The Billionaire's Apprentice: The Rise of the Indian-American Elite and the Fall of the Galleon Hedge Fund (11 page)

Gupta approached his first big move since coming to the United States with little fuss or fanfare. McKinsey offered Gupta the chance to visit its Copenhagen office before committing. Gupta was amused. Why would he need to go see a McKinsey office? He knew what people at McKinsey looked like and what their backgrounds were. Visiting was an indulgence he didn’t need or want. Why waste company money?

Just before the Guptas were about to move, though, he and Anita took up the firm on a house-hunting trip. They couldn’t go for long because their daughter was still a toddler. After spending a day looking at a dozen houses, they realized they weren’t going to be able to settle on anything before they left. In a move worthy of a seasoned psychologist—build trust by empowering others with a personal decision—Gupta asked his new colleagues in the office to make the final decision. “Here are the three best ones we like. You could get us either one of these or anything that is similar.” One of his colleagues chose his house and, in 1981, the Guptas headed to Copenhagen to live in it.

Scandinavia was “a very homogeneous environment,” Gupta would say years later. “When I went there, they had never seen anybody with dark skin and dark eyes, I don’t think. It was a very closed environment.”

In Copenhagen, the quiet Gupta finally got the chance to show his superiors his promise as a leader. For years, there were whispers about the head of McKinsey’s Copenhagen office and his penchant for excessive drinking, but Gupta appreciated the seriousness of the problem only a year after arriving in Scandinavia.

“He was a brilliant guy but an alcoholic,” said Gupta years later. “It was beginning to impact his work, and his relationships with clients and colleagues.” At first Gupta and two of his peers in the office tried to cover for him and back him up at client meetings to make sure he was not an embarrassment. But “at some point in time, it became a very, very impossible situation,” said Gupta. “And there were some very embarrassing incidents and client situations.”

Gupta and his colleagues wrestled with the problem for weeks, offering different solutions and discarding them almost as soon as they came up with them. If Gupta raised the matter with New York, his boss would feel that it was a personal betrayal. It could also jeopardize his career. But the man needed help. “Office managers had a lot of power, and no one had the gumption to take him on,” says Gupta’s IIT friend Chatterjee. What Gupta did was to unite the other partners in the office and convince them that they had to take up the matter with Daniel, McKinsey’s then managing director. Gupta built a coalition and then he led it.

Daniel happened to be in Paris for the firm’s executive committee meetings when Gupta and two colleagues, a Swede and a Dane, visited him.

“We’re having a big professional issue,” Gupta told Daniel, and then he went on to explain the problem in the office. The next day, Daniel summoned the Copenhagen office manager to Paris, relieved him of his duties, and had him check into the Betty Ford Center, which treats individuals with drug and alcohol dependencies.

As Gupta expected, his boss was livid because he felt he’d been sold out. But only two years after the partner sought professional help, the two men reconciled. When he returned to Scandinavia after treatment, he invited Gupta and his two colleagues to dinner. They went with some trepidation, knowing that their last meeting had been filled with rancor. The partner, now a recovering alcoholic, was grateful to the consultants for what they had done.

“He had realized that we had saved his life,” said Gupta years later, “and he came to thank us…because if he had gone on in the way he had gone on, he probably would not have lived for very long.”

Some at McKinsey interpreted Gupta’s humility and quiet manner as a sign of weakness. But McKinsey head Ron Daniel knew from his own experience that Gupta was every bit as much the go-getter as the next consultant. Daniel tapped Gupta, then age thirty-two, to run the Scandinavian business, making him one of the youngest consultants at McKinsey to hold the position of office manager.

Gupta turned his taciturn style into a powerful tool with clients. Christian Caspar, a McKinsey colleague, remembers Gupta’s presentation of a change-management program for a large corporation. At a pivotal point, when the client wondered if the inevitable disruption was worth it, Gupta, rather than offering his opinion to the client, said nothing. “He just looked them right in the eyes,” says Caspar. “A minute must have passed in silence. It was quite effective, because the client had to make the decision. It wasn’t ours to make.”

