The Billionaire's Apprentice: The Rise of the Indian-American Elite and the Fall of the Galleon Hedge Fund (7 page)

This “arbitraging of consensus” favored hedge funds. Unlike analysts at the banks, who are judged by the forward-looking accuracy of their calls and are slow to change estimates, hedge funds like Galleon can be more fleet-footed, adjusting their assessments of a company and its prospects at will. And unlike mutual funds, hedge funds can take short positions, or have pessimistic views of a stock.

Even at times when Rengan was trying to seem humble he came off as arrogant. When asked whether the $700,000 he invested in Sedna was his risk capital, he replied, “I’m single. I am a bachelor. I live in the same apartment I lived in for five years, my rent is a couple grand. I don’t spend money. If I lost it, it wouldn’t touch my life.”

The one item Rengan was prepared to make a concession on was the quality of record keeping at Sedna. He admitted to the SEC lawyers that Sedna kept poor records, failing to preserve emails as required by a hedge fund that registers with the SEC as a “regulated investment adviser.” Not all funds seek the title. While it can give a fund an aura of legitimacy, it imposes strict reporting requirements that are expensive for small funds like Sedna. SAC Capital, run by Rengan’s former boss, Steven Cohen, did not seek the SEC imprimatur until 2012, and Sedna got it only in January 2006, nearly two years after it was launched.

“This is kind of the mistake we made,” Rengan told the SEC lawyers. He said at one time Sedna’s analysts “used to actually burn the emails to the CD-ROM drive, take it home and keep it in Brooklyn, God forbid anything happened in New York.” Wadhwa suspected Rengan’s contrition was calculated and the allusions to a 9/11-type event deliberate. All too often an SEC lawyer, confronted with a hedge fund manager who can’t produce the emails he is requesting, will charge the fund with a books-and-records violation—essentially a slap on the wrist. Wadhwa found it hard to believe that a manager like Rengan, who had worked at SAC Capital and who seemed well put together, was unable to lay his hands on all of Sedna’s emails. At 4:57 p.m., after nearly seven hours of questioning, the deposition ended.

Rengan felt good about it. When his brother asked how it went, he said well. At the SEC, though, Wadhwa and Michaelson were left with a different impression: they had no doubt that Rengan was dissembling when he gave testimony.

In the fall of 1971, Rajat Gupta said good-bye to his college sweetheart, Anita, and boarded a KLM airplane from New Delhi, making the first leg in his journey to the United States. The flight was Gupta’s maiden trip outside India. After a stopover in Amsterdam, where he and a friend marveled at the spanking-new Mercedes cab they hailed—nothing like the clunky Ambassador cars on the streets of Delhi—they landed in London. There they caught a play and Gupta bought a London Fog raincoat. Gupta and his friend quibbled over which coat to buy. In the end, Gupta wisely bought the more expensive one with a lining. Boston winters, he would discover, are brutal.

At Harvard, Gupta found himself in the company of accomplished men from pedigreed backgrounds who went to the best private schools, summered in Europe, and, through family ties, landed jobs at Fortune 500 companies or clubby Wall Street banks before even arriving at Harvard. They had an easy confidence and an aura of sophistication. Many, like Edward Shoen, a classmate of Gupta’s, were part of an exclusive, moneyed club. Shoen would one day run
U-Haul
International, the company his father founded. For others, like Ray Dalio, the son of a jazz clarinet and saxophone player, Harvard would become a way station en route to founding one of the world’s largest hedge funds, Bridgewater Associates.

If Gupta was intimidated by it all, he didn’t show it. Instead he struck a balance between assimilating and retaining his Indianness. During the week, he absorbed American culture from his dorm mates, but on weekends, he often took to the campus of MIT to catch a Hindi movie or joined a married friend from Delhi for an Indian meal. He so missed the spicy food from home he kept a jar of hot pickles in his room.

His quiet confidence was all the more striking given that he was one of the youngest members of the HBS class of 1973 and one of three from India. Of the 768 students in his class, there were only 30 women and half as many Asian students. “There were a lot of Brits, Aussies, and an occasional Japanese student” at the school, recalls Grover T. Wickersham, a member of the class. “But in those days there weren’t many foreign students from India.”

