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

by Anita Raghavan

  A guard showed Gupta and Naftalis and his two associates into the testimony room. Despite his rumpled appearance, Naftalis is one of the most celebrated white-collar defense attorneys in New York. The Wall Street Journal referred to him as “the Zelig of the white-collar bar: He’s everywhere.” He has represented everyone from former Walt Disney Company chief Michael D. Eisner to Wall Street hotshot Kenneth Langone. Like many defense lawyers, Naftalis spent six years at the US attorney’s office for the Southern District of New York (the district that made Rudy Giuliani’s career). He rose to be deputy chief of the Criminal Division before going into private practice. Naftalis had accompanied clients to interviews like this one innumerable times. He knew the script by heart and was a skilled performer inside a conference room, a pro’s pro.

  A few minutes after Gupta and his legal team settled in the room, Sanjay Wadhwa, Jason Friedman, and another SEC attorney, John Henderson, entered. Wadhwa was a little taken aback to find Gupta and his lawyers already seated. Typically, the SEC attorneys arrived before the witnesses to control the order of seating. Witnesses being deposed are usually ushered to seats facing the window so they can relax and be more loquacious. Having a guard escort the group in earlier, the wily Naftalis instructed his client to sit next to him with their backs to the window.

  Naftalis greeted Henderson warmly, asking the young SEC lawyer about his holiday plans and his two-and-a-half-year-old son. Before joining the SEC, Henderson, a Yankees fan, had worked at Naftalis’s law firm, Kramer Levin Naftalis & Frankel. He’d sat three hundred yards from Naftalis, a big Mets fan. After the usual introductory pleasantries—Gupta gave Wadhwa a half smile when they shook hands—the witness was sworn in. Wadhwa found Gupta controlled and inscrutable. If he was irritated by the SEC’s invitation to testify, he didn’t let on. As Henderson launched into the SEC interrogation, Wadhwa kept an eye on Gupta to see if he was showing signs of nervous body language or looking shifty. He didn’t betray a thing.

  “Mr. Gupta, are you taking any medication or drugs that would affect your ability to recall events or answer truthfully?”

  “No,” Gupta replied.

  Then Henderson drilled into the heart of the case. He first asked whether Gupta reviewed any documents in preparation for his testimony.

  “Upon advice of the counsel, I respectfully decline to answer the question at this time based on my right under the United States Constitution not to be compelled to be a witness against myself,” Gupta replied.

  “There are different ways to formulate that,” Henderson said. He spoke formally yet awkwardly, clearly surprised by Gupta’s response. He told Gupta that if he wanted to assert his privilege against self-incrimination, “you need merely state that you refuse to answer on the grounds that it may incriminate you. In other words, you are not compelled to answer questions if you believe that a truthful answer to the question would tend to show that you committed a crime, and you wish to assert your privilege against self-incrimination.”

  Henderson asked Gupta if he understood what he was telling him. Gupta fell back on the elaborate response he’d offered moments earlier, one that the savvy Naftalis had coached him to give.

  Naftalis then asked to go off the record.

  A few minutes later, Henderson summarized the point of discussion for the stenographer on the record: “For the sake of efficiency…we can agree that if you say ‘I take the Fifth,’ or ‘Five,’ it will mean ‘Based on my Fifth Amendment privilege against self-incrimination I decline to answer the question.” Henderson looked to Naftalis. “Gary, is that an acceptable formulation for you?”

  “I don’t like that formulation.” Naftalis understood how damning “I take the Fifth” would be for Gupta in the public record. Headlines like “Gupta Takes the Fifth” could destroy him. Wadhwa suspected it was the reason Naftalis and his client Gupta had been pushing to delay the SEC testimony until after the Rajaratnam trial. Naftalis said his preference was for Gupta to “say ‘same answer’ or something like that.”

  Jason Friedman jumped in. He wanted to make clear that “same answer” referred to the response Naftalis so clearly did not want his client to articulate. “Can we agree that the representation, that the formulation he read before into the record is an invocation of his Fifth Amendment privilege against self-incrimination?”

  “Yes,” replied Naftalis.