Gupta’s rise coincided with Daniel’s makeover of McKinsey. Daniel recognized that McKinsey needed to innovate and offer clients much more than a nearby regional office. Strategic, organizational, and operational expertise was required. McKinsey’s best consultants were put in charge of developing new thinking in each area: Fred Gluck in strategy, Tom Peters and Bob Waterman in organization, and other stars from Cleveland and Germany in operations. “What a change,” exults Skilling. “
In Search of Excellence
was researched and developed and the strategy effort came up with world-beating, actually BCG-beating ideas. Even the operations guys developed some powerful tools. Suddenly McKinsey was leading the thinking.”

Unlike its rivals BCG and Bain, which had office scale, McKinsey’s average office size was small, making it imperative that its managers embrace an office-to-office esprit de corps. Some of the old guard, the entrenched office managers protecting their power base, resisted the shift. But Gupta embraced it.

Skilling remembers being invited to speak to two of Gupta’s clients. In one instance, in his role as head of McKinsey’s natural gas practice, he talked to a Scandinavian energy company about the impact of deregulation. Another time, in his role as head of McKinsey’s North American chemical practice, Skilling discussed the microeconomics of commodity chemical prices so that the client could figure out how to better model the economics of an acquisition. During the meetings, Skilling was struck by the “low-key, comfortable relationship” that Gupta had with the client executive. “He didn’t ever try to show that he ‘knew everything,’” Skilling says. “There was a lot of question asking and Rajat would ask a lot of questions—he was amazingly willing to show his lack of knowledge and uncertainty. He felt no need to be all knowing, something that a lot of partners had a tough time with.”

The meetings Skilling had in Scandinavia with Gupta’s clients were different from others he had with other offices. In those meetings, the local manager would act as a go-between, not a colleague. The office chiefs would dissociate themselves from their visiting McKinsey colleague until it was clear that their client was on board with the advice. “I could understand this posture since it gave the local people a second shot if something went wrong, but it was a bit cowardly,” says Skilling. “Rajat didn’t play that game. He was up front and transparent. The term ‘trustworthy’ often came to mind.”

By the time Gupta was ready to leave Scandinavia in 1986, he had grown the McKinsey practice from 15 to 125 professionals, expanding its reach into Norway,
and
he had made it profitable. “To this day, our competitors find it hard to compete with us in that region,” Daniel says of the historic strength of McKinsey’s practice in Scandinavia. Skilling believes that Gupta’s achievements there were profound and that his approach “probably foreshadowed McKinsey’s phenomenal worldwide success in the late 80s and early 90s.”

Gupta made plans to leave Scandinavia during the Christmas holiday. To say good-bye and mark his time in the office, Christian Caspar, his successor, hosted a farewell party, to which he invited all the partners in Scandinavia. Caspar arranged for children to sing Christmas carols. He even organized a Santa Claus for the occasion.

When Santa appeared, Caspar told Gupta that it fell to him to guess who Santa was. As hard as Gupta tried, he couldn’t fathom the identity of Santa, who stayed mute. Gupta was about to give up when Santa finally spoke. The conscience of the company had flown four thousand miles to personally thank him.

Santa Claus was Marvin Bower.

In the spring of 1998, Intel Corporation did something extraordinary. It installed a hidden video camera above a new fax machine at its Santa Clara, California, offices. By design, the fax feeder required that documents be laid faceup on the machine so that the overhead camera would capture an image of the document being faxed. Intel also installed a camera in a fabric divider panel to record the face of the faxer. And without the specific employee’s knowledge, the semiconductor giant fixed a hidden camera above her desk and recorded her comings and goings. The time clock on the digital camera was synchronized with the clock on the fax so that there would be no dispute over when a specific document caught on camera was actually faxed.

