The Billionaire's Apprentice: The Rise of the Indian-American Elite and the Fall of the Galleon Hedge Fund (22 page)

Even though Rajaratnam was making good money on AMD, he told Kumar in 2005 that his advice was not as valuable as he’d expected it would be. Kumar failed to get the detailed quarterly financial results that Rajaratnam was looking for from AMD or other McKinsey clients. Rajaratnam knew it was time to tie Kumar’s compensation to his information. Kumar would get paid now only if his information paid.

Rajaratnam proposed that they change the relationship. Instead of giving Kumar cash, he would buy based on Kumar’s information and split any trading profits. The plan left Kumar queasy. He thought a consulting-like arrangement more appropriate and less risky. If Rajaratnam bought shares, how would he let Kumar know that he had bought the shares or tell him what price he had paid? Rajaratnam would probably have to email him or post some documents to him. It was a scheme that seemed too prone to discovery.

It was also a setup that would force Kumar to come face-to-face with what he was doing. Somehow, Kumar felt a little sheltered by the cash-for-information deal he had cooked up with Rajaratnam; he could rationalize the whole arrangement. After all, he didn’t know exactly what Rajaratnam was doing with the information he supplied. But if Rajaratnam started buying shares based on the tips he provided, there would be a direct link between the information he gave and the money he made. This tit for tat struck him as a much bigger crime. Emotionally, he thought, it would stare him in the face and make him feel uncomfortable. At the very least, it would be hard to ignore his role in the seamy affair.

For a while, the two debated an alternative payment plan. As they thought about a new arrangement, for three months Rajaratnam did not pay Kumar. Finally Kumar suggested something even better than the stock-trading scheme; it was a payment plan akin to an arrangement McKinsey had with some of its clients. He told Rajaratnam he would be happy if at the end of each year Rajaratnam decided how much to pay him based on his judgment of Kumar’s contribution for the year. He would be like a nonsalaried investment banker. All of his pay would be in the form of a bonus, decided by his boss, Rajaratnam.

Anil Kumar had always done well for himself when he was trying to perform for a higher-up, be it his masters at Doon or his mentor, Rajat Gupta, at McKinsey. He felt comfortable in the employee/boss dynamic. Rajaratnam was more than comfortable. He had Kumar right where he wanted him.

Galleon employees first started noticing Rajat Gupta visiting their offices in the spring of 2005. Their boss, Raj Rajaratnam, was a consummate networker, always meeting new people, many of them South Asians. Some came to talk to him about Galleon—either a job at the hedge fund or an investment with it. But many more came to chat with Rajaratnam about new ventures. If there was one thing Galleon employees knew about their boss, it was that he had his fingers in an array of businesses. He owned a share in Manhattan restaurant Rosa Mexicano; he had a 5 percent stake in a large Sri Lankan conglomerate; and he even was an early investor in Marquis Jet, a private plane leasing company. (One of the perks of the investment was that Rajaratnam received free flying time. When Galleon was still small, he flew the firm down to New Orleans for a company trip in a Gulfstream IV private jet.)

But Gupta was distinctive, different from many of the other callers. He was impressive in an understated way. Whereas Rajaratnam was garrulous, his new friend was quiet but always polite. Since stepping down from the helm of McKinsey, Rajat Gupta, by now fifty-seven years old, had been casting about trying to determine his next move in life.

Gupta had always been intrigued by the investment business. He was a prodigious investor, soaking money into everything from private equity to friends’ start-up ventures. When the daughter of new age physician Deepak Chopra was trying to launch an Internet company, Gupta, who believed in lending a hand to enterprising youngsters, readily agreed to invest $250,000. The business never took off and Gupta was not able to recoup his investment, but he never once mentioned the loss to Chopra. It was not the only time he had lost money on the Internet. During the dot-com bust of 2001, Gupta had suffered searing losses in technology stocks, but he made a killing on an investment in Scandent Solutions, a company started by a friend of his, Ramesh Vangal. Now that he was gradually phasing out of McKinsey, he was thinking about getting into the investment business himself. As he did with everything in his life, he approached it with lofty aspirations.

Gupta and a friend, Ravi Trehan, whom Gupta met one summer when Trehan rented a guesthouse in Connecticut from Gupta, had come to sound out Rajaratnam on the idea of buying an investment management company. The firm—which Trehan had found in Florida—was a so-called fund of funds, which raises money from institutional and high-net-worth investors and then allocates money to different kinds of hedge funds. Gupta and Trehan, a seasoned investor with an enviable track record of structuring deals, told Rajaratnam that they thought they could buy the company for 2 percent of assets. At the time, investment managers were trading at about ten times assets. Gupta and Trehan were looking for $100 million from Rajaratnam as equity capital to buy the company. Rajaratnam was skeptical and the plan went nowhere, but another idea caught his imagination.

It was an investment vehicle called Voyager Capital Partners. Voyager, essentially a creation of Trehan’s, would invest in a smattering of funds and strategies—some run by Galleon and some by Trehan’s investment firm BroadStreet Group.