Unlike a number of his peers, who worked on Wall Street or served in the military before making their way to Harvard, Gupta was a greenhorn, arriving in Allston, Massachusetts, straight from IIT Delhi. John Carberry met Gupta on his first day at Harvard at their dormitory, Morris Hall, which, like all the dorms at Harvard Business School at the time, was fittingly named after a leading figure in finance, in this case Robert Morris, who saw to the bankrolling of the Revolutionary War. “My immediate impression was what a nice guy this is,” says Carberry. “There wasn’t a cockiness about him. If anything there was a sweetness, a kindness about him—maybe a little naive but always upbeat, always pleasant.”

Gupta and Carberry were part of the same “can group”; they each belonged to a set of four two-room suites connected to a can, the slang for “bathroom.” Typical of his friends in his first year was David Manly, who was as provincial as Gupta was exotic. He came to HBS from a small town in upstate New York and was taken with Rajat’s gracious manner and his roots in the “mysterious east.” On his study table in his room, Gupta kept a tattered piece of paper. It read, “But I have promises to keep and miles to go before I sleep—Robert Frost.” He had received the piece of paper from his father during his final days. Close to Nehru, Ashwini Gupta knew that the poem was a favorite of the Indian leader.

The eight members of the can were a tight group, often strolling into each other’s rooms for help with cases or simply for a late-night chat to break the relentless grind. Every evening, they would make the quarter-mile trek to Kresge Hall for dinner, wending their way in the bitterly cold Boston winters through the underground tunnels that were a signature feature of the HBS campus. “All we ever did during those walks—and over dinner—was to go over the case discussions earlier that day or see if anyone started on the cases for the next day,” says Carberry.

Operating along the lines of a top music conservatory, HBS culled the business-world equivalent of highly talented pianists and violinists who were yet to realize their full potential as concert-level artists. Like any good music school, Harvard recognized that talent itself was not enough to produce effective leaders. So the bedrock of its philosophy was practice, practice, practice. The view was, “You don’t teach business by having people read textbooks; you teach business by having people make many, many decisions during their two years,” says Fred Sturdivant.

Thirty-two years old and self-described as cocky, Sturdivant struck students as a youthful Professor Charles W. Kingsfield Jr., the exacting Harvard Law School professor immortalized in the 1973 movie
The Paper Chase
. Like in Kingsfield’s law class, one of the key teaching devices at HBS was “cold calling,” in which students were randomly selected to answer questions. Sturdivant kicked off by walking into the large amphitheater-style classroom “like a Gestapo officer,” Carberry recalls. Without even looking up, and with his back turned, Sturdivant said, “Mr. Clarke, will you begin.” Townsend Clarke, or Towney, was hardly a slouch. He was about six foot four and 240 pounds, with wispy blond hair and a square jaw. He was said to be the last all-American football player to graduate from West Point and arrived at Harvard fresh from his latest tour of duty in Vietnam. For fifteen minutes, Clarke offered a penetrating diagnosis of Hesper Silver, a case about marketing silver flatware. When he finished, Sturdivant, seeming singularly unimpressed, declared, “Mr. Clarke, if you can’t do anything better than recite the case, I think we had better ask someone else.”

It was no accident that Clarke was selected to be the first target of the new class. At a party the night before, Sturdivant said he was looking for a “strong student”—someone who could take the pressure of leading off on the first day. When students offered up Clarke’s name, Sturdivant didn’t quite appreciate what he was getting. “The minute I said, ‘Mr. Clarke would you begin please,’ the young man jumped to his feet, snapped to, and barked, ‘Sir, yes, sir,’” says Sturdivant. “It scared the hell out of me. Everybody sat there traumatized, thinking,
Is this what I am supposed to do?
”

As Carberry and other students slogged through their first term at Harvard, Gupta appeared to cruise. “Rajat constantly just floated above all this,” says Carberry. “We all got the impression that the academic challenges at Harvard Business School were not that much of a challenge for him.” Even though Gupta had no experience working in the business world, he was as fluent at navigating an income statement as his classmates who’d held jobs at companies before coming to Harvard. Friends marveled at the ease with which he tackled problems, getting to the nub of cases so much faster than they did. “If you had a problem with a case, Rajat would gladly help you out,” says Carberry. “He wouldn’t give you the answer, but he would say, ‘Have you thought about that?’ He would open some doors for you.”

