Rajat K. Gupta on Trial: The SEC’s Civil Complaint

On October 26, 2011, the day Rajat K. Gupta (“Gupta”) was arrested on five counts of securities fraud and one count of conspiracy to commit securities fraud, the Securities and Exchange Commission (“SEC” or “the Commission”) filed a civil complaint in the United States District Court for Southern New York, pursuant to its authority under Section 20(b) of the 1933 Securities Act and Section 21(d) of the 1934 Act. 15 U.S.C. § 77t(b), and 15 U.S.C. § 78u(d) respectively, alleging Gupta violated Section 10(b) of the Act, Rule 10b-5, and Section 17(a) of the Act.

The SEC brought suit against both Gupta and his alleged co-conspirator, Raj Rajaratnam (“Rajaratnam”). Rajaratnam was recently tried and convicted for insider trading; he was sentenced to 11 years in prison, and he received a $10 million fine, and a $53.8 million forfeiture. The complaint seeks permanent injunctions against Gupta and Rajaratnam, “enjoining each from engaging in the transactions, acts, practices, and courses of business…” The SEC seeks disgorgement of all profits and/or losses avoided. Gupta would also be barred from serving as an officer or director of any issuer that has a class of securities registered with the SEC or that is required to file reports and enjoined from associating with any broker, dealer, or investment advisor.

The complaint alleged an “extensive insider trading scheme conducted by Gupta and Rajaratnam.” The SEC alleged that Gupta disclosed material nonpublic information that he had access to as a result of his positions on the board of directors for Goldman Sachs Group, Inc. (“Goldman Sachs”) and The Procter & Gamble Company (“P&G”). Gupta allegedly called Rajaratnam on several occasions after board meetings, and Rajaratnam, as managing partner of large hedge fund investment company Galleon Management LLP (“Galleon”), would cause the fund to buy or sell shares to gain profit or avoid losses.

The complaint focuses on four alleged insider trading incidents. The first was trades that occurred before the $5 billion investment in Goldman Sachs by Berkshire Hathaway, which was publicly announced after market close on September 23, 2008. The SEC alleged that Gupta learned of the potential for the Berkshire investment during a board meeting on September 21, 2008. The next morning Gupta placed a four minute phone call to Rajaratnam’s office. Rajaratnam caused Galleon to purchase over 100,000 Goldman Sachs shares. The next day, September 23, Rajaratnam placed a call to Gupta’s office and then again directed Galleon to purchase 50,000 Goldman Sachs shares. A special telephonic meeting of the Goldman Sachs board was called at 3:15 p.m. on September 23, 2008. During the meeting the board approved the Berkshire investment and a public equity offering. Immediately after disconnecting from the board meeting, Gupta called Rajaratnam’s office. Just minutes before market close, Galleon purchased 217,200 Goldman Sachs shares. Goldman Sachs stock increased 6.36% the day following the announcement of the Berkshire investment. On September 24, 2008, Rajaratnam liquidated Goldman Sachs shares, generating $800,000.

The second alleged insider trading surrounded Goldman Sachs’ 2008 fourth quarter financial results. In October 23, 2008, during a telephonic board meeting, Gupta learned that Goldman Sachs was operating an estimated loss of $1.96 per share. Twenty-three seconds after disconnecting from the board meeting, Gupta placed a thirteen minute phone call to Rajaratnam. At the opening of the market the next day, Galleon sold all of this Goldman Sachs stock. Rajaratnam allegedly stated that he “heard the prior day from a member of the Goldman Sachs Board that the company was actually going to lose $2 per share.” Galleon avoided a loss of more than $3.6 million dollars by selling the Goldman Sachs shares before the public announcement of the quarter’s loss in December 2008.

The third insider trading alleged surrounded Goldman Sachs’ 2008 second quarter financials. One week before the announcement of Goldman Sachs’ financials, Gupta spoke with the company’s chief executive about the company’s strong financial position. Later that same night Gupta called Rajaratnam at his home. Minutes after the market opened the next day, Galleon purchased over 7,350 shares of Goldman Sachs stock. Over the next few days Rajaratnam purchased an additional 350,000 shares. Rajaratnam caused Galleon to sell call options, profiting by approximately $9.3 million. The following day after the announcement, Rajaratnam caused Galleon to sell Goldman Sachs shares, profiting by over $9 million.

The fourth alleged incident was based on P&G’s 2008 second quarter financials. On January 29, 2009, Gupta met telephonically with P&G’s Audit Committee and they discussed expectations for the company to grow 2-5% in the fiscal year. That afternoon, Gupta called Rajaratnam. Rajaratnam allegedly stated that “he had learned from a contact on Procter & Gamble’s Board that the company’s organic sales growth would be lower than expected.” Galleon then sold short 180,000 P&G shares. After the public announcement stock declined 6.39%, resulting in $570,000 of avoided loss.

As a director, Gupta owed fiduciary duties to Goldman Sachs and P&G. Disclosing material nonpublic information about the companies would constitute a breach of the fiduciary duty of confidentiality. Additionally, Goldman Sachs’s guidelines provided that board meetings were confidential, and directors who had knowledge of material nonpublic information were prohibited from buying or selling the company’s stock or recommending others do so. P&G’s policy prohibited directors in possession of material nonpublic information, from conveying the information to others.

The primary materials for this case may be found on the DU Corporate Governance website.