Circle of Friends (27 page)

“I'm giving him a million dollars a year for doing literally nothing,” Rajaratnam complained to a mutual friend. That wasn't true at all. Indeed, as the growing web of wiretaps showed, Kumar was furiously supplying Rajaratnam with information on AMD, including the timing of the proposed spin-off of the manufacturing arm.

No character portrait of Rajaratnam is complete without an appreciation of just how well he understood the criminal mind—his own and others. His arrogance led him to believe he would never get caught, which people who know him say is the main reason he blathered so much on the telephone.

But his knowledge of the white-collar criminal mind was sharp and he knew that at bottom, all of them, from Anil Kumar to Rajat Gupta to people like Danielle Chiesi, were motivated by vaunting greed and—perhaps even more astutely noted on Rajaratnam's part—the need to please. They would do anything he asked if he could press the right button.

That's why Kumar was so valuable despite Rajaratnam's complaints. For that $1 million he helped steer tips Rajaratnam's way, and as investigators discovered, served as a recruiter as well.

In fact, it was Kumar who introduced Rajaratnam to Gupta, one of corporate America's leading statesmen and soon to be co-conspirator as one of the most important members in Rajaratnam's circle.

Wadhwa and the SEC were on to Gupta from the minute they got hold of Rajaratnam's telephone records; they also knew that Kumar and Gupta had founded a business school in India together and that the two remained close. Kumar considered Gupta his mentor, and on paper it's easy to see, given their mutual corporate pedigree.

But it took some more digging to determine just how low Gupta, an icon of the business community, had sunk. This was, after all, a man who counted as friends Kofi Annan, then secretary-general of the United Nations, and Microsoft cofounder Bill Gates. Gupta raised millions of dollars to fight AIDS, malaria, and tuberculosis across the globe. As it turns out, Gupta's record at McKinsey held some clues for why he turned bad. The white-shoe consulting firm had for years been a place for high-quality services delivered in specialized fashion. Gupta, according to people there, changed the dynamic. McKinsey began to ramp up the fees and hired more low-level talent to pitch more work.

McKinsey, as the
Financial Times
once pointed out, had a tradition that ran counter to the “sins of self-enrichment and self-aggrandizement” that could be found all over Wall Street. Gupta's tenure was controversial, according to some former partners, because the firm operated more like a bank; it embraced both of those sins as a way to ramp up fees and profits at the expense of its clients. Yes, the Gupta years were profitable, and huge bonuses were awarded to senior executives, obviously including Gupta himself, but the drive for more money changed the firm's culture—some would say for the worse.

Yet Gupta's drive to make money held obvious value to Rajaratnam. Gupta had sat on the board of directors of several firms since he left McKinsey in 2003, including Goldman Sachs and Procter & Gamble, and he knew just about every major CEO in the country and many around the world.

He was worth an estimated $100 million at sixty-five years of age, but by all indications he wanted more. So, not long after leaving McKinsey in 2003, he reached out to Kumar to set up a meeting with Rajaratnam about creating a hedge fund.

The fund never made it out of the starting gate, but the Gupta-Rajaratnam relationship flourished, as he too became a member of the Rajaratnam circle. Over at the FBI, the connection became apparent the minute they began taping Rajaratnam's calls. One key moment came in 2008, as the financial crisis started to accelerate and Gupta began feeding Rajaratnam confidential information about Goldman board meetings.

Rajaratnam called to tell Gupta that rumors were rampant that Goldman was looking to buy a commercial bank like Wachovia, which was run by former Goldman executive Bob Steel. There were obvious benefits to Goldman in such a purchase, as Wall Street slowly slipped into crisis mode during the summer and fall of 2008. A commercial bank, unlike a traditional investment bank, has consumer deposits. These deposits could be drawn down to fund the firm's operations if Goldman's own lenders ended up pulling back, if and when the crisis became more acute.