Among the pride of alpha males at HBS, Gupta was distinctive in a very non-alpha-male way. In a picture that appears in the class prospectus, Gupta appears very reserved. “When you look at the guy, he is kind of a Nehru. Even without a jacket, he seemed like he had a high collar,” says Wickersham. In study groups, students would often ask, “What is the deal with Rajat?” recalls Wickersham. Few really had a sense of what IIT was at the time except to know “it is three times harder than MIT. Everyone figured he got here so he is pretty smart. He did everything on a slide rule that everyone at MIT did with massive computers.” Wickersham got the impression that Gupta came from a modest background—he wasn’t the kind of guy who made it to HBS because he was born with a silver spoon in his mouth. “I looked at Rajat and used to think he’s the guy who vindicates the system,” says Wickersham. “It’s the American approach of meritocracy. It doesn’t matter who you are or what kind of family you are from. Rajat is the guy who should have gotten in if you believe in meritocracy. He, to me, was the shining light; he went the distance. If they made movies like
Rocky
about a business guy, he would be the guy.”

During the first six weeks at HBS, Wickersham says, an engineer like Gupta thrived because the course work was quantitatively driven. But when the courses started having a more liberal arts flavor to them, Wickersham expected Gupta to struggle, like some of the math geeks did. He didn’t. What was remarkable was that Gupta excelled even though he was reticent in class. It was well known that a large part of one’s grade came from class participation, triggering a curious pattern of one-upmanship in class, with one student trying to outdo the next in the heated competition for airtime.

In later years, Gupta would acknowledge his silence as one of his personal shortcomings at HBS and would attribute it to his Indian upbringing, in which children were judged in school by their written work rather than their class participation. In the end, Gupta said he made a deal with three of the five professors who taught him; he would be judged on his written final exam rather than his contributions in class.

Despite his quiet way, Gupta was learning a lot at HBS—both inside and outside the classroom. At times, Carberry says, he would return home from the library at about eleven o’clock at night and find Gupta working on cases as he kept one eye on the television, often to watch
Monday Night Football
. Gupta proved to be a quick learner. By mid-November of his first semester at Harvard, he could carry on an intelligent conversation about the game, filling in Carberry on the strategy of a given team or how its players lined up. About two or three months after Gupta arrived in the country, he and Carberry were watching a football game in their suite. “I think it was the Vikings versus the Giants,” says Carberry. “At one crucial point in the game, with the Vikings having the ball, Rajat says to me, “I think the Giants need to ‘red dog’ here.” (“Red dog” is an old-school term for “blitz.”)

At other times, Carberry would return to Morris Hall late at night and find his can mate Gupta watching Johnny Carson. “He was picking up on American culture,” says Carberry as he thinks back on Gupta’s first year in the United States. “He would say, ‘What is Johnny Carson doing with Ed McMahon? Sometimes he is funny and sometimes he is not.’”

As eager as Gupta was to soak in American culture, he kept silent about one of the most salient features of life in America at the time, the Vietnam War. Classmate John Hook remembers sitting in a class next to Clarke, the celebrated West Point graduate, one day when “I proposed we stopped the bombing.” The class was divided between students who served in the military and believed the bombing was necessary and appropriate retaliation for a North Vietnamese offensive that started in late March, and civilians in the class who adamantly opposed the escalation. What was clear was that when heated discussions like this flared up, “someone like Rajat would be silent through these debates,” says Hook, who is now an adviser on global trends to hedge funds. “Rajat would not take controversial positions—I would say that is not his thing.” Growing up in India, Gupta was always likened to his father; he shared his dad’s brilliance and his breathtakingly good looks. But as he matured into a grown man in America, Gupta would stand apart from his father; over time, the similarities between the two would fade and be overshadowed by differences.

