Rajat Gupta and Goldman's Insider Trading Bombshell

Rajat Gupta was trusted by McKinsey, Goldman, and AMR. But the SEC says he shared insider secrets so a hedge fund could make millions improperly in the market. Allan Dodds Frank reports.

03.02.11 6:52 AM ET

The reputation of McKinsey, the world’s most important consulting firm, is built on the perception that its high-priced consultants are the brightest and most trustworthy group available anywhere. Now Rajat Gupta, who served as McKinsey’s global managing director for nearly a decade, is enmeshed in Wall Street’s biggest insider trading scandal ever.

The ultimate kings of capitalism—Warren Buffett’s Berkshire Hathaway and the boards of directors of Goldman Sachs and Procter & Gamble—are the latest alleged victims of a vast insider-trading ring that penetrated Wall Street during the last decade.

Perhaps most shocking is the allegation that the Judas who betrayed the royal court of corporate America during the economic turmoil of late 2008 was Rajat K. Gupta, the now 62-year-old, much celebrated, international business leader who ran McKinsey from 1994 to 2003.

At McKinsey, the spokeswoman Yolande Daeninck, put out a statement that reads like a spiritual obituary and puts Gupta clearly in McKinsey's past tense: "We were saddened to learn about the civil charges against our former colleague."

According to the Securities & Exchange Commission administrative filing, Gupta—as a board member of Goldman Sachs—learned on Sunday, Sept. 21, 2008, that Berkshire Hathaway chairman Warren Buffett was going to pump $5 billion into Goldman during Wall Street’s dark hours barely a week after the collapse of Lehman Brothers.

“Mr. Gupta was honored with the highest trust of leading public companies, and he betrayed that trust by disclosing their most sensitive and valuable secrets,” said SEC director of enforcement Robert Khuzami in a statement.

Galleon made more than $14 million in profits and avoided more than $3 million more in losses, allegedly thanks to Gupta’s information about the Berkshire deal and Goldman’s quarterly earnings.

On Monday morning Sept. 22, 2008, the SEC says, Gupta “very likely” had a telephone conversation with Galleon Hedge Fund founder Raj Rajaratnam—the Sri Lankan-born leader of the alleged insider-trading ring. Not long after that call, Galleon bought more than 80,000 shares of Goldman Sachs. The next morning, before any announcement of the Berkshire deal had been made public, Rajaratnam called Gupta for 14 minutes. “Less than a minute after the call began,” says the SEC, Galleon bought 40,000 more Goldman shares.

Ultimately, Galleon made more than $14 million in profits and avoided more than $3 million more in losses, allegedly thanks to Gupta’s information about the Berkshire deal and Goldman’s quarterly earnings. Galleon allegedly earned another half million dollars on inside information from Gupta about P&G’s earnings.

The SEC action was unusual—filed as an administrative proceeding to be heard by an administrative judge, rather than as a civil suit that might be tried before a jury in U.S. District Court. Many SEC civil actions are accompanied by criminal charges filed by Justice Department prosecutors who usually allege a similar—if not identical—set of facts.

The Galleon criminal investigation—called the largest insider trading case ever by prosecutors—involves thousands of wire-tapped calls, and although, there have been mentions of calls involving Gupta, it may be none of the calls mentioned in Tuesday’s filing were recorded. The evidence, at least what has been revealed so far, seems to be based on telephone records that show the timing and duration of calls; not what was said on them.

Gary Naftalis, a onetime federal prosecutor who has been a top-ranked defense attorney for more than three decades, represents Gupta. Born in Calcutta, India, Gupta earned a degree in mechanical engineering at the Indian Institute of Technology in New Delhi and an M.B.A at Harvard before starting at McKinsey in 1973.

In a statement, Naftalis said: “The SEC allegations are totally baseless. Mr. Gupta’s 40-year-record of ethical conduct, integrity, and commitment to guarding his client’s confidences is beyond reproach. Mr. Gupta has done nothing wrong… 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.”

