Floating like a butterfly and stinging like a bee, habitual punters with the right dose of guile and guts slip information and trespass insider trading norms with impunity and rob the investing public. Is this something new?
Insider trading has suddenly become headlines news in India not because the Securities and Exchange Board of India (SEBI) unearthed and prosecuted high profile perpetrators. But the new case of Rajat K Gupta, the former head of McKinsey and that of Raj Rajaratnam of Galleon and others have brought sharp focus back into this age old malaise which courts have judged as “fraud akin to embezzlement”.
I was pondering over the recent trial and conviction of Mr. Rajat K Gupta who was a role model for many. In India he had an image that was considered impeccable. He was secretly admired and some even judged him to be a paragon of virtue and a huge success considering his background, having lost both his parents as a teenager, living alone with his siblings, earning a scholarship, then to study at IIT Delhi and later graduate from Harvard to join McKinsey, the prestigious consulting firm and then to be elected and elevated to the level of Global Managing Partner; A lot of real hard work and phenomenal tenacity. He truly became a “trusted advisor” No mean achievement. What more did he want out of life?
Are trusted advisors being busted with a vengeance? Do you remember the meteoric rise of Enron which was headed by Jeffrey Skilling, a Harvard Business School Graduate and who worked for McKinsey for over 10 years? He was convicted of multiple federal felony charges for Enron’s financial collapse and is currently serving a 24-year, four-month prison sentence at the Federal Correctional Institution in Englewood, Colorado. In the days when Enron collapsed, many suggested that McKinsey may have planted the rogue seed known as “atomising” – attacking and atomising traditional industry structures. It is another matter that Enron collapsed while Mr. Gupta was at the helm and he certainly may not have even in his wildest dreams thought that he will one day face prosecution for an entirely different issue. When an elephant falls, smaller creatures get crushed. Andersen, one of the largest accounting firms too collapsed for the sin of auditing (or not auditing) Enron. That firm was wiped out of the business map.
I haven’t met Mr. Rajat Gupta. But I have met and interacted with two other very senior partners of McKinsey and co-founders of the Indian School of Business. They adored him like many others in India and the world over. One of them, of Indian origin, was involved in this very insider trading case, but pleaded guilty and testified on behalf of the prosecution which also contributed its mite to critically damage his once upon a time boss Gupta’s case. Like the Rajat Gupta Jury foreman Richard Lepkowski, I also wanted to believe that the allegations levelled against Mr. Gupta weren’t true. His professional image and education mirror well in his personality and his impeccable dress. I don’t know if it is fair to say that somehow you don’t get that feeling when you look at Rajaratnam. Mr. Gupta’s father was a journalist in India and a freedom fighter who had gone to jail many times for an entirely noble cause for the sake of the country. Is it sad that his parents didn’t live to see their illustrious son rise to starry heights but who knows it may be a blessing in disguise that they did not have to see this self made man and millionaire go to jail for felony. His personal banker testified at the trial that his client was worth US $84 million. The 12 jurors have convicted Mr. Gupta of one count of conspiracy and three counts of securities fraud. Mr. Gupta can get prison terms of up to 20 years. He is now 63. How did he get into trouble like this? Why did he choose to partner with slimy fellows like Rajaratnam and others? What was his motive?
Judge Jed Rakoff allowed Mr. Gupta’s team to present limited testimony relating to his character. Two of his Indian friends testified for him before the jury about Mr. Gupta’s character. There is even a website called Friends of Rajat where some prominent people have stood by him. But there are many names that are conspicuous by its absence in this website. When Mr. Gupta’s propensity for philanthropic exuberance was arrayed at the proceedings, this Judge seems to have said “If Mother Teresa were charged with bank robbery, the jury would still have to determine whether or not she committed a bank robbery,”
The interesting question that arises here is about character and conduct. Are they two different things? A simple question but not so simple if one was to examine the nuances. Conduct is defined as the way a person acts, the manner in which a person behaves, especially in a particular place or situation. Character is the mental and moral qualities distinctive to an individual. Abraham Lincoln said “Character is like a tree and reputation like its shadow. The shadow is what we think of it; the tree is the real thing “. When we say – in (or out of) character – it means “in keeping (or not in keeping) with someone’s usual pattern of behaviour and motives: (for example, his outburst was entirely in character). A person may have an exemplary character but his conduct or behaviour sometimes may be out of character. But in legal parlance, even if you have a good character, if your conduct trespasses the line, you will be prosecuted. Again we shouldn’t mistake personality for character!