After complaints two years earlier from investors, Intel resorted to these unprecedented measures to plug internal leaks of sensitive corporate information. Early investigations of its phone records turned the company’s suspicions to a junior employee working in Intel’s product-marketing area. The worker raised a red flag herself when she told a colleague that she had access to important data on computer chip sales. “If you sell this information, you can get real money for it,” she remarked.

In the mid-1990s big institutional investors noticed that some of Intel’s most sensitive financial data was leaking into the market before it was publicly released. Institutional investors—mutual funds, insurance companies, banks, hedge funds, and pension funds—invest large pools of money. They buy and sell hundreds of millions of dollars of stock in companies like Intel every day. They live and die on quarterly profit figures (publicly traded companies are required to report earnings or losses every three months) and make large bets in the stock market in anticipation of a company’s earnings. If earnings exceed analyst expectations, a company’s stock usually rises. If a company misses projections, the stock usually declines.

An investor who has an early bead on quarterly earnings can make a killing—and show up his rivals along the way. Those whose performance declines face the risk of losing customers. Knowing the earnings of a company before they are announced is the holy grail in the information-gathering game, but even nuggets like the number of computer chips a technology company like Intel sells and the price at which they are sold can be extraordinarily valuable. Production figures also provide a savvy investor with an astonishingly accurate tally of the company’s revenue.

Many investors had come to believe that someone at Intel was divulging confidential information about the company before its earnings were announced. The recipient of the information was widely thought to be a fast-rising analyst at a boutique investment bank named Needham & Co. The information the Needham analyst Raj Rajaratnam was receiving was making its way into a must-read newsletter Rajaratnam published entitled
First Call
. The investors were livid over the leaks. Many of them competed with Rajaratnam for money to manage, and by 1998, Rajaratnam had gone from being a behind-the-scenes research analyst who produced reports for star traders like them to being a fearsome rival. He now trolled for money in the same investing waters as they did. And he was drawing a boatload of it.

Just a year earlier, in 1997, after a decade at Needham, Rajaratnam had struck out on his own. He had been chafing for some time, tired of his job as a manager dealing with mundane matters. “I was spending two or three hours a day as a shrink dealing with people issues, organizational issues and strategic planning issues,” he remembers. He was also frustrated that the firm’s owner, George Needham, did not share his ambition to grow the company. Needham liked to say that he could see the face of every client on every dollar that the firm took in. Employees suspected Rajaratnam did not care one bit whose face was gracing the dollars flowing in. He just wanted to book more dollars.

In January, he and three lieutenants from Needham—Gary Rosenbach; Krishen Sud, his close chum from his days at Wharton; and Ari Arjavalingam—launched the Galleon Group. Galleon was yet another hedge fund, one of thousands of lightly regulated investment pools targeted to wealthy investors and institutions. The funds charge a small percentage of a client’s assets as a managing fee, but they make the real money on profits, typically charging 20 percent on the dollar for any return they provide the client.

Few knew it at the time, but Rajaratnam’s arrival would coincide with one of the hedge fund industry’s greatest periods of growth. Within a decade after he set up Galleon, assets at hedge funds would swell to nearly $1.5 trillion compared to $257 billion in 1996, and the number of hedge funds would triple to a little over seven thousand from about twenty-four hundred. Along the way, the industry would mint a whole new class of billionaires. Unlike the tycoons of bygone times, who husbanded their money discreetly, the titans of the hedge fund world were all too ready to flash their cash. One of the most visible was Steven A. Cohen, the founder of SAC Capital Advisors, who ranked fortieth in 2012 on the Forbes 400 list of richest Americans. A Wharton grad, Cohen grew SAC from $25 million in assets in 1992 to $14 billion today. He lives in a massive 1920s estate in north Greenwich, Connecticut. Cohen bought the property for $14.8 million in 1998. He then added a twelve-thousand-square-foot annex with a basketball court, an indoor pool, and a movie theater that seats twenty. The palatial property houses Cohen’s humongous art collection—an eclectic mix that includes masterworks of Cézanne, Picasso, Damien Hirst, and Jeff Koons.

