SEC’s boardroom bombshell: directors can be costly

March 4, 2011

Traders work in the Goldman Sachs stall on the floor of the New York Stock Exchange July 16, 2010.  REUTERS/Brendan McDermidNEW YORK, March 4 (Westlaw Business) Being an insider with a fiduciary duty sure is risky, as heavyweight Rajat Gupta is now finding out amidst serious SEC charges. So is having board members, as Goldman Sachs and Procter and Gamble are now worrying. Of great concern to each are the reputational risks and attendant costs that this might impose on them. The potential risks could relate to a broad range of issues, ranging from inside information, to disclosure of SEC investigation and board member protection. Though this likelihood may seem remote, recent experiences from Bank of America to Goldman Sachs itself show them to be painfully possible.

With a plot literally ripped from the headlines and a narrative crackling like a Law & Order script, the Commission has charged Gupta in the spreading Galleon insider trading scandal. The case links Berkshire Hathaway, Goldman Sachs and Procter and Gamble (P&G) to what is shaping up to be one of the biggest non-Madoff financial crime stories of the young century.

An SEC press release credits Sanjay Wadhwa, Jason Friedman and John Henderson of the Commission’s Market Abuse Team, as well as Diego Brucculeri and James D’Avino of the SEC’s New York Regional Office, with conducting the continuing investigation.

According to the SEC, Gupta, a director at both P&G and Goldman, allegedly passed on material, non-public information to Galleon Management, LP founder, Raj Rajaratnam. Even more impressive than the amounts at issue—under $20 million in illicit gains or losses avoided—is the timeline that the feds have reconstructed in building their case. Risks are posed to each of Gupta, Goldman and P&G as a result.

As the financial world trembled in late September 2008, Goldman appeared to salvage a lifeline with a $5 billion investment from Berkshire Hathaway. The SEC’s account reads with increasingly dramatic pace:

Telephone records and calendar entries indicate that, on the morning of Monday, September 22 — the day after the Sunday evening Goldman Sachs Board meeting — Gupta and Rajaratnam very likely had a telephone conversation. Shortly after that conversation, Rajaratnam caused the Galleon Tech funds, which held no preexisting long or short position in Goldman Sachs securities at the time, to purchase over 80,000 Goldman Sachs shares.

On the morning of September 23, Rajaratnam placed a call to Gupta which lasted over 14 minutes. Less than a minute after the call began, Rajaratnam caused the Galleon Tech funds to purchase more than 40,000 additional Goldman Sachs shares.

A Special Telephonic Meeting of the Goldman Sachs Board was convened at 3:15 p.m. on September 23, during which the Board considered and approved a $5 billion preferred stock investment by Berkshire in Goldman Sachs and a public equity offering. As Gupta knew, Berkshire was one of the most respected and influential investors and its decision to make such a large investment in Goldman Sachs would likely be viewed as a strong vote of confidence in the firm when the information was disclosed to the public. The infusion of a large amount of new capital in the firm also would likely be viewed favorably by investors. Gupta participated in the Board meeting telephonically, staying connected to the call until approximately 3:53 p.m. Immediately after disconnecting from the Board call, Gupta called Rajaratnam from the same line. Within a minute after this telephone conversation, at 3:56 p.m. and 3:57 p.m., and just minutes before the close of the markets,Rajaratnam caused the Galleon Tech funds to purchase more than 175,000 additional Goldman Sachs shares. Rajaratnam later informed a conspirator that he received the information upon which he placed the trades minutes before the close.

Thus, in the span of two days Rajaratnam allegedly pocketed nearly $1 million.1 The SEC, however, unearthed still more (and more lucrative) insider deals involving thousands of Goldman put contracts and hundreds of thousands of Goldman shares. With Gupta allegedly tipping inside information about Goldman’s second quarter numbers, the SEC says that:

[o]n the night of June 10, 2008, at 9:24 p.m., Gupta placed a short call to Rajaratnam’s home. The call was the first in a flurry of short calls between the two over an 18-minute span that night, which culminated in a 4-minute call from Rajaratnam to Gupta, at 9:42 p.m. On the following morning, June 11, at 8:43 a.m., Rajaratnam placed another call to Gupta that lasted about 2.5 minutes.

In a week’s time, this “flurry of short calls” netted Rajaratnam approximately $13.3 million, according to the SEC.

Nor was Goldman the only victim of Gupta’s alleged tipping. The SEC also claims that in January 2009, Gupta phoned Rajaratnam with inside dope gleaned from Procter & Gamble’s audit committee. Allegedly armed with this information, Rajaratnam went on to post $570,000 in illicit profits.

Although the Galleon web continues to ensnare more alleged conspirators, the charges against Gupta have yet to be answered and, of course, the only legal presumption at this point is one of innocence. The SEC has fixed a date for an evidentiary hearing not less than 30 days (nor more than 60) from the date of the Order.


The charges seem particularly sordid given the rarefied air of big-time board rooms like those of Goldman and P&G. But Gupta had other links beyond these blue chips.

