Devens Federal Medical Center houses insider traders

By Peter S. Cohan WALL & MAIN

Drive about 26 miles North from downtown Worcester and you arrive at the gates of the Federal Medical Center Devens, located in Ayer. In addition to being the temporary dwelling place of alleged Boston Marathon bomber, Dzhokhar Tsarnaev, FMC Devens houses two former Manhattan masters of the universe.

One of them, Raj Rajaratnam, was a Sri Lankan native and billionaire who used to run a $3.7 billion hedge fund called Galleon Group. The other, Rajat Gupta, a native of India and former global managing director of the international consulting firm, McKinsey & Co., and board member of Goldman Sachs and Procter & Gamble, was a relative pauper who was convicted of breaching his fiduciary duty to Goldman Sachs.

That's because Mr. Gupta let a mere 23 seconds elapse between the time he left a board meeting at Goldman and the time he called Mr. Rajaratnam — who on May 11, 2011 was found guilty of 14 counts of securities fraud and conspiracy and has spent the last three-and-a-half years serving an 11 year sentence — to tell him about the investment bank's $5 billion investment from Warren Buffett.

Now they are living in diminished circumstances at FMC Devens. At least that's according to Business Insider that wrote on December 6, 2011, "Disgraced Galleon chief Raj Rajaratnam vacated his luxury Sutton Place apartment in Manhattan yesterday and checked into federal prison that houses high-level sex offenders."

Business Insider notes that FMC Devens has about 1,000 inmates, and according to Bureau of Prison's website, "A significant portion of those inmates are sex offenders who require intensive, therapeutic treatment, while others suffer from severe substance abuse."

FMC Devens does not seem to have much entertainment. According to Ed Bales, a managing director for Federal Prison Consultants, "For entertainment at Devens, there are recreational rooms, but no individual televisions in the cells, There are gym facilities the inmates can use, but they are limited with equipment choices because they aren't supposed to bulk up."

Insider trading is when an officer, director or other insider — like an investment banker — of a publicly traded company breaches their fiduciary duty by giving material, non-public information about the company to another person who trades on that information.

For example, if the CEO of a public company tells a golfing buddy that his company is about to acquire another company, and the golfing buddy buys shares of the target before the announcement, that's insider trading.

A recent study hints that the Securities and Exchange Commission is prosecuting about one in 20 incidents of insider trading. The New York Times reported on a recent study — that examined "hundreds of transactions from 1996 through the end of 2012 — by two professors at the Stern School of Business at New York University and one professor from McGill University, concluding that a quarter of all public company merger deals may involve some kind of insider trading." 

The professors examined stock option movements — when an investor buys an option to acquire a stock in the future at a set price — as a way of determining whether unusual activity took place in the 30 days before a deal's announcement. They found that there was virtually no chance — about three in a trillion — that the unusually good option performance was due to chance. But they observed that the SEC litigated only "about 4.7 percent of the 1,859 M&A deals included in [their] sample."

Among the insider trading incidents that were litigated was the one that put Mr. Gupta in FMC Devens on June 17 for the next two years.

Here are the facts: on September 23, 2008, Warren Buffett agreed to pay $5 billion for preferred shares of Goldman Sachs, information that was announced at 6 p.m. after the NYSE had closed on that day. Prior to that announcement, Mr. Rajaratnam bought 175,000 shares of Goldman Sachs, which he sold the next day for a $900,000 profit. Mr. Gupta was convicted of telling Mr. Rajaratnam over the phone about the Buffett investment before Goldman officially announced the information.

In April 2012, the now-65-year-old Mr. Gupta was convicted of insider trading and was ordered to make $6 million in restitution to Goldman and pay a $5 million fine, according to Reuters.

This leaves open the question of why Mr. Gupta was willing to take the enormous risk to his career on September 23, 2008, that ended him up at FMC Devens with Mr. Rajaratnam nearly six years later. What is particularly striking is that Mr. Gupta did not even receive any financial payoff from breaking the law on behalf of Mr. Rajaratnam.

CNBC's John Carney offered an interesting guess about Mr. Gupta's motive in an October 2012 column: "I've now been led to believe, though numerous conversations with people connected with Gupta and some of the other players in the insider-trading case, it was something else. Gupta needed to feel like he was, in the words of one of his former friends, 'a real player.' He intensely desired to be seen as a great man, someone important, someone in the know. Leaking secret information was a way of demonstrating this."

I wonder whether Mr. Rajaratnam and Mr. Gupta will spend time talking about this as they while away the hours at FMC Devens.

Correction: In a column last week, I wrote about AMSC in Devens, and mentioned I could not find a clear indication whether it was cash flow positive in 2014. Upon further investigation, I found a quote from AMSC executive vice president, chief financial officer and treasurer David Henry, which he said in a conference call to investors: 'Excluding financing proceeds, we generated positive net cash flows of $3.6 million in the quarter ending March 2014, driven by positive operating cash flows of $5.1 million.'

Peter Cohan of Marlboro heads a management consulting and venture capital firm, and teaches business strategy and entrepreneurship at Babson College. His email address is peter@petercohan.com.