When Rajaratnam started, he worked out of a cramped and shabby office on Lexington and Fifty-Seventh Street, about a block from his old company Needham, managing about $350 million that he cobbled together from close friends and family. His firm was called Galleon Group after the large ships that traded in spices and ivory with Sri Lanka, his birthplace, known long ago as the Isle of Serendip. Galleon stuck to its knitting. It drew on Rajaratnam’s expertise, technology stocks. On the walls of his new office, he hung prints of galleons, and on the sides of the room he displayed models of ships. On his desk, he had a small flag signifying his support for the Tamil cause. To kick off his new venture, he reached out to the prominent Silicon Valley executives he’d cultivated over the years.

As an analyst, Rajaratnam had written copious research reports on their fledgling firms, which had long been neglected by big Wall Street investment banks. It was he who exposed their companies to institutional investors in the first place. Emboldened by the success he had managing their money in the small hedge fund he ran on the side at Needham, he went back to the same people to seed Galleon. Many of his early investors were familiar names in the tech space—men like Ken Levy of KLA Instruments, Neil Bonke of Electroglas, and Kris Chellam of Xilinx. Just as he did at Needham, he would rely on some of them, such as Chellam, to serve as his eyes and ears on the industry. He was not shy about the role they played in Galleon’s success. In marketing tours and early pitch books, he highlighted the fact that around seventy-five officers of tech companies were also investors in Galleon.

Like many South Asians, Rajaratnam was close to his parents. Impressed by his hot streak, his father—a soft-spoken and conservative businessman who loathed risk—invested in his new hedge fund. He and his wife lived with their son and daughter-in-law in a postwar building at Sutton Place, a tony enclave of apartments overlooking the East River. At one time Marilyn Monroe lived at the address with her then husband playwright Arthur Miller, and today it counts among its famous residents former New York governor Mario Cuomo. When Rajaratnam first moved in, he was hardly a bold-faced name on Wall Street. Neighbors suspected his lack of stature accounted for his buying into one of the community’s least desirable buildings. But that didn’t stop him from making the most of his purchase. In 2000, when he moved to combine the two apartments he owned at 60 Sutton Place, he told city officials that he needed two kitchens for religious reasons. Typically, only one kitchen per unit is allowed. The reason cited in his application was “adherence to Jewish traditions,” whch seemed a stretch for a Hindu. Rajaratnam liked to game the system—not just at work but even at home.

He could not have picked a better moment to pour money into technology stocks. The industry was on the cusp of an intoxicating bubble that would make brash young kids—the exuberant entrepreneurs of the tech world—wealthy overnight. The surge began on August 9, 1995, when Netscape, the brainchild of Marc Andreessen, then a twenty-three-year-old computer prodigy, went public. Netscape made Web browsers that ordinary people could use. It transformed the Internet, making it accessible to millions and millions of consumers. It spawned a virtual world with a revolutionary new business platform where in time hundreds of billions of dollars in commerce would flow. Between 1995 and 1999, 435 technology companies debuted on the stock market, start-ups including Yahoo!, Amazon, and Akamai Technologies, raising a little over $21 billion in capital.

Rajaratnam had a vision and the experience analyzing tech companies to understand the potential of the Internet. He believed it would eclipse the first revolution in tech—the personal computer—as an economic force. Many thought he was crazy, but his reasoning was sound. “It took the personal computer industry about six years to reach ten million users,” Rajaratnam told Antoine Bernheim, the publisher of
Hedge Fund News
, in an interview in April 1997, just four months after he set up shop. By contrast, the Internet had 10 million users in only ten months.

He knew it was not enough to be investing in a hot area. If Galleon was to be huge, it needed cachet. So he stacked its board of advisers with impressive names including hedge fund titan Stanley Druckenmiller and Paine Webber chief Don Marron. Druckenmiller and Rajaratnam had gotten to know each other when Druckenmiller was at Soros and Rajaratnam was at Needham. Druckenmiller had a clutch of Wall Street analysts he trusted for insightful research, and Rajaratnam, the number one semiconductor analyst on the street, was one of them. When Rajaratnam launched Galleon, Druckenmiller and his mentor, George Soros, threw some money his way. He had made money for them as an analyst at Needham. They had no reason to believe he wouldn’t make money for them again as a hedge fund trader.

