SEC now freer to hike whistleblower awards
Tuesday, July 27, 2010
With powerful senators watching closely, federal investigators search high and low for evidence of insider trading in shares of Microsoft. One of Wall Street's best-known hedge fund managers is targeted, but the feds can't find proof. Years pass, and they close the case without filing charges.
Then a nasty, and apparently unrelated, divorce and child-custody battle ensues in Connecticut. A woman discovers on a family hard drive evidence that potentially implicates her ex-husband and the hedge fund in the insider trading scandal. She turns it over to investigators, who use it to shut down the fund and assess tens of millions of dollars in penalties. And then they pay $1 million to the woman for ratting on her ex.
It sounds like a tale spun in Hollywood, but it's the real-life story behind a recent Securities and Exchange Commission case, which could hint at the course of future investigations as the agency capitalizes on brand-new powers to financially reward whistleblowers.
On Friday, the SEC said it would pay $1 million to Karen and Glen Kaiser of Southbury, Conn., who provided information and documents that helped the SEC build its case against Arthur J. Samberg, founder of the hedge fund Pequot Capital Management, and David E. Zilkha, a former Microsoft employee. Karen Kaiser was once married to Zilkha.
It is the largest amount ever awarded by the SEC under a former authority to reward whistleblowers in insider-trading cases. But the size of the award underscores how the SEC plans to use an expanded power to reward people who provide help that can stop securities fraud.
The financial regulatory law signed by President Obama last week grants the SEC the authority to pay up to 30 percent of any monetary sanction to a whistleblower -- even if the whistleblower took part in misconduct. Although the previous law limited payments to insider-trading cases, money can now be doled out for information on any securities law violation.
The SEC's whistleblower system, until recently, had been considered ineffective. Only five people received whistleblower payments before the Kaisers. The biggest payment was $55,220, the lowest $3,500.
Harry Markopolos, the whistleblower who tried to persuade the SEC that Bernard Madoff was running a Ponzi scheme, blasted the agency's program last year. "If my experience is any guide, the treatment accorded whistleblowers ranges from dismissive to outright unwelcome," he told a Congress.
The agency's internal watchdog has been equally critical. "We believe that the minimal use of the SEC bounty program can be attributed primarily to the fact that the program has not been widely publicized, internally within the agency or externally to the public," SEC Inspector General H. David Kotz wrote in a report this year.Even before passage of the new law, SEC officials said they were working to improve the agency's whistleblower procedures, building a database to consolidate complaints and creating a new whistleblower office.
In the recent case, the SEC charged that Pequot, Samberg and Zilkha engaged in insider trading in shares of Microsoft. The agency alleged that, in 2001, Samberg reached out to Zilkha for information on whether the company would meet its earnings estimates. Zilkha, then working for Microsoft, checked by e-mail with fellow employees to find out whether Microsoft would meet or beat its estimates.
Zilkha then gave Samberg the information, the SEC said, and Samberg traded, earning Pequot more than $14 million. Zilkha later joined Pequot for a short time, earning millions of dollars.
The e-mail from Zilkha to a colleague at Microsoft was the crucial document Kaiser turned over to the SEC. "We initially got involved to figure out why David Zilkha seemed so reluctant to tell Karen about this $2.1 million payment from Pequot," said Mark Sherman, the Kaisers' attorney. "Once we analyzed the family hard drive, we were able to help the SEC connect the dots in their investigation."
In May, Pequot and Samberg agreed to settle the charge for $28 million, including a $10 million penalty, the basis for the whistleblower payment. The case against Zilkha continues in administrative court.
"Mr. Zilkha engaged in no wrongdoing and intends to take this matter to a hearing at which he will demonstrate he is innocent of any improper conduct," said Henry Putzel III, Zilkha's attorney.
Pequot and Samberg didn't admit or deny wrongdoing in the settlement. A spokesman declined to comment.