The beauty of Voyager was that it would be highly leveraged, which amplified its investment firepower. Essentially the fund would borrow money, invest it, and then seek to pay back the debt after its investors made an acceptable profit. Under the structure, Rajaratnam put in $40 million, giving him an 80 percent stake in the entity, Trehan invested $5 million for 10 percent of the equity, and Gupta $5 million for 10 percent. On the back of the $50 million in equity, Voyager borrowed $350 million, pumping up the vehicle’s investment capacity—and the potential returns—to its three partners.

Most of the loan—$300 million—came from Lehman Brothers, which bore the least risk in the event there were losses in Voyager. The three equity partners—Gupta, Trehan, and Rajaratnam—carried the greatest risk. If there were losses in Voyager, they would shoulder them first.

From the start, Voyager was highly lucrative for its partners and even more so for BroadStreet, which was Voyager’s investment manager, doing the paperwork, allocating the money to different funds, and receiving fees for its role. On January 11, 2006, just three months after Voyager was set up, the equity of the shareholders stood at $58,382,958, a return of nearly 17 percent. But while the profits were piling up, the goodwill between the two key partners, Trehan and Rajaratnam, frayed.

One day in early 2006, Rajaratnam, Gupta, and Trehan were meeting at Galleon’s offices when Rajaratnam started laying into Trehan. Instead of BroadStreet serving as the investment manager of Voyager, Rajaratnam was angling for Galleon to be making the asset allocation decisions at Voyager (and getting a bit of the lucrative management fees). At one point, Rajaratnam became so abusive that Trehan, a seasoned investor with a successful track record, got fed up and said, “I don’t want to do business with you if that is the way you are going to act.” Then Trehan walked out of Rajaratnam’s office. Gupta stayed. He did not follow his friend.

People noticed that Rajaratnam always addressed Gupta with great deference, unlike the way he treated others. He liked to refer to Gupta as a South Asian “rock star” and explained to friends that Gupta was a half generation older than him and, in Asia, it was the custom to treat elders with respect. Shortly after the falling out, Trehan sold his investment in Voyager to Rajaratnam and for a while, Rajaratnam owned 90 percent of the equity of the vehicle and Gupta held 10 percent.

In 2006, Gupta was starting to focus on his life after McKinsey; even though he had stepped down as managing director in 2003, he remained a partner and had signaled to colleagues that he wanted to stay on at the firm until 2008, when he turned sixty. His outside activities, though, were making it increasingly difficult for him to continue. One of the most nettlesome was a new money management company that Gupta was in the throes of setting up even as he was still on McKinsey’s payroll as a partner.

In early 2006, Gupta confided in Kumar that he wanted to start a large, world-class asset management company, focused not just on hedge funds but on private equity too, that would be targeted at investing in South Asia—mainly India but also China and, to a lesser extent, the Islamic world, Pakistan and the Middle East. His plan was to enlist well-regarded money managers of South Asian origin to run the assets. Gupta said he had already teamed up with three other partners, Parag Saxena, who had expertise in private equity; Rajaratnam, who was a hedge fund pro; and Mark Schwartz, a former Goldman Sachs executive who had worked for many years in Asia. The foursome had an ambitious goal: they wanted to raise $2 billion for the new fund. They were deeply committed to the project, proposing to match the total amount raised—ultimately $1.25 billion—by putting in 10 percent of their own money. The seed money of $130 million was to be divided equally, but Gupta told his partners to count him in for less: $22.5 million.

The new venture, which was called Taj Capital and later renamed New Silk Route (NSR), at first operated out of space adjacent to Galleon’s offices on the thirty-fourth floor at 590 Madison Avenue. To facilitate his movements in and out of Galleon’s offices, Gupta also received a key card allowing him to come and go as he pleased. Sometimes, his free access caused problems for Rajaratnam. One time, Gupta arrived at the office without an appointment. Rajaratnam told his secretary, Caryn Eisenberg, to lie and tell Gupta he wasn’t there. But Gupta was determined to find him. He got into the office using his key card and eventually tracked Rajaratnam down.

Gupta poured his energies into raising money for the new fund, tapping into his impressive array of contacts. In mid-2006, when the four partners settled on their plans, the group put together a priority list of investors to target. Gupta was responsible for reaching out to some of the biggest names on the list. He and Schwartz were to go after the investment officers of the endowments for preeminent institutions such as Harvard University, where Gupta’s daughter worked, and Yale. They were also to reach out to Bill Gates and the Walton Family Foundation. (Harvard did not invest, citing as a factor a conflict of interest because Gupta’s daughter worked there; Goldman also passed on the opportunity, raising similar concerns, in this case because Gupta was a board member.) Gupta alone would approach Edgar Bronfman Jr., whose family built a fortune through the spirits company Seagram, even though his McKinsey colleague Anil Kumar, who had been considering joining the fund, had already spoken to Bronfman’s older brother, Sam.

