This article was originally written for and featured in InCOMPLIANCE.
On 15 June 2012, Rajat Gupta, the once highly esteemed retired chief executive officer of McKinsey & Company and a former director of Goldman Sachs, was convicted, after fewer than 10 hours of deliberation, by a federal jury in New York on three counts of securities fraud and one count of conspiracy (he was acquitted of two other counts of securities fraud because the evidence in support was not presented to the Court).
This case generated headlines across the world, but garnered particular interest in Wall Street, the City of London and India, not only because of the rags to riches rise of Mr Gupta but also due to the fact that the US federal prosecutors won the case based largely on circumstantial evidence.
The facts of this case began in April 2010, during the investigation by the FBI into the activities of billionaire hedge fund manager, Raj Rajaratnam, who was found guilty in May 2011 for 14 counts of conspiracy and securities fraud and subsequently sentenced to 11 years in prison and fined over US$150 million. Prosecutors believed that Mr Gupta used his position at Goldman Sachs to disclose to Mr Rajaratnam that Berkshire Hathaway was planning to invest in US$5 billion in Goldman Sachs. That inside information (allegedly gained by Mr Gupta during a Goldman Sachs board meeting on 23 September 2008) enabled Mr Rajaratnam to purchase Goldman Sachs shares before the news was made public, resulting in a profit for Mr Rajaratnam of US$800,000. In March 2011, the US SEC brought charges against Mr Gupta in an administrative proceeding for his involvement with Mr Rajaratnam’s insider dealing. Mr Gupta then countersued and eventually both sides dropped hands. However, later that year, on 26 October 2011, the US attorney brought criminal charges against Mr Gupta, alleging that he tipped off Mr Rajaratnam in relation to the Goldman Sachs information and also for passing on inside information in relation to Procter and Gamble, on whose board he sat from 2007 to March 2011.
What makes Mr Gupta’s case stand out is the reliance by the prosecution on circumstantial evidence. According to Mr Gupta’s attorney, Gary Naftalis: “they found no real, hard, direct evidence” of insider trading. The mountain of evidence relied upon comprised witness evidence that Mr Gupta had access to confidential information, evidence that Mr Gupta had contacted Mr Rajaratnam prior to large, unusual but successful trades, and recordings of two calls on 29 July and 23 September 2008 between Mr Gupta and Mr Rajaratnam. The telephone call of 29 July records general observations about a Goldman Sachs board meeting in which the prospect of Goldman Sachs buying a commercial bank were mooted. No recording exists of the telephone call on 23 September. The only other evidence was the a recording of a wire-tapped conversation between Mr Rajaratnam and a co-conspirator in which Mr Rajaratnam stated that he had the benefit of inside information from a Goldman Sachs board member.
Mr Rich Lepowski, the foreman of the jury that convicted Mr Gupta, has been widely reported in the American press as saying: “on the counts we convicted, we felt there was enough circumstantial evidence that any reasonable person could make that connection,” although he also reports that: “we looked at him and what he had done professionally. We were hoping he would walk out of this courthouse.” The press also described how the decision left some jurors demonstrably upset with several members of the jury weeping as the verdict was read out.
Commentators have analysed this case as being a great victory for the US prosecuting authorities and is likely to encourage the prosecution of more insider dealing cases. The US is widely recognised as being the leading country in prosecuting insider dealing. Recent years have seen some of the biggest cases insider dealing cases in US legal history. Some put this down to the zeal of Preet Bharara, the US Attorney for the Southern District of New York, who, earlier this year, was named by Time magazine as one of the most 100 influential people in the world. Mr Bharara is quoted as saying that the cases he has prosecuted have “reaffirmed his office’s leading role in pursuing corporate crime [relying] on aggressive prosecutorial methods and unprecedented tactics.”
Across the Pond
But what of the attitude on this side of the pond? Insider dealing has been a criminal offence in the UK since 1980 and the relevant legislation can be found in Part V of the Criminal Justice Act 1993. Section 118 of the Financial Services and Markets Act 2000 (“FSMA”) creates parallel civil penalties for insider dealing and market abuse . Both the FSA and the Department of Business Innovation and Skills have the power to investigate and enforce those provisions, but primary responsibility rests with the FSA.
Overall, the view of the authors is that whilst historically only a very few cases have been successfully prosecuted in England and Wales, there is now a much greater appetite on the part of the FSA to investigate forcefully and uncompromisingly instances of suspected insider dealing which has resulted in corresponding increase in the number of successful prosecutions. A recent high-profile success for the FSA is conviction in July of six individuals: Ali Mustafa, Pardip Saini, Neten Shah, Bijal Shah, Paresh Shah and Truptesh Patel who obtained inside information from a print-room at JP Morgan in relation to takeover and other such market-sensitive information.
Tracey McDermott, acting director of the FSA’s enforcement and financial crime division, commented on the successful prosecution: “this is another significant milestone in our fight against insider dealing. It demonstrates that we can successfully present the issues in a long and complex case so that a jury understands them and has the confidence to convict criminals involved in insider dealing rings.”
Ms McDermott’s comment is interesting in that it highlights the importance of ensuring that sufficient evidence is obtained which is presented in such a way that the jury can understand what can be exceptionally complicated factual and legal issues. This is one of the reasons why the FSA has in the past preferred to pursue cases under section 118 of FSMA: because there is no jury to persuade (there is also interesting academic debate as to whether the lower civil burden of proof (on the balance of probability) needs to be met rather than the much stricter criminal standard (beyond reasonable doubt) – there is an argument that a higher burden of proof needs to be met in matters involving fraud). However, that is led the FSA to bear the brunt of much criticism as it has been considered that the criminal penalty for insider dealing of imprisonment and a fine is much more likely to act as a deterrent than a civil prosecution. Indeed although the FSA was delegated criminal prosecution powers in 2001, it only secured its first criminal conviction for insider dealing some eight years later in 2009.
The reason why the FSA has found it difficult to prosecute insider dealing cases is a practical matter of cost. Inside dealing cases are extremely time-consuming and expensive to investigate. It was reported that Messrs Mustafa, Saini, Shah, Shah, Shan and Patel collectively made a gain of £730,000. That sum was less than 15 per cent of the cost of the FSA investigation and prosecution.
Moreover, to an American, our legislature and judiciary would also seem ostensibly to have a more lax approach to insider dealing. By way of example, the maximum sentence in the UK for insider dealing is seven years. Contrast the fate of Christian Littlewood, a banker at Dresdner Kleinwort who has given a 40 month prison sentence with that of Mr Gupta who may well spend the rest of his life in prison (the sentence is due to be handed down in October 2012, although an appeal is likely).
Added to that is the fact that under current UK legislation, wire-tap evidence cannot be obtained lawfully, although FSA regulated firms must record all telephone conversations and electronic communications relating to client orders and the conclusion of transactions, and such evidence has been invaluable in obtaining successful prosecution, such as that of James Sanders of Blue Index. Mr Sanders received the longest ever UK insider trading sentence, and much of the evidence came from two years worth of telephone calls.
Firms and individuals can take steps to protect themselves from ill-founded charges of insider dealing and market abuse. The actual mechanics can be difficult but in essence, firms should, for example, ensure that information is only disseminated on a strict need to know basis, that e-mails and telephone calls should be monitored by the firm (in accordance with well drafted employment policies) to ensure that staff act within strict guidelines about the dissemination of information and that any third parties involved in market sensitive activities, such as print-rooms, are carefully vetted.