New Evidence Emerges in Closed Insider-Trading Case

By Amit R. Paley
Washington Post Staff Writer
Friday, December 12, 2008

New evidence has emerged in an insider-trading investigation that the Securities and Exchange Commission closed two years ago without filing charges, raising questions on Capitol Hill about the government's oversight of what was once one of the nation's most prominent hedge funds.

According to documents, the hedge fund -- Pequot Capital Management -- secretly began to pay $2.1 million to a key witness in the case last spring, just three months after several senators called on the SEC to reopen its investigation.

Top Republicans on the Senate Finance and Judiciary committees asked Pequot's chairman this week to provide records related to the payments. The FBI is also looking into the matter, according to people familiar with the case.

"The timing is suspicious and the explanation looks thin, so the payments should be investigated to determine if they were legitimate," said Sen. Charles E. Grassley (R-Iowa), the ranking member of the Senate Finance Committee, who led the congressional probe into the matter.

A spokesman for Pequot said that the payments were related to an employment issue and that the firm "will cooperate fully with the senators' request."

Allegations about insider trading at Pequot -- which had $15 billion under management in 2001 -- date to January 2002, when the New York Stock Exchange flagged several trades as questionable. The SEC intensified an investigation into the hedge fund in 2004, but the agency and federal prosecutors declined to bring any charges and closed the case in late 2006.

The case began to attract congressional scrutiny after SEC lawyer Gary Aguirre was fired from the agency in late 2005 and filed a complaint alleging that the Pequot investigation had been botched.

In late January 2007, prominent senators called on the SEC to reopen the case and issued an interim version of a 707-page report on the matter.

Three months later, Pequot paid $700,000 to a key witness in the case, according to documents that emerged last month in divorce proceedings between the witness and his ex-wife in a Connecticut court. The witness, David Zilkha, was then paid the same amount exactly one year later and is scheduled to receive a final installment of $700,000 in 2009, the court documents show.

"The payments made to David Zilkha are pursuant to the settlement of a civil claim related to his employment and termination by Pequot that was first presented to the firm in January 2007 after all investigations had been closed," Pequot spokesman Jonathan Gasthalter said in an e-mail.

Personal e-mails between Zilkha and his attorneys show that Zilkha, who was let go in 2001, was advised in 2004 that he had a "marginal" claim against Pequot. "You were an acknowledged at-will employee, meaning you could quit or be fired at will. This makes any recovery difficult," one attorney wrote.

An attorney for Zilkha did not return phone and e-mail messages this week, and Zilkha could not be reached. Spokesmen for both the SEC and the FBI also declined to comment for this story.

The original investigation included questions about whether Arthur J. Samberg, the chairman and chief executive of Pequot, received inside information from Zilkha, who was a $68,000-a-year Microsoft employee with no financial services experience when Samberg hired him in February 2001 as an analyst at Pequot. He was to be paid $250,000 a year with the expectation of a bonus of at least $250,000.

According to documents made public earlier in the Senate investigation, Samberg's e-mail offering Zilkha a job also asked for an opinion on buying options in Microsoft.

"Might as well pick your brain before you go on the payroll!!" Samberg wrote.

Two weeks before Zilkha started working at Pequot, on April 23, Samberg asked whether he had any "tidbits" about Microsoft. Zilkha said he would respond "ASAP." Samberg followed up by buying 30,000 Microsoft options in a bet that the stock would rise, suddenly reversing course from his previous bets that the stock would drop.

The bet paid off. Pequot made at least $12 million that April, according to figures estimated by an SEC lawyer who ran the Pequot investigation.

"I shouldn't say this, but you have probably paid for yourself already!" Samberg wrote in a later e-mail to Zilkha.

By that summer, though, Zilkha told his bosses that Microsoft employees would no longer return his phone calls. Samberg asked him to leave in September.

"We believe that Samberg fired Zilkha, at least in part, because he no longer has access to confidential, material, non-public information regarding Microsoft and therefore was no longer of use," James Eichner, an SEC lawyer, wrote in an internal agency document.

During the course of the inquiry, the FBI interviewed Zilkha, who said he did not believe he had engaged in insider trading. Law enforcement officials also spoke with Samberg, who denied participating in insider trading and said he could not remember why he placed the trades.

People close to the situation said investigators never asked to interview Zilkha's then-wife or requested access to his home computer. Senate staffers are attempting to review documents from the computer, sources said.

Some senators expressed dismay that law enforcement officials failed to discover key evidence in the Pequot case after so many years of scrutiny.

"This certainly supports what Mr. Aguirre said before about the possibility of insider information," said Sen. Arlen Specter (Pa.), ranking Republican on the Senate Judiciary Committee and who led the Senate probe. "It raises a serious question in my mind about the adequacy of the investigations conducted heretofore."

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