The lifeboat out of McKinsey now awaited Kumar, but it was the last thing he wanted to pursue. His dissatisfaction with his lot had prompted him to toy with outside ventures, but he knew in his heart that he was most comfortable as a salaryman at a big firm. He desperately hoped that in three years when a new managing director ascended to the helm of McKinsey, his career would be back on track.

For now, though, he figured that it didn’t hurt to be deeply involved in the planning of NSR. Operating against company practices, Kumar often fired off emails about the new fund from his account at McKinsey. Sometimes his efforts landed him in near scrapes with his employer. In early October 2006, Kumar sent an email with the subject line “URGENT” in all capitals to the founding partners of NSR. Two of them, Rajaratnam and Saxena, planned to have a meeting with a potential investor, Dr. Hosein Khajeh-Hosseiny, at Northgate, a “fund of funds” that allocated money to various private equity firms. Many of Northgate’s principals had worked at McKinsey. “I spoke with Dr. Hosselnys [
sic
] asst yesterday. Given Northgate’s special relationship with McKinsey she was puzzled as to why I was joining this meeting today,” Kumar wrote to them. The best positioning for these meetings is that “I am a ‘founding investor’ and an old school friend of Raj and Parag.”

McKinsey failed to spot Kumar’s work for NSR and that Kumar was angling to be paid hundreds of thousands of dollars by NSR for his efforts even as he was on McKinsey’s payroll. Kumar’s second attempt to moonlight never came to anything because one of the principals of NSR, Parag Saxena, was vehemently opposed to the idea. As a compromise, it was agreed that Kumar would receive a stake, albeit smaller than that of the founding principals, if he decided to join NSR in three years.

Meanwhile, Gupta’s outside activities, while he was still affiliated with McKinsey, did not go unnoticed. Ironically, though, it was not his fund-raising for NSR that came to McKinsey’s attention but rather his desire to join the board of Goldman Sachs. In 2005, Lloyd Blankfein’s predecessor and former secretary of the Treasury Henry M. “Hank” Paulson Jr. had approached Gupta about joining the Goldman board of directors. Paulson had first met Gupta when the two were working on an assignment for Sara Lee. Many years later, in 1996, John Bryan, Sara Lee’s chief executive, reintroduced the two at his sixtieth-birthday party at his home in Chicago. When Gupta moved to New York, the two became better acquainted. They both served on a Harvard Business School alumni advisory committee, and one year Gupta invited Paulson, a nature lover, on a trip to Indonesia to see the Komodo dragons, a large species of lizard.

The first time Paulson approached Gupta about joining the Goldman board, he appeared eager but then demurred. McKinsey would not waive the restriction it had prohibiting partners from joining corporate boards. But in November 2006, Gupta retired as a partner and became a consultant to the firm. Almost immediately he stepped onto the Goldman board, taking up the first of many board seats. In 2007, he was named a director on the board of consumer products giant Procter & Gamble. Two years earlier, Gupta helped P&G’s then chairman and CEO A. G. Lafley sketch the company’s $57 billion takeover bid to buy Gillette. And when the talks hit a roadblock, Gupta, who was close to Gillette’s then chief executive James Kilts, helped bring the two back to the negotiating table. He sat for hours with the men in a room hashing out their differences until a deal was struck. Kilts remembers Gupta’s role to this day. At a thorny point in the talks, there was only one person Lafley and he trusted to call: “That person was Rajat.”

As a former managing director of McKinsey and a consultant to the firm now, Gupta still retained many of his old perks, including his Stamford office, his countless McKinsey phones and BlackBerry, and his access to the company’s email, which he would rely on to solicit investors for NSR.

Tireless in his fund-raising, Gupta turned to his vast database of contacts to find people to pitch. He fired off dozens and dozens of impersonal, form-like letters to McKinsey partners he had worked with at the firm as well as to corporate chieftains he had come to know over the years and even to neighbors. “I hope you remember me,” he started one letter he emailed to Robert Devlin, the former chief executive of insurer American General. A letter he sent to former Citigroup chief Sandy Weill, whom he knew from being on the board of Weill Cornell Medical College, was emblematic of the marketing push: “Dear Sandy, I am the chairman of a new 1.5 billion dollar private equity fund called New Silk Route (NSR) and I would very much like you to consider investing in it.” Gupta went on to lay out brief profiles of his investment partners, noting that they had put in $125 million of their own money. “We are now in the process of offering the final $200 million to a few friends and family in the range of $1–5 million each and hope to have a final close in the next 30 days.”

As part of the NSR fund-raising drive, Gupta sent similar letters to Ajit Jain of Berkshire Hathaway, a top lieutenant of Buffett’s and a contender to succeed him; Herb Allison of TIAA-CREF; Goldman board members John Bryan and Bill George; Marcus Wallenberg, a member of the prominent Swedish family; PepsiCo chief executive Indra Nooyi; and dozens of others. The efforts paid off, and NSR succeeded in raising $1.3 billion for its private equity arm; its capital drive for the hedge fund side failed, though, and that business was never launched.