  So over the next fifteen minutes, Henderson asked Gupta fifty-three questions. His response to all fifty-three questions was a weary “same answer.”

  As Wadhwa watched Gupta during the absurd exercise, he saw his facial expression change from that of the implacable stoic to a more human one. He seemed far away, lost in a great sadness. It was as if Gupta was internally reviewing his life story and thinking, I can’t believe I am sitting here.

  * * *

  As Rajat Gupta grew up, there was a sense among friends that he would be as remarkable as his baba. “He got the brilliance of his father,” says Udayan Bhattarcharyya, who lived in the same compound in New Delhi as the Guptas.

  When “he decided on something, it had to happen,” says his cousin, Damayanti Gupta-Wicklander. One time when the family was setting off on an outing in New Delhi, young Rajat decided to climb onto the car hood and lie flat on his stomach. Repeated efforts at coaxing and cajoling failed to bring him down, so the family finally resorted to the one inducement that always seemed to work: sweets. They—along with bananas—were a great weakness of his and he quickly succumbed.

  When Rajat was five years old, his father, Ashwini, was given a tall task, moving to the nation’s capital and founding the Delhi edition of Bengal’s English-language paper, the Hindusthan Standard. It was a difficult assignment because at that time people tended to read local newspapers.

  Despite the challenge, the Guptas’ early years in Delhi were among the family’s happiest. They enjoyed a comfortable, middle-class Indian life, living in a twelve-hundred-square-foot company flat housed in a big enclosed compound not far from the old Delhi Railway Station. It was a protected world, a self-contained city with its own soccer field. On weekend nights, Ashwini Gupta and friends walked to Connaught Place, a business district in the center of Delhi, to catch one of the English-language movies coming out of Hollywood. Sometimes the men would play bridge while the boys kept busy with chess, a game Rajat quickly mastered.

  At the time the Guptas moved to New Delhi, there were two elite schools in the city. One was St. Columba’s, a Catholic boys’ school, and the other was the Modern School on Barakhamba Road, not far from Connaught Place. Founded at the height of the British Raj, the Modern School married Indian ways of education with modern pedagogy. It was “‘the’ school in those days,” recalls Mukul Mudgal, the retired chief justice of the High Court of Punjab and Haryana.

  Students from the 1950s and 1960s tell long tales of how they got a place at Modern. Some used money or influence; others who had neither resorted to determination. It is not known if Ashwini Gupta used his connections to get young Rajat enrolled at Modern. It didn’t matter. Rajat quickly showed that he deserved as much as anyone else to be at the school. He was a living embodiment of the school’s motto, a Sanskrit saying that translates into English as “Self-realization cannot be achieved by the weak-willed.”

  Like his father, Rajat worked hard, often putting in long hours to overcome deficiencies in subjects such as written English. Once when a classmate scored a perfect mark on a pop quiz in physics on the topic of momentum, the young Rajat insisted on sitting next to the classmate to examine the work he did. He later borrowed the classmate’s paper to review the work further. That was the first and last time the classmate got the top marks in Rajat’s class.

  Modern’s virtue was that it brought together students from all walks of life. A classmate of Rajat’s was a maharaja from a princely state who lived near the school but sometimes showed up in a fancy chauffeur-driven car. Young Rajat, by contrast, traveled to school on the creaky, often overcrowded buses of Del
hi Transport, the public bus system, with a pack of close friends, carrying khaki knapsacks.

  Within the walls of Modern, the differences between the high and mighty and the hoi polloi were imperceptible. Boys all came dressed in a uniform of blue shirts and gray-blue shorts. Almost every interest was nourished—riding horses, playing soccer, and bowling on a cricket pitch with a grass wicket, the type favored by professionals. Rajat soaked it up, acting in plays, reciting poetry, and studying Sanskrit. Often, during the lunch break, he and his friends would take to whacking a tennis ball along the walls of the assembly hall, playing a game akin to handball.

