S.E.C. Is Reported to Be Examining a Big Hedge Fund
The New York Times
By Walt Bogdanich and Gretchen Morgenson
June 23, 2006
One of the nation's most prominent hedge funds, Pequot Capital Management, is under investigation by the Securities and Exchange Commission for possible insider trading, according to government officials briefed on the case.
The S.E.C. declined to confirm or deny that it was investigating Pequot, a $7 billion fund overseen by Arthur J. Samberg, 65, a leading money manager and philanthropist. But a lawyer who once led the agency's investigation has told Congress that the fund's trading had repeatedly aroused suspicion among stock exchange officials, prompting them on 18 occasions to refer cases to the S.E.C. for further investigation, records show.
In one instance, Pequot made $18 million by investing in companies that soon after announced a major corporate merger, in July 2001, the lawyer told Congress.
The investigation has not resulted in any charges against Pequot, and the fund has denied any wrongdoing.
At the same time, the S.E.C.'s handling of the Pequot inquiry has itself come under scrutiny by Congress and the Office of Special Counsel, a federal agency that examines whistle-blower complaints. These officials are examining charges by Gary J. Aguirre, the S.E.C. lawyer who ran the Pequot investigation until last summer, that senior S.E.C. officials had backed his inquiry including the issuance of scores of subpoenas until he sought the testimony of an influential Wall Street executive.
Mr. Aguirre, 66, told Congress that he was fired on Sept. 1 while on vacation, after losing an argument with superiors over whether he could take the executive's testimony.
Senate investigators want to know, among other things, whether political considerations played a role in the S.E.C.'s firing of Mr. Aguirre only 11 days after awarding him a two-step merit pay increase and after his supervisor had praised his work on the Pequot investigation.
"His efforts have uncovered evidence of potential insider trading and possible manipulative trading by the fund," his supervisor, Robert Hanson, wrote in a performance evaluation before the firing, documents show. "He has consistently gone the extra mile, and then some."
Mr. Aguirre made his allegations in an 18-page letter to Senator Chuck Hagel, the Republican chairman of the Senate Subcommittee on Securities and Investment, and Senator Christopher J. Dodd, the panel's ranking Democrat. His complaints to the chairmen of two Senate committees, Richard C. Shelby and Charles E. Grassley, prompted them to ask S.E.C. officials for a confidential briefing on Mr. Aguirre's allegations about the Pequot investigation.
One of the Oldest Hedge Funds
The investigation brings the S.E.C. to the door of one of the oldest and most powerful hedge funds in America. While the S.E.C. has filed suit against several hedge funds in recent years, it is not known to have focused on a fund as large or as widely known as Pequot.
It is unclear to what extent Mr. Aguirre's firing may have interrupted the inquiry, but government officials who have been briefed on the investigation say it is continuing.
Asked to comment, Jonathan Gasthalter, a Pequot spokesman said, "At all times, Pequot's securities trading has been entirely proper and not based on insider information."
Mr. Aguirre's letter to Congress did not specifically identify any of the trades. But according to government officials, the trades Mr. Aguirre said had made the fund $18 million involved one of the biggest mergers in 2001: the General Electric Capital Corporation's $5.25 billion buyout of Heller Financial, a Chicago-based lender to businesses. Heller's stock rose 50 percent the day the acquisition was announced.
Mr. Gasthalter said the fund's trades were made in "the ordinary course of the firm's business." He added that, "Nobody at Pequot was tipped by anyone regarding the Heller acquisition or any other corporate events."
The S.E.C.'s investigation and the questions surrounding it come at a time of growing concern on Capitol Hill about the power of hedge funds, which are lightly regulated investment pools that cater to wealthy individuals, as well as institutional investors, pension funds and foundations. Hedge funds now account for about 30 percent of all trades in the nation's stock exchanges.
Mr. Aguirre, a former California trial lawyer who worked at the S.E.C. for just shy of a year, declined to elaborate on the letter or to provide a copy. The New York Times obtained it from a government official who released it without authorization and asked not to be identified.
In the letter, Mr. Aguirre said the investigation was halted last summer when S.E.C. officials, bowing to political considerations, stopped him from taking testimony from the person he identified only as a former head of an investment bank.
Government officials with knowledge of the allegations say he was referring to John J. Mack, chief executive of Morgan Stanley, who was being considered to run the investment firm at the time and who had previously been chief executive of Credit Suisse First Boston. Mr. Mack, a long-time acquaintance of Pequot's founder and a major fund-raiser for President Bush, was chairman of Pequot briefly during June 2005; his family foundation has invested in Pequot funds, public records show.