Rajaratnam goes on trial in federal court in New York March 8 and several news organizations quoted his lawyer, John Dowd, as saying the SEC attack on Gupta was “simply an effort to destroy a favorable witness. There is no case, absolutely none. No conversations, no benefits, no nothing.”

No criminal charges have been filed against Gupta, and as things stand now, he would face a fine if he lost the administrative proceeding and elected not to appeal.

The SEC says Gupta had money invested with Galleon’s founder, although Naftalis says his client lost $10 million in a Galleon Fund, proving that insider trading was not driving his actions. The SEC also says Gupta and Rajaratnam were partners in an investment firm called “ New Silk Route Partners.”

When elected Managing Director of McKinsey in 1994, Gupta was hailed in the Indian magazine Business Today as “the first-ever India-born CEO of a US transglobal corporation.” After stepping down as Managing Director in 2003, Gupta spent four years as a senior partner before departing McKinsey and joining the boards of Goldman, P&G, and AMR, the parent company of American Airlines. He also served as a trustee or advisor to other significant non-profit institutions, including the University of Chicago, the Rockefeller Foundation and the United Nations.

In the highest circles of international business, from the ski slopes of Davos to the maharajahs of Indian commerce, Gupta had unprecedented access, a high-ranking consultant to CEOs and Fortune 100 company boards tells The Daily Beast. “There are not many consultants on major boards like that, so he is unique in the trust they had in him.” About the damage this allegation could do to corporate chieftains’ perceptions of McKinsey, he says: “A consultant’s reputation is very much based on their ability to keep confidential information sacred. If you can’t trust a strategy consultant to do that, then what can you trust them to do?”

As a co-founder of the Indian School of Business in Hyderabad in the 1990s, Gupta became acquainted with Rajaratnam, a major donor. Another co-founder of the school, Anil Kumar, was a partner at McKinsey from 2003 to 2009 when he fed inside information about technology companies to the insider-trading scheme. As part of the Galleon case, he pleaded guilty to two counts in January 2010 and still awaits sentencing. Should Gupta be charged in a criminal case, Kumar might be a key witness.

The accusation of insider trading against Gupta reverberates through the small, close-knit world of Indian-born CEOs who run multi-national corporations in the United States. Two of them: Vikrim Pandit, the CEO of Citigroup and Indra Nooyi, the Pepsi CEO who was a onetime consultant for two of McKinsey’s competitors, each run companies that have been McKinsey clients. Then there is Ajit Jain, a highly regarded Berkshire Hathaway executive who also is a Harvard Business School graduate and former McKinsey consultant.

Even though he was no longer the global boss at McKinsey when his alleged tipping to insider traders took place, the charges against Gupta still cast a shadow on McKinsey culture. For three, three-year terms as the elected top executive of a company that operates in more than 50 countries, Gupta was the man promulgating corporate culture. Even now, the company website, in a section about “keeping clients’ trust” quotes Gupta praising Marvin Bower, the man regarded as the founder of the modern McKinsey.

How these charges against Gupta might affect McKinsey is not clear. The consultants there make much of their multi-million dollar fees helping the likes of Goldman Sachs and P&G in three stages: 1. Thinking of strategies that lead to reasons for buying or spinning off assets. 2. Putting together the merger and acquisition deals and 3. Handling the post-merger integration of companies.

McKinsey clients who are unhappy may find the competition—Boston Consulting Group, Bain, Oliver Wyman and Booz Allen Hamilton—already fully booked.

One former McKinsey consultant says: “The pipeline of IPOs and M&A deals at most investment banks is huge right now. They are all anticipating it is going to coming flooding out soon.” Each stage, the McKinsey alum notes, is rife with potentially valuable information for insider traders. Now comes the question about what lip service consultants will pay to assure clients their secrets are safe from the information predators on Wall Street.

Allan Dodds Frank is a business investigative correspondent who specializes in white collar crime stories. He also is the former president of the Overseas Press Club of America.