Rajaratnam quickly moved to staff his new firm with analysts and portfolio managers from Wall Street’s Ivy League, Goldman Sachs and Morgan Stanley. The Needham name was simply not going to bring in investor dollars, so he created his own A-team. He hired Prem Lachman, a health-care analyst from Goldman; David Slaine, a trader from Morgan Stanley; and, as Galleon grew, he brought on board Rick Schutte and Rick Sherlund, the Goldman software analyst who helped take Microsoft public.

On the surface, Galleon had the veneer of a respectable hedge fund whose returns flowed from Rajaratnam’s undeniable expertise as a technology analyst. And Rajaratnam, its captain, exuded the aura of an upstanding money manager. After having breakfast with his family, he generally walked to his office on Fifty-Seventh Street, a short walk from his apartment on Sutton Place. Every day at 8:30 a.m. sharp, Galleon’s analysts and portfolio managers and traders gathered to review the companies that were reporting earnings that day and discuss other market-impacting developments. Rajaratnam would sit like a general at the head of a long conference table and fire a barrage of questions. He was a stickler for punctuality. At a firm that shelled out multimillion-dollar bonuses every year, analysts and portfolio managers routinely tripped over each other to make it to the meeting on time to avoid Rajaratnam’s $25 fine for latecomers.

Even as the firm grew, Rajaratnam made it a point to know if an analyst had recommended buying the stock of a company that later posted abysmal profits or selling a stock about to surge. Whenever that happened, Rajaratnam was legendary for his public floggings. He liked to reduce grown men to quivering sacks of jelly, but only when appropriate. A keen leader, Rajaratnam also knew when it was best to be ice-cold.

When Galleon’s restaurant analyst predicted that McDonald’s would report disappointing same-store sales only to watch in horror as the company posted better-than-expected sales and its stock price rose, Rajaratnam confronted the analyst: “Tell us what happened.”

“People ate a lot of burgers this month,” the analyst deadpanned.

No one laughed.

Though it didn’t appear that any Galleon funds had taken a position based on the analyst’s call, Rajaratnam was livid. He couldn’t believe the analyst had the nerve to make a joke about something so serious. Rajaratnam knew it was not the time for showing explosive rage. Displays of anger signaled a loss of control. Instead, a week later the analyst was let go in a collective culling.

Rajaratnam told prospective investors that the fund’s returns were driven by “bottoms-up research” carried out by a team of analysts who visited more than three hundred companies a month. Analysts were urged to travel as much as they wanted and to visit as many companies as they could. Rajaratnam had only one requirement: at the end of the day, the analysts had to email or fax an explanation of what they learned during their company visit. If they didn’t, their travel expenses were not reimbursed.

When Galleon started, eight of its ten analysts were engineers by training and worked in the technology industry. David Blaustein, the manager who ran Galleon’s health-care fund for a time, got his start as an emergency room/trauma doctor at Yale University before arriving on Wall Street in the mid-1990s. Rajaratnam liked to boast that his analysts weren’t “blindsided by the marketing hype.” An engineer by training himself, he often said it was easier to teach an engineer how to pick stocks than to teach engineering to a stock picker.

Rajaratnam imbued Galleon with his playful and fun-loving personality. On Thursdays, employees could sign up for massages at the office. He would hold job interviews at the topless club Scores. And in the hothouse culture of the Galleon trading floor, he indulged his passion for pranks. Traders who made bets and lost would be required to spend the day wearing lingerie. He would offer $5,000 to anyone who would drink ten tequila shots or $1,000 if they could eat a whole loaf of bread without drinking a glass of water. Even as the firm grew and his stature rose, he acquiesced in the freewheeling culture.