Sometimes we tend to put some people on a pedestal and may be they do not belong there. Listen to this 18 minutes FBI wiretap of a conversation between Mr. Gupta and Rajaratnam (founder of Galleon Group). This is now in the public domain. No wonder, one of the jurors said that Rajaratnam is the “snake in the grass”
I was earlier closely following the insider trading cases against Mr. Raj Rajaratnam and Mr. Anil Kumar (of McKinsey). But once you read the sealed indictment in the case – United States of America Vs Rajat K Gupta 11 CRIM 907 – U.S. District Court, Southern District of New York – the facts are telling and even if you are an ordinary member of the jury, a common man with all the sympathy at his command for a handsome man with a wonderful family, it will be very difficult to ignore these evidences. You can see the copy of this indictment which is now publicly available. Consider a sample of this
“Gupta obtained the Inside Information in his capacity as a member of the Goldman Sachs and Procter & Gamble board. In violation of duties of trust and confidence that Gupta owed to Goldman Sachs and Procter & Gamble, and their respective shareholders, Gupta disclosed the inside information to Rajaratnam, with the understanding that Rajaratnam would use the inside information to purchase and sell securities”.
The US Attorney Mr. Preet Bharara has made some sharp and compelling remarks that can pierce through even the thick skin of a rhinoceros. He said “Violating clear and sacrosanct duties of confidentiality, Mr Gupta illegally provided a virtual open line into the board room for his benefactor and business partner, Raj Rajaratnam.” He also went on to say “ Having fallen from respected insider to convicted insider trader, Gupta has now exchanged the lofty board room for the prospect of a lowly jail cell”. Very sharp words indeed!
What is this insider trading? Insider trading of a prohibited variety is a financial crime. Yes there is a permitted variety which is legal where corporate insiders like officers, directors and employees buy or sell stocks of their own companies within the regulatory framework for such trades. According to SEC one must follow the “disclose or abstain rule”. Therefore, insiders who are in possession of material non-public information must disclose before trading or refrain from trading until the information is publicly circulated.
The simple principle of prohibited insider trading is that it is detrimental to market integrity. The rule enunciated by Courts in the US is that “no one should be allowed to trade with the benefit of inside information because it operates as a fraud on all other buyers and sellers in the market”
The court further laid down that “the undisclosed misappropriation of confidential information in violation of a fiduciary duty…constitutes fraud akin to embezzlement “
Many of the insider trading prosecutions by SEC also included directors, auditors, in-house counsel and audit committee members. Prosecution included allegations that a board member who was privy to a potential acquisition erred, an attorney who was involved in the due diligence of the deal slipped vital information, an audit committee member tipped his close friend on earnings shortfall of the company, a general counsel of the company traded on insider information, two former auditors were caught for trading in shares of audit clients and the list goes on. If anyone of you reading this is an independent/professional director on the board of any listed company, please re-evaluate your risks. Read my Ten Commandments for Directors. Others who are in possession of insider information, beware, you are carrying a potentially dangerous detonator. Often many people foolishly display their “bravo” in the midst of “big” people just to gain attention and boost their own “ego”.
The Oscar winning movie “Wall Street” was modelled after Ivan Boesky, the world’s most (in) famous arbitrageur who was on the cover page of the Time magazine in 1986. He illegally obtained tips about mergers on the horizon through a network of contacts and began trading before mergers became public knowledge. He made several hundreds of millions most of which he lost as fine to SEC and then spent a prison term for about two years. Who knows twenty six years later the TIME magazine may put this high profile Indian – Mr. Rajat Gupta on their cover.
In an interesting case Chiarella v. United States, a financial printer’s conviction that he misappropriated non-public information on a certain merger from documents given to him for printing and used it for his gain was reversed by the Supreme Court. In response to this decision, the SEC plugged the rules. Printers who are privy to such non public information could well be soft targets by the operators who are sly and have the nerve. I am not aware if any printer has been caught again for insider trading. I mean in the US.
In India, the Securities Exchange Board of India (SEBI) has the power to prosecute offenders who violate the provisions relating to insider trading and who deal in securities in contravention of the provisions of the regulation. It is interesting to note that the Board has the right to investigate suo motu upon its own knowledge or information in its possession to protect the interest of investors in securities against breach of these regulations. Schedules I & II of these regulations have certain model code of conduct and disclosure practices that are required to be followed by a number of specified parties and that list includes all the professional firms such as auditors, accountancy firms, law firms, analysts, consultants, etc., assisting or advising listed companies.
Professional firms that do legal services, due diligence work, internal audit, statutory audits, consulting work for mergers and acquisitions, valuations etc. all have potentially price sensitive information and it is naive to assume that there are no punters or their friends in and around these entities who scavenge for sensitive information from willing employees. And in today’s time when people want to get rich quick, the temptation to exploit by those who have access to sensitive price information is too much to suppress or resist especially when they bask under the belief that they cannot be caught or will never be caught.
