Risk & Compliance

Pequot Case: ‘The Plot Grows Thicker’

An SEC official tells the Senate Judiciary Committee that the commission's probe into charges of insider trading by the hedge fund "smelled rotten."
Marie LeoneDecember 5, 2006

“The plot grows thicker,” declared Senate Judiciary Committee Chairman Arlen Specter at the conclusion of a Tuesday hearing aimed at finding out if the Securities and Exchange Commission mishandled an investigation into Pequot Capital Management and later violated the rights of a whistleblower.

“It is very, very troubling what the SEC has done,” asserted Specter, a Pennsylvania Republican, after SEC Inspector General Walter Stachnik told the Senate panel that the Department of Justice had advised him not to discuss a related matter with the Senate Judiciary Committee.

The committee is investigating the SEC’s commitment to the Pequot investigation as well as whether the regulator retaliated against a former employee who accused the SEC of quashing the investigation because a key subject of the investigation, Morgan Stanley Chief Executive Officer John Mack, had “powerful” political connections.

Last Friday, the SEC cleared Mack of all charges. However, to judge from their tenacious questioning, the Judiciary Committee is bullish on continuing their investigation in the new year. At that time, Specter and other lawmakers are expected to introduce new whistleblower protection bills.

Specter and Senate Finance Committee Chairman Charles Grassley, an Iowa Republican who is also a member of the Judiciary Committee, vigorously defended former SEC investigator Gary Aguirre as a whistleblower during the hearing. Aguirre and another SEC investigator, Eric Ribelin, testified that they were uncomfortable with the way the commission handled the Pequot investigation.

The senators used Aguirre and Ribelin’s accusations as a springboard to aggressively question current and former SEC officials about the details of the Pequot probe and the timing of Aguirre’s termination. Earlier in the hearing, Ribelin had testified that the Pequot investigation “smelled rotten.”

Specter fired questions at Aguirre’s former boss, Robert Hanson, a branch chief in the SEC’s enforcement division, about why the commission delayed questioning Mack until after the statute of limitations had expired on certain enforcement rules. By waiting, Specter noted, prosecutors were limited to the types of penalties that could be levied against Mack if he was found guilty of insider trading.

Hanson contended that the SEC did not question Mack earlier than it did because the case presented by Aguirre against the investment-banking executive was not strong. Aguirre had alleged that Mack illegally passed along inside information to help Pequot benefit from an as-yet-undisclosed merger.

But Specter offered another theory about why Mack was questioned late. The senator read an E-mail message to the committee in which Hanson wrote that Mack had “juice,” or what Specter characterized in his closing remarks as political sway. For his part, Hanson replied that he simply wanted the SEC to have “all of its ducks in a row,” before it asked Mack to testify.

Specter also asked Hanson and other SEC officials why a supplemental performance evaluation was added to Aguirre’s personnel file—without Aguirre’s knowledge—after the whistleblower accused the SEC of going easy on Mack. The supplemental evaluation gave Aguirre an unfavorable performance rating two months after he received a favorable rating on his regular evaluation.

The supplemental evaluation was used to build a case for Aguirre’s termination. When asked what about Aguirre’s performance changed to warrant an unfavorable rating, Mark Kreitman, assistant director of the SEC Division of Enforcement, told the committee that “perhaps, erroneously, we were generous to [Aguirre],” on the original evaluation.

Last to testify was Stachnik. Earlier in the year, Aguirre’s whistleblower accusations were referred to the Inspector General’s Office for vetting. Stachnik’s office reported that Aguirre had failed to substantiate his charges, and the office closed the case. At the hearing, lawmakers pointed out that the IG never interviewed Aguirre before dismissing his case.

The IG has since reopened the case, now that Congress is interested in conducting its own investigation into the SEC’s Pequot probe. What’s more, the IG now wants the Judiciary Committee to turn over its records related to Aguirre, especially correspondence between the whistleblower and the committee, noted Grassley. Congress is wary of turning over the documents, mainly because they believe the SEC may try to intimidate Aguirre, added Grassley. What’s more, Grassley stressed, if the IG was doing its job investigating the Aguirre case, then it should already have most of the documents.

Aguirre testified that he turned over the same documents to the SEC that he had given to Congress, so the IG should have everything except the correspondence with the committee.

Nevertheless, the Department of Justice is acting as the IG’s legal counsel, and may go to court to force the Senate to turn over its records on Aguirre. At the hearing Grassley asked if Stachnik would be satisfied with the Pequot documents, minus the correspondence between Aguirre and the committee. But Stanchnik said that he was advised by the DOJ not to comment on the subject.

Apparently frustrated by Stanchnik’s refusal to answer, Grassley blurted out, “You may be playing footsies with an agency that wants to curb congressional inquiries.” Grassley added that, like Specter, he would support legislation that expressly banned federal agencies from intimidating whistleblowers, “so people can come to us about waste, fraud, and abuse without getting slapped with a subpoena.”

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