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

by Anita Raghavan

  These numbers “suggest a HUGE increase in Director compensation,” says Skilling. “It also suggests a selfishness of the directors since the ratio was not held constant.” In effect, the firm wasn’t naming new partners as fast as it was hiring associates. Growth profited the few. More money was spread over the same number of partners. It was the opposite environment from 1973, when Gupta joined McKinsey.

  When the bubble burst in 2001, it aggravated McKinsey’s pain.

  McKinsey typically hired two thousand people a year, including business analysts. To get two thousand new recruits, it made roughly three thousand offers, giving it a 66 percent acceptance rate, one of the highest among large employers. But in 2001 McKinsey found that between twenty-seven and twenty-eight hundred applicants accepted its offers, a 95 percent acceptance rate. The high rate came at a time when the firm was already saddled with lots of consultants who in McKinsey parlance were “on the beach,” or had nothing to do.

  To address the mismatch between supply and demand, McKinsey decided it was not going to lay off people or renege on the offers it had made to business school graduates. Gupta was proud that the firm was able to keep its commitments to its new hires, but within the firm the policy that McKinsey embarked on to deal with the bust was arguably more controversial. The firm began culling its ranks through more rigorous performance reviews.

  Between 2001 and 2004, its consulting staff fell from a little over seventy-five hundred to a little over fifty-five hundred. It was a stark change from the way McKinsey typically handled the departure of associates, who were given time to find another position or “counseled out,” an elegant term that did not carry the obviously pejorative implication of being fired. Many at the firm openly blamed Kumar and his ilk in Silicon Valley for McKinsey’s indiscriminate bloodletting. Rajat Gupta did not escape the criticism either. Everyone knew that without the backing of his mentor, Gupta, Kumar would have never succeeded in building up McKinsey’s e-commerce practice.

  Besides the implosion of his business, Kumar had another reason to worry about his future at McKinsey. His longtime mentor, Gupta, was retiring as managing director of McKinsey, and it was widely known that Gupta’s successor, Ian Davis, planned to chart a different course. Davis, an upright Englishman with a degree in PPE—philosophy, politics, and economics—from Balliol College, Oxford, was keen for a return to the “values-based” McKinsey, not a growth-at-all-costs McKinsey. He was viewed as being disenchanted with McKinsey’s growing and obvious commercialism and was not a big fan of Kumar, whom some colleagues felt embodied the business-driven culture that had seeped into the firm over the previous decade.

  At one time, Kumar had given his friends in India the impression that he might someday be in a position to succeed Gupta. But now he was singing a different tune. “I have to find something beyond McKinsey,” he told a friend. Kumar was too private and tight-lipped to divulge anything about his changed circumstances at McKinsey, but old friends sensed that Kumar’s star at the firm had faded.

  Upon ascending to the top job, McKinsey’s new managing director, Davis, made it clear to Kumar that he had no plans to elevate him to a leadership role. Other senior partners at McKinsey advised Kumar that it might be time to seek employment elsewhere. Stung and disappointed, Kumar turned to Rajaratnam and confided in him, telling him all about his woes at work.

  At the Indian School of Business cocktail party in September 2003, Kumar recalled that at one time Rajaratnam had shown interest in engaging McKinsey. In the summer of 2002, he came to Kumar with an intriguing business proposal. Rajaratnam said he received about $100 million a year in so-called soft dollars, which could be channeled to pay for stock research or consulting services. Soft dollars were controversial but legal. Regulators saw them as essentially kickbacks for diverting trading commissions to certain brokerage firms. Many big mutual funds like Fidelity Investments in Boston stopped accepting them, but Galleon, like many hedge funds, took a kinder view of soft dollars, regarding them as rebates on the fat brokerage commissions paid out each year to Wall Street.

