by Julie DiMauro on June 19, 2012
The insider-trading conviction of Rajat Gupta, a former McKinsey group chairman and a-list board member, had federal prosecutors and securities regulators glowing. But companies face stiff challenges protecting their boards from breaches of confidentiality by directors and the reputational and other damages that ensue, consultants and lawyers said.
The conviction also draws a contrast with the relative lack of high-level prosecutions stemming from the 2008 financial crisis, which analysts said was rooted in practices harder to establish a case on. A Manhattan federal court jury on Friday found Gupta, a former director of Goldman Sachs and Procter & Gamble, guilty of leaking material nonpublic information on Goldman to Raj Rajaratnam, head of the Galleon hedge fund group. Gupta was convicted of conspiracy to commit securities fraud and three counts of tipping Rajaratnam about Goldman, but was acquitted of leaking information on P&G, and of one Goldman-related count.
Gupta faces up to five years in prison on the conspiracy charge and up to 20 years on each of the fraud charges when federal judge Jed Rakoff sentences him, which is scheduled for October 18.
Rajaratnam is serving an 11-year prison sentence.
“Almost two years ago, we said that insider trading is rampant, and today’s conviction puts that claim into stark relief,” said Manhattan U.S. Attorney Preet Bharara.
The evidence showed that Gupta called Rajaratnam within about 60 seconds of a Goldman board meeting approving a $5 billion investment by Berkshire Hathaway and within 23 seconds of learning that Goldman was facing its first quarterly loss as a public company, Bharara’s office said. The first call resulted in significant gains by Rajaratnam’s funds and the second call avoided millions of dollars in losses.
“Those who engage in insider trading, irrespective of their station in life, can expect to be prosecuted to the fullest extent of the law,” added Robert Khuzami, enforcement director of the Securities and Exchange Commission, which separately sued Rajaratnam, Gupta and others for violating the federal securities laws.
What – if anything – can boards do to protect themselves?
The verdict indeed warns corporate officers and directors to not commit securities fraud, but neither Bharara nor Khuzami addressed guidance to boards on how to protect themselves against insiders sharing boardroom or executive suite secrets. Companies have fewer tools than enforcement authorities.
“The insider trading-related violation that Mr. Gupta is alleged to have engaged in, tipping outsiders with information he gleaned in his role as director, is particularly difficult for an issuer to prevent,” Philip Thomas, director of Asian operations for CompliGlobe, a regulatory adviser, told Thomson Reuters Accelus. “The tools the government used in this instance – bugged conversations and informants – helped make the case against Mr. Gupta. These are not tools ordinarily at an issuer’s disposal,” he said.
If the insider does not personally trade on information, there may be little that boards can do to prevent a director from tipping off an associate.
“It is very difficult to monitor a director’s phone calls and communications. The directors are not usually employees, and if they decide they want to share inside information, there is little the company can do to stop them. Using insider information, however, is a different story. Companies should monitor trading by their directors and insiders and be on the lookout for any unusual trading in advance of any corporate announcements,” added a financial industry legal source who asked to not be identified because of professional ties to companies named in the charges against Gupta.
Thomas said companies need to review their policies in light of the Gupta case.
“Boards should redouble their efforts in the area of insider-sharing prevention and detection, and be held to account where red flags have been ignored. … Internal counsel should be, at this moment, preparing a briefing for their boards on the implications of the Gupta situation. And a review of the policies designed to prevent insider-trading abuses by directors should also be underway by the chief compliance officer, with lessons learned from recent cases baked in,” Thomas told Thomson Reuters Accelus.
One immediate impact of the verdict may be to focus on directors’ business and other relationships, which are often among the reasons they were nominated in the first place, said Francis H. Byrd, senior vice president and corporate governance risk practice leader at Laurel Hill Advisory Group, LLC in New York City.
“Boards will need to spend more time on determining potential conflicts and examining the potentially problematic relationship of their board members. But it should be noted strongly that no review system or conflict check will fully deter people motivated to commit disclosing material information. Independent directors should be asking their boards to review existing director and officers policies and understand that coverage in the event a director is found to have breached his or her fiduciary duties to the company,” said Francis H. Byrd, senior vice president and corporate governance risk practice leader at Laurel Hill Advisory Group, LLC in New York City.
Another immediate impact may be to sow distrust in the boardroom.
“Board members may never look at each other across the table the same way again after the Gupta verdict. At the present time, compliance procedures relating to board members on a personal level are not widely used; however, we believe this area may be further developed in the future as a result of the Gupta case,” added Judy Gross, a principal of JG Advisory Services LLC in New York City.
Want a daily digest of articles like this one, plus the latest compliance jobs at top-tier organizations? Join 40,000 other compliance, risk governance, and regulatory professionals and subscribe to our free afternoon newsletter.
Julie DiMauro reports on financial services regulatory compliance issues for Thomson Reuters.