Gupta's answer: “Yeah. This was a big discussion at the board meeting.” However, he added that he would be surprised that the firm's desire to splurge to buy a bank was “imminent.” For one thing, Goldman had no funding problems just yet.

Was that enough to nail either party? Not by a long shot. The information wasn't acted upon, and in and of itself, knowing that Goldman was considering something that was rumored in the market took away from the standard of nonpublicness that a dirty tip would have to meet.

But it was a start, and given Gupta's apparent comfort level and ease in sharing with Rajaratnam board discussions that were supposed to remain confidential, the investigators were sure better stuff awaited.

That better stuff came a few months later, in September 2008. Lehman Brothers had just filed for bankruptcy and the entire financial system was in turmoil. A massive government bailout was unfolding, one that would inject tens of billions of dollars into the remaining investment banks.

And still it wasn't enough to calm the jittery markets as investors continued to sell the shares of financial firms and refused to lend them money to finance their operations. For Goldman, buying a commercial bank like Wachovia never looked so good except for the fact that Wachovia was now in trouble as well. It was about to fail, as its investments in housing-related securities tore into its balance sheet (as similar housing bubble deals did to the rest of the banking system).

But Goldman being Goldman, historically one of the savviest and most creative firms on the Street, came up with a solution—a $5 billion infusion of cash from legendary investor Warren Buffett.

The Buffett investment was controversial for several reasons. Some critics would say he traded on something similar to inside information, knowing that Goldman was being bailed by the federal government through various post-crisis programs, including the Troubled Asset Relief Program, or TARP. The same charge would be made against several lawmakers who traded in and around the crisis. Yet such moves were perfectly legal under the law. Buffett and these lawmakers may have had an informational edge against the average investor but it was in the type of information that was legal—it wasn't misappropriated from any company, just possibly the massive rumor mill known as the U.S. government.

Goldman, meanwhile, was less focused on any insider trading around its stock than it was in surviving the tumult as investors began dumping shares and closing lines of credit to a bank that had until now avoided the worst of the financial crisis. In exchange for the money, Goldman agreed to Buffett's extortion-like albeit perfectly legal terms: Lloyd Blankfein, the firm's CEO, said Buffett would provide Goldman with an immediate $5 billion in cash in exchange for preferred stock with a 10 percent dividend, as well as warrants to buy shares at $115, which were good until 2013. The investment, Blankfein knew, would ensure Buffett a huge payday, $500 million annually, or as Buffett later boasted, “we're getting fifteen dollars a second from this investment.”

Rajaratnam, thanks to Gupta, didn't do too shabbily, either, though unlike Buffett's, his methods were far from legal. The Buffett deal was sealed during a board meeting on September 23, which Gupta attended via conference call; he dialed in from an office that he still had at McKinsey's New York headquarters.

Then he called Rajaratnam with the news before it was made public. Goldman now had the blessing of the world's most prominent investor; shares would almost certainly spike when that was announced the following day.

The conversation wasn't recorded because rather than calling Rajaratnam's cell, Gupta called his office phone, which wasn't wiretapped. But investigators had a trace on Rajaratnam's phone records and trading account. The Goldman board meeting ended around 3:50 p.m. and a few moments later, records indicated, Gupta called Rajaratnam. Just before the markets closed, Rajaratnam began snapping up Goldman shares.

He would earn a quick $1 million on the trade, and as he would explain in a telephone call that was recorded with a Galleon trader, “I got a call, right, saying something good might happen to Goldman.”

T
he “good” that was happening wasn't confined to Goldman's bailout. It also included the increasingly airtight case against Rajaratnam and his cohorts. By the end of 2008 and into early 2009 dozens of people were facing charges in one form or the other from the Kang investigation, and dozens more were being developed separately by the Chaves/Makol squad, with Wadhwa in the middle.

One irony still lost on the government apparatus assembled to take down Rajaratnam and Gupta and possibly larger players in the future was that the biggest insider trading investigation in the nation's history was coming together at a time when the public couldn't care less about insider trading.

