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Rajat Gupta's Weird and Weak 'No Profits' Defense

Rajat Gupta
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Rajat Gupta

Rajat Gupta vigorously denies the insider trading charges the SEC has lodged against him, calling them “totally baseless.”

The circumstantial evidence against Gupta, however, is very strong. In fact, the pattern of behavior alleged by the SEC—obtaining confidential board information and then immediately calling Raj Rajaratnam, the man who then traded on the stocks—is damning.

Remember, this is just a civil proceeding. The SEC’s burden of proof is just to show that it is “more likely than not” that Gupta violated securities laws. There’s no need to prove it “beyond a reasonable doubt.” Absent contrary evidence, the pattern of meetings, calls, trading seems enough to find Gupta liable.

His lawyer issued a statement yesterday. A close reading of the statement, however, reveals that it might not really deny very much except for a legal technicality. Here’s the statement:

"The SEC's allegations are totally baseless. Mr. Gupta's 40-year record of ethical conduct, integrity, and commitment to guarding his clients' confidences is beyond reproach. Mr. Gupta has done nothing wrong and is confident that these unfounded allegations will be rejected by any fair and impartial fact finder. There is no allegation that Mr. Gupta traded in any of these securities or shared in any profits as part of any quid pro quo. In fact, Mr. Gupta had lost his entire $10 million investment in the GB Voyager Fund managed by Rajaratnam at the time of these events, negating any motive to deviate from a lifetime of honesty and integrity.”

What we don’t have here is a denial that Gupta called Rajaratnam, or even that they discussed confidential board matters. This would have been easy enough. Just say, “Mr. Gupta never gave Rajaratnam information of a confidential nature.”

Instead, we get this: “There is no allegation that Mr. Gupta traded in any of these securities or shared in any profits as part of any quid pro quo.”

That looks like the lawyer is trying to say that the legal case against Gupta fails what lawyers call the “personal benefit test,” something necessary to prove an insider trading case. That is, a person who doesn’t trade on inside information himself but only passes on information, must usually be shown to have expected some personal benefit from passing on the information. Accidentally passing it on isn’t enough.

Gupta was not paid for tipping off Rajaratnam. There’s no evidence he received any of the profits Rajaratnam made from trading. And that’s the point I think Gupta’s lawyers are making: Gupta didn’t make any money off this.

But not making money doesn’t mean you haven’t benefited. Some courts define “personal benefit” expansively. Proof that a tipper gave information to a relative or friend has been found sufficient to constitute a “personal benefit” to the tipper. In 1998, the Second Circuit held that the benefit of “maintaining a good relationship” was enough of a “personal benefit” to give rise to insider trading liability. In that case, the tipper and tippee sold real estate together, split commissions and were personal friends. In SEC v. Maio, the Seventh Circuit held that “hypothetical benefits” between close personal friends were enough to constitute a finding of “personal benefits.”

So perhaps what Gupta intends to argue is that he just wasn’t close enough to Rajaratnam to expect any friendship benefits. Unfortunately, Gupta is not only reportedly a personal friend of Rajaratnam—he has also been his business partner.

Dan Primack of Fortune explained in his morning email:

Gupta also serves as chairman and co-founder of New Silk Route, an India-focused private equity firm with $1.4 billion in capital under management. Its portfolio includes Cafe Coffee Day (a co-investment with KKR) and Reliance Telecom Infrastructure.

That last one was a co-investment with Galleon, and the two firms' ties run deep. Galleon founder Rajaratnam was listed as a New Silk Route principal in a 2008 SEC filing, but later was removed from the company's website (perhaps around the same time that he was arrested for insider trading).

Moreover, Dealbreaker reported last year that New Silk Route's original fundraising was for $2 billion (under the name Taj Capital)—and that the first $600 million or so was allocated for investment in Galleon hedge funds.

Those don’t seem like good facts for someone who wants to argue he wasn’t close enough to Rajaratnam to get a “personal benefit” from tipping him off to confidential board information.

What's more, if Gupta does attempt to defend himself on purely technical grounds, his career will be over. "I didn't like the guy who I gave secret board information to" might be a valid legal defense. But it won't save Gupta's reputation.

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