Former McKinsey head and Harvard graduate Rajat Gupta?s case brings to the forefront new challenges that the Securities and Exchange Commission, and the Justice Department have not faced in other cases involving securities fraud by the hedge fund manager Raj Rajaratnam. Gupta has been accused of tipping Raj Rajaratnam with material, non-public information about Warren E Buffett?s $5 billion investment in Goldman Sachs and the fact that Goldman Sachs would announce its first quarterly loss. Gupta has also been accused of providing material, non-public information to Raj Rajaratnam about quarterly results at Procter & Gamble. It is alleged that Gupta had obtained this information in his capacity as a member of the Goldman Sachs board and the Procter & Gamble board. Later, Raj Rajaratnam and others part of the Galleon group earned illegal profits (and illegally avoided losses) of millions of dollars based on this information.

Gupta pleaded not guilty to these charges, setting the stage for an intense courtroom battle involving questions that go to the heart of securities regulation law, criminal law and evidence law in the US.

The legal term that the prosecution would use to identify Gupta would be a ?tipper?. A ?tipper? is a person who discloses material, non-public information to another individual. Similarly, a ?tippee? (Raj Rajaratnam in the current case) is a person who trades on the basis of the information received from the tipper. A tipper is exposed to insider trading liability for simply communicating material, non-public information even if he did not personally use the information to trade in the company?s securities.

In Dirks vs SEC, the US Supreme Court ruled that an insider of a public company breaches his duty to shareholders and violates Section 10(b) and Rule 10b-5 of the Securities and

Exchange Act of 1934 when for his ?personal benefit?, he tips material non-public information about his company to an outsider who trades the company?s securities on the basis of such information. Thus, in order to successfully prosecute Gupta, the prosecution will have to largely prove two elements: (1) the disclosure of material, non-public information in breach of fiduciary duty by Gupta, and (2) the receipt of a personal benefit as a result of the disclosure.

The case presents a challenge to the prosecution because it remains to be seen whether the wiretaps of Raj Rajaratnam (that played such a huge role in his conviction) will be admissible in court against Gupta. The wiretaps in question relate to two intercepted calls that Raj

Rajaratnam made to a trader in his firm disclosing that he had a source inside Goldman Sachs who was providing information about Warren E Buffett?s $5 billion investment in Goldman and the fact that the firm would make known its first quarterly loss. Gupta was not party to these two intercepted calls, and clearly the usage of the same against him would constitute hearsay.

However, Gupta has also been charged with conspiracy to commit securities fraud under the provisions of the Securities and Exchange Act of 1934. This presents an interesting

opportunity to the prosecution to use Rule 801(d)(2)(E) of the Federal Rules of Evidence, and argue for the admissibility of the two wiretaps against Gupta. Rule 801(d)(2)(E) provides

for a ?co-conspirator exception? to hearsay, and is perhaps the most important advantage available to a prosecutor in a criminal conspiracy case. In essence, it provides that otherwise inadmissible hearsay declarations of co-conspirators (Raj Rajaratnam?s in the current case) are admissible at trial against the defendant (Gupta) so long as they were made during the course of and in furtherance of the conspiracy.

As a starting point, the prosecution will have to persuade the trial judge of the existence of a conspiracy. For proving the existence of a conspiracy, some evidence is required in addition to the content of the statement itself. This preliminary question needs to be decided by the trial judge, and the standard for admissibility is ?preponderance of the evidence?, and not the stringent ?proof beyond a reasonable doubt? standard. This lower threshold may prove helpful to the prosecution. However, numerous other problems related to the ?during the course? and ?in furtherance? requirement can prove to be vital to the trial, and must be addressed by the prosecution.

If the wiretaps are not admissible, the prosecution will have to prove disclosure of material, non-public information by Gupta to Raj Rajaratnam through inference and circumstantial evidence. The prosecution would seek to do so by proving telephone records which show that Gupta spoke to Raj Rajaratnam moments after he learnt of the material, non-public

information. However, the mere fact that calls were exchanged between Gupta and Raj Rajaratnam would not be enough to raise an inference of guilt against Gupta.

Most importantly, the prosecutors will also have to prove that disclosure of the material, non-public information resulted in a personal benefit to Gupta. The US Supreme Court has firmly established that the personal benefit test must be considered when assessing the liability of the tipper (Dirks v. SEC). The personal benefit test was established because the US Supreme Court observed that not all communication of material, non-public information by insiders should be prosecuted as insider trading. Rather, the court said that an insider should incur insider trading liability only when he communicates material, non-public information for an improper purpose. The personal benefit test is a means of determining whether disclosure of material, non-public information by a tipper to a tippee is improper.

The indictment is ambiguous as to how Gupta benefited from disclosing the material, non-public information. The US Supreme Court in Dirks identified three types of personal benefits that a tipper may receive from making a tip: (1) a pecuniary benefit (financial payment, kickbacks, profit-sharing arrangement); (2) a reputational benefit (example may include a corporate officer providing information to an analyst in the hope of a favourable report); and (3) a benefit from making a gift (gift made due to a personal relationship). The prosecutors have not alleged that Gupta received any pecuniary benefit or a reputational benefit, and will urge the jury to infer a benefit under the ?gift theory?. Proving this through circumstantial evidence will be critical to the prosecution?s case.

Consequently, the insider trading prosecution of Gupta will largely be built on circumstantial evidence. The defense lawyers of Gupta will try to convince the jury that the prosecution?s circumstantial evidence is not evidence at all, but mere ambiguous circumstances from which they asks the jury to hypothesise as to what might have occurred. The jury will be continually reminded that it cannot convict Gupta based on speculation or guilt by association. Just because Gupta and Raj Rajaratnam spoke and Raj Rajaratnam traded, it does not mean a violation of the law had occurred.

The judge has set an October 1, 2012, trial date for the lawsuit against Gupta. One thing is certain, the entire Wall Street will be following the trial with bated breath.

The author is an associate attorney in an international law firm in Paris, and holds an LLM from Harvard Law School