Investors were now shell-shocked by far bigger issues; between the end of 2008 and March 2009, the country would go through wrenching change, including a new president, after Barack Obama, a junior senator from Illinois, beat his Republican challenger, Senator John McCain of Arizona.

Even during the height of the financial crisis, Obama was receiving huge contributions from the big Wall Street firms and many hedge fund players—in part because he was the likely winner, after a Republican had held the office for two terms, and in part because in private meetings he seemed very smart on economic matters.

But within a few weeks of his election investors saw something else in the new president: He was a novice when it came to the economy. That realization began to set in when he selected an unsteady bureaucrat, Timothy Geithner, then the president of the New York branch of the Federal Reserve, to be his Treasury secretary.

The markets initially cheered when Geithner was appointed because he was seen as one of the architects of the bank bailouts and had knowledge of the financial system. But it wasn't long before he started making public statements about the economy and the banking system that gave investors just the opposite reaction, sending the Dow Jones Industrial Average to around 6,000—its lowest point since 1996—in March 2009.

It didn't help, of course, that Obama and Geithner and the SEC had the financial crisis to contend with, or the Bernie Madoff scheme to unravel. But one thing is certain: Investors made it clear that their lack of trust in the economy or the markets was grounded in simple concepts: They didn't believe in the health of the financial system or the acumen of the new administration enough to jump back into the markets.

Insider trading, much less Rajaratnam, Steve Cohen, or any of the other traders on the government's unofficial white-collar crime most wanted list, wasn't on public investors' radar.

Yet even with a new SEC chief, Mary Schapiro, and her new enforcement chief, a former prosecutor named Robert Khuzami, the insider trading investigation rolled on. For a few months after joining the commission, Khuzami decided to “recuse himself” from the Galleon portion of the investigation. Before taking the SEC post he had been general counsel of Deutsche Bank, which did business with the hedge fund. But not Schapiro, who was appointed SEC chief by President Obama, approved by the Senate, and shortly after held a private meeting with Wadhwa on what he had been doing for the past two years.

Wadhwa was said to be impressed with the show of additional support. He had never met Chris Cox, and he wasn't even sure Cox knew about the Galleon probe. But Shapiro did, it appears, almost immediately when she started to run the agency.

The reason was simple: Word of Wadhwa's success filtered through Washington, and for the political types who run the SEC, insider trading was viewed as the easiest way to restore the agency's reputation following the Madoff catastrophe and the image hit taken in the aftermath of the financial crisis.

T
he enforcement division of the SEC was known as an independent unit (within an independent agency), theoretically immune from political pressure by the presidentially appointed chairman. The reality is somewhat different.

The enforcement agenda is set by the chairman, a presidential appointee who bears the brunt of the political pressure exerted by the White House. Arthur Levitt, the longtime SEC chairman, appointed by President Bill Clinton, created the image of being a crusader for the small investor, installing rules that were supposed to democratize the release of company information among small and large investors. But he also ushered in an era of deregulation of the securities business—a move advocated by Clinton when he signed into law a bill that allowed commercial banks to merge with investment banks.

There would be much wealth creation in the Clinton years, of course, bolstered by the big banks that were created after the passage of the Gramm-Leach-Bliley “financial modernization” act. New mega-banks like Citigroup used all their financial might to take greater levels of risk and developed new and more profitable investments. The collateralized debt obligation was a way to package all kinds of consumer loans, from mortgages to credit card bills, into a bond that had the practical effect of allowing banks to extend greater and greater amounts of credit to more and more people regardless of their long-term ability to repay loans. Through financial alchemy, risk was being reduced by having bonds that were sold to other parties and not held on the banks' balance sheets, or so the story went.

The banks created other ways to hedge it: The credit default swap (CDS) was an insurance contract that could theoretically cover any bond in the market. The holder of a CDS on the bonds of a big bank, for instance, would have a guarantee that the issuer of the contract (often an insurance company like AIG) would repay the bonds if the bank defaulted.