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Corrupt Fortune: The Billionaire's Apprentice and the Gaming of Wall Street

  |   June 10, 2013   11:13 AM ET

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A Modern Great Gatsby: Rajat Gupta vs. Raj Rajaratnam and the Great Wall Street Scandal

  |   May 22, 2013   11:48 AM ET

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America's New Math: 1 Wall Street Hour = 21 Years of Hard Work For the Rest of Us

  |   April 22, 2013    6:13 PM ET

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Is Wall Street's Business Model Corrupt?

Les Leopold   |   February 12, 2013    4:37 PM ET

"Given the scope of the allegations to date, we are not talking simply about the occasional corrupt individual. We are talking about something verging on a corrupt business model." -- U.S. Attorney Preet Bharara, NYT, May 27, 2011

As the evidence mounts, the raison d'être for Occupy Wall Street is proving correct. Much of high finance, it seems, is based on a "corrupt business model." Here's a brief tour of its contours. (For more detail please see How to Make a Million Dollars an Hour.)

1. Rating Agencies Turn Tricks for Cash:

The three major rating agencies, by regulation, have special status in our economy. Their job is to help police the financial system by scrutinizing the credit worthiness of new securities created and sold by banks and other financial institutions. The higher the rating, the easier it is to market the securities. (Pension funds, for example, are only permitted to buy highly rated securities. And triple A-rated securities allow banks to hold and count such securities as Tier 1 capital against their loans, an extremely valuable attribute.) During the housing boom, banks found ways to "securitize" junk mortgages to sell to investors all over the world. Even though the underlying sub-prime mortgages were extremely risky, the banks claimed their bundling and slicing techniques made most of the securities extremely safe.

How safe? Well, the banks, using questionable modeling, "convinced" the rating agencies to provide AAA ratings to many of these dubious securities -- the same ratings as those awarded to the safest government bonds. Since the rating agencies are paid by the banks, it's easy to see why these ratings agencies would aim to please their benefactors.

This blatant conflict of interested greatly exacerbated the housing bubble and financial crash. On the way up the AAA ratings allowed for the generation of more and more sub-prime loans. No one cared if those taking out those mortgages could pay them back, or even if the borrowers were still breathing. The goal was to grab the mortgages, securitize them, get AAA ratings, and then pawn them off as fast as possible. After the toxic mortgages metastasized, the rating agencies quickly changed thousands of the AAA ratings to junk status, forcing banks and pension funds to dump the securities into declining markets. This further collapsed prices and intensified the crash. Meanwhile, the rating agencies became among the most profitable companies on Wall Street.

Since the crash, many of us have been screaming for the federal government to break up this prostitution ring. Finally, the Justice Department is asking for $5 billion in restitution from Standard and Poor's. But as far as we can tell, not one penny of the fines comes directly from any of the rating agency executives who so handsomely profited from this scam year after year.

(For a hard-hitting analysis see Marhall Auerback's "Credit Agencies are the Pimps of Wall Street." )

2. Money laundering for Drug Cartels:

The American division of HSBC, which is regulated by the Federal Reserve, is a division of one of largest most profitable banks in the world. Some of those super-profits result directly from massive money laundering in behalf of Mexican drug cartels. This was no mom-and-pop operation. Nor was it the work of just a few rogue bank officials, hoping to skim a few bucks on the side. No, this was the big time, a main event to the tune "at least $881 billion in drug proceeds" laundered through the U.S. financial system according to the Department of Justice. To compound matters, the bank was cited for "willful flouting of U.S. sanctions laws and regulations [that] resulted in the processing of hundreds of millions of dollars in... prohibited transactions" with rogue nations and even terrorist organizations.

The penalty for this blatant corruption is $1.9 billion, which comes to less than six weeks of HSBC's 2011 profits. What about criminal penalties? As the NYT laments in an editorial, "Too Big to Indict":

"It is a dark day for the rule of law. Federal and state authorities have chosen not to indict HSBC, the London-based bank, on charges of vast and prolonged money laundering, for fear that criminal prosecution would topple the bank and, in the process, endanger the financial system. They also have not charged any top HSBC banker in the case, though it boggles the mind that a bank could launder money as HSBC did without anyone in a position of authority making culpable decisions."

3. Creating securities designed to fail and then betting against them:

Imagine this: You sell a car that you claim is safe and sound. But you design it so that it will crash within the first few months of operation. Then you surreptitiously take out insurance on the car in order to collect the proceeds from the accident. You profit when you sell the car. You profit when you collect the insurance. This in a nutshell is how banks and hedge funds colluded in creating disastrous mortgage-related securities called synthetic CDOs.

We are awash with government evidence that the largest banks including JPMorgan Chase and Goldman Sachs worked hand in glove with hedge funds to create mortgage-related securities based on the worst mortgage pools that could be found. In fact, these venerable banks permitted the hedge funds to select the junk mortgage pools in order to make certain the mortgages would fail as soon as possible. The hedge funds then bet against (shorted) the new securities. JPMorgan Chase was fined $296.9 million and Goldman Sachs was fined $550 million for not disclosing these pernicious details to those who were sold the built-to-fail securities. But security law is such that the hedge funds involved were able to keep their booty.

