Rajat Gupta convicted of insider trading

Manhattan jury finds Gupta guilty on three counts of securities fraud and one count of conspiracy out of six charges; faces upto 20 years in prison


Rajat Gupta, 63, whose meteoric rise to head McKinsey & Company, is considered one of the biggest Indian success stories, has been convicted of insider trading by a US court.

Gupta, an IIT Delhi and Harvard Business School alumnus, was charged with breach of fiduciary duties and for passing on inside information to Raj Rajaratnam, billionaire founder of the Galleon Group hedge fund, who is already serving an 11-year prison sentence after being convicted for securities fraud.

After a four-week trial, the jury at a Manhattan federal court found Gupta guilty on four out of six charges – these were three counts of securities fraud and one count of conspiracy. Interestingly, the date for sentencing is 18th October. Ironically, the Manhattan district attorney, Preet Bharara, who led the action against Mr Gupta is also of Indian origin with the reputation of being a tough crusader against white collar crime.

After a successful stint at McKinsey, Mr Gupta went on to become a director of top global companies such as Proctor & Gamble, Goldman Sachs, Rockefeller Foundation and the Bill & Melinda Gates Foundation. Mr Gupta was accused of leaking information to Mr Rajaratnam about investment guru Warren Buffet’s plan to invest $5billion in Goldman Sachs at the height of the financial crisis of 2008. Goldman Sach’s CEO Lloyd Blankfein was among those who testified against Mr Gupta during the trail.

The evidence against Gupta was believed to be mainly circumstantial, although one wire-tapped phone conversation used by the prosecution to bring charges against him has been widely circulated on the internet. It is learnt that Mr Anil Kumar, a close friend and colleague of Mr Gupta from McKinsey, who has pleaded guilty in the Galleon case, may have provided evidence against him as part of a plea bargain.

Interestingly, right until the judgement, Mr Gupta’s defence has held that there is no evidence of him having profited from the leak of confidential information to Mr Rajarathnam. But this only makes his indiscretion and leaks all the more curious and perplexing.

After his stint at McKinsey, Mr Gupta has spent a lot of time in India forging strong connections with Indian business. In an unusual display of solidarity, Indian industrialist including Mukesh Ambani, Adi Godrej, Kushal Pal Singh of DLF, Analjit Singh of Max India, Yogesh Deveshwar of ITC and Rajendra Pawar of NIIT and us based author Deepak Chopra posted messages of support on a website started by another former colleague from McKinsey. Ashok Alexander, India CEO of the Bill & Melinda Gates Foundation (and son of the late Maharashtra Governor, Dr PC Alexander) was among those who was to testify for Mr Gupta. As the verdict shows, none of this made any difference to the jury.

Interestingly, Mr Gupta’s conviction is another blow to the Indian School of Business in Hyderabad of which he was a founder. However, Moneylife has always had a different take on Mr Gupta and his association with a series of dodgy Indian companies and some dubious acquisitions. However, so enormous was his reputation that nobody dared to question his motives. On the contrary, the Indian Prime Minsiter sought his advice and also invited him to head the prestigious Public Health Foundation of India (PHFI) which was quietly empowered to frame health policies and received astonishingly generous funding, land and budgetary support (running into hundreds of crore rupes) from the Union and state governments.

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Rajat Gupta's journey from board room to jail cell

Having fallen from respected insider to convicted inside trader, Rajat Gupta has now exchanged the lofty board room for the prospect of a lowly jail cell

Rajat Gupta, former Director of Goldman Sachs and the poster boy of Indians at the Wall Street, was found guilty of illegally tipping off his friend Raj Rajaratnam of confidential market information, in one of America's biggest insider trading cases, reports PTI.

After three weeks of trial, a US court held the 63-year- old guilty of providing insider information to Galleon hedge fund founder Rajaratnam, who was sentenced last year to 11 years in prison for insider trading.

"Rajat Gupta once stood at the apex of the international business community. Today, he stands convicted of securities fraud. He achieved remarkable success and stature, but he threw it all away," said Indian-origin chief Manhattan prosecutor Preet Bharara said in a statement.

"Having fallen from respected insider to convicted inside trader, Mr Gupta has now exchanged the lofty board room for the prospect of a lowly jail cell," he said.

Gupta was found guilty by a federal court in Manhattan on four counts, out of six. The court will pronounce the sentence on 18th October.

The conviction marks a tragic fall for the Kolkata-born financial wizard, who rose from a modest background to become a force to reckon with at the Wall Street.

The jury, which convicted one of the most prominent Indian-Americans in the US Rajat Gupta of securities fraud, said it wanted him to walk a free man after the trial, but the evidence against him and his "need for greed" was just too "overwhelming."

