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SEC Investigators Are Themselves Investigated By Whistleblower

Expert Witness: Fulcrum Inquiry
Last week, a federal Court ordered the SEC to produce thousands of pages of potentially damaging documents involving insider trading that the SEC did not pursue. Both the Senate and the Court are critical of the SEC’s lack of action. We summarize this interesting case.

Last week, a federal Court ordered the Securities and Exchange Commission (SEC) to produce thousands of pages of emails, trans, trading records, and other documents that it had previously refused to provide pursuant to a Freedom of Information Act (FOIA) filing. The Court’s ruling is a serious setback in a three-year old case with whistleblower and former SEC employee Gary Aguirre. The Order also requires the SEC to make a more thorough search for allegedly missing materials from the Mr. Aguirre’s personnel file.

Based on the previously-withheld information, the SEC will likely have some explaining to do. The background information contained in the rest of this article already is interesting. Stay tuned.

Aguirre is fired shortly after receiving favorable evaluations and a raise

Mr. Aguirre was an SEC Senior Counsel in the Division of Enforcement. The SEC abruptly fired him in September 2005 following his attempt to subpoena John Mack. Mr. Mack is now Morgan’s Stanley’s CEO and Chairman of the Board.

According to Aguirre, his superior told him in June 2005 that it would be difficult to take testimony from one of his suspects because the suspect had powerful political connections. After Aguirre did not drop the investigation, Aguirre claims that he was told both verbally and in writing that the investigation needed to stop because the suspect had “political clout” and “juice”. From June until Aguirre was fired in September, Aguirre’s bosses blocked the issuance of subpoenas for both testimony and records.

Just eleven days before his firing, Mr. Aguirre received a merit-based pay raise. The raise was partially supported by his superior’s evaluation, which includes the following:

“Gary worked extremely hard on one investigation during his time in the group, a significant matter involving the trading by [redacted, but subsequently identified as the matter described below], one of the nation’s largest hedge funds.

Gary has an unmatched dedication to this case (often working well beyond normal work hours) and his efforts have uncovered evidence of potential insider trading and possible manipulative trading by the fund and its principals. He has been able to overcome a number of obstacles opposing counsel put in his path on the investigation. Gary worked closely with the Office of Compliance Inspection and Examinations to develop the case and worked with several self-regulatory organizations to develop a number of potential leads. He has consistently gone the extra mile, and then some.”

The Court and Senate both conclude the SEC was lax in its investigation

In 2007, the Senate issued a 108 page report that strongly criticized the SEC’s investigation into the insider trading allegations. In reaching its decision to require additional production, the Court provided the following factual background which largely comes from the Senate’s findings:

“Pequot, a large investment advisory firm that manages over $15 billion in assets, is run by Arthur Samberg, its Chairman and CEO. Beginning on July 2, 2001, Mr. Samberg directed his traders to aggressively buy shares of Heller Financial stock. In fact, from July 2 to July 27, he attempted to purchase many more shares of Heller than his traders could safely execute without driving up the price. On six days during this period, the number of shares sought by Pequot exceeded the total volume of Heller shares traded, and on two days, the number of shares sought was more than twice Heller’s daily volume. Pequot had no position in Heller at the beginning of the month, but by July 27th, it was “long” 1,148,200 shares.

On July 25, 2001, at a time when Pequot had amassed a large long position in Heller, it began selling short General Electric (“GE”) stock. Pequot shorted over 1.5 million shares of GE during the three-day period from July 25 to July 27. By the close of business on Friday, July 27, Pequot was poised to profit if the price of Heller increased or if the price of GE decreased.

