Pequot Probe Reopened
by Scot J. Paltrow
Jan 7 2009
Federal agents seek computer files from potential witness in an old insider-trading investigation. Millions in payments from Pequot Capital are in question.
Spurred by the surprise emergence of new evidence on a computer hard drive, the Securities and Exchange Commission has reopened a major insider trading investigation it was strongly criticized for dropping, people with knowledge of the case said.
The inquiry has to do with giant hedge fund Pequot Capital Management and its chairman and C.E.O., Arthur Samberg. Portfolio.com has learned that within the last two weeks the S.E.C. issued a subpoena in the case, a step taken only in a formal investigation approved by senior agency officials.
Reopening the investigation marks a new embarrassment for the beleaguered S.E.C., suggesting that, as in the Bernard Madoff case, it may have failed earlier to follow up adequately on strong indications of possible wrongdoing.
People close to the case said the subpoena is for the hard drive from a computer owned by David Zilkha, a former Microsoft employee who briefly worked for Pequot in 2001. The S.E.C. and other federal investigators already have printouts of e-mail messages on the hard drive.
Copies of the emails obtained by Portfolio.com appear to show Zilkha soliciting nonpublic information about Microsoft from a neighbor who was a more senior official at the software company.
The original S.E.C. investigation, which ended in 2006 without the agency taking any action, had looked into whether Samberg had made highly profitable trades based on confidential information from Zilkha about Microsoft earnings.
The earlier investigation, which had focused on Pequot trading in 2001, drew wide attention after the S.E.C. in 2005 fired the lawyer handling it. The S.E.C. lawyer, Gary Aguirre, contended he'd been fired for political reasons relating to a separate facet of the case: Whether Morgan Stanley C.E.O. John Mack may have given Samberg inside information relating to a planned acquisition by General Electric.
Aguirre claimed he was fired because higher ups at the S.E.C. didn't want him to depose the politically connected Mack. A subsequent investigation by two Senate committees, and by the S.E.C.'s own inspector general, backed Aguirre and found that the S.E.C. was wrong to have shut down the investigation.
Ever since, two Republican Senators, Arlen Specter of Pennsylvania and Charles Grassley of Iowa, have pressed the S.E.C. to reopen the case.
The existence of the hard drive became known through Zilkha's contested divorce case in Connecticut. People close to the case say that Zilkha's now ex-wife had obtained and kept the hard drive from his home computer before they split up.
The drive contains email exchanges between Zilkha and Mark Spain, a more senior Microsoft official, in 2001, when they were both living in Redmond, Washington.
At the time, Zilkha was still working for Microsoft, although Samberg had offered him a job and was pressing him for information on Microsoft.
Copies of the newly obtained emails show, for example, that on April 7, 2001, Zilkha sent Spain an email with the subject line "Any visibility on the recent quarter?" The message said: "Hey there. Have you heard whether we will miss estimates? Any other info? David."
A reply from Spain the next day said: "march was the best march on record. made up the shortfall in us sub w2k pro major contributor. on trace for revised forecast (MYR)" That email appeared to indicate that Microsoft was likely to do much better than the substantially lower earnings analysts at the time were predicting. "w2k" pro evidently refers to sales of Microsoft's Windows 2000 program, and "MYR" to mid-year review.
As a product manager, Zilkha normally wouldn't have been privy to overall corporate earnings information.
The hard drive doesn't contain any evidence that Zilkha passed the information to Samberg. But the exchange between Zilkha and Spain appears to fill a key gap in evidence obtained during the original S.E.C. investigation. The timing coincides with Samberg trades in Microsoft puts and calls, and fits in with other email traffic between Samberg and Zilkha.
On April 6, 2001, for example, Samberg wrote to Zilkha that he owned Microsoft but was worried about reports that Microsoft was about to disclose weak profits. "Any tidbits you might care to lob in would be appreciated," Samberg wrote.
The records show that Samberg had been considering reducing his position in Microsoft at the beginning of April 2001, after he'd suffered losses and analysts had forecast that Microsoft would report a drop in earnings.
But on April 9, Samberg started buying thousands of Microsoft puts and calls, which had the effect of greatly increasing his bet that the stock would rise. When Microsoft disclosed better-than-expected earnings on April 19, Samberg reaped an indicated profit of more than $12 million on his added investment.
The day after Microsoft's earnings announcement, Samberg emailed Zilkha: "I shouldn't say this, but you probably have paid for yourself already."
While the newly obtained emails from Zilkha's home computer don't prove that he passed information to Samberg, people close to the case said it would provide additional basis for the S.E.C. to investigate whether Zilkha had communicated inside information to him.
The Senate committees' report in 2007 had specifically faulted the S.E.C. for not looking into any communication between Samberg and Zilkha between April 6 and April 9, 2001.
New questions about Samberg's relationship with Zilkha began cropping up a few weeks ago. As Portfolio.com reported, recently filed records in Zilkha's divorce showed that beginning in April 2007, Samberg paid Zilkha $1.4 million, and has promised to pay him an additional $700,000 in April 2009.
Senate investigators have been looking into whether the payments may have been some type of reward to Zilkha for not giving information to investigators. Zilkha had worked for Pequot for only a few months in 2001 before Samberg fired him, testimony from the S.E.C. investigation shows, and Zilkha has had no known link to Pequot or Samberg since then.
The Senate Judiciary and Finance committees recently demanded that Samberg turn over any records explaining the payments to Zilkha. He responded, but in the Senate on Tuesday Specter said that the information wasn't adequate and that the committee was trying to obtain more.
Meanwhile, Specter disclosed that he had written to S.E.C. chairman Christopher Cox on Dec. 29, demanding that the insider trading investigation be reopened.
The issue cropped up in the divorce case because Zilkha disclosed the payments on financial statements he is required to file with the court. The ex-wife, Karen Zilkha, is seeking to her ex-husband and Samberg about the payments under oath.
Aguirre, the former S.E.C. lawyer, went further than Specter. In a January 2, 2009 letter to Cox, he called for opening a criminal investigationinto "possible witness tampering, bribery, obstruction of justice" and conspiracy.
In addition to the Samberg payments to Zilkha, Aguirre wrote that prosecutors should look into Zilkha's apparent failure to have turned over the email records while the original investigation was still open. A December 2005 S.E.C. subpoena to Zilkha required him to turn over all email records of his contacts in 2001 with Microsoft and Samberg.
The S.E.C. declined to comment. David Zilkha didn't respond to messages left on his cell phone number seeking comment. His attorney, Henry Putzel III, said he wouldn't have any comment. Mark Spain didn't immediately respond to a message left at his office phone number at Microsoft. A Microsoft spokeswoman said the company wouldn't have any comment.
A Pequot spokesman said he wouldn't comment on specific developments but said: "We will cooperate fully with all requests for information and are confident that Pequot's trading in Microsoft was at all times proper."
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