Mary Jo White, the former New York federal prosecutor now at the law firm of Debevoise & Plimpton, said Morgan Stanley's board hired her to help vet Mr. Mack before he was named to head the company last June 30. Ms. White said she gave him a clean bill of health. "We never asked or suggested to anyone at the S.E.C. that any investigation be closed down," Ms. White said.
Morgan Stanley said in a statement: "Mr. Mack has never been contacted on this matter by the S.E.C., and we have no reason to believe that the S.E.C. has any interest in Mr. Mack in connection with this matter. During more than 30 years on Wall Street, Mr. Mack has had an unblemished record of personal integrity."
According to his written account, Mr. Aguirre said his supervisor told him that getting authorization to subpoena the Wall Street executive would be difficult because of the executive's "powerful political connections."
But Walter G. Ricciardi, the S.E.C.'s deputy director of enforcement, said that while he could not confirm or deny the existence of an investigation, no one had tried to exert improper influence. "Integrity is the foremost core value of the enforcement division and we welcome any Congressional interest," Mr. Ricciardi said.
S.E.C. officials did not believe Mr. Aguirre made a strong enough case for taking Mr. Mack's deposition, according to people with knowledge of the agency's position. There are no hard and fast rules about when S.E.C. investigators can subpoena someone's testimony, law enforcement officials say.
Mr. Aguirre's letter to Congress includes no underlying documentation for why he wanted to interview Mr. Mack. But in the letter Mr. Aguirre said that he provided a 42-page sworn statement outlining his allegations, along with 46 supporting exhibits, to Kathleen L. Casey, a lawyer on the Senate Banking Committee. Ms. Casey has since been nominated by President Bush to be an S.E.C. commissioner.
A spokesman for the Banking Committee said it was continuing to work with the Finance Committee, headed by Senator Grassley, "in their ongoing investigation" of Mr. Aguirre's firing.
While declining to comment on even the existence of a Pequot investigation, the S.E.C. refused to provide documents on the circumstances leading to Mr. Aguirre's firing, requested under the federal Freedom of Information Act, stating that to do so "could reasonably be expected to interfere with enforcement activities."
Mr. Ricciardi said, "As a matter of fairness, we conduct our investigations in private because often investigations conclude with no enforcement action being brought."
Insider trading cases are difficult to prove because they are often based on circumstantial evidence.
Pequot began in 1986 as Dawson-Samberg, named for its founders, Mr. Samberg, a former securities analyst, and Jonathan T. Dawson, a money manager. The fund was hurt badly by the stock market crash of 1987 but recovered and by 1992 had $100 million in assets under management.
The next year, Mr. Samberg hired Daniel C. Benton, a respected technology stock analyst at Goldman Sachs, to run a new technology portfolio. In 1998, Mr. Samberg and Mr. Dawson dissolved their partnership.
During the 1990's, the fund profited handsomely from its technology bets; but the technology boom ended in early 2000. In 2001, Mr. Benton left the firm to set up his own shop. He and Mr. Samberg split the $15 billion fund in two.
From 1994 through the end of last year, Pequot's flagship fund has returned an average 16.5 percent each year. Mr. Samberg last month gave $25 million to Columbia Business School, his alma mater.
Pequot's rise to prominence came during a time of explosive growth in hedge funds. These investment pools buy and sell a wide array of securities and count as their clients wealthy individuals and institutional investors like pension funds, corporations and endowments.
The hedge fund world is highly secretive and has, until recently, operated relatively free of regulatory scrutiny. Because these funds offer their services to sophisticated investors, who are presumed to be able to do their own policing, hedge funds are not required to make the same kind of extensive filings of their activities with regulators as do mutual funds.
Hedge Funds Growing Quickly
Hedge funds control an estimated $1.2 trillion in assets currently, almost 3,000 percent more than they did 16 years ago. Last year, almost 2,100 hedge funds opened for business. Despite their growth, hedge fund assets total much less than the $9.2 trillion invested in mutual funds domestically.
But while hedge fund represent only 5 percent of assets under management in the United States, they account for 30 percent of stock trading volume nationwide. As a result, hedge funds can have an enormous impact on the nation's securities markets.
The S.E.C. filed 78 enforcement actions against hedge funds from 2002 through 2005. Most involved fraud by hedge funds against their own investors or cases in which hedge funds profited from advance knowledge that a company was going to raise money issuing additional shares, known as Public Investments in Private Equity, or P.I.P.E., cases.