The SEBI regulations make a mention of the so called Chinese wall (it is considered a legal flotsam and now a day’s the term is ethical wall or screening devices). This wall has pores and is farcical in today’s world of high tech communications and loose data protection laws in the developing world. The decision in the famous case of Chinese wall in Brunei – Prince Jefri Bolkiah Vs KPMG gives an interesting insight into the world of conflicts of interest and confidentiality.
The prevention of insider trading is widely treated as an important function of securities regulation. It is one thing to have a set of regulations in place yet another to have the skill, will and the means to implement them to protect investors.
Unlike anywhere else in the world, the US regulations on insider trading and their knack to prosecute offenders by peeling layer after layer of evidence are remarkable. In spite of all these persistent efforts, SEC is still under fire for many scandals in the US including the Madoff Ponzi Scheme. With a huge workforce (it has some 3500 staff!) and surging work load, its annual budget for 2012 is a whopping US$1.321 Billions.
Compare this to what SEBI has, just 583 staff ( about 25% of which are secretaries and other staff) to deal with multifarious activities that it does with stock exchanges, stock brokers and sub-brokers, mutual funds, venture capital funds, portfolio managers, not to speak of dealing with a vibrant investing population that relies more on tips and tippers than anything else. I could not find any financial data in their 2010-11 annual report. But a focussed search revealed that their budget estimate for 2011-12 is a meagre Rs. 160 crores for revenue expenditure and Rs. 217 crores for capital expenditure. Put together that is some meagre $69 Millions.
For 2010-11 as per SEBI’s website, the number of insider trading investigations taken up was just 28 and only 15 of them were completed. This is dismal performance and all those who get away with slipping insider information and those who merrily use them will laugh at this. It is time SEBI got some serious funding to acquire appropriate technologies and talents. It must enhance its monitoring mechanisms to garner its own intelligence to initiate suo moto action as proclaimed in regulation 5(2)(b). Simply updating these rules and regulations now and then may be of no use. It should get high tech and partner with professionals to use appropriate data mining, analytics and surveillance tools to detect and prosecute operators that are suspected to be involved in insider trading. With a whopping Rs. 25 crores penalty( about US$ 5 Million) that it can impose, the investment in skill and technology will pay handsome dividends.
Since 2007, the federal authorities in New York have charged 68 people for insider trading and to date 62 people have been found guilty. That is a 91% conviction. Rajat K. Gupta is awaiting sentencing. It is scheduled for mid October 2012. It is alleged that Galleon earned or saved more than $16 Million from Gupta’s tips. Legal pundits believe that it is highly unlikely that the appeal by Rajaratnam challenging the legality of wiretaps used against him and others will yield any relief.
It is hard not to harbour thoughts that if Mr. Gupta and his friends were in India, they may never have been caught and even if caught, they could have easily slipped through unless they did something of gigantic proportions. One cannot be so sure and it is not so simple any more in India. But it must be said to the credit of Mr. Gupta that he went through this whole agonising process with a sense of dignity and deportment. Mr. Gupta was perhaps not clever enough to pay a fine and get out of this like his protégé who paid something like US$ 2.5 Millions and became a prosecution witness against his own boss.
Some people have written that he was so emotionless during the trial that even if the jury was willing to be emotionally moved, he did not give them any opportunity to be influenced. Perhaps his personality weighed against this possibility. Unlike the late Rajan Pillai he did not run away to India. I cannot forget the “wasted death” of biscuit king Rajan Pillai who met with his end in Tihar Jail, a Delhi prison on 7th July 1995. His was not an insider trading case but one of near bankruptcy that forced him to flee Singapore and take refuge in India. But alas, a red alert notice awaited him and he was nabbed in a hotel in Delhi to be incarcerated in the prison. Nearly after 16 years, the Delhi High Court held the state liable for his death and awarded a compensation of Rs. 10 Lakhs ( some US $ 20,000). A recent Right to Information (RTI) action has revealed that there are about 650 live red alert notices against Indians. None of them are being hunted down like they did in the case of Rajan Pillai. Delhi’s inner circles silently murmur of a plot to “finish him off”. Few lived like him and none died like him was the thought echoed at a book release titled Wasted Death on Rajan Pillai. Remember Harshad Mehta; he too died inside the prison for securities fraud.
Is it a coincidence that Rajan Pillai, Rajat K. Gupta, Raj Rajaratnam and recently Raja all share somewhat a common name?