiders moonlighting as consultants to hedge funds cannot blatantly peddle their company’s confidential information for personal gain,” Robert Khuzami, director of the SEC’s Division of Enforcement, said in a statement.
According to the SEC, Longoria collected more than 130,000 in consulting fees from primary Global, while DeVore was paid about $145,000, Shimoon $13,600 and Jiau $200,000. The complaint filed by the SEC asks to prevent Longoria, Shimoon and DeVore from acting as an officer or director of any registered public company, to repay any gains including interest and pay additional penalties. Similar cases in the past have also resulted in jail time.
By Stephen Grocer
Seems Qualcomm’s bid to buy Atheros was one piece of information about Atheros that didn’t leaked.
Atheros and other semiconductor companies such as AMD, Marvell Technology, Broadcom and Intel have been embroiled in the insider trader probes the past two years.
Atheros’s name has come up twice, in fact. One of its executives tipped hedge fund manager Ali Far to the firm’s financial performance for the fiscal quarter ended in December 2008. In the spearate but related “expert network” probe, Don Ching Trang Chu, an employee at Primary Global Research, allegedly provided inside information about Atheros directly to Richard Choo-Beng Lee, who was a cooperating witness in the Galleon case and co-founded Spherix Capital with Far.
So was there any suspicious Atheros trading before last week’s deal?
The short answer: No.
Atheros’s shares opened the day at $37.14 and were trading at $37.18 at 3 p.m. when the New York Times broke the news of an impending deal. As the chart below shows, it shares did not surge until after the news came out. Often in recent years, there is a jump in shares of a target company in the days before a transaction is announced.  For example, Merck’s acquisition of Schering-Plough. Shares and options, which had been languishing for more than a year, had spikes in the days before the $32.6 billion offer.
What about the options market? Deal Journal colleague Brendan Conway reports
In the stock-options market, the big Atheros action came only after the first reports of the deal. There were dribs and drabs of trading activity Monday and then a tidal wave of volume on Tuesday afternoon that continued into Wednesday.
In the options market, a favorite venue for traders who make speculative takeover bets, it’s always possible that some of the dribs were the work of traders acting on inside information. But, as in the stock market, market participants weren’t crying foul the way they often do when others have acted illegally on their knowledge.
