"U.S. v Gupta" - Collateral Damage
Jane is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
High-profile trials such as “U.S. v Gupta” can cause considerable collateral damage. Although it wound up being settled out of court, the closely followed libel trial “Westmoreland v CBS” hurt trust in the leadership of the American military and raised questions about the journalistic standards of television network CBS. That latter’s cash cow was investigative reporting. One wonders if those institutions have recovered even yet.
As you see here in the “U.S. v Gupta” indictment, the counts essentially concern securities law. This is at a time when both Wall Street and the investor relations practices of public companies such as Facebook and Groupon are, one might say, on trial daily. In addition since the John Edwards’ trial about campaign finance laws ended in a mistrial, the authority and motives of the federal government in pursuing brandname alleged miscreants are being questioned. Given that this is a presidential election year, all this can provide useful material for either party.
Clearly, not only is the guilt or innocence of defendant Rajat Gupta, former head of management consulting firm McKinsey, at stake. Also on the line is the credibility of the federal government. If that receives another major hit such as if Gupta is acquitted, then Wall Street might feel less heat and therefore receive less negative media attention. In response, Congress could back off on conducting hearings on how the financial sector operates and enacting new laws. But no matter what the jury verdict is, public companies have been in the spotlight during the trial. For Goldman Sachs (NYSE: GS) and Berkshire Hathaway (NYSE: BRK-A), the exposure has been direct. For Citigroup (NYSE: C), it has been indirect. That is, media coverage has been presenting earlier rulings by presiding U.S. District Judge Jed Rakoff. Last November he rejected the settlement between Citigroup and the SEC which called for a big fine but no admission of guilt. Let’s look at some of this.
U.S. Attorney Preet Bharara entered this trial in a position of strength in pursuing law breakers in the financial sector. Since 2009, he has won 59 convictions or plea bargains out of 66. His biggest victory was the conviction of insider trader Raj Rajaratnam who had founded Galleon hedge fund. However, in that case there had been actual evidence such as the defendant’s conversations on wiretapped phone calls.
In this case the evidence is circumstantial, as in demonstrating through phone logs that a call was placed from McKinsey to Galleon on the date around the time Rajaratnam made a trade with a $1 million gain. Should this matter then have been brought to trial or have been tossed as not having merit?
If there is a mistrial or acquittal, this would reinforce the perception post-Edwards’ trial that the federal government might be out of control. As a public relations comeback strategy Gupta could make his mission returning fairness to the legal system.
Bharara and his colleagues could fall from grace, but for different reasons, as did former New York State Attorney General Eliot Spitzer, once known as “the sheriff of Wall Street.”
Chairman and Chief Executive Officer (CEO) Lloyd Blankfein testified, just as he had at the Rajaratnam trial. The allegation is that, in 2008 while a board member, Gupta passed on the material information to Galleon that Warren Buffett was going to invest $5 billion in the distressed company. Also out there is the contention that the company is full of leaks, with allegedly David Loeb in Asian equities one of them. Should Loeb and other company employees be prosecuted, the company can be perceived as poorly managed. There have been calls for Blankfein’s resignation.
On the stand, the CEO seemed to play his role out of the “don’t let ‘em see you sweat” school of performance art. His persona was outsized, punctuating his testimony with wit and smiles. That traditional style as practiced by financial services leaders such as JPMorgan Chase’s CEO Jamie Dimon may be out of date. However, the company doesn’t seem to be suffering unduly, at least not right now. In fact, it has proved itself strong and resilient, recovering from former employee Greg Smith’s allegation that it does not value customers. Back then about $2 billion of market capitalization was lost.
On June 8, The Street gave it a “hold,” with 3 out of 5 stars for growth, 3.5 out of 5 for income, and most importantly in this volatile era, 5 out of 5 for solvency. Among others, Warren Buffett supports keeping Blankfein, which is a plus. CEO churn, as seen at Hewlett-Packard, can augment, not solve problems.
During the trial, about the only hit Berkshire Hathaway took was that the Judge made the description of its head Warren Buffett be reframed by the prosecution witness Bryon Trott, former Goldman Sachs vice chairman, from “the most respected businessman and investor in America” to “a very large and well-known investor.”
Actually the trial’s focus on the $5 billion investment can be a plus for the company whose investments in General Media and GM are being questioned. Last year Goldman Sachs repaid the investment, along with a one-time preferred dividend of $1.64 billion. In addition Buffett can exercise warrants for $5 billion of common stock with a strike price of $115 in 2013. Now, with the stock at 94.54, they are out of the money. But things could change. What the financial media have emphasized about this deal is the nice profit for Buffett.
On the one hand, investors might be pleased that Citigroup, along with the SEC, appealed Judge Rakoff’s ruling. In a preliminary hearing a higher court found that the decision might have represented an overstepping of authority. Settlement provides a narrow passageway out of possible trouble. Given the expense of a trial even a huge fine is a small price to pay. Shrewd decision by Citigroup. some investors might conclude.
On the other hand, there are those who would wring their hands that Citigroup is in this particular spotlight for possible wrong doing. Will its executives be included in those round-up hearings conducted in Congress, especially if the Democrats keep the White House? There is the danger that the scrutiny of Wall Street could intensify and Citigroup is all over the media.
However, exactly because it is on the radar, analysts seem to be paying more attention to its fundamentals. For instance, on investor guidance sites the Citigroup numbers are being posted and discussed. They include its 5-year average cash flow of $5.56 per share, operating margins of 21.8%, and the increase in net income to $11.06 last year from a loss of $1.6 billion in 2009. Another factor which makes it stand out is the lousy pickle JPMorgan Chase is in. By comparision it seems to be playing inside the controlled-risk box.
How much damage – or benefit – “U.S. v Gupta” will be associated with depends on the jury verdict. If it’s a mistrial or an acquittal, Wall Street and many companies might exhale. The election isn’t far away and a conservative in the White House could tame the reformist spirit. If it’s a conviction, the prosecution could feel emboldened and indict more suspected insider traders. That will increase distrust in investing in public companies. They, as a number of watchers of capitalism have been warning, could become an endangered species.
janegenova has no positions in the stocks mentioned above. The Motley Fool owns shares of Citigroup Inc. Motley Fool newsletter services recommend Goldman Sachs Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.