“In addition,” explains the SEC, “Gupta was an investor in, and a director of, Galleon’s GB Voyager Multi-Strategy Fund SPC, Ltd., a master fund with assets that were invested in numerous Galleon hedge funds, including those that traded based on Gupta’s illegal tips.” Earlier this week, Rajat Gupta resigned as a member of P&G’s board.

If the charges prove true, the breach of fiduciary duty and the betrayal of shareholders shocks the conscience. The timelines alleged—minutes or less between board meeting and tip—depict a mole turning over data almost in real time. Unlike some marginal back office cipher or an eavesdropping assistant, pouring confidential information to a multi-billion dollar hedge fund seems acutely cheap for a board member of a public company.

Gupta is not the first insider in recent memory to be charged by the Commission with slipping confidential information to funds in which they had a role.

Further, the lessons of these charges may not work to Gupta’s favor.  Consider, as one example the recent case of SEC v. Benhamou. In that matter, the Commission charged a French doctor with tipping advisors at hedge funds about negative results from a clinical trial. Human Genome Sciences, Inc. (HGSI), a biotech firm for which Dr. Benhamou had served on the clinical trials’ steering committee.

Benhamou also served as a consultant for a portfolio manager. Having received information that the clinical trial resulted in negative findings, the tippees were able to avoid some $30 million in losses by liquidating their positions ahead of the rest of the market. The Benhamou complaint cited half-a-dozen unnamed hedge funds and advisers as having profited from the information. Instant messaging transcripts obtained during the investigation running up to the complaint lend an air of real-time eavesdropping to the way in which traders act on hot tips.

Benhamou was in a different relationship with HGSI than Gupta was with the boards on which he sat. Perhaps more strikingly, this may not work to Gupta’s favor or those of the companies on whose boards he sat. Benhamou was a consultant and reportedly had a duty of confidence to HGSI; however, he arguably owed no fiduciary duty to HGSI’s shareholders. By contrast, Gupta as board member undoubtedly owed fiduciary duty to shareholders.


This could open both Gupta personally and the companies he helped govern to shareholder claims and, incongruously, could even lead to unexpected payouts to cover Gupta. As a board member at both Goldman and P&G, reputational and litigation risks may exist for each of these companies. These risks arise from issues of both disclosure and director protections, among other things. This set of issues has recently concerned brand name companies from Bank of America/Countrywide to Goldman itself, as both have had quite recent and somewhat painful experience with these.

Goldman, for one, has learned the hard way of disclosure-driven risks to reputation and litigation, amidst SEC investigation. Goldman received a Wells Notice regarding an SEC investigation into disclosures surrounding its now-infamous ABACUS deal. In that case, the Notice was not disclosed. The results were a painful $550 million fine and a settlement agreement with the SEC imposing a series of new procedures.

Disclosure-related liabilities very much depend on as yet unknown fact patterns, as well as certain legal considerations. Gupta might have received a Wells Notice from the SEC, as is typically done amidst SEC investigation. If past SEC investigations are any guide he would have, though we don’t yet know as it hasn’t been disclosed. Further, we don’t know whether Gupta further disclosed these investigations to the companies he helped govern. If indeed he had so disclosed, then company obligations to disclose to shareholders may have kicked in. Even there, however, differing approaches are taken as to disclosing Wells Notices. For more information, see Goldman’s Golden Rules: SEC and FSA Set New Global Standards for Compliance.

Another, admittedly-unlikely source of cost to Gupta-affiliated companies, could be the cost of director protections to Gupta. As a general rule, board membership is protected by charter-based indemnification and D&O insurance. This sort of director protection was the recent focus of Bank of America, surrounding payments made to controversial Countrywide ex-CEO Angelo Mozilo pursuant to company charter documents. For more information, see D&O Indemnification: A Lifeline for Accused Executives?

Indemnification appears unlikely in Gupta’s case. However unlikely, it is not unprecedented, as Mozilo had SEC penalties covered by Bank of American/Countrywide.

Payout under D&O insurance likewise appears remote, though it will depend on underlying insurance policies, legal strategies and overall “stomach” of each company as it enters a difficult period. Consider the recent case of Allen Stanford, whose egregious actions were deemed culpable by the Federal judge Nancy F. Atlas. In that case, insurer Lloyds successfully argued that no payout was due under the D&O insurance policy, which contained carveouts relating to money laundering.

As seen with the Martha Stewart case, high-profile insider trading actions garner plenty of publicity. Rajat Gupta, though a big deal in corporate circles, was no celebrity. Derivative suits no longer generate the headlines they once did, but winds may be changing. For proponents of the fraud-on-the-market theory, cases like this mean more than injured Goldman or P&G shareholders; if true, the market as a whole has been compromised. As facts continue to come to light, the man on the street has to wonder: How many more haven’t been caught?

(This article was first published by ThomsonReuters’ Westlaw Business Currents, a leading provider of legal analysis and news on governance, transactions and legal risk. Visit Westlaw Business Currents online at

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