4. Insider trading:

When we say that Wall Street is a casino, we give casinos a bad name. After all, public casinos are regulated, the odds are posted, and the games of chance aren't rigged. Not so with hedge funds and proprietary trading desks within large banks. They like to gamble only when they know the outcome before they bet. Trading on insider information is the method of choice.

Take the jailed billionaire Raj Rajaratnam, for example. His hedge fund made nearly a million dollars in only a few minutes after his source -- a director of Goldman Sachs -- provided a key bit of inside information in the tumultuous fall of 2008. With markets turning against investment banks, Goldman Sachs was to announce after the closing bell that Warren Buffett would invest $5 billion in the investment bank, thereby giving it an enormous seal of approval. The Raj, as he likes to be called, used his illegal tip to net a quick $900,000. To borrow a phrase from Nomi Prins, the former Goldman Sachs managing director, "Even the squirrels in my backyard could make money on that play."

So far, the New York U.S. attorney has nailed approximately 70 hedge fund cheats. Since it is very difficult to prosecute these cases, we can be certain those apprehended represent but a small fraction of those engaged in illegal insider trading.

5. Fixing interest rates:

The London Interbank Offered Rate (LIBOR) is the benchmark interest rate used by lenders all over the world to set short-term adjustable rates on everything from credit cards to car loans. The rate is supposed to reflect how much the largest banks in London would charge to loan money to each other. But bank traders and their hedge fund friends realized that if they could artificially inflate or deflate that rate at will, they could place bets knowing precisely which direction the rates would go and make a certain profit. So they did. Fines are being assessed against bank after bank both here and in London.

And the list goes on and on.

  • The big banks are being fined over $8 billion for illegal robo-signings of home foreclosure documents.
  • They will be fined billions more for selling crap mortgages to Fannie and Freddie.
  • Then there's the utter senselessness of high frequency automated trading which technically is legal.
  • And as Mad Money's Jim Cramer once confessed in a web interview, rumor mongering and media manipulation were key to the hedge fund he once ran.

As Cramer put it, the art of being a successful money manager is to lie: "But what's important when you're in that hedge fund mode is to not do a thing remotely truthful because the truth is so against your view that it's important to create a new truth -- to develop a fiction."

Why so much corruption?

In researching How to Make a Million Dollars an Hour I came across an interesting article by Professor Lynn Stout, a professor at the UCLA School of Law, entitled, "How Hedge Funds Create Criminals." Stout claims that hedge funds, "both individually and as a group can send three powerful social signals that have been repeatedly shown in formal experiments to suppress pro-social behavior." For the ethically-challenged, these signals can create what she calls a "criminogenic" environment that I believe applies to wide variety of financiers, not just hedge fund managers.

Signal 1: "Authority doesn't care about ethics." Clearly, when $881 million in illegal drug money is laundered through a bank, everyone knows that the higher-ups worry little about the ethics of the deal. And how could any top banker or hedge fund manager believe that it is appropriate to create products designed to fail and then bet against them?

Signal 2: "Other Traders aren't acting ethically." From insider trading cases, to mass robo-signings, to LIBOR rate fixing, hedge funds and bankers use the grade school excuse -- "Everybody else is doing it, too!"

Signal 3: "Unethical Behavior isn't Harmful." When what you do is make money from money, it seems as if breaking or avoiding laws and rules create victimless crimes. It's all a big game, where each person is trying to out-hustle the other. It's him or me so what does it matter if we both cheat a bit? But in truth, there are plenty of victims -- like the nine million workers who lost their jobs in a matter of months when the rigged game crashed in 2008. Millions more lost their homes, their savings, and their way of life. Victimless in finance only means that you don't ever see them face to face.

Right now Professor Stout's signals are flashing like strobe lights all over our financial system. The problems are so extensive that nothing short of a massive restructuring stands any chance of success. The steps are obvious: Break up all the big banks. Outlaw the rating agencies. Ban the use of derivatives. And place a financial transaction tax on all sales of stocks, bonds, options, futures, etc.

The choice is clear: Either we put our regulatory feet squarely on the neck of Wall Street like we did during the New Deal through the post-WWII eras, or we become an uglier nation: A billionaire bailout society where too-big-to-fail and too-big-to-jail are a way of life.

Les Leopold is the Executive Director of the Labor Institute and author of How to Make a Million Dollars an Hour: Why Hedge Funds get away with Siphoning off America's Wealth (John Wiley and Sons, 2013)

Greed and Punishment: Criminalize Moral Hazard to Fix Wall Street

Sanjay Sanghoee   |   January 15, 2013   12:42 PM ET

One thing that our biggest banks are great at is taking unconscionable risks with other people's money, also known as moral hazard. From the subprime mortgage fiasco that brought down Lehman Brothers and the catastrophic bets placed on derivatives by AIG to the London whale losses incurred by JPMorgan Chase, our financial institutions have demonstrated repeatedly that they cannot be trusted to manage money responsibly.

Some of this led to the controversial bailout of our financial system after 2008 and will probably lead to further bailouts in the future. Too big to fail is not a policy of the U.S. government, it is a reality of our financial system, and the reason for that is counter-party risk. Financial institutions do not function in a vacuum. They have clients whose money they have been entrusted with, investors and lenders whose principal they use to ply their trade, small businesses whose existence depends upon the availability of credit, companies and individuals who depend on insurance policies to manage their own risk, and trading partners who take the other side of transactions. As a result, when a bank or insurance company goes down, it has the potential to take thousands or even millions of other parties with it.