  Rajaratnam had suggested to Kumar that there might be a way for Galleon to put its soft dollars to work by hiring McKinsey. Kumar quickly mobilized a team to draft a proposal on the kind of industry research McKinsey could offer a technology fund such as Galleon. On September 26, 2002, before a call with Rajaratnam that day, McKinsey consultant Tom Stephenson sent Rajaratnam an eighteen-page PowerPoint presentation laying out the ways McKinsey could assist Galleon.

  The document, marked “Confidential,” boasted of McKinsey’s strengths. It represented more than half the world’s five hundred largest companies and was retained on thirty-five hundred engagements a year. In the high-tech sphere, McKinsey counted as clients eight of the ten largest semiconductor companies and nine of the top ten software companies. It was also a powerhouse in health care, another area of interest to Galleon. Its clients included seventeen US-based biotechnology companies, mainly on the West Coast. It could offer expertise in a variety of disciplines, among them the hot area of stem cell therapies. Tellingly, the presentation made no claim about McKinsey’s knowledge and experience in serving hedge funds.

  Rajaratnam was singularly unimpressed, but he did not let on. Instead, he politely listened to Stephenson’s pitch and then asked some penetrating questions. After the meeting, he felt there was nothing the McKinsey consultant could tell him that he didn’t already know. And he thought McKinsey’s rates were far too high.

  Stephenson, however, came away upbeat. “Good meeting with Raj,” he said in an email he fired off to Kumar and the rest of the pitch team. “It seems like Raj’s approach to investing matches well with our perspective on serving buy-side firms.” Stephenson’s read turned out to be off. Months lapsed after the McKinsey call with Rajaratnam. In early 2003, Kumar confronted Rajaratnam. He told him that he was disappointed that the Galleon hedge fund manager hadn’t even bothered to respond to the McKinsey proposal after all the work his people had put into developing it.

  “Just send it to me again,” said Rajaratnam, raising Kumar’s hopes once more.

  Kumar dutifully followed up, getting his lieutenant to send another proposal that detailed McKinsey’s areas of strength. With its army of experts and doctors as consultants, the firm could help a hedge fund like Galleon divine the winning drug therapies in the race to cure cancer or determine the speed with which consumers would adopt broadband at different price points. Again the pitch met with silence from Rajaratnam.

  That fall evening in 2003, as the two men were leaving the Indian School of Business cocktail and dinner, Rajaratnam pulled Kumar aside.

  “You know you sent that document,” Rajaratnam said, referring to the proposal Kumar had sent about the ways McKinsey could advise Galleon. “You do realize that that’s not really what I want. I would much rather have you as a consultant than McKinsey.”

  Kumar very matter-of-factly told Rajaratnam that he was not allowed by McKinsey to accept outside consulting work. But Rajaratnam persisted, preying on Kumar’s ego and obvious envy of Rajaratnam’s wealth.

  “You work very, very hard, you travel a lot, you are underpaid,” he told Kumar. “People have made fortunes while you were away in India and you deserve more.” Rajaratnam said he was willing to pay Kumar $500,000 to be a consultant to Galleon. All Kumar had to do was speak to him every four to six weeks and share his insights about the tech industry. “You have such good knowledge—it is worth a lot of money,” he told Kumar. McKinsey wouldn’t have to know anything about their arrangement. If Kumar could find someone outside the United States who would act as a go-between and accept the consulting work, then there was no reason McKinsey should find out about Kumar’s moonlighting.

  It was a tantalizing opportunity coming at a time when Kumar was feeling vulnerable.

  Raj Rajaratnam always knew more than he let on. When he made his overture after the cocktail party in 2003, he knew that Kumar had spent time in India in the 1990s
. As he brainstormed about setting up a consulting arrangement with Kumar, he suggested finding someone in India who could accept the payments for the consulting services. Then that person could have that money reinvested in one of Galleon’s stable of funds.

  “I don’t think Indian regulations allow that,” Kumar countered, again very matter-of-factly. Undeterred, Rajaratnam proposed creating an offshore company to receive payments from Galleon. “I can even tell you how to do that,” he offered. But Kumar didn’t want to deal with the messiness of an offshore entity.

