SEC v. Rajat Gupta: Some thoughts and observations (Part 3)

The case against Rajat Gupta is mostly a matter of proving facts rather than establishing the law.  The staff at the SEC will have to show that he tipped material non-public information to Rajaratnam in violation of a duty.  But there is one interesting legal issue.

Insider trading for fiduciaries (directors of companies qualify) must meet the standard set out by the Supreme Court in SEC v. Dirks.  Dirks required a showing that the insider violated a fiduciary duty when giving out the material non-public information.  Limiting insider trading to a breach of fiduciary duty was problematic.   It of course ignored the persons who had material non-public information but were not fiduciaries, starting with accounting firms, lawyers and investment banks hired by the issuer.  To address that issue, the Court has to invent the "temporary" insider doctrine, thereby trying to fill an analytical weakness in its own approach.  

The mistake was compounded, however, when the Court defined a breach as the receipt of a personal benefit, something presumably limited to pecuniary gain.  In the Rajaratnam trial, the court defined personal benefit this way:

• The government must also prove beyond a reasonable doubt that the insider who disclosed the information personally benefited in some way, directly or indirectly, from disclosing that information.  Benefit may be monetary or financial.  The benefit, however, need not be a specific or tangible benefit received in exchange for the information.  It can also include a reputational benefit that will translate into future earnings, or the satisfaction which comes from making a gift to a relative or friend.  Evidence of the relationship between the insider and the recipient of the insider's intention may be circumstantial evidence that the insider receive a benefit.

Transcript, at 5622. 

In the SEC's case against Rajat Gupta, the staff did not allege a gift of the information from Gupta to Rajaratnam.  This likely reflects the narrow nature of the gift analysis, something typically limited to family members or close friends. 

The staff did, however, allege a monetary or financial benefit.  According to the complaint:

• During the relevant period, Gupta had a variety of business dealings with Rajaratnam and stood to benefit from his relationship with Rajaratnam.  In addition, Gupta was an investor in, and a director of, Galleon’s GB Voyager Multi-Strategy Fund SPC, Ltd., a master fund with assets that were invested in numerous Galleon hedge funds, including those that traded based on Gupta’s illegal tips.

The Voyager Fund, according to one source, "was wiped out in the 2008 financial crisis, costing Gupta his $10 million investment." 

The complaint provides no details on the alleged business dealings.  The staff will presumably need to connect the business dealings to the disclosure of material non-public information. 

The investment by Voyager into the Galleon funds that took advantage of the allegedly illegal tips clearly suggests a benefit.  Profiting from the information by trading on it is perhaps the quintessential example of benefit in the insider trading context.  Yet it is also possible that the amount of investment by Voyager into these particular funds was insignificant.  It will pose for the ALJ the question of whether benefit means material benefit.  

To the extent that the SEC proves that Gupta gave the information to Rajaratnam, the agency should not have to show some kind of personal benefit.  Proof that a director routinely gave material non-public information to those trading on it, without a strong corporate justification, ought to be enough to show insider trading.  But as the Supreme Court has indicated, that is not the case.