The easing of regulations during the Clinton and Bush eras, which permitted financial institutions like Citigroup, Bank of America, and AIG to become the behemoths they did, is partially responsible for this mess. But I say "partially" because that is only one part of the problem.

The other part is the lack of personal accountability on Wall Street.

Currently, the only real deterrents to excessive risk-taking are laughably small fines levied against financial institutions by the SEC and a smattering of other government bodies, and occasionally shareholder lawsuits, but this system is inadequate and, for the most part, misdirected. Punishing a financial institution for the choices and actions of its employees is like burning down an entire neighborhood because one of its residents committed murder. The problem lies with the individuals who set the standards for the institutions, not the institutions themselves.

By individuals, of course, I don't just mean those executives who place the bad bets but also those who abet those decisions, such as their colleagues, the board of directors, and sometimes even large investors who have their own agenda. These are the parties truly culpable and who should be punished to discourage reckless behavior. Going after the institutions themselves serves no purpose but to hurt rank and file employees, customers, and small shareholders since they are the ones who ultimately pay for those fines and lawsuits; while the people who actually put the organization in jeopardy have sailed off into the sunset with millions of dollars in inflated compensation and legal indemnity.

It's a farce that needs to end now. Breaking up big financial institutions so that our economy's fate is not tied to theirs will certainly help but it will not be enough, for the wizards of Wall Street will simply find other arenas in which to gamble. The casino mentality in our financial markets will not abate until the gamblers themselves are reined in, and that requires personal accountability and severe penalties. Nothing less will do -- not in an environment where executives can make astronomical amounts of money through high-stakes betting without having to risk their own capital, and with no incentive not to do so.

Criminalizing financial decisions may sound extreme but only because the practitioners of those crimes can afford an expensive PR machine to whitewash the consequences of their actions. A bad loan becomes a regrettable business decision, a bad trade becomes a miscalculation of market timing, and a bad insurance policy becomes an actuarial error. Yet what these innocuously worded "missteps" really are are mini economic bombs, and when enough of them pile up, the smallest spark can trigger a chain reaction of explosions resulting in a total collapse of our system. In that context, criminalizing such decisions should not be a stretch at all.

The other reason that criminalization is not only justifiable but the only way to address the problem of moral hazard is that jail time is pretty much the only thing that scares most white collar criminals. Financial penalties or public tongue-lashings by Congress are a joke for people who make several multiples of the GDP of small nations and have the wherewithal to retire to some remote paradise after screwing everyone. For such people, buying their way out of trouble is simply a cost of doing business.

Take someone like Raj Rajaratnam, for example, whose $157 million fine (including all penalties and forfeitures) for breaking the law on insider trading was only 10 percent of his vast fortune (at least at the time) and so the real punishment for him is not the money but the 11 years in prison he has to serve. Insider trading is also instructive because it is one of the few financial crimes that carries a meaningful penalty.

We need more of the same.

Opponents of criminalization argue that executives who make bad decisions pay for it through clawbacks in compensation and through the plummeting value of their own stock options. That may be true in theory, but in reality clawbacks are extremely rare and for every Dick Fuld or Jimmy Cayne who lost their personal fortune due to their mismanagement, a hundred other executives, including several directly responsible for the subprime mortgage disaster, are either still profitably employed or have gotten away with golden parachutes and a complete lack of regulatory scrutiny; and if that is not a miscarriage of justice, what is?

It also sends a very bad message to Wall Street, namely that their pivotal position in our economy makes them bulletproof.

If the president of the United States lies to the American public, he can be impeached, if a policeman falsifies evidence, he can be jailed, yet that is precisely what housing loan originators, investment banks who sold those loans as collateralized securities while secretly betting on the collapse of the housing market, and the rating agencies who put their AAA imprimatur on junk, all did during the financial crisis, and so far the reckoning has been non-existent. Sure, some banks have been slapped with fines and some civil suits have been settled, but that does not punish those who put the entire system in that position in the first place, and even those heads that rolled have magically sprung up elsewhere to lead new bodies and claim new victims in the future.

Are financial institutions too big to fail? Unfortunately, yes, and I highly doubt that breaking them up will mitigate all the risk. But are the stewards of these institutions too big to jail? Definitely not, and if we want to see real reform on Wall Street, that is absolutely necessary.

SANJAY SANGHOEE has worked at leading investment banks Lazard Freres and Dresdner Kleinwort Wasserstein as well as at a multi-billion dollar hedge fund. He has an MBA from Columbia Business School and is the author of two financial thrillers, including "Merger" which Chicago Tribune called "Timely, Gripping, and Original". Please visit his Facebook page for more information.

  |   December 27, 2012    5:01 PM ET

(Reuters) - U.S. hedge fund manager Raj Rajaratnam has agreed to pay disgorgement of about $1.5 million in a civil lawsuit filed by the Securities and Exchange Commission, and to waive his right to appeal the judgment, court papers showed.

Rajaratnam would make the payment, representing the profits obtained by unlawful means, to the SEC within 90 days after the entry of the final judgment in court records, according to a filing.

Rajaratnam, currently serving a 11-year prison term, was convicted of securities fraud and conspiracy in May 2011. He was accused of running a network of friends and associates who leaked corporate secrets to him for years.

