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Corporate Oct 28, 2011

FBI case against Rajat Gupta is not as solid as it looks

By RK Raghavan

(Gupta) became the illegal eyes and ears in the boardroom for his friend and business associate, Raj Rajaratnam, who reaped enormous profits from Mr Gupta's breach of duty.

- US Attorney Preet Bharara on Rajat Gupta, former chief of McKinsey.

The indictment (on 26 October) of India-born former McKinsey chief Rajat Gupta by the Federal Bureau of Investigation (FBI) for insider trading-related charges comes close on the heels of the sentencing, for 11 years in prison, of Raj Rajaratnam, founder of Galleon Technology, once a leading hedge fund.

Gupta and Rajaratnam (of Sri Lankan origin and a Wharton graduate) were good friends ever since the latter gave generous support to Gupta in establishing the Indian School of Business (ISB), Hyderabad. Significantly, the US Securities and Exchange Commission (SEC) had last year brought, unsuccessfully, a civil fraud charge against Gupta for transactions linking him with Rajaratnam.

Thereafter, there was near total passivity in US government proceedings against Gupta, and the case was hanging loosely for nearly a year, as one observer put it. After this week's FBI action, however, Gupta faces criminal charges on one count of conspiracy to commit securities fraud and five counts of securities fraud. These involve a penalty of 105 years in prison.

Rajat Kumar Gupta, former Goldman Sachs board member, leaves a Manhattan court. AFP

In their indictment, the prosecutors cited specific instances of help to Rajaratnam by Gupta through leakage of privileged and confidential information. The first piece of information related to the Goldman Sachs board decision (23 October 2008) to post losses, for the first time since it went public in 1999.

Immediately on hearing this, Rajaratnam is learnt to have quickly offloaded the bulk of his holdings in that company. When Gupta subsequently informed him of the proposed huge investment ($5 billion) in Goldman Sachs by Warren Buffett, Rajaratnam bought large chunks of shares as the stock price went up appreciably. Thus, Rajaratnam not only escaped huge losses, but actually made remarkable profits taking advantage of what he had heard from Rajat Gupta.

The FBI assistant director handling the case said: "The conduct alleged is not an inadvertent slip of the tongue by Mr Gupta... His eagerness to pass along inside information to Rajaratnam is nowhere more starkly evident than in the two instances where a total of 39 seconds elapsed between his learning of crucial Goldman Sachs information and lavishing it on his good friend."

In the second series of transactions under the FBI scanner, in early 2009, Gupta, as a member of the Procter & Gamble board, passed on information to Rajaratnam to the effect that the company had not fulfilled the usual expectation of sales growth. On hearing this, Rajaratnam passed on the tip to a portfolio manager, following which certain funds sold short about 180,000 P&G shares.

Gupta's counsel Gary Naftalis has dismissed the charges against his client as without basis. On Gupta pleading not guilty, he has been released on bail on a huge surety of $10 million. The trial is to start in early April.

The case against both Rajaratnam and Rajat Gupta, as also against a few other accomplices, rests heavily on evidence collected through wire-tapping.

It is known that the FBI had done such eavesdropping after being authorised by the appropriate court. (In India, the home secretary is the designated authority.) Such telephone monitoring can be only in respect of offences listed in the Omnibus Crime Control and Safe Streets Act of 1968 (also known as Title III).

Basically, these are organised crimes involving drug cartels and human traffickers. Whether investigators can use this tool for probing insider trading charges had always been doubtful. In the present case against Raj Rajaratnam, a federal judge held last year that when a crime had been committed through a telephone, monitoring was totally lawful in investigating it.

This argument seems a little tenuous. I expect the ruling to be taken on appeal to the US Supreme Court. If the latter overturns the District Court's decision, the benefit will go to both the accused and their accomplices. But this would take several years, a fact that may dampen Rajaratnam, who has a grave kidney ailment, and may shortly need a transplant.

While the case against Rajaratnam has been built on many facts other than what was picked up through telephone monitoring, the one against Rajat Gupta seems to rest solely on circumstances surrounding telephonic conversations with Rajaratnam. The proximity of his calls to interactions with Goldman Sachs board members has been cited as the strongest circumstance supporting the prosecution.

According to one report, what the investigators have been able to come up with is only the fact that calls were exchanged between Gupta and Rajaratnam. It is conjectured that the text of conversation is not available to buttress the prosecution. If this is true, Gupta cannot be held guilty only on the circumstance that Rajaratnam took certain commercial decisions which had been suspected to have been aided by the information passed on by Gupta.

The prosecution will be trying to match the date and time of telephonic conversations and the rationale and proximity of certain stock market decisions taken by Rajaratnam. These may not be enough to sustain a conviction of Gupta. One must remember that Gupta is charged with a 'crime', and in the jurisprudence that democratic countries profess the world over, no suspect can be convicted unless 'conclusive evidence' that is beyond any reasonable doubt is available. Criminal law does not take cognisance of any evidence short of it.

Two other facts weaken the case against Gupta. The evidence against him rests solely on the telephonic conversations between him and Rajaratnam. There is nothing to show that, as a follow-up, Gupta ever spoke to anybody else or took any step to promote Rajaratnam's interests.

The two do share some business interests in the form of investments made by Gupta in funds managed by Rajaratnam. In one of these Gupta was actually known to have suffered a massive loss. But there is no nexus between this fact of a common interest and the alleged impropriety committed by Gupta.

Perhaps the strongest circumstance that favours him is the failure of the prosecution to establish that Gupta ever gained by the improper disclosure of privileged information to an unauthorised person. The fundamental axiom of criminal law in the jurisprudence of most countries is that, for a crime suspect to be proven guilty, there should be some mens rea (criminal intention). Or else the whole case crumbles.

From available reports the prosecution has not sought to establish this, a fact which alone enhances the prospects of acquittal for Gupta. Let us hope that this happens, because he has an unsullied record. The fact that he was elected thrice to lead McKinsey, one of world's leading consulting firms, by its partners and the first non-American to be so chosen is proof enough that he is a professional to the core who will not commit the indiscretions of the kind attributed to him.

(RK Raghavan is a former Director of the Central Bureau of Investigation)


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