The hedge-fund scandal rocking Wall Street

Stellar names from US corporate life have been dragged into the prosecution of an alleged insider-dealer ring. Sean Farrell reports

Saturday 05 March 2011 01:00

One of Gordon Gekko's catchphrases from the original Wall Street film holds just as true today as it did in 1987. "The most valuable commodity I know of isinformation," Gekko told his minion.

Now the passing of inside information about companies is at the heart of a US investigation that this week moved from the opaque world of hedge funds to draw in the great and the good of American corporate life.

The story centres on Raj Rajaratnam, the billionaire who ran Galleon, once one of the world's biggest hedge funds. Mr Rajaratnam was arrested by the FBI in October 2009 and charged with making millions of dollars from trading on inside information about companies including Google and Hilton Hotels. Prosecutors said his arrest with five alleged conspirators had uncovered the biggest insider-trading ring linked to a hedge fund.

The US Securities and Exchange Commission (SEC) now claims that one of Mr Rajaratnam's key sources was Rajat Gupta, whose high-flying career as the former boss of the world's leading management consultancy, McKinsey & Co, secured him directorships of corporate giants Goldman Sachs and Procter & Gamble (P&G).

The SEC stunned the financial world on Tuesday with details of its civil charges against Mr Gupta; it accuses him of leaking highly sensitive information about Goldman and P&G to his friend Mr Rajaratnam.

The watchdog alleges Mr Gupta benefited from Galleon's bets through investments in the fund. Mr Gupta's lawyers say the SEC charges are baseless and that he lost his $10m (£6.2m) investment in a Galleon fund. Now, with the former Galleon boss's trial due to start on Tuesday, Goldman boss Lloyd Blankfein has agreed to testify if called for the prosecution as the authorities seek to establish the links between Mr Rajaratnam and Mr Gupta.

Goldman declined to comment.

The most startling SEC charge is that Mr Gupta called Mr Rajaratnam immediately after a Goldman Sachs board meeting in September 2008 at which the investment bank approved a $5bn investment by Warren Buffett's Berkshire Hathaway.

The vote of confidence from the world's canniest investor at the height of the crisis boosted Goldman's shares. That price movement made Galleon more than $900,000 on the shares Mr Rajaratnam bought one minute after Mr Gupta's call, the SEC claims.

Mr Blankein himself was included in the SEC's account of Mr Gupta's activities. After discussing Goldman's second-quarter results for 2008 with the bank's boss, Mr Gupta took part in "a flurry of calls" with Mr Rajaratnam that netted Galleon more than $13m of illegal profit on hundreds of thousands of Goldman shares bought after their conversations.

Mr Gupta's reputation and contacts also got him a place on the board of Proctor & Gamble, another of the grandest of US corporate names. The SEC alleges Mr Gupta tipped Mr Rajaratnam off that the maker of Head & Shoulders' fourth-quarter results would disappoint, prompting his friend to short the shares and reap almost $600,000, the SEC says.

Mr Gupta resigned from the P&G board on Tuesday.

As well as his Goldman and P&G directorships, Mr Gupta, 62, hasadvised the United Nations Secretary General on management reforms and is chairman of the International Chamber of Commerce.

To top off his credentials, he chairs the global development advisory panel for the Bill & Melinda Gates Foundation.

Peter Hahn, a former US investment banker who is now a lecturer at Cass Business School, said: "We continue to see that the great and the good have feet of clay like everybody else. You can't assume that because someone has achieved a lot in their career it implies more about their conduct.

"It is extraordinary to find things like this leaking out of a board. It's an extraordinary situation and it has reputational damage that will be hard to repair for all those associated with it."

When Mr Gupta joined the Goldman board as an external director in late 2006, Mr Blankfein praised him as a "valued source of counsel toinstitutions, governments and business leaders around the world".

Goldman announced in March 2010 that Mr Gupta would stand down from the board without giving a reason, but a month later it emerged the SEC was looking into his contacts with Mr Rajaratnam.

For McKinsey, the case against Mr Gupta is a second blow from the Galleon affair. The consultancy was forced to defend its reputation in 2009 when Anil Kumar, one of the firm's partners, was arrested for passing information about clients to Mr Rajaratnam.

None of the SEC's claims about Mr Gupta cover the time before he left McKinsey in 2007 but he was the firm's standard bearer and a confiidante to top chief executives for many years. Any suspicion that he was tempted to discuss McKinsey clients with outsiders could damage the global constultant's brand.

McKinsey's global managing partner, Dominic Barton, worked the phones to reassure clients when Mr Kumar was arrested and will no doubt have been in similar crisis mode after his former boss was accused of illegal indiscretions.

A McKinsey spokesman says: "We are saddened to learn about the civil charges brought against our former colleague."

The SEC's crackdown on hedge funds has caught dozens of alleged wrongdoers. The US market watchdog went to unprecedented lengths such as wiretaps to quash the usual claims that suspiciously timed market bets were flukes by pinning down who traded when – and why.

If the regulators do manage to nail the elusive insider dealers, they will have taken a leaf out of Gordon Gekko's book, As Michael Douglas said on screen all those years ago: "I don't throw darts at a board. I bet on sure things."

Fratricide in Federal Court

Raj Rajaratnam's trial, which starts on Tuesday in a Manhattan federal court, will see a cast of former friends, colleagues and contacts testifying, with many taking the stand against him.

The highest-profile person involved is Rajat Gupta, above left, the former head of McKinsey. Others included hedge fund managers and senior executives at some of the biggest US companies.

Rajaratnam attended the elite Wharton Business School with alleged conspirators Rajiv Goel, above centre, a former Intel executive, and former McKinsey partner Anil Kumar, above right. Both are cooperating with prosecutors against him.

Another former Intel employee Roomy Khan, also known as Tipper A, started helping prosecutors prepare a case against Rajaratnam in 2007. Robert Moffat is serving six months in prison for leaking information about a former employer to a Rajaratnam hedge fund contact Danielle Chiesi, whom Moffat accuses of "playing him" for tips during an "intimate relationship". Chiesi is not cooperating with Rajaratnam's prosecutors after pleading guilty to securities fraud.

Join our new commenting forum

Join thought-provoking conversations, follow other Independent readers and see their replies

View comments