Former Goldman Sachs Group Inc director Rajat Gupta, a former chief of consulting firm McKinsey & Co, has also been charged with leaking tips to Rajaratnam. Gupta denies the charges.

Rajaratnam, the founder of Galleon Group, has already paid $63.8 million in criminal penalties, and a judge had earlier ordered him to pay $92.8 million in a civil case brought by the SEC.

The case is SEC vs Rajaratnam et al, U.S. District Court for the Southern District of New York, No. 11-07566.

(Reporting by Sakthi Prasad in Bangalore; Editing by Ryan Woo)

Stop the Presses

David Crisanti   |   December 6, 2012   11:49 AM ET

There is nothing the press likes more than a story about the press, so the biggest news in England last week was the release of the Leveson report on the media and its relation to politics and power in the UK. Every major paper lead with the story and some went so far as to carry special supplements to report on the report, as it were. You'd have thought Princess Di had been reanimated and played strip pool with her sons for all the coverage.

The report itself recommends that the mainstream print media be regulated by an independent body created by Parliament. The finding is controversial because it potentially threatens freedom of the press. Lord Justice Leveson, who wrote the report in response to the phone hacking scandal, essentially found that given the power of the press, they simply have to act more responsibly than they have under self-regulation.

You can guess how the press feels about this, but the idea of standards for mainstream media is appealing to me. Not necessarily to ward off the dangers of phone hacking, but because I have a disease -- a disease that causes me to read the WSJ and then react with a tantrum whenever I read something that is absurd. Given the up-and-down content of the Journal I am in a near constant state of dyspepsia.

We don't have to go far to find examples. In this weekend's WSJ there was an article on MLPs -- publicly traded domestic energy partnerships that pay out much of their cash flow to investors and enjoy certain tax advantages. The article left unchallenged a money manager's claim that he does well buying ETFs (exchange traded funds) of MLPs rather than individual MLPs. The reality is the money manager is terribly derelict in his duties since the ETF charges nearly 1 percent in annual fees and disallows the tax breaks investors receive when buying the MLPs individually. Isn't the money manager there to do exactly the opposite, to make sure investors receive all the credits available and pay as few unnecessary fees as possible? The idea that anyone is well served by buying the MLP ETF let alone by investing with a money manager that will charge him additional fees for the privilege is risible (unless you are the money manager, who is also enjoying free advertising courtesy of the WSJ).

Elsewhere in that day's paper is Holman Jenkin's column.

He writes informatively and well on telecoms and other technical sectors -- or so I think: I don't have any direct experience in those sectors myself, so don't know for certain if what he writes is true. But when he writes about what I do for a living -- trading -- I know he is wrong. For the third or fourth time since the guilty verdicts in the Raj Rajaratnam insider trading case, he has written that insider trading is a victimless crime, one in which all parties are unaffected by insider activity.

He is incontrovertibly and demonstrably incorrect.

Jenkins cites the recent case in the news where a hedge fund trader at SAC saved his company approximately $275 million by exiting a long position once he obtained inside information from a doctor that clinical trials for an Alzheimer's drug were going poorly. Once the trial news became public, i.e., after SAC had sold, the stock dropped 70 percent. Jenkins has valid points when he notes that it's hard for industrious traders doing diligent research to know for sure where the line is that separates good work from criminal work. But he is factually wrong when he writes that the buyers would have bought the stock anyway, whether SAC was selling or not. However many shares SAC sold is exactly the number of shares now owned by the rest of the market that they wouldn't have owned if SAC hadn't sold. It's a zero sum game, shares are neither created nor destroyed and if SAC still owns them, someone(s) else doesn't. And as much money as SAC saved or made by selling those shares ($275 million in this case), it's exactly the amount lost by others -- money they wouldn't have lost if SAC hadn't acted. We may not know the exact name of the victim, and in fact there may be many victims, but that doesn't mean they don't exist.

We can't blame Jenkins; he is not a trader so perhaps he shouldn't know better, but we can blame the WSJ for allowing such fallacious content. And we should care about this beyond my dyspepsia because papers like the Journal not only shape opinion, they shape legislation. And if you think the public has abandoned the equity market due to the phantom threat of electronic market making, wait until you see what they do when they regularly get creamed if insider trading is made legal. Jenkin's article is titled "The High Cost of Ignorant Stock Prices." How high is the cost of ignorant journalism?

Doctors Who Advise Wall Street Investors Operate In Ethical Grey Zone

Ben Hallman   |   November 27, 2012    9:35 PM ET

Once upon a time on Wall Street, the enterprising trader looking for a nugget of inside information about a public company worked the phones, developed sources at law firms and pestered friends and family for tips.

According to allegations made in a recent $276 million insider trading fraud lawsuit -- and several other high-profile cases in recent years -- the aspiring fraudster now has an easier path: hire an "expert network" company to find those sources.

Expert network companies have been around for about a decade. They sign up thousands of academics and industry professionals as consultants, then offer their services to money managers, investors or anyone else willing to pay top dollar for an hour or two of that person's time. Consultants, and the industry, describe what they do as matchmaking, pairing subject-matter experts with analysts and others who make investing decisions.

Federal authorities have said the relationships can be conduits to fraud, giving hedge funds and other money managers easy access to people with market-moving information about a drug or another product.

The increased scrutiny of these relationships has led a handful of financial firms to sever ties with the expert companies. Now, some medical ethicists are urging their peers to do the same, warning that the risks might outweigh the financial reward.