At the tail end of January 2007, Wadhwa and Markowitz decided to dispatch a team from the SEC’s examination staff to Galleon, Raj Rajaratnam’s firm. Their antennae were raised by the curious instant messages between Rengan and his brother Raj about stocks around which the SEC suspected insider trading was occurring.

Even before the examiners arrived at Galleon’s offices at 590 Madison Avenue, the 603-foot-high black stone skyscraper on Fifty-Seventh Street formerly known as the IBM Building, they knew what they were looking for. A couple of the staffers on the SEC’s Galleon exam team were camped out at Sedna months earlier and were up to speed on the touch points between the two brothers’ firms.

On the morning of Monday, February 12, 2007, four SEC examiners met with a team from Galleon—Lindi E. Beaudreault, Galleon’s outside lawyer; George Lau, its compliance officer; and Tom Fernandez, its head of investor relations and a college buddy of Raj Rajaratnam’s. At a welcome meeting, during which Rajaratnam popped in to say hello, Beaudreault painted a picture of a hedge fund operating in full compliance with US securities laws. She told the examiners that Galleon adhered to a very detailed policy on insider trading, which was reviewed every year with the hedge fund’s one hundred employees, comprising largely portfolio managers, traders, and analysts. The SEC team smiled and nodded. This was not the first time they’d heard this speech.

The Galleon portrait Beaudreault painted eroded over the next few weeks as the team examined the emails and instant messages themselves. A couple of IM exchanges in particular piqued their curiosity. In one, on April 21, 2006, just a few days before Computer Associates, which trades under the stock symbol CA, unveiled quarterly earnings guidance, Rajaratnam chatted with Quint Slattery, the manager of Symmetry Peak, a fund in which Rajaratnam was invested:

The exchange was so ham-fisted that it was an insult to regulators. Did Rajaratnam really think they would buy that he was referring to a press release about the Yankees’ star baseball player Derek Jeter? It demanded a response, but building a case from the casual chatter alone was difficult. When Michaelson delved into Galleon’s records, he found that the hedge fund did trade Computer Associates stock around the time of the IM banter. But the name of Rajaratnam’s source—the individual who Rajaratnam boasted had seen the press release and the indispensable link to build an insider trading case—eluded him entirely.

Michaelson checked the contacts in Rajaratnam’s Microsoft Outlook folder, he reviewed all his IMs and emails and trolled through his copious phone records, but he came up empty-handed. He even reached out to Computer Associates, which sent a thick document detailing all the people at the firm and outside it who were briefed on its earnings, but the document did not help uncover the source. Besides showing that material nonpublic information has been divulged, to bring an insider trading case the SEC needs to demonstrate there has been a breach of duty when the information is given. But after weeks of digging, Michaelson couldn’t turn up Rajaratnam’s source. Without an informant, it was tough to allege a breach. As long as Rajaratnam had so many diverse sources of information—some of the tips he traded on came from middlemen, other hedge fund managers, for instance—the SEC could do nothing to dredge up his source.

From the beginning, Markowitz believed that the Sedna-Galleon case would be one the SEC referred to the criminal authorities. Unlike other insider trading cases that fell on his desk, many of them isolated instances of individuals trying to profit from corporate news they accidentally stumbled upon, there were early signs that trading on inside information at the two hedge funds run by the Rajaratnam brothers was widespread and that it rose to the level of criminal behavior.

But there was a downside to bringing in the big criminal guns. Whenever the SEC enlists their help, it can lose control of a case. The SEC is a civil body and typically has a lower threshold for cases than the US attorney’s office, which lives and dies by the “beyond a reasonable doubt” yardstick. Many times, the SEC has to wait for prosecutors before it can bring an action. And prosecutors want “winners,” which means building an unbeatable criminal case.

There was another issue. Wadhwa and Markowitz had got wind that a previous insider trading investigation into Rajaratnam in the late 1990s was squashed because a criminal probe into his possible involvement with a Tamil insurgent group had taken precedence. They didn’t want to waste their time and have that happen again.