  By the time Rajat was a teenager, he was a force. His nickname was Gaju Gupta—a moniker that fit him well. It rhymed with Raju and was a play on the Hindi word for “carrot.” With his hair close-cropped at the base and rising straight up, he looked like a flattened carrot top. Well liked, he was a standout student and succeeded in securing a place for himself in Section D—a group of high achievers focused on the sciences, a sure path to future success in India. “People were in awe of him because of his intensity,” says a classmate. One year, he prepared so hard for a public speaking contest that involved the recitation in English of a passage from an Indian religious tract that he won the first prize in the competition. What was impressive was that he unseated a classmate who was widely regarded as a shoo-in because he’d spent his early years in England.

  * * *

  After his father died in 1964, friends noticed a new seriousness sweeping over young Rajat, who applied himself more vigorously than ever to his studies.

  Few knew it, but Rajat had no choice but to be strong and focused. His mother was frail; she had been diagnosed with incurable heart disease. It fell to him as the eldest son to hold the family together and to be a father figure to his younger brother, Kanchan, who was only seven years old when his baba passed away, and his younger sister, Jayashree.

  Every morning, Rajat woke up at the crack of dawn to help his younger brother pack his schoolbag and get dressed, even seeing to it that his tie was properly tied. At night, he supervised homework. One time when Jayashree came back crying from school after having to shoulder her heavy schoolbag on the public transport system, Rajat patiently wiped away her tears and consoled her, assuring her that the difficult times would soon pass.

  It wasn’t clear they would, though. One of Rajat’s responsibilities as the eldest son was to manage the family’s finances. Faced with mounting expenses, he, like his father, started tutoring young children to earn extra money.

  Debasish Bhattacharya, who grew up with Gupta in Delhi, says that Rajat may have coped admirably with his father’s death because he had no choice. “He did not come from a big family that showered him with money,” says Bhattacharya. After their father died, the Guptas realized “they had to make something of themselves.”

  Rajat quickly showed he had every intention of doing exactly that. In his final year at Modern, he placed fifteenth in the national entrance examination for the Indian Institutes of Technology, then a little-known collection of state-sponsored universities that in twenty years would be harder to get into than Harvard or Yale.

  Chapter Three

  A Family Affair

  Rajat Gupta’s and Sanjay Wadhwa’s paths might never have crossed if not for the brief that landed on the SEC attorney’s desk on August 22, 2006.

  On that late summer afternoon four years before Gupta would plead the Fifth, John Moon, an in-house lawyer working in New York for Swiss bank UBS, paid a visit to Wadhwa and his boss, David Markowitz, at their office at Three World Financial Center. He had come to inform the SEC about a tiny hedge fund called Sedna Capital.

  Moon’s firm, UBS, is a significant player in a highly profitable business on Wall Street known as prime brokerage. Banks provide back-office support, IT, office space, and custody services to independent hedge funds and earn money by lending cash and stock to the funds. For most of its history, prime brokerage was an unsexy business and not much of a moneymaker for investment banks. At some white-shoe firms like Morgan Stanley, prime brokerage departments were relegated to Brooklyn, where the back-office services were. But in the late 1990s, as hedge funds exploded onto the investment landscape and multiplied like weeds, Wall Street rediscovered prime brokerage and dressed it up. In a sign of the times, Morgan Stanley moved its department that serviced hedge funds to Manhattan.

  After its acquisition of ABN AMRO’s prime brokerage unit in 2003, UBS inherited a thriving business catering to small hedge funds. These funds were lower-tier grinders, ignored by behemoths like Goldman Sachs. UBS’s John Moon had come to see Wadhwa and Markowitz about one grinder UBS serviced, an off-the-radar hedge fund called Sedna Capital. A heady thirty-five-year-old money manager named Rajarengan Rajaratnam ran it.

  After graduating from the University of Pennsylvania in 1992, Rengan, as he was known to friends, bounced around Wall Street, working at investment bank Morgan Stanley and at hedge fund SAC Capital Advisors. Rengan lasted at SAC, named after its enigmatic founder, Steven A. Cohen, for only eight months. One day, Cohen asked Rengan why SAC was not involved in telecommunications equipment stocks, which were rallying at the time. Rengan, who covered the sector, said he’d traded the stocks a few months before. “How come we are not involved now?” Cohen asked. Before long, the discussion devolved into a screaming match, with Rengan yelling about his pay and Cohen about Rengan’s performance. When it was all over, Cohen told Rengan, “If you don’t like it, leave.”