"There's one reason for these investment firms to get involved, and that is to get the inside dope on a product," said Arthur Caplan, director of the Center for Bioethics at New York University.

He said physicians should steer clear. "This work has nothing to do with being a doctor," he said.

In separate interviews with The Huffington Post, three doctors said that they followed ethical practices during consultations for fees that averaged about $400 an hour. They said they supplied general information and opinions only on subjects in the public domain and that the conversations helped them better understand how market forces shape their profession.

"There's too much at risk," said John Hsu, director of anesthesiology at Presbyterian Intercommunity Hospital in Whittier, Calif., who consults through Gerson Lehrman. "If I am convicted of insider trading, that means jail. I would lose my license and lose my reputation. It's not worth it."

The doctors -- two of which asked to remain anonymous for fear hurting their consulting business -- didn't agree among themselves about what counts as fair game to disclose to a money manager or other questioner. For example, one oncologist said he would divulge whether a particular drug was effective -- and would be willing to reveal, for example, how many patients out of 10 it had helped.

Hsu, on the other hand, said he would only reveal his general impressions of the effectiveness of a drug, and would not be willing to say how many people it had helped.

Hsu said he had been asked this kind of question, and others that probed at what he might know about a drug under development, but had never revealed that kind of information. "I don't want to screw up," he said. "I'm always watching what I say."

Federal authorities allege that some of these relationships have far exceeded the legal bounds. In the most recent case, federal prosecutors and the Securities and Exchange Commission claim that Mathew Martoma, a former portfolio manager at an affiliate of the powerful hedge fund SAC Capital Advisors, traded on insider information given to him by University of Michigan neurology professor Sid Gilman.

Gilman, according to the allegations, served on a committee monitoring the safety of an Alzheimer's drug under development by drug companies Elan and Wyeth. In 2008, according to the criminal complaint, Gilman told authorities that he passed along information about the trial, which prompted SAC Capital to sell out its large positions in the companies within days.

Gilman received $108,000 in consulting fees through an expert network company -- later identified in press reports as Gerson Lehrman Group -- but did not otherwise profit from the information he passed along, according to the allegations. The hedge fund, run by the fantastically wealthy Stephen Cohen, did quite a bit better: earning $276 million, counting profit from short positions taken in the stocks soon after the fund sold them off, the government claims.

The fraud unfolded "on a scale that has no historical precedent," Manhattan U.S. Attorney Preet Bharara said at a news conference.

Gerson Lehrman did not respond to a request for comment and has not been accused of wrongdoing. In the past, the company has said it requires its consultants to sign nondisclosure agreements and not to discuss their own companies. Professionals who have accepted consulting jobs through Gerson have said they must take a yearly ethics review quiz and sign off before each new assignment asserting that they do not have a conflict that would prevent them from discussing the topic.

Stories about illicit activity enabled by expert network companies date at least as far back as 2005, when the Seattle Times identified 26 instances in which doctors leaked confidential details about ongoing drug research to Wall Street firms.

The expert network company that has received the most attention in recent years is Primary Global Research, which turned up in the insider trading case involving Raj Rajaratnam, the former Galleon Group head who was convicted of securities fraud last year. Several Primary Global employees have since been convicted of insider trading-related charges.

In another high-profile case, Broadband Research founder John Kinnucan pleaded guilty in July to passing along illegal tips to hedge fund clients and obstructing justice. He had previously made waves when he sent out an email to those clients in which he said he refused to wear an FBI wire. More than a dozen insider trading arrests followed in an operation that Manhattan U.S. Attorney Preet Bharara and the FBI called "Perfect Hedge."

What worries Eric Campbell, the director of research at the Morgan Institute for Health Policy, part of Harvard Medical School, is how little academic institutions know about the relationships between their staff and these outside consultancies -- or the financial firms that pay big fees to hire them.

"There is no common disclosure standard," he said. "If you asked me how frequently these consultations take place, I couldn't tell you. There is no data. Nobody knows."

Campbell said this lack of oversight puts the institutions at risk. He noted that other relationships, such as those between pharmaceutical companies and doctors, are very closely scrutinized, even though those can be greatly beneficial, leading to the development of a powerful new drug, for example.

Even if above board, there is no obvious societal benefit to a relationship with a financial company," he said. "The outcome is financial gain for a very select group of people."

Mark Gongloff   |   October 24, 2012    2:15 PM ET

Rajat Gupta already has friends in high places. Now he will get to make some new friends in prison.

The former Goldman Sachs director was sentenced on Wednesday to two years in prison, followed by another year of parole, and ordered to pay a $5 million fine. He was convicted in June on insider-trading charges, following a trial that included testimony from Goldman CEO Lloyd Blankfein.

“With today’s sentence, Rajat Gupta now must face the grave consequences of his crime – a term of imprisonment," Manhattan U.S. Attorney Preet Bharara said in a statement. "His conduct has forever tarnished a once-sterling reputation that took years to cultivate.

"We hope that others who might consider breaking the securities laws will take heed from this sad occasion and choose not to follow in Mr. Gupta’s footsteps," Bharara added.

It remains to be seen how much of a deterrent Gupta's sentence will be. At the time of his conviction, many experts suggested that such convictions attract attention for a little while and then fade in memory. Insider trading is fairly rampant, in part because there's so much money to be made at it, and few of the people doing it ever think about getting caught.

