With Dodd-Frank, the SEC Goes After Big Game

The U.S. Securities and Exchange Commission on Mar. 1 sued Rajat K. Gupta for insider trading. It's the latest move in an evolving insider-trading crackdown that began with the late-2009 arrest of Raj Rajaratnam, the billionaire co-founder of the Galleon Group hedge fund—and instantly moves the case up the notoriety scale.

Gupta, a former head of McKinsey & Co., the global consulting firm, has a gold-plated résumé, including stints on the boards of Goldman Sachs (GS) and Procter & Gamble (PG). He would be a far bigger catch than the other 26 individuals charged so far in the government's investigation. The SEC's civil case, in which the regulator used streamlined administrative procedures now available under the Dodd-Frank financial reform law, also may serve as a model for future insider-trading cases.

Born in Kolkata, India, Gupta, 62, earned an MBA from Harvard Business School and ran McKinsey from 1994 to 2003. He remained a partner there until 2007. "McKinsey is the closest thing the business world has to a confessional, and he was the high priest," says Terry Connelly, dean of the Ageno School of Business at Golden Gate University in San Francisco.

The SEC's civil suit alleges that in 2008 and 2009, after stepping down from McKinsey, Gupta passed confidential information to Rajaratnam, including early word on quarterly earnings at Goldman Sachs and P&G. Gupta called Rajaratnam 23 seconds after an October 2008 Goldman Sachs board conference call during which senior executives informed the board of poor results at the bank, the SEC says.

A month earlier, the SEC claims, Gupta informed Rajaratnam about Berkshire Hathaway (BRK.A) Chief Executive Officer and Chairman Warren Buffett's plans to buy $5 billion worth of Goldman's preferred shares. The information generated more than $18 million in illicit profits (or losses that were avoided) by Galleon, the SEC says. "Gupta was honored with the highest trust of leading public companies, and he betrayed that trust by disclosing their most sensitive and valuable secrets," Robert Khuzami, the SEC's enforcement director, said in a statement.

The allegations are "totally baseless," Gary Naftalis, a lawyer for Gupta, said in a statement. Gupta's "40-year record of ethical conduct, integrity, and commitment to guarding his clients' confidences is beyond reproach." John Dowd, Rajaratnam's attorney at Akin Gump Strauss Hauer & Feld in Washington, calls the SEC action "simply an effort to destroy a favorable witness," and says that there "is no case, absolutely none."

In preparing its case, the SEC took full advantage of its expanded administrative powers under the 2010 financial reform law named after former Connecticut Democratic Senator Chris Dodd and Representative Barney Frank (D-Mass.). Before passage of the law, the SEC would have to go to federal court to seek penalties against an executive who didn't work at a brokerage firm, investment bank, or mutual fund (in short, businesses it already regulates). Now the SEC is able to bring such cases before its own administrative law judges and can also seek monetary penalties—not just disgorgement of illicit profits as before. The regulator can also go after any public company—and its current or former officers—that it believes has violated federal securities law.

Administrative proceedings have some decided advantages for the SEC, starting with limited discovery rights for defendants. Those accused can subpoena documents from third parties but aren't allowed to take their own depositions. Another plus for the SEC: Its case is heard by an administrative judge employed by the agency rather than a jury. "If the Gupta case had been filed in federal court, the SEC could face a three-ring circus of depositions," says Steve Crimmins, a former SEC trial attorney who's now a partner at K&L Gates in Washington. It would raise the possibility that "testimony developed in the Gupta case would add new and possibly conflicting elements to the evidentiary record in the Rajaratnam case on the eve of trial." The Galleon co-founder's trial is scheduled to begin on Mar. 8.

Gupta resigned on Mar. 1 from the P&G board "to prevent any distraction," says Paul Fox, a spokesman for the Cincinnati-based consumer-products company. "We were saddened to learn about the civil charges against our former colleague," Yolande Daeninck, a spokeswoman for McKinsey in New York, said in a statement. Ed Canaday, a spokesman for Goldman Sachs, where Gupta stepped down from his board position last year, declined to comment. The Bill & Melinda Gates Foundation, where Gupta serves on a global development panel, says that "Rajat is a valued member" and will remain on board.

The SEC lawsuit "goes to the heart of the market's credibility," says Connelly, the business school dean at Golden Gate University. "All the SEC has done today is introduce the possibility that this kind of chicanery has gone on at what can only be called the highest levels."

The bottom line: The SEC's expanded administrative powers under Dodd-Frank helped shape its insider-trading case against Gupta, a business legend.

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