The question that remains on a lot of people's minds is, "Why did he do it"?
By now the story of Rajat Gupta is a familiar one. He was man who came from humble beginnings in India and rose to the pinnacle of power and prestige in the United States. In the Indian-American community especially, he was revered. Yet he risked everything by passing along confidential corporate information to Raj Rajaratnam, his friend and business partner who ran the Galleon hedge fund. What makes it all the more puzzling is that Gupta did not benefit directly from this information nor any of the trades. Last Friday, a jury found him guilty of several counts of security fraud and conspiracy.
Why did he do it?
Unfortunately, a definitive answer about his motive did not emerge from his trial. Although it's debatable, the prosecution technically did not have to demonstrate any motive at all. In its 1997 decision in United States vs. O' Hagan, the Supreme Court validated the "misappropriation theory" of insider trading. Under this theory, person commits fraud anytime he misappropriates confidential information for security trading purposes, because it is considered a breach of duty owed to the source of the information. So you don't have to necessarily profit from the insider trading - the mere act of passing along confidential information will get you in trouble.
But in Gupta's case, the prosecution was in a bind. Unlike the trial against Rajaratnam, there were no wiretaps of Gupta's phone as he was tipping off his friend. So the prosecution tried to establish motive by detailing their business dealings. It's true that Gupta could have possibly benefited from closer business ties with Rajaratnam. By giving his friend this confidential information, perhaps Gupta was counting on some quid-pro-quo and getting a slice of the huge profits at Galleon. But those were speculative arguments, which the defense rightfully pounced on.
The dialogue in the press offered up the familiar reasons for "motive" and why the rich and powerful get into trouble: they are cloistered in their own world, consider themselves above the law, feel they can get away with it, and get a rush from "living on the edge."
As usual, I'm not completely happy with any of these explanations. Not that they are wrong, but mainly because they are inconsistent with who Gupta was outside of his dealings with Rajaratnam. From what we can tell, he conducted all his other affairs with competence and integrity. The prosecution didn't (and couldn't) bring up any other dealings from Gupta's life which would indicate he was predisposed to this kind of illicit behavior.
So the question remains: why did he do it?
This had been nagging me ever since the whole Galleon case became public. The beginnings of an answer came last week when I was reminded of a conversation I had in the early 1990s with a physics graduate student at the University of Chicago. I was an intern at Argonne National Lab (just south of Chicago) and was at the university with my mentor to discuss some research results. The University is famous for the extraordinary number of Nobel laureates associated with it - on the faculty, retired, or otherwise. Apparently there were so many laureates that, within that elite group, a pecking order had developed. Amongst all the science departments for example, Subrahmanyan Chandrasekhar was unquestionably at the top of the laureate heap. He was an astrophysicist who won the 1983 Nobel Prize for a calculation he did almost 50 years earlier on the back of an envelope while traveling to England on a ship. I didn't much care for finance back then, but I'm confident the pecking order in the Economics department would have culminated with Milton Friedman.
According to our host, it was almost comical to watch these laureates at seminars trying to outdo each other in the way they talked and asked questions. Winning the Nobel Prize is the pinnacle of a career in science - you have nothing to prove after that (so we think). Yet here were these men jostling with each other, sizing each other up while berating the poor guest speaker.
This act of sizing up and evaluating of others is discussed in a remarkable book, Envy Up, Scorn Down, published recently by Princeton psychology professor Susan Fiske. As she explains, human beings are constantly comparing themselves to each other as individuals and as groups. We are "comparison machines" by our DNA and evolution. Her research into the neuroscience behind this illustrates how these comparisons form the basis of self-knowledge. After all, knowing how we rank amongst each other informs us of our own strengths and weaknesses. These social comparisons evoke the two emotions of envy and scorn mentioned in the title. Fiske provides a model and explains in great detail how these emotions can account for a wide range of interactions, motives, and emotions we feel towards one another. Why do we resent a rich neighbor? Why do elites sometimes "dumb down" who they are? Why do we feel the need to put certain people or groups in their place? Our actions can range from the harmless, benign neglect of certain groups to grotesque violence.
I cannot possibly do justice to the enormous amount of research, including her own work, which is presented. But Fiske's work suffices as a framework for understanding interactions in our own lives and what happened in the Gupta case. The key point is that we are all wired to compare. We are social beings -- whether we'll admit to it or not, sizing up others is part of the game.
For example, how many times have we played up the importance of the work we do when talking with peers or competitors? I'll share one story with you. In the late 1990s, during my time a graduate student at Stanford, I saw Palo Alto get overrun by people who moved out here to work at dot-com start-ups. Striking up conversations with them at local bars downtown had many of the elements discussed in Fiske's work. These "dot-commers" weren't my rivals in any direct way, but they had chosen a path that I could have chosen and some were rewarded handsomely for it. I was envious and maybe even a little resentful. Even if they weren't rich yet, the perception was that they would soon be loaded. Plus they were doing something that was now considered sexy and cool and had captured everyone's imagination. And here I was stuck in a lab day and night. So in those conversations, I had to exaggerate the importance of my research. 'I am solving big, important scientific problems … you are just a Java developer.' I'm sure the conversation in their mind was similar: "That dude goes to Stanford but he has no money!" Thankfully the dot-com bust took a lot of this excess away so I could feel better about myself and not have to fight for a seat at the bars anymore.
A lonely graduate student playing up his research was as pathetic as it was emotionally necessary. A bunch of Nobel-prize winning physicists thumping their chest probably just added comic relief to an otherwise boring seminar - predictable given the competitive setting of UChicago, but ultimately harmless. However, when two powerful men were brought together in a complex, competitive relationship, things become more interesting … and more toxic.