But the government is clearly making a notable effort to stop it, winning convictions of more than 70 people during a wide-ranging, three-year assault, notes Peter Lattman of the New York Times.

A former head of the global consulting firm McKinsey & Co. and board member of Procter & Gamble, Gupta is the most notable conviction so far in the government's campaign. He's such a big deal, in fact, that he managed to get people like Bill Gates and Kofi Annan to write letters pleading for leniency in his case, largely because of a lifetime of charitable works. Gupta had asked to be sent to Rwanda to help fight HIV/AIDS and malaria, in lieu of prison. Judge Jed S. Rakoff of the Federal District Court in Manhattan did seem swayed by these arguments, going lighter on Gupta than the eight to ten years recommended by sentencing guidelines. The maximum possible sentence for Gupta was 20 years for securities fraud and another five for conspiracy.

"The Court can say without exaggeration that it has never encountered a defendant whose prior history suggests such an extraordinary devotion, not only to humanity writ large, but also to individual human beings in their times of need," Rakoff wrote in his sentencing order. But Rakoff also noted that Gupta would be free to continue his charitable works after his prison term is over, and that some prison time was necessary as a deterrent to other inside-traders.

"When one looks at the nature and circumstances of the offense, the picture darkens considerably," Rakoff wrote, adding that "his criminal acts represented the very antithesis of the values he had previously embodied."

Gupta was convicted of giving tips to another convicted inside-trader, former hedge-fund manager Raj Rajaratnam, who was sentenced to 11 years in prison. Gupta's defense team said the evidence was circumstantial, including evidence of a phone call Gupta made to Rajaratnam immediately after a September 2008 conference call discussing an offer from Warren Buffett to invest $5 billion in Goldman to carry it through the financial crisis. Rajaratnam bought up a bunch of Goldman stock after the call from Gupta, turning an immediate profit of more than $1 million after Buffett's investment became public knowledge.

In Rakoff's words, Gupta's tip was "the functional equivalent of stabbing Goldman in the back."

Gupta was ordered to report to prison by 2:00 p.m. ET on January 8, 2013.

This post has been updated with details throughout.

Oversight: Why Congress Needs to Back the Securities and Exchange Commission

  |   September 17, 2012   12:12 PM ET

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  |   July 16, 2012    7:32 PM ET

* Kumar to be sentenced Thursday, faces up to 25 years

* US praises Kumar for testimony against Rajaratnam, Gupta

* Kumar pleaded guilty to helping Rajaratnam

By Basil Katz

NEW YORK, July 16 (Reuters) - A disgraced former McKinsey & Co partner whose testimony helped convict Wall Street giants Raj Rajaratnam and Rajat Gupta on insider trading charges deserves leniency at sentencing because his cooperation was exceptional, federal prosecutors said

In a letter to Judge Denny Chin on Monday, Manhattan federal prosecutors said that Anil Kumar's cooperation was "nothing short of extraordinary."

Kumar, 53, is expected to be sentenced on Thursday in Manhattan federal court. He is among a handful of people who, after being charged criminally, chose to plead guilty and help prosecutors and the Federal Bureau of Investigation in their wide-ranging probe of illicit trading on Wall Street.

"From the first day of Kumar's cooperation through the present, he's been one of the best and most important cooperating witnesses that the (prosecutors) working on the Rajaratnam investigation have worked with in securities fraud cases," the letter said.

In the letter, prosecutors said Kumar was essential in helping the government improve its case and convict Rajaratnam and Gupta, "two of the most important securities fraud trials in history."

They said Kumar's testimony at the successive trials of the two men was particularly convincing because he had opted to turn against one person who had been his friend for over 25 years, and the other who had been his mentor at McKinsey.

Galleon-group hedge fund founder Rajaratnam is serving an 11-year prison term after being convicted last year.

Gupta, a former board member at Goldman Sachs who headed elite business consultancy McKinsey & Co for nine years, was convicted in June. He faces up to 25 years in prison when he is sentenced in October.

Kumar's lawyer, Gregory Morvillo, declined comment on any sentencing submission by Kumar's defense because it had not yet been made public.

"We are very pleased that the United States Attorney's Office thought so highly of Mr. Kumar's cooperation," Morvillo said. "We think it is a very strong letter."

Kumar, as part of an agreement with prosecutors, pleaded guilty in January 2010 to one count of conspiracy to commit securities fraud and one count of securities fraud tied to feeding Rajaratnam secret stock tips. The charges carry a combined maximum of 25 years in prison.

Known as a "5K1" letter, Monday's filing is standard. The letter tells the judge in the case whether the defendant fulfilled the terms agreed to in his cooperation agreement with prosecutors, and if so, how much assistance he provided and at what personal cost.

It is then up to the judge to decide whether to credit the assistance and give the defendant a break in his sentence.

In fact, as is common in these types of cases, Judge Chin may opt to impose only a very light prison term on Kumar, or may decide that no prison time at all is warranted. Kumar is free on bail and lives in California.

Last month, Adam Smith, a former Galleon employee turned government cooperator, was sentenced to two years probation by U.S. District Judge Jed Rakoff in Manhattan. Rakoff also oversaw the Gupta trial.

