The Rajaratnam Verdict: Tip of the Iceberg – ANALYSIS

May 18, 2011

NEW YORK, May 18 (Business Law Currents) – The U.S. Securities and Exchange Commission’s trophy case gets a new addition with the conviction of Raj Rajaratnam, but shelf room is still available.

For all its publicity, the Rajaratnam case was merely one of many; since late 2009, insider trading probes related to Galleon have resulted in 13 additional guilty pleas. In recent months, some of the country’s most prestigious names have been linked to what appears to be a widening net of scandals. Fallout from these and others yet to be named should continue to generate headlines for the foreseeable future.

Ostensibly promulgated to clean up the nation’s sublimely messy financial market, the signal component of the Dodd-Frank Wall Street Reform and Consumer Protection Act is reform. As exposed in the Galleon case, a new controversial measure — an administrative proceeding — has already surfaced and its merits will be batted back and forth. What may get lost in the discussion, though, are the hits to reputations of individuals, companies and even law firms, whose respective culpability may range from perpetrator to victim.

The government’s case against Galleon founder Rajaratnam had not one but two linchpins: witness testimony and wiretap evidence. Introduction of the latter will almost certainly be appealed. Central to this critical wiretap evidence were conversations between Rajaratnam and Rajat Gupta, former worldwide managing director of McKinsey & Co, and board member at Goldman Sachs and Procter and Gamble. Although not yet charged with criminal wrongdoing, Gupta has been named in an SEC administrative proceeding. Gupta immediately challenged this action with a suit of his own, arguing among other things, that the administrative hearing device unfairly singles him out, and Dodd-Frank’s retroactive application violates his constitutional rights.

Application of the administrative proceeding is controversial, and has been dubbed by critics as “Gitmo-style” Wall Street justice. Casting the proceeding as “Gitmo-style” may be hyperbolic, but there is a kernel of substance to the charge. The administrative proceeding, conducted before an administrative law judge, is not a criminal trial, but that doesn’t mean criminal defenses won’t be implicated. Evidentiary standards, such as the priceless hearsay rule, do not control these proceedings. With the Dodd-Frank-delivered authority to fast-track these civil hearings, a potential criminal defendant faces a difficult choice: Testify and risk compromising a criminal case or plead the Fifth and effectively hand the SEC the civil equivalent of a grand jury indictment. Weighed down by serious constitutional issues and a well-heeled defendant, the ultimate resolution of this statutory device is far from settled.


No less settled is what collateral damage these insider trading cases will have to a spreading number of people. Berkshire Hathaway, for instance, is linked — albeit passively — to two such cases. In the first, Gupta was recorded tipping Rajaratnam of Berkshire’s imminent $5 billion lifeline investment on the eve of the 2008 meltdown. In the second, Warren Buffett consigliere David Sokol reportedly profited to the tune of several million dollars ahead of Berkshire’s acquisition of Lubrizol, Inc.

Although Sokol has not been charged in the incident, both Buffett and Berkshire Hathaway have been sued by a shareholder in Delaware Chancery court. For Buffett, whose legendary investing ethos has made the company synonymous with governance rectitude, the contretemps may be his career’s most embarrassing incident.

But Warren Buffett is not the only one to suffer embarrassment by association. In another high-profile insider trading action, attorney Matthew Kluger is a defendant in a years-long scheme that netted the disgraced lawyer more than $34 million according to Reuters. According to testimony by Kluger’s admitted conspirator, Kenneth Robinson, Kluger passed on inside tips relating to upcoming mergers and acquisitions. Initially, the complaint against Kluger mentioned by name only the prestigious Silicon Valley firm of Wilson Sonsini Goodrich & Rosati.

With Robinson’s plea deal, however, the names of several other prominent law firms were thrust into the mix. According to Reuters, Prosecutors have said Kluger began leaking merger tips as early as 1994, including when he worked as an associate at the law firms Cravath Swaine & Moore LLP and Skadden, Arps, Slate, Meagher & Flom LLP. These earlier leaks are not now part of the criminal case. Robinson said he also obtained tips from Kluger when the lawyer worked at a fourth law firm, Fried, Frank, Harris, Shriver & Jacobson LLP, which was not named in court papers.

Significantly, none of the firms has been charged with wrongdoing. Reuters reports that Fried Frank “is cooperating with the investigation, and has policies to protect clients’ confidential information.”

Like Berkshire Hathaway in the Gupta case, 3Com, McAfee and Hewlett-Packard have also been linked — through no fault of their own — to these scandals. It should also be remembered that clients were also victimized by having their transactions leaked at the expense of their shareholders.

Directors (such as Gupta) and lawyers (like Kluger) don’t have a monopoly on violating fiduciary duties. A sub-genre of insider trading, one that surfaced in the Galleon case, has been that of the “expert network.” Consultants, in the course of being retained, become privy to a client company’s most closely-guarded information.

When these trusted insiders turn around and sell that information, as seen in the SAC Capital and Frontpoint Partners cases, lawmakers cannot underestimate the erosion of confidence in the market.

The confluence of heightened SEC action and the passage of the Dodd-Frank Act is no accident. A system widely viewed as compromised allowed a reform bill the size of a mattress to fly through Congress. The Obama administration’s appetite for rigorous enforcement of the nation’s securities laws seems to have escaped charges of political haymaking. As guilty pleas and convictions mount, it’s difficult to make a case that prosecutorial resources are being misdirected.

As the Dodd-Frank Act has yet to be fully implemented, it’s too early to tell how much of the statute will remain intact following what are sure to be multi-frontal attacks. Should the device of the administrative proceeding not be somehow enjoined, the field should be cleared for additional actions against not only insider trading, but any number of frauds and other bad actors.


(This article was first published by Business Law Currents, a leading provider of legal analysis and news on governance, transactions and legal risk from Thomson Reuters Accelus. Visit Business Law Currents online at







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