  Rajaratnam persisted with his pitch. He knew that the Kumars had an Indian housekeeper living with them in California. They had brought Manju Das over from Delhi to help take care of their son, Aman, who had a variety of health issues.

  Rajaratnam asked Kumar if his housekeeper still carried an Indian passport. When he said she did, Rajaratnam offered up the perfect solution, a way of having Kumar consult for him without McKinsey ever knowing. Rajaratnam suggested that Kumar set up an account offshore in his housekeeper’s name so the arrangement was kept well away from McKinsey. Kumar found the idea appealing because it would avoid awkward structures such as an offshore company. But he had a worry in the back of his head. If his housekeeper was going to be the recipient of the consulting payments Rajaratnam planned to make, then how could he be assured that he would get his money back? That’s easy, Rajaratnam told him.

  There was a standard way of dealing with this situation, Rajaratnam explained. Kumar would simply write a nominating letter that would be signed by his housekeeper, giving Kumar authorization to act on her behalf. Not long after their meeting at the ISB reception, Rajaratnam dictated the letter and Kumar typed it.

  Chapter Twenty

  A Vanaprastha on the Hudson

  By the late 1990s, as McKinsey was humming amid one of the greatest economic booms in modern-day history, Rajat Gupta began contemplating a life transition. In the Hindu religion, whose spiritual tenets Rajat soaked up during his coming of age in India, a man’s life is divided into four stages. The first, known as brahmacharya, represents the early part of a man’s life and is a time of learning during which a young man leaves home to spend time with a guru. The second stage is when a man becomes a householder, or grihastha. He marries, builds a home, and accumulates wealth for himself and society. Midway through life, a man starts becoming a vanaprastha, or hermit, characterized by a growing renunciation of physical, material, and sexual pleasures. At this point, a man is supposed to retreat into the forest, where he spends his days in prayer. It is all preparation for the final stage, sanyaasa, which is marked by a total devotion to God and no attachment to worldly pleasures.

  At the height of the dot-com boom, McKinsey flew fifty-odd hand-picked members of the Harvard Business School class of 2000 to Château Élan, a sprawling thirty-five-hundred-acre luxury resort just outside Atlanta. Few if any of the HBS students descending on Atlanta that weekend had come for recreation or entertainment. They had traveled south to make one of the most important decisions of their lives: whether to join McKinsey after getting an MBA from Harvard Business School or dip their toes in the brave new economy. The group was a cosmopolitan crew, and the big draw was the man whose very appointment to the top job changed the face of McKinsey, quite literally transforming it from a white-shoe consultancy into a multicultural meritocracy.

  Rajat Gupta had a reputation for applying Indian philosophy to the Western business milieu. He liked to recite passages from the Hindu scriptures or draw parallels to Hinduism to explain his approach to business or elaborate on his vision of how a firm like McKinsey worked. Often he invoked verses to offer valuable life lessons. A Gupta principle that he drew from the Bhagavad Gita holds that man has a right to work but not to the fruits that arise from his labor.

  When coworkers were confronted with a challenging situation, he would impress upon them “to do what you think is the right thing” and not to “really get attached to the fruits thereof” or worry about the results. Often his goal-driven American colleagues would challenge him, asking, “If something doesn’t go right, ‘Aren’t you unhappy about it?’” Gupta would offer a philosopher king–like reply entirely uncharacteristic of the operating style of a corporate executive. It was as if he was more new age than new economy.

  “I think if we judge ourselves by results too much, we’re always out of balance…Either we are far happier than we should be or far sadder.”

  Gupta again turned to the subject of Hinduism in his speech to the young HBS students. Rightly suspecting that many in the audience did not have a clue about the topic, he laid out the four stages of a man’s life. Then he surprised the group of mostly alpha males by declaring, “I think I am in my third stage,” or becoming a vanaprastha, which is marked by a gradual retreat of a man into the woods.

  The assertion did not go down well.

  “It really struck me: here is the CEO of a major company and he is talking about retreating into the forest,” said one student in the audience.

