Former McKinsey & Company head and
Goldman and Procter & Gamble board member Rajat Gupta has been convicted of
securities fraud and conspiracy for giving away confidential information from
boardroom meetings. This makes him the latest in a string of convictions
related to the insider trading scandal centered on hedge fund Galleon Group. The
court cases since the scandal have revealed a pattern of information collection
from board directors followed by quick and profitable trades, with involvement
all the way to Galleon’s top. Its founder Raj Rajaratnam was convicted in
October 2011, and many Galleon traders have also been convinced, as have their
information sources.
An irony of Rajat Gupta’s conviction is
that he appears not to have profited from the inside information he passed on. Rather,
he passed on information, and Galleon traded on it, without any trades on his
own behalf or (traceable) kickback. Indeed, prosecutors were quoted saying that
his information leaks were “motivated not by quick profits but rather a
lifestyle where inside tips are the currency of friendships and elite business
relationships.” This quote sounds familiar to me, because along with Gerald
Davis I have studied how boards of directors form their own norms of
conduct, as reflected in the type of governance innovations they adopt. We
found that they indeed determine norms through interacting with other board
members, though we did not study anything illegal such as violating
confidentiality.
But the investigation and conviction has
another irony as well. A recent Wall Street Journal article has a map of the
network of individuals implicated in the Galleon trades, as well as their
current status in the court system. Of particular interest are those with
status pleaded guilty (cooperating witness), because they were used (along with wiretaps) to break the case open. I study networks, and
one glance at the map is enough to be impressed with the investigation. The
central person they targeted, Galleon head Raj Rajaratnam, is surrounded
by cooperative witnesses, and his closest associates are also nicely bracketed
by cooperating witnesses. Clearly the investigators were able to follow the
network of individuals involved through traces like suspicious trading
patterns, phone call records, and eventually wiretaps, and once they knew who
was spilling information to whom they went to work turning some witnesses in
order to get at the main targets of the investigation. And hedge fund traders and
leaky board members appear to be easy to turn cooperative compared with other organizations
that the FBI has dealt with in the past. In Rajat Gupta's case they did not even need a direct wiretap or cooperative witness because the other evidence from phone records and suspicious trades was so compelling.
So, this incident really deserves the Tolkien
headline: One network to bring them all and in the darkness bind them.
Davis, G.
F. & Greve, H. R. 1997. Corporate elite networksand governance changes in the 1980s. American
Journal of Sociology, 103(July): 1-37.
Bray, C. Rothfeld, M, and R. Albergotti.
2012/6/15. Insider Case Lands Big Catch. Wall
Street Journal. Interactive graphic (may require subscription):