Despite the potential downside of bringing in the feds, Markowitz decided to refer the case to the US attorney’s office for the Southern District of New York in March 2007. The office, dubbed the
Sovereign
District of New York because of its storied reputation for independence, covers the boroughs of Manhattan and the Bronx and has far more cases to choose from than it can handle. Wadhwa and Markowitz knew that they had to convince the criminal authorities that the developing case against Galleon was worth their time and effort. Markowitz was encouraged when the prosecutors said they would be willing to come to the SEC’s offices for a meeting. Usually it was the SEC lawyers who made the trek across Lower Manhattan.

“This is our best shot at getting into hedge fund insider trading,” said Markowitz. His subtext was
This is a headline-grabbing case
. The SEC lawyers shared with their criminal counterparts some of the suspicious instant messages the exam staff had uncovered. William F. Johnson, deputy chief of the Securities and Commodities Fraud Task Force, appeared intrigued. “Wow, that is good evidence,” he said. Then Michaelson handed over a binder focused on trading in two stocks, AMD and Arris; two DVDs containing emails; and a CD containing a trade blotter and some instant messages. Soon after the meeting, the US attorney’s office in Manhattan embarked on a criminal investigation. Wadhwa and Markowitz were thrilled; their pitch to the US attorney’s office had worked.

At the same time, an anonymous letter arrived at the offices of the SEC. It was postmarked Queens, New York, and was addressed to the SEC’s New York Regional Office director. “It is hedge funds like Galleon Group that create wealth for their shareholders and themselves at the expense of innocent investors,” the letter began. The writer went on to say that the limited partners in Galleon “are industry executives…and Board Members of large public companies…They share quarterly results with the management of this fund prior to release to the public. In return the fund provides greater returns on their money.”

The anonymous letter writer claimed never to have worked for Galleon but seemed astonishingly well-informed about the company’s practices. “Faxes are delivered from companies containing financials, product mix data etc. on Galleon management’s desk prior to release the next day.” The letter’s author waxed colorful when describing the corporate culture: “Prostitution is rampant for executives visiting Galleon. You will find that the superbowl [
sic
] parties for the executives, paid for by the Galleon Group, including [
sic
] prostitutes and other forms of illegal entertainment. In return, the executives provide Galleon the unfair edge that the fund leverages so well.” The letter closed by throwing down the gauntlet to the SEC: “I’m sure you will not have to dig too deep to unravel the truth behind this manipulative hedge fund.” It was signed “Seeking Integrity in Business,” but its author, whom SEC lawyers suspected was a disgruntled employee, could not be found.

By April it was clear to Galleon’s lawyers that the SEC was training its sights on Galleon rather than Sedna. At a deposition of a Sedna employee, the fund’s lawyer Jerry Isenberg asked Wadhwa point-blank, “Is this an investigation of Galleon or an investigation of Sedna?”

The inscrutable Wadhwa did not answer. He was not required to respond. At Galleon, where Rajaratnam tended to cultivate silos, in keeping with his secretive management style, few except for a handful of Rajaratnam’s closest lieutenants were aware of the escalating probe. But for anyone who cared to look, there were clues. Sedna Capital, Rajaratnam’s brother’s hedge fund, whose suspicious trading activity sparked the investigation into Galleon in the first place, suddenly closed, largely on account of poor performance. Tellingly, its employees were absorbed by Galleon.

As the SEC examination continued into spring, Galleon and its lawyers turned hostile. In April, Beaudreault telephoned Wadhwa and charged that it was improper for the SEC to be investigating Galleon under an order sanctioning a probe of Sedna. When Wadhwa failed to act, her colleague Isenberg telephoned Wadhwa’s boss, David Markowitz, and claimed that the SEC was on a fishing expedition. Wadhwa was furious but Markowitz backed him, telling Isenberg that if he thought that kind of tactic was going to work,
he
didn’t understand how things worked at the SEC.