  What the HBS students didn’t know was that Gupta by the turn of the millennium was ready to channel his energies elsewhere. His first two terms at the helm of McKinsey were extraordinary and explosive, both aggressively expansionist and intently customer-satisfaction driven. He pushed a firm initiative called “100 percent cubed” that promised to make McKinsey more client-centric by delivering 100 percent of the firm, 100 percent of the time, to 100 percent of its clients.

  He expanded the firm’s footprint to eighty-four worldwide locations from fifty-eight, more than doubled the consulting staff to seventy-seven hundred from twenty-nine hundred, and nearly tripled its revenues to $3.4 billion from $1.2 billion in 1993. He pounded away at making McKinsey more global in outlook. During the February 1996 partners’ meeting, held at Disney World, in Orlando, Florida, over which he presided, the global message was subliminally driven home.

  Partners from each of McKinsey’s offices were asked to march in an Olympic-like torch-carrying procession, singing “We Are the World,” with each office displaying its homeland’s distinctive cultural touchstone. As the London office walked in, looking regal with top hats on their heads, the Scandinavians sparked a furor by showing up with beautiful blondes on their arms. The display didn’t sit well with the few women partners at the firm. Gupta’s message of going global was on the nose and not exactly in the stuffed-shirt McKinsey tradition.

  As he met with greater success, Gupta shed his simple ways. When Gupta was first elected managing director in 1994, he made a conscious—and surprising—choice to run the global consulting powerhouse from Chicago. Personally, it made sense. The Gupta girls were still in school. Uprooting them would have been wrenching for his family. Professionally, Gupta running McKinsey from Chicago implicitly signaled that New York’s decades-old dominance over the rest of the firm was over.

  As McKinsey’s reach around the world grew, though, it was harder and harder for Gupta to remain in the Windy City. Most of McKinsey’s overseas clients passed through New York when they came to the United States; rarely did they stop off in Chicago. In the late nineties, with his eldest daughter now in college and two others approaching university, Gupta relocated from the Chicago to the New York office. The move was very different from his previous two. This time, he did not buy a modest house sight unseen. He splurged, paying $6.125 million to buy the waterfront estate once owned by James Cash Penney Jr., a cofounder of the retailing empire J.C. Penney Corporation. As managing director of McKinsey, he could afford it; he was earning about $5 million a year.

  The gracious cream-colored mansion in Westport, Connecticut, was built in the 1920s and had eight bedrooms and eight baths. It sat on more than two acres of land. When the Guptas bought the house, it was somewhat tired, but they poured money into it, lifting its image to fit with the public persona of its owner, who by the late 1990s was growing immeasurably in stature. The householder had reached his pinnacle.

  The first three decades of Gup
ta’s life in the United States had been marked by nonstop striving—making the top grade at HBS, getting a job at McKinsey and climbing its ranks, and then running a worldwide consulting juggernaut so it was operating at peak performance. But by 2000, Gupta appeared exhausted.

  As exhilarating as growth was, it was also wearing. During the last few years of his second term, he was under tremendous pressure from partners to take the firm public, just like Goldman Sachs had done, or to seed a venture capital fund like rival Bain had done. “If I look back on my time as MD and where I made the most impact, I would pick the time when the bubble was going on and it was fascinating because lots and lots of people were getting instantly rich,” he said years later. There was an “enormous amount of pressure to start new ventures, take equity ownership, to do a whole bunch of things to become more instantly rich where I had to take a strong personal stand. The most important contribution I made during my tenure as managing director is to make sure we didn’t go public, we didn’t start a venture fund, we didn’t go into starting businesses.”

  Yet to McKinsey veterans the growth spurt that Gupta championed had frayed the firm, and his focus on growing the additional awards—or bonuses—ran against the company’s values. Robert Waterman remembers attending a meeting of former directors like himself around the turn of the millennium. “I got a sense that the firm had grown way too fast and we had lost a sense of professionalism in the process,” says Waterman.