The case is USA v. Anil Kumar, U.S. District Court, Southern District of New York, No. 10-cr-00013.

Susan Antilla   |   July 5, 2012    3:06 PM ET

Bloomberg View:

Rajat Gupta, the former McKinsey & Co. chief and pal of imprisoned inside trader Raj Rajaratnam, has one goal after being convicted last month of securities fraud: To convince federal Judge Jed Rakoff that he deserves minimal jail time.

There is a compelling public interest, after all, in keeping white-collar criminals on the street. The financial markets need liquidity, as any summer intern at a Washington lobbying firm can tell you, and we would be facing dark days if we lost our best talent at leaking confidential information. What good is a tipster in a place where high-frequency trading means swapping cigarettes for a batch of washed and folded laundry?

I don’t mean to suggest that his lawyers and throng of big- name business friends aren’t already doing a serviceable job of portraying Gupta as an honorable man who doesn’t belong in jail. Gupta’s lawyer, Gary P. Naftalis, pushed so hard to be allowed to tell the jurors about Gupta’s philanthropy that Rakoff had to offer a reminder: Even Mother Teresa would be judged on the evidence -- but presumably not her saintliness -- if charged with robbing a bank. And on the website, a collection of supporters cite everything from Gupta’s role as a founding board member of the Global Fund for AIDS, malaria and tuberculosis to his selfless offer to pay for a friend’s son to go to college.

Going Far

The effort to tout his charity and good heart is a respectable start for the former Goldman Sachs Group Inc. (GS) director. But it doesn’t go far enough.

With the sentencing slated for Oct. 18, there’s no harm in maxing out on every possible pitch as to why the man found guilty of leaking confidential information to Rajaratnam should get a break. The community-service alternatives alone are boundless. A not-for-profit to wage war on bullying of school- bus monitors comes to mind. Or maybe a faux-feminist foundation that cranks out op-ed articles on why it’s bad for women to receive equal pay to men.

Speaking of op-eds, it wouldn’t be the worst idea for him to get his worker bees cracking on a competition among news media outlets for first dibs on a Gupta byline. If Gupta’s lawyers balk, at least the public-relations people could ghostwrite a sermon on Gupta’s finer points, and hunt down a big name in business willing to put his or her name on it. You know, the types who are on important corporate boards and maybe even run global management-consulting firms.

White-collar defendants with bottomless checkbooks have been known to make colossal efforts to paint themselves as philanthropic pillars of the community. Sometimes that charity begins right around the time investigators deliver their first subpoena. Other times, as in the case of Gupta, magnanimity is a long-established practice.

You might wonder who would care if a rich person found guilty of a crime has sprinkled a few crumbs among the little people -- and juries often wonder the same thing. Experts in selecting and analyzing juries say that jurors in mock trials and focus groups get turned off when there’s too much talk about a defendant’s good works. Philip K. Anthony, the director of jury consulting at DecisionQuest Inc. in Los Angeles, says jurors often mention that wealthy defendants derive benefits from their largess, including tax write-offs and goodwill from business associates and the community.

Paul Neale, the chief executive officer of Doar Litigation Consulting -- the Lynbrook, New York-based firm that worked on the Gupta case -- declined to comment on the trial. But he did say he has never seen philanthropy as a “definitive factor” in 23 years of mock trials that his firm has conducted.

Reality Play

Reality, though, can play out differently. Richard M. Scrushy, the former CEO of HealthSouth Corp., was acquitted by a jury in 2005 on charges he directed an accounting fraud. The Birmingham, Alabama, community got a heavy dose of his pious side even during the trial. Scrushy delivered a lecture and donated $5,000 to a church attended by one of the jurors. He and his wife hosted a Bible show that aired five days a week on local TV during the months before the trial began.

Even Rajaratnam benefited from hundreds of supportive letters to the court. Federal Judge Richard Holwell acknowledged Rajaratnam’s “very significant dedication to others” at sentencing, giving him 11 years even though sentencing guidelines called for as much as 24 1/2 years.

Maybe it wouldn’t hurt for Gupta to consider the example of Ronald Ferguson, the former CEO of General Reinsurance Corp. who faced a potential life sentence for helping American International Group Inc. deceive shareholders. Part of his pitch to the judge at sentencing was that he wanted to get back to his seminary education “and live my purpose to serve others.” Though his conviction was reversed on appeal and then settled in June in advance of a retrial, U.S. District Judge Christopher Droney sentenced him to only two years back in 2008. “We will never know why such a good man did such a bad thing,” Droney said. Ferguson’s supporters flooded the court with 379 letters.

A seminary stint may not be in Gupta’s future, but perhaps he could catch a break if he winds up filing an appeal and selects a new legal team with the magic touch.

In one of the most famous insider-trading cases of the late 1980s, Martin Siegel faced as much as 10 years in prison and a $260,000 fine. He had sold inside information in return for suitcases full of cash. Despite his crime, he spent only two months in prison, five years of probation, and received no fine.

It’s a pity that Gupta won’t have a shot at hiring the lawyer who shepherded Siegel to his propitious outcome. Siegel used Jed Rakoff, the guy who will decide what sentence suits Gupta’s crimes.

(Susan Antilla, who has written about Wall Street and business for three decades and is the author of “Tales From the Boom-Boom Room,” a book about sexual harassment at financial companies, is a Bloomberg View columnist. The opinions expressed are her own.)