Jury foreman Richard Lepkowski, 51, who read out the verdict in court said he had not wanted to convict Harvard-educated Gupta of insider trading. He said Gupta was a person who came to the US and rose through the ranks. He led a "story book life" and had full support of the family as he saw during the trial.

Gupta was convicted on three counts of securities fraud and one count of conspiracy for passing confidential boardroom information about Goldman and Proctor & Gamble companies to the hedge fund that earned millions of dollars trading on his tips.

He was acquitted of two counts of securities fraud.

Reacting to the verdict by a 12-member jury, defence lawyer Gary Naftalis said he was disappointed that the jury convicted Gupta on four charges.

"This was only round one of the case and we would appeal if necessary," said Naftalis, adding they continued to believe that Gupta acted with integrity and honesty and never pocketed a dishonest dime.

Gupta's wife and four daughters broke down as the jury read out the sentence but Gupta was expressionless.

As the jury left the court room, Gupta hugged his family members. He did not talk to media as he walked out of the courtroom.

Naftalis said that he was "pleased" that at least Gupta was acquitted on one count of disclosing information about P&G.

The verdict is being regarded as a major victory for US prosecutors as the government drives to stop leaking of corporate secrets to Wall Street.

Gupta was found guilty for passing information about the $5 billion investment by Warren Buffett's Berkshire Hathaway Inc, and of providing information to Rajaratnam on 24 October 2008 about Goldman stock.

At the trial, Goldman Sach's chief executive Lloyd Blankfein testified that he had briefed his board members over the phone on the Buffett investment beginning at 3:15pm. Within a minute after the call with the directors concluded at 3:53pm, Rajaratnam answered a call on his private line from a McKinsey conference room being used by Gupta, according to phone records and testimony.

Rajaratnam then got off a call and hurriedly told a Galleon trader Ananth Muniyappa to buy Goldman Sachs stock, Muniyappa testified.

Galleon bought 267,000 shares. Prosecutors played a wiretapped recording of a Rajaratnam phone call from the next day.

"I got a call at 3:58, right?" Rajaratnam could be heard telling trader Ian Horowitz. "Saying something good might happen to Goldman."

Other evidence focused on Galleon's sale of 150,000 Goldman Sachs shares on 24 October 2008, when the bank was losing money while Wall Street expected a profit.

There were five security fraud charges and once conspiracy charge against him. Out of the five security fraud charges, he was found guilty on three and on the lone conspiracy charge.

FBI Assistant Director Janice K Fedarcyk said the verdict was a "milestone" in the agency's drive, initiated in 2007, against illegal conduct in the hedge fund industry.

"Rajat Gupta broke the law, plain and simple. Gupta used his exclusive access to the board room to violate his fiduciary responsibility, repeatedly sharing confidential, inside information with his friend Raj Rajaratnam," said Fedarcyk.

The high-profile trial of Gupta, who served on the board of Goldman Sachs and headed McKinsey & Co, began on 21st May and lasted for three weeks.

Securities fraud carries a maximum prison sentence of 20 years while conspiracy carries a five-year maximum prison sentence. Gupta will remain free on bail until his sentencing.

Much of the evidence against Gupta was circumstantial, including phone records that showed he promptly called Rajaratnam after receiving confidential information.

Gupta's defence, however, pointed out to the lack of direct evidence against him. They also told the court that Gupta had fallen out with Rajaratnam over a $10 million loss he incurred in investment with him.

Gupta's undoing began when his billionaire friend Raj Rajaratnam, a Sri Lankan, was charged by federal prosecutors of running of one of the biggest insider trading scams in US history.

Gupta met Galleon hedge fund founder Rajaratnam through another Indian-American McKinsey partner Anil Kumar.

Rajaratnam had made an anonymous contribution of a million dollars to the Indian School of Business, Hyderabad, which Gupta had co-founded with Kumar.

Together, they helped start New Silk Route Partners, a private equity firm focused on investments in India.

The two became friends and occasionally had lunch together, eating Indian takeout in Rajaratnam's office in Manhattan.

Rajaratnam is currently serving an 11-year prison sentence for making millions of dollars in profits and avoiding large scale losses thanks to confidential information he received.

In addition to Procter & Gamble and Goldman, Gupta was a director of the AMR Corporation, the parent company of American Airlines.

The Rockefeller Foundation appointed him a trustee; he was named an adviser to the former US President Bill Clinton and Bill Gates, Co-founder and Chairman of Microsoft, on their global health initiatives. He is also the co-founder of the Indian School of Business (ISB) in Hyderabad.