  The word on Wall Street was that Cohen then preemptively called Rengan’s influential brother, billionaire and hedge fund impressario Raj Rajaratnam, to break the news. “Someone came up to me on the floor and he was complaining about something, so I fired him,” Cohen said. “The bad news is that it was your brother.”

  In May 2004, Rengan Rajaratnam and a trader whom he shared an office with at SAC started Sedna Capital, plowing in “every single dime we’ve ever earned” and raising some money from a couple of investors who like Rengan had gone to Penn. The two created a stable of funds that were supposed to be run on an equal footing, with trades distributed proportionately to all funds, and by mid-2006, Sedna’s assets under management had swelled to $80 million. During a family vacation that summer to Gila, New Mexico, Rengan, while chatting with his big brother Raj, floated the idea of creating a high-risk fund that would deliver big returns. Raj was encouraging, and in July 2006, Rengan opened a new fund, the Sedna Strategic Opportunities fund, an investment pool for friends and family. When he hit up the small circle for money, he didn’t sugarcoat the risks: “Listen, give me as much money as you are willing to lose.”

  The new entity was seeded with $700,000 of Rengan’s savings. Investing in it was a family affair. Rengan’s sister, Vathani, threw in $50,000 and his middle brother, R.K.—the nickname of their brother Ragakanthan—forked over $25,000. Rengan’s father declined to invest because he thought the fund was too risky. But Rengan’s older brother Raj put in $1 million, making him the single largest outside investor.

  The new fund raised eyebrows at UBS almost as soon as it began. Its performance seemed too good to be true. Between late July 2006, when the fund started trading, and late August 2006, it doubled its money. Two million dollars ballooned to almost $4 million in a month—a stunning 100 percent return in the span of thirty days, all because of Rengan’s investing “prowess.” Behind the big gains were ten trades—every one of which was a winner. There was another irregularity: after a blockbuster first month, Rengan forced investors to redeem some of their money. Typically, investors like to keep their money in a fund that is beating the street, but in late August Raj Rajaratnam got back half his cash after his brother distributed the funds to investors.

  UBS first noticed the fund’s heady success after it executed a trade on July 26 in the stock of Arris Group, selling “short” $1.4 million worth of shares, the maximum allowable position in the friends and family fund. Short selling, a sign an investor
is bearish about a stock, is a method of trading in which an individual sells borrowed shares at one price on the hope of buying back the stock later at a lower price and repaying the loan with the cheaper shares. A profit is made when the borrowed stock is replaced with less expensive shares. For instance, selling one borrowed share today for $20 and replacing it later when the stock is then trading at $19 allows the trader to pocket a $1 profit.

  After saying he wanted to be “long into numbers”—Wall Street–speak for taking an optimistic view about a stock ahead of a company’s earnings—Rengan Rajaratnam switched course and bet heavily against Arris Group in the friends and family fund and the main investment pool. It was a prescient move. On July 27, the company’s stock fell 20 percent after Arris, a communication equipment maker, reported second-quarter earnings that fell short of expectations. “The timing [of Sedna’s trade] was impeccable,” Moon remarked.

  Sedna overall made more than $1.1 million on the Arris trade alone, and Rengan, the only investor in the friends and family fund at the time, personally netted $270,000 overnight. It was such a home run that even his older brother Raj noticed and gave him a backhanded compliment.

  “U r my heroine…u da man…keep the streak alive,” Raj messaged Rengan on July 27, 2006, at 9:21 a.m.

  Raj did not have to say so. They both knew that in the Rajaratnam family he was always the hero and Rengan always the heroine. This made for a fractious relationship. At one point, Rengan worked for Raj, but word was his big brother threw him out of his company, the Galleon Group, after a falling-out. They never stayed mad at each other for long, though. Raj was always protective of his kid brother, much to the astonishment of associates, who considered Rengan arrogant. He had a way of making everyone around him feel small. One time Rengan asked an analyst at Galleon what he should do for his girlfriend for Valentine’s Day.