Read more opinion online from Bloomberg View: Mandate Not the Only Health Tax Republicans Backed and The Other Big Case the Supreme Court Got Right.

Dear 'Big Daddie': 'Tiddie Biddie' Emails Reveal Raj's Intimate Ties

Jillian Berman   |   June 22, 2012   11:50 AM ET

Guys, if you want to pass some insider “tiddie biddies” about major companies along to your friends you probably shouldn’t do it in writing.

David Loeb, a current Goldman Sachs managing director, exchanged emails with Raj Rajaratnam that included what he described as “tiddie biddies” about Apple, Intel and other technology companies, the Wall Street Journal reports.

It appears the two had an especially close relationship, according to the emails reviewed by the WSJ; Loeb affectionately referred to Rajaratnam as “Dr. RR” and “big daddie” and signed his emails “CBF” reportedly an acronym for "Chunky But Funky."

Dr. RR currently has his chunky self parked in prison. The Galleon Group hedge fund founder, was convicted of insider trading last year and is serving an 11 year sentence. Loeb is under FBI investigation for allegedly passing insider information about technology companies along to hedge funds. The e-mails indicate that the two were closer than previously thought.

Loeb’s relationship with Rajaratnam was a subject of controversy during the trial of Rajat Gupta, a former Goldman Sachs director who was found guilty earlier this month of passing secret information from Goldman board meetings to Rajaratnam.

One of Gupta’s key defenses -- which was based partly on a wiretapped conversation in which Loeb passed insider information to Rajaratnam -- was that Rajaratnam had other sources at Goldman for tips besides Gupta. Ultimately the judge excluded the tapes of the wiretapped conversations between Loeb and Rajaratnam from evidence.

The investigations into Loeb, Gupta and Rajaratnam are part of a widespread effort on the part of a variety of government agencies to crack down on insider trading by targeting high profile suspects. Still, it's unclear whether the convictions in the Gupta and Rajaratnam cases will do much to deter insider trading in the future.

Inside Traders May Not Heed Gupta Message

Mark Gongloff   |   June 15, 2012    5:59 PM ET

The conviction of Rajat Gupta on insider trading charges is a real score for government prosecutors -- maybe the biggest such conviction in history.

It will also probably barely deter other people from insider trading.

"I think for the next few days people will talk about Gupta, and for the next few days they will be more thoughtful about their actions," said Dan Ariely, a behavioral economist at the Duke University Fuqua School of Business. "And then it will stop."

A federal jury on Friday convicted Gupta, a former Goldman Sachs director, of passing on nonpublic information from Goldman board meetings to former hedge fund manager Raj Rajaratnam, who has already been convicted and jailed for insider trading.

Several lawyers and analysts praised Preet Bharara, the U.S. attorney in Manhattan, for winning a conviction against Gupta despite having only circumstantial evidence. The success could lay the groundwork for more aggressive cases in the future, these experts said.

"This is a big win for the prosecution," said Philip S. Khinda, co-head of the SEC Enforcement Practice at the law firm Steptoe & Johnson. "It will embolden the government."

Just as impressive, Gupta was not just some low-rent hedge fund manager, but someone who had reached the highest ramparts of the business world. As such, he makes an unforgettable example for potential wrongdoers.

"I think people are going to take a look at this and say, ‘That could be me,’" said Thomas Gorman, a lawyer at the firm Dorsey & Whitney who defends clients against Securities and Exchange Commission and Justice Department securities investigations. "This is one of their own, a man at the pinnacle of corporate America. That sends a big message."

"In the history of insider trading, Rajat Gupta is probably the highest-level person in corporate America who’s been convicted on inside trading," said Richard Sylla, a professor of economics and financial history at the New York University Stern School of Business.

Impressive. But the memory will fade, Sylla warned. "The effect of these things wears off."

Though Bharara is being widely praised for his prosecutions, other industry watchdogs are mostly asleep and don't seem likely to perk up any time soon.

"This should be a model for the rest of the law enforcement community on Wall Street, but I don't have much hope for that," said Dennis Kelleher, president of Better Markets, a non-profit group pushing for financial reform. "While this case may be a deterrent, the juxtaposition of slack enforcement in any other arena green-lights people to do what they want."

A possibly more fundamental problem is human nature: The people who are considering trading on inside information don't typically stop and think about the long-term potential consequences, according to Duke professor Ariely.

Ariely, the author of a new book, "The Honest Truth About Dishonesty," has as part of his research talked to more than a dozen people who have been accused and/or convicted of insider trading. None even stopped to even think about the possibility that they might be caught, Ariely said.

In that way, inside traders are like any of us who text while we drive, eat food that's bad for us, or partake in any number of other behaviors that could have horrible long-term consequences.

"There's recent analysis that looks at whether there's evidence the death penalty is reducing crime, and there's no evidence for it," Ariely said. "And if you don't find clear and strong evidence there, what are the chances that this will work out?"

What's more, these inside traders felt like their behavior was socially acceptable -- everybody was doing it, in other words, Ariely said.

And everybody is doing it because it makes them money. Always has, always will.

"It will make people on Wall Street pause, but because the motivation on Wall Street is to make money, people will always violate the law," said Michael S. Weinstein, a former federal prosecutor who chairs the white collar defense practice at the law firm Cole Schotz. "This case is not going to prosecute away insider trading."