Gupta was also appointed as special advisor on management reform to then UN Secretary-General Kofi Annan. He additionally served on the UN Commission on the Private Sector and Development and was co-chairman of the United Nations Association of America.


Critical risk and issues in regulating bank business correspondents

The business correspondent model to financial inclusion can work, but since it transfers various types of risk, responsibility and management compliance to third parties, it requires appropriate regulation and supervision


With the ongoing bidding for the whole of India, the business correspondent (BC) model is surely on its way to become a pan-India effort of huge scale and deep penetration with regard to financial inclusion. While I am certainly not comfortable with the (low) bidding values and have discussed it in a previous article Business correspondent model at near-zero cost may fail with deep negative impact, I do however believe that the BC model can perhaps effectively serve the cause of financial inclusion if it is structured appropriately. That said, in my opinion, there are many risks and serious regulatory and supervisory issues that need to be addressed by the RBI for this to become a reality. The key ones are briefly highlighted hereafter.

Specifically, under the proposed BC model, a regulated entity (bank) is to use a third party (BC and its sub-agents) to perform activities on a continuing basis that would normally be undertaken by the regulated entity (bank)—in other words, it would outsource the activities to various kinds of business correspondents and its sub-agents.

Thus, in the business correspondent model, in effect, there is a transfer of an activity (or a part of that activity) from a regulated entity (bank) to a third party (BC and its sub-agents). There is no doubt that financial service businesses throughout the world are increasingly using third parties to carry out activities that they themselves would normally have undertaken. While industry research and surveys by regulators/others show financial firms outsourcing significant parts of their regulated and unregulated activities, especially because of cost and other considerations, there is no doubt that these outsourcing arrangements are also becoming increasingly complex and, as a result, causing problems on the ground as well.

The fundamental issue here is that such outsourcing by banks, as envisaged in the business correspondent model, has the potential to transfer risk, management and compliance to third parties (BC and their sub-agents) who may not be as well regulated and supervised—especially in line with the financial functions that they may be performing (which certainly calls for an appropriate kind of regulation/supervision).

Several concerns arise in this regard:

a.    In these situations, how can the regulator and/or the regulated financial service businesses (banks, in this case) remain confident that they are indeed in charge of their own business and in control of their business/other risks?

A look at the 2010 microfinance crisis in India suggests that neither the regulator/supervisor nor DFIs/banks were aware of any of the ground-level problems/happenings in Andhra Pradesh and their real causes. The presence of unscrupulous agents, rampant multiple lending, serious corporate governance violations, ghost clients and several other issues including violation of priority sector norms and the like were neither known/anticipated nor dealt with appropriately/nipped in the bud. This is a serious aspect that needs to be recognized by all stakeholders, including regulators/supervisors, and it calls for appropriate supervision arrangements with regard to the proposed business correspondent outsourcing activities as well. I am not sure whether these are in place and hence, my cautionary note with regard to the ongoing bidding which envisages upscaling of the business correspondents model. And let us not forget what happened when regulatory/supervisory arrangements (including the self-regulatory mechanism) with regard to microfinance were almost absent over a five-year period.

b.    How do the regulated financial service businesses (banks, in this case) know they are complying with their extant regulatory responsibilities as per the Banking Regulation Act and other periodic circulars and notifications? How can these regulated financial service businesses demonstrate that they are doing so when regulators/supervisors ask them?

Let us take the microfinance crisis as an example again. There were many serious violations with regard to KYC (know your customer) and, in many cases, the last mile end user clients were just not known. Imagine the consequences of this for the anti- money laundering regulations based on the global Financial Services Task Force (FSTF) recommendations. There have been many cases of lending to non-priority sector clients (including loans to founder directors) and there are no safeguards against these even as on date. Many a time, KYC forms have included people who are no longer alive. There is documentary evidence of several such cases in Andhra Pradesh and other states. Again, I am not sure that banks currently have the capacity and ability to ensure compliance in real time and therefore, I would like to stress that while arrangements like business correspondents (BCs) are upscaled, the banks, on their part, must also demonstrate the willingness and capacity to have appropriate supervisory mechanisms (for example, rigorous internal audits) in line with their regulatory responsibilities. We need commercial banks to be more accountable and transparent with regard to the regulatory responsibilities they are discharging. After all, they mainly intermediate public deposits.

c.    Most importantly, how can the regulated financial service businesses (outsourcing banks) assure themselves that their business correspondents (and sub-agents), who are 3rd parties, are not engaging in practices that could contribute to institutional and other failures including client level abuses?

Again, it was demonstrated during the recent microfinance crisis that banks and DFIs assumed that MFI practices were good on the ground and regulators/supervisors also did do. The consequences are out there for all of you to see and judge.