Through the reporting, wiretaps, and other evidence presented in the case, we get an interesting picture of how these men interacted in private and their sometimes convoluted relationship.
Rajat Gupta was the ultimate corporate insider who had worked his way up the ladder at McKinsey & Co. In 1994 he was elected managing director, becoming the first Indian-born CEO of a major multinational company. He is widely credited with McKinsey's successful expansion and cementing its reputation as the top consulting firm in the world. The list of companies, non-profits, business schools, and other institutions he was affiliated with is simply staggering. He was very active in philanthropy, focusing on global health and education issues. Combined with his position at McKinsey, he was in the orbit of anyone who was important in the business world.
In contrast, Raj Rajaratnam was a trader at a long/short equity hedge fund. As a manager of a similar (but much, much smaller) fund myself, it was quite gratifying to learn that Rajaratnam's trading wasn't overly sophisticated (I'm sure Susan Fiske could appreciate that sentiment!). He traded stocks and options actively around several core positions and proclaimed to his investors that it was all based on rigorous fundamental analysis. His trading was no big deal - every long/short fund does this one way or another.
If there was any "sophistication" in Rajaratnam's operation, it was his "expert network" of agents on Wall Street and Silicon Valley, which he had assiduously cultivated over the years. We now know that much of that " rigorous analysis" was confidential information gained illegally and used to make significant profits.
I'm not denying that money could have been some motive for Gupta to pass on secrets - but perhaps not in the way we've been led to believe. Indeed, both were keenly aware of each other's income and net worth. The reported sums that Gupta could have gotten from his actions (but didn't) aren't anywhere close to what Rajaratnam or the top Wall Street leaders make. Let me illustrate a quick back-of-the-envelope calculation: Rajaratnam wanted to grow Galleon from a $7 billion to a $10 billion hedge fund (making it one of the largest on Wall Street). At $10B, if the fund's returns were 10% in a year, the profits would be $1 billion. Assuming standard fees, Rajaratnam would earn 20% of those profits, or $200 million a year. He already had a net worth of over $1 billion. By comparison, Gupta's entire net worth was estimated at $100 million. The point is that Rajaratnam's single-year profits were on track to rival Gupta's entire lifetime's net worth.
Gupta had nothing on the horizon - no job, no partnership - that would have put him in that same league. The prosecution's case made it sound like there was a symbiotic business relationship between these two men. The fact is that there was nothing really concrete that would have earned Gupta the type of money his friend was making. Gupta had spent decades around Wall Street - these people were embedded in his social life. He was keenly aware of his place on the money ladder and that he had nothing which would catapult him significantly ahead.
When we question why Gupta, such an accomplished and revered man, would risk it all for seemingly little gain, we are asking the question from the wrong frame of reference. Gupta was not looking in the rear view mirror, content with a lifetime's worth of achievement. He was comparing himself to what was in front of him, and was becoming increasingly insecure about where he stood in the competitive landscape.
What Gupta saw in Rajaratnam was a friend as well as a rival. They were business partners who were congenial and talked regularly. Under the surface, there was a level of fierce comparison and competition that belied their public persona. Gupta was a pioneer in consulting - he was instrumental in building a business that helped others create great things. Rajaratnam didn't create anything except more money -- to Gupta he was just like everyone else on Wall Street. I would hear Raj Gupta's name often in Indian social circles while growing up in New York in the 1980s. The first I heard of Rajaratnam was when he was in handcuffs. Gupta was as connected as anyone could be with the who's who of the world. Rajaratnam was a bottom feeder for confidential information from friends in low places. Yet it was Rajaratnam's whose wealth that was growing by leaps and bounds, not Gupta's.
However, Gupta had one key thing that Rajaratnam didn't: a seat at the table. In fact, Gupta had a seat at many tables, and his rival didn't. And Gupta was going to let Rajaratnam know it. We can only guess whether Gupta felt envy or scorn towards Rajaratnam. Given the complexity of their relationship, it was likely a mixture of both. But as Professor Fiske describes, the actions that result as a consequence of both emotions can often be detrimental. By passing along the nuggets of confidential information, Gupta was subtly reminding his rival about where he stood in the pecking order.
This is why the "money as the motive" argument doesn't really work. The fact that they had both achieved wealth and success beyond their wildest dreams was irrelevant. They were not comparing themselves to us but to each other. What drove Gupta was a toxic combination of emotions that form the core of who we are as social beings. Gupta's actions were as pathetic as they were emotionally necessary. And this ultimately led to his downfall.
There was a very interesting wiretapped conversation that was part of this case. While this particular piece of evidence wasn't central to the case against Gupta, to me it said quite a lot. It was a conversation between Rajaratnam and Anil Kumar, a former McKinsey executive and a friend of both men. They were discussing Gupta's interest in joining KKR, a top private equity firm known for its generous compensation. Interestingly, it was Rajaratnam who points out Gupta's financial insecurity. "I think he [Gupta] wants to be in that circle", Rajaratnam gossips to Kumar, "That's a billionaire circle, right? … Goldman (NYSE:GS) is like the hundreds of millions circle, right?" It was not the only time Rajaratnam would speak disparagingly of his business partner.
To understand why Raj Gupta did what he did, we have to look no further than ourselves. He was a superstar who will likely spend most of his remaining years in prison. He was found guilty on three counts of securities fraud and one count of conspiracy. In the end, what he is really guilty of is being all too human.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.