Mr. Aguirre wrote to Congress that his investigation had begun when he was assigned to look into trades by a hedge fund, according to his letter. He said he discovered that the fund had been the subject of 13 insider-trading referrals that "had been gathering dust" at the S.E.C. Market surveillance officials made several other referrals. Mr. Aguirre's letter did not name the fund, but government officials said it was Pequot.
Mr. Aguirre wrote that he wanted to know whether some of the fund's profits might have resulted from trading on nonpublic information. Of the 18 referrals the S.E.C. received from stock exchanges, Mr. Aguirre wrote, in each case "the hedge fund traded shortly before a public announcement sharply increased the value of its new holding."
He further contended that in all but two cases, the fund made at least $1 million. But it was one series of trades in July 2001 that attracted the most regulatory attention. Mr. Aguirre has told Congress that the fund bought some $44 million in Heller Financial before the public announcement that G.E. was buying it. Heller's stock rose 50 percent after the announcement.
That document also contends that Pequot shorted $36 million in G.E. stock, which is a bet that the stock price will fall. As is typical in buyouts, the acquirer's stock did drop, in this case, 2.3 percent on July 30, 2001, the day the deal was announced, records show. By the end of the following month, G.E.'s shares had lost 7.8 percent more, as investors absorbed other G.E. news, like the collapse of its proposed merger with Honeywell.
Pequot's version of events, according to a person close to the fund, is that its trades in Heller Financial were typical of its investing activities. The Heller position was small relative to other holdings in the fund, this person said, and was amassed over the course of a month, beginning on July 2, 2001. Moreover, this person said, Mr. Samberg had told investors in April 2001 that he intended to increase his stake in financial services stocks from 4 percent of the portfolio to 14 percent.
Because Pequot trades so frequently, the person said, it is not surprising that some of its investments would have been made before a public announcement that made those holdings more valuable. Pequot's frequent trading, this person said, could also have attracted the attention of stock exchange officials while still being entirely proper.
Mr. Aguirre states that the investigation was proceeding, and that he had obtained a voluminous number of e-mail messages and other records by issuing scores of subpoenas. He had also taken the testimony of Mr. Samberg.
By June of last year, Mr. Aguirre wrote, he decided that he needed testimony from Mr. Mack, who had left his position as chief executive at Credit Suisse in June 2004 after three years running the firm. Mr. Aguirre said his supervisors did not let him take Mr. Mack's testimony. Mr. Aguirre vigorously protested, stating that he sent more than 30 complaints to his supervisors, all the way up to Christopher Cox, the S.E.C. chairman.
A Dedicated Employee
The S.E.C. fired him even though his supervisor had said in an undated evaluation that Mr. Aguirre had shown "an unmatched dedication" to the hedge fund investigation. Another evaluation showed that he had received passing marks in all categories of performance.
John Nester, the S.E.C. spokesman, said that while he could not speak to the specifics of Mr. Aguirre's firing, as a general rule probationary employees can be fired after a positive evaluation if the quality of their work suddenly slips.
A lawyer for Mr. Aguirre, Joanne Royce of the Government Accountability Project, said, "Until he spoke out, his supervisors officially and unofficially praised his performance and found it exceeded all applicable S.E.C. standards."
Michael Clampitt, an S.E.C. lawyer and accountant who runs a union chapter of S.E.C. employees, said he knew of no one who got a pay increase, particularly one so significant, and was then fired with no written warnings. "Never happened before," Mr. Clampitt said. "He's doing great because of the merit increase, then suddenly boom, he's gone."
Mr. Clampitt said that as far as he knew the agency had given Mr. Aguirre no written documentation of his shortcomings, as is its custom, before he was fired.
Mr. Clampitt said that according to 2004 figures, the most recent year available, there were 108 S.E.C. lawyers at Mr. Aguirre's pay grade and that just 31 of them got bigger pay increases. "It's incomprehensible the way this came down, totally bewildering," Mr. Clampitt said.
Mr. Aguirre had been at odds from time to time with the S.E.C. When there was a delay in his hiring, he suspected that his age he was then in his 60's was the reason and he filed an administrative complaint with the Equal Employment Opportunity Commission.
After he joined the S.E.C., the complaint was eventually dismissed.
Before joining the S.E.C., Mr. Aguirre had a reputation as an innovative plaintiffs' lawyer in Southern California, representing victims of shoddy home construction. A 1992 article in California Lawyer magazine said he used "aggressive some say temperamental" courtroom tactics to win several big cases.
The S.E.C.'s inspector general, Walter J. Stachnik, reviewed Mr. Aguirre's complaint, a Congressional investigator said. A spokeswoman for the inspector general declined to comment.
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