On the following Monday, July 30, GE announced its plan to acquire Heller. As often happens when an acquisition is announced, the stock price of the acquiring company (GE) decreased while that of the target company (Heller) increased. Pequot was positioned to profit from the news of the acquisition: both its long position in Heller and its short position in GE increased in value. Mr. Samberg sold all of his Heller stock on the day of the announcement by GE, and on the following day, he covered his short position in GE. Pequot made approximately $18 million from its trades involving Heller and GE.” [Citations omitted]

Given this suspicious trading activity, there was reason to suspect that Mr. Samberg had inside information about GE’s plan to acquire Heller. … If Mr. Samberg did have prior knowledge of the GE-Heller deal, he profited from material, non-public information in violation of federal insider trading laws. In the eyes of the Senate, Mr. Samberg failed to adequately explain his motivation for these trades. When he first testified at a deposition at the SEC on May 3, 2005, Mr. Samberg cited several reasons why he purchased Heller stock in July 2001. (Id. 23.) However, the SEC soon learned that all of these purported motives had appeared in a Legg Mason analyst report, which Mr. Samberg had only reviewed in preparation for his SEC testimony. During his second deposition on June 7, 2005, Mr. Samberg conceded that he had not read the Legg Mason report, or any other analyst materials, prior to ordering the trades. In addition, this conduct was contrary to Pequot’s regular decision-making practice of relying on a “research driven approach” prior to making trades. …

John Mack was a ‘close associate’ of Mr. Samberg and an investor in Pequot. On May 11, 2001, Mr. Samberg wrote an e-mail describing Mr. Mack’s interest in making additional investments in Pequot: “John Mack would like to put $5mm into Partners [a Pequot fund] at the 1st available opening. He’d also like to put more $ into Scout [another Pequot fund], if that’s possible, and would like a recap of what he has where.” On June 20, 2001, less than two weeks before Mr. Samberg started buying Heller stock, Mr. Mack lobbied Mr. Samberg for the opportunity to invest in a start-up company with the code name “Fresh Start.” … John Mack was meeting with senior officials at Credit Suisse (Credit Suisse First Boston’s parent company)[and an investment banker in the GE/Heller transaction] in Switzerland from June 26 to June 28, 2001. Upon his return, on June 29, 2001, Mr. Mack called Mr. Samberg. Two things happened after this telephone conversation. First, Mr. Mack was allowed to invest $5 million in Fresh Start. He was the only individual investor to be given this opportunity. Second, on the following Monday Mr. Samberg made large purchases of shares in Heller. Mr. Mack’s investment in Fresh Start proved to be very profitable; he more than tripled his money in less than a year. …

The Senate Report determined that there were several convincing reasons to suspect that John Mack told Arthur Samberg about the GE-Heller deal before that information became public: Mack was a close associate of Samberg and an investor in Pequot funds. Mack was thus in a position to share in any profits the funds might make by trading on inside information. Mack also had been in employment negotiations with a firm working on the deal at the time of the trades, which meant he might have had an opportunity to learn of the GE-Heller acquisition before the public announcement. Moreover, an e-mail from Samberg indicated that he had spoken to Mack on June 29, 2001. Samberg began directing large purchases of Heller stock on the next trading day. Nevertheless, as explained in more detail below, the SEC resisted plaintiff’s efforts to take Mr. Mack’s testimony. In fact, it was not until this matter was publicly exposed in a front-page New York Times article on June 23, 2006, that the SEC began to re-evaluate Mr. Mack as a potential tipper. Nonetheless, the SEC did not depose Mr. Mack until August 1, 2006, five days after the statute of limitations for civil and criminal penalties had expired.” [Citations omitted]

The SEC closed its file without taking any action against Mr. Mack, Pequot, or Pequot’s management.

Mr. Aguirre’s situation raises serious questions regarding the SEC’s consistent investigation and enforcement of the securities laws. Even if the SEC is ultimately vindicated, the Aguirre matter also demonstrates that employee complaints need to be treated seriously before appearances make matters worse.

Mr. Nolte has 30 years experience in financial and economic consulting. He has served as an expert witness in over 100 trials. He has also regularly served as an arbitrator. Mr. Nolte has achieved the following credentials, CPA, MBA, CMA and ASA.

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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.

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