Report Says S.E.C. Erred on Pequot
The New York Times
By Gretchen Morgenson and Walt Bogdanich
August 4, 2007
The Securities and Exchange Commission bungled a promising investigation two years ago into suspicious trading at Pequot Capital Management, a giant hedge fund, according to the final report released yesterday by Congressional investigators looking into the matter.
Among the commissions failings, the report said, were delays in the Pequot investigation, disclosure of sensitive case information by high-level S.E.C. officials to lawyers for those under scrutiny, a detrimental narrowing of its scope after a meeting with a Pequot lawyer, and the appearance of undue deference to a prominent Wall Street executive that resulted in the postponement of his interview until after the cases statute of limitations had expired.
The 108-page report by the Senate Finance and Judiciary committees under the leadership of Charles E. Grassley, Republican of Iowa, and Arlen Specter, Republican of Pennsylvania, caps a yearlong investigation into the S.E.C.s firing of Gary J. Aguirre, a former staff lawyer, in September 2005.
Mr. Aguirre, who led the commissions investigation into suspect trading by Pequot and its founder, Arthur J. Samberg, was fired after he complained that superiors had thwarted his efforts by barring his interview of John J. Mack, currently the chief executive of Morgan Stanley and a close friend of Mr. Samberg.
Mr. Mack was asked to testify before the S.E.C. last summer after Mr. Aguirres allegations had become public and Congress had begun investigating the commissions handling of the matter. The S.E.C. closed the Pequot inquiry last fall without taking action against the fund or its management. A Pequot spokesman declined to comment on the report.
The Senate report said there was no evidence that Mr. Mack had provided information to Mr. Samberg or that Mr. Mack had done anything to prevent or delay his testimony.
The investigation of Pequot Capital Management could have been an ideal opportunity for the S.E.C. to develop expertise and visibility into the operations of a major hedge fund while deterring institutional insider trading and market manipulation through vigorous enforcement, the report said. Instead, the S.E.C.s inquiry was undermined by a series of missteps, according to Senate staff workers who took the testimony of 30 people and reviewed 10,000 pages of documents.
Mr. Aguirre responded to the report yesterday, saying that Christopher Cox, the S.E.C. chairman, can bless the conduct of those senior S.E.C. officials criticized in the report or he can protect the capital markets by cleaning house.
Mr. Cox issued a statement last night saying he looks forward to reading the full report, adding, The agencys commitment to prosecuting insider trading has never been stronger, and initiatives such as our hedge fund insider trading task force in the enforcement division will ensure that remains true in the future.
Pequot Capital came under regulatory scrutiny in 2004 after stock exchange officials had identified 17 to 25 sets of suspicious trades by the hedge fund. Such transactions are routinely turned over to the commission, whose officials then decide whether to investigate them.
One series of trades, which made Pequot $18 million, came just ahead of the announcement in 2001 by the General Electric Capital Corporation that it would buy Heller Financial. Advisers on the deal were Credit Suisse, a firm that was wooing Mr. Mack to be its chief executive at the time, and Morgan Stanley.
But after Mr. Aguirres investigation was under way, the report said, lawyers for both Mr. Samberg and Morgan Stanleys board, which was then considering hiring Mr. Mack as chief executive, received access to high-level S.E.C. enforcement officials outside the presence of Mr. Aguirre, who was leading the Pequot inquiry. After these contacts, the scope of the Pequot investigation narrowed and Mr. Aguirre was barred from interviewing Mr. Mack.
When Mr. Aguirre complained, the S.E.C. retaliated by firing him, Senate investigators concluded.
The report paints a picture of an agency that does not always treat prospective witnesses equally.
By allowing the perception that going over the head of S.E.C. staff attorneys yields results, the report said, the S.E.C. undermines public confidence in the integrity of its investigations and exacerbates the problems associated with regulatory capture.