On May 14, 2007, nearly nine months after the initial tip that Rengan Rajaratnam’s Sedna Capital was engaging in some sketchy trades, the SEC issued a subpoena to Galleon for information on all trading activities, all trade blotters from September 2005 to the present, recording purchases and sales of securities, diaries, date books, and calendars, and all documents concerning specific securities such as AMD, the security that the Sedna friends and family fund made a killing on in 2006. They also issued a subpoena for Rajaratnam’s testimony. Galleon fired back immediately, canceling a scheduled SEC interview with Tom Fernandez, Galleon’s investor relations head, and effectively ending the exam.

“My team is getting kicked out,” George DeAngelis, a branch chief in the SEC’s Investment Adviser/Investment Company Examination Program in New York, told Wadhwa. (Members of DeAngelis’s team are the beat cops who patrol broker-dealers, the hedge fund and mutual fund industry, and other large swaths of the country’s financial infrastructure. If they spot troubling and pervasive activity, they can enlist Wadhwa and his enforcement group.)

“Don’t worry,” Wadhwa replied. By this time, he was comfortable that the SEC had enough strands of suspicious activity at Galleon to chase. It had a good idea, for instance, of the stocks Galleon made money on in 2006. One winning trade that stood out was a huge bet that Rajaratnam made on ATI Technologies, which was acquired by AMD. Surely the suspicious instant messages between Raj and his brother Rengan about AMD a few weeks later were not just a coincidence. The SEC could not prove it yet, but Wadhwa and Michaelson were just about convinced that Raj had an inside source on AMD and Raj was tipping off his brother.

The question the SEC lawyers now faced was whether to take testimony from Raj Rajaratnam immediately or subpoena more documents and then depose him. Ultimately they decided there was little harm in bringing him in straightaway. There was always a chance he might be able to offer a believable explanation for the suspicious threads the SEC lawyers were starting to tug at. After weeks of combing through emails and IMs, the SEC examination team had not nailed down any of his inside sources. In any case, if it needed to, the SEC could ask him to return, and there was always the possibility it could catch a break. Rajaratnam might say something that was provably false that could be used against him later. He might even slip and give up the name of a source, the indispensable element needed to build a case.

On the morning of June 7, 2007, as Wadhwa was walking with his colleague DeAngelis to take Rajaratnam’s testimony, DeAngelis spotted an email on his BlackBerry. One of his staffers had found “some interesting” chatter in a stack of instant messages between Rajaratnam and a person using the IM handle “roomy81.”

This was the first time Wadhwa and Michaelson had heard of roomy81. Not knowing the person behind the IM handle and wanting to do more digging, they filed the name away. They made a conscious decision not to ask Rajaratnam about the exchanges between him and roomy81. The last thing they wanted was for him to get the idea that they were going after roomy81. If he did, he could simply coordinate stories and cover up any impropriety. The less they appeared to know, the better. Walking to the deposition, they quickly devised a seemingly innocent way of asking Rajaratnam about the identity of the person behind the IM handle.

At 10 a.m., Raj Rajaratnam, flanked by the same two lawyers who had accompanied his brother Rengan six months earlier, walked into the SEC’s Testimony Room 416. With windows looking out onto the World Financial Center’s Winter Garden, Room 416 is rectangular, with a stained beige carpet. Rajaratnam wore a blue blazer and looked relaxed. Unlike his brother, he was smooth and understated. He explained the foundation for all his suspicious trades in a calm, matter-of-fact way, never losing his composure and never appearing arrogant or high-handed.

But, like his younger brother, he plied the SEC lawyers with half-truths. The SEC lawyers were not surprised. It was a tack they often encountered. When people are deposed by the agency, they have three choices. They can tell the whole truth, which could lead to the SEC bringing a case against them. They can invoke their right against self-incrimination and plead the Fifth Amendment, which the SEC could present to an SEC administrative law judge in any future civil case. Or they can lie. While invoking the Fifth Amendment can’t be presented as evidence in a criminal proceeding, it is permissible in a civil action. Some executives take the gamble that lying under oath is better than invoking the Fifth Amendment in the event that the SEC brings a civil complaint and their pleading of the Fifth is used against them.