Therefore, I would really hope that there is serious regulatory and supervisory introspection into issues such as those given above while upscaling the business correspondent model. And before I sign off, I would like to leave you with a list of potential risks (certainly not exhaustive) in the business correspondent model for the benefit of banks and regulators/supervisors and I really hope that the banks and regulators devise appropriate strategies to mitigate these risks…

A)    Strategic Risk

1.    The BC (and/or their sub-agents) may conduct activities which are inconsistent with the overall strategic goals (of the outsourcing banks) with regard to financial inclusion. This is a very critical issue
2.    A second issue relates to the failure of the outsourcing bank to implement appropriate oversight with regard to activities outsourced to the BC and its sub-agents. This could arise also because of the fact that the outsourcing bank has inadequate expertise (for example in internal audits or compliance) to oversee the BC and their sub-agents. Here, one must not forget what the public sector banks have been saying with regard to the BC model and outsourcing in the recent times—“We need to work out a proper model. Public sector banks are poor in managing outsourcing as we don't have experience in outsourcing like our private peers. There are internal challenges as well as our employees did not accept this alternate channel of banking”—A Krishna Kumar, State Bank of India managing director .  

B)    Operational Risk     

1.    Since much of the present BC model hinges on use of technology, technology failure (at the level of the BC and their sub-agents) is a critical issue here. A related issue is the compatibility and integration of technology between BC (and its sub-agents) with that of the outsourcing banks    
2.    The BC and their sub-agents may have inadequate financial and other capacity to fulfil their obligations and/or provide remedies in case of serious frauds or errors. This again needs to be looked into, especially given the scale of operations envisaged and volume of money to be physically intermediated
3.    Further, given the proposed vast outreach of each cluster and the difficult physical terrains, the outsourcing bank and/or BC may find it difficult and costly to undertake rigorous internal audits and inspections. This needs to be evaluated and mitigated appropriately

C)    Compliance Risk     

4.    Processes, procedures, activities and practices at BC (and their sub-agents) are not in accordance with the stipulated processes, procedures, activities and practices of the outsourcing bank (which is a regulated entity and has to comply with prevailing laws as the Banking regulation Act)
5.    The BC and its sub-agents do not comply with confidentiality aspects and related privacy laws
6.    The BC has compliance systems and controls that are inadequate with regard to its sub-agents  
7.    In fact, all non-compliance brings a huge reputation risk as well

D)    Reputation Risk

8.    The BCs and their sub-agents provide poor service to their clients in terms of all features of service quality—level of service, consistency, timeliness, adaptability, etc
9.    Customer interaction and engagement by the BC and their sub-agents do not meet the overall quality levels of the outsourcing bank (which as a regulated entity is supposed to maintain as the BR Act and prevailing voluntary codes of conduct). Apart from quality levels, consistency is a critical issue here

E)    Exit Strategy Risk

10.    The risk that appropriate exit strategies are not in place is another key issue. This could arise from several factors: (a) over-reliance on one firm (like common BC and sub-agents for a cluster; (b) the loss of relevant skills in the outsourcing bank (s) themselves thereby preventing banks from bringing the activity back in-house at a later date; and (c) contractual terms that could make a quick exit prohibitively expensive. These need to be addressed as well

F)    Information and Access Risk

11.    Outsourcing arrangements like in the present BC model greatly affects the ability of the regulated entity (outsourcing bank in this case) to provide accurate, necessary and timely data/information with regard to financial inclusion to regulators/supervisors. The RBI needs to be aware of this critical risk and manage it appropriately
12.    When the BC and its sub-agents operate, there will be several additional layers of difficulty for the regulator/supervisor not only in terms of accessing accurate, necessary and timely information but also understanding the various activities of the BCs (and their sub-agents) in remote locations. That needs to be factored in as well in formulating regulatory/supervisory arrangements

G)    Systemic and Concentration Risk

13.    The financial inclusion industry (all banks together) has significant exposure to one or few BCs. This concentration could result in lack of control of individual banks over the concerned BC(s). Again, this needs to be assessed closely given what some of the public sector banks have been saying.
14.    Additionally, if the BC model were to become unsound, the few BCs together pose a huge systemic risk to financial inclusion and banking industry as a whole. This is especially true given the huge scale of operations and the large volume of money proposed to be intermediated

(Ramesh S Arunachalam has over two decades of strong grass-roots and institutional experience in rural finance, MSME development, agriculture and rural livelihood systems, rural and urban development and urban poverty alleviation across Asia, Africa, North America and Europe. He has worked with national and state governments and multilateral agencies. His book—Indian Microfinance, The Way Forward—is the first authentic compendium on the history of microfinance in India and its possible future.)


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