For example, on June 26, 2005, Linda Thomsen, the director of enforcement, spoke by telephone about the Pequot case to Mary Jo White, a lawyer at Debevoise & Plimpton, who was representing the Morgan Stanley board and was concerned about Mr. Macks possible involvement, the report said.
Ms. Thomsen said she had told Ms. White nothing about the case during the call. But according to Ms. Whites account of that conversation, Ms. Thomsen disclosed that subpoenaed e-mail messages showed that there was smoke there though surely not fire.
Earlier in the case, in February 2005, Audrey Strauss, a lawyer at Fried, Frank, Harris, Shriver & Jacobson representing Pequot, met with Stephen M. Cutler, then director of enforcement at the commission. Two weeks after the meeting, the report said, the investigation into Pequot was narrowed. The staff was ordered to investigate only a few of the suspicious transactions flagged by the New York Stock Exchange, the report said.
A spokeswoman for Mr. Cutler said he could not be reached for comment last night.
This narrowing of the case made an already difficult job of demonstrating a pattern of illicit trading more difficult, the report said.
The report also concluded that Paul R. Berger, then an associate director of enforcement and one of Mr. Aguirres supervisors, did not recuse himself from the Pequot case in a timely manner once he had expressed interest in working for Debevoise, the law firm hired by Morgan Stanleys board to vet Mr. Mack before naming him chief executive.
Mr. Berger, who eventually took a job at Debevoise, initially told Senate investigators that he had stopped working on any matters involving Debevoise in early 2006, around the time he first considered seeking employment at the firm. But Senate investigators said they had found that the previous September, just days after Mr. Aguirres firing, Mr. Berger authorized an S.E.C. colleague to tell Debevoise that he might be interested in working there.
Mary Jo just called, the colleague wrote to Mr. Berger, referring to Ms. White in an e-mail message dated Sept. 8, 2005. I mentioned your interest.
Asked why he had failed to tell Senate investigators about this earlier exchange, Mr. Berger said that I was very concerned about having any discussions without first talking with the S.E.C. and getting authorization.
The Senate report accused Mr. Berger of giving investigators incomplete answers, but says it found no evidence of an explicit link between Mr. Bergers role in the Mack dispute and his subsequent job at Debevoise.
Mr. Berger said yesterday that any suggestion that he had not properly recused himself is unfair and inaccurate. He added: I did what I was supposed to do. I contacted the chief ethics officer in the general counsels office of the S.E.C. and they told me I did not have to recuse myself.
The Senate report suggested that the S.E.C. had failed to pursue the Pequot investigation vigorously after Mr. Aguirres firing. For instance, when the commission took Mr. Macks testimony on Aug. 1, 2006, the report said, it did not seriously test a theory put forward by Mr. Aguirre that Mr. Samberg had rewarded Mr. Mack for information on the Heller deal by letting him invest alongside Pequot in a private company that was sold for three times his investment in little over a year.
Mr. Mack was the only individual investor allowed to participate in the deal, the report noted. The next trading day after Pequot officials allowed Mr. Mack in the deal, Mr. Samberg began his aggressive buying of Heller Financial stock.
A spokeswoman for Morgan Stanley, where Mr. Mack is chief executive, declined to comment on the report.
The report also stated that Liban A. Jama, a staff lawyer, had complained that he was given less than two days to prepare for critical testimony from two witnesses. Without more time, Mr. Jama wrote in an e-mail message to Mark Kreitman, his supervisor and assistant director in the enforcement division, I would not feel comfortable taking the testimony. Mr. Jama said he was surprised by Mr. Kreitmans response. He said, You dont need to prepare that much for it, which I found strange.
The report also noted that Mr. Aguirre was not the only S.E.C. official to suffer after complaining about practices at the agency. A second unidentified staff investigator had protested what he believed might have been an inappropriate contact between an outside lawyer and Ms. Thomsen, the enforcement director. This investigator also received a negative re-evaluation of his job performance shortly after he complained in July 2005, the report said.
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