Condemning Emails, Revived SEC Probe Contribute to Decision to Voluntarily Shutdown Pequot Capital

DCIG has posted several blogs discussing the economic downturn, the banking crisis and the role that hedge funds played in the seemingly endless stream of bad news and frauds that have graced the headlines. So, when it was announced that the prominent hedge fund was shutting down due to the SEC reopening an insider trading probe, it was another sign that the largely unregulated hedge fund industry is back once again in the SEC's crosshairs.

When I started looking into the alleged insider trading scandal I found not only interesting facts on Pequot, but also some interesting insight into how the SEC investigated the allegations of insider trading. Pequot was founded by Arthur Samberg and has been a respected hedge fund since 1998. The fund reportedly manages $3 billion in assets but at one time reportedly managed $15 billion. But, with investors already highly suspect of any bad news based on previous scandals, Samberg decided it was in everybody's best interest to close the fund.

With that recent history aside, insider trading allegations regarding Pequot were actually discussed in front of the U.S. Senate Committee on the Judiciary in December of 2006. According to testimony by Director of Division Enforcement, Linda Chatman, there were 10 transactions occurring between February 2002 and April 2005 that were forwarded to investigators working on the Pequot investigation. Investigating attorney Gary Aguirre claims he was fired for his requests to interview persons relevant to the case but, after all of the investigative work was done, Pequot Capitol was found to have not executed transactions based on insider knowledge.

What really caught my attention was in the "Case Closing Recommendation" documents there are several specific instances involving Pequot and insider trading allegations. During these investigations it became clear that the SEC is very conscious of email communications and looks closely at email in any investigation regarding insider trading. Email communications between Arthur Samberg are highlighted throughout to show either a link to possible wrong-doing or, more importantly, where email exonerates wrong-doing.

A specific example is in the investigation of Pequot accumulating Heller stock and shorting GE stock before a GE acquisition announcement of Heller was made public. Within the documentation the SEC specifically states it "reviewed the emails obtained from Pequot to identify other potential tippers. The staff then compiled information about each person identified, including searching for relevant documents in the database of emails provided by Pequot."

Pequot was also closely scrutinized in a trade involving Microsoft stock after Pequot hired former Microsoft employee David Zilkha in April of 2001. Before starting work for Pequot, David Zilkha started providing information about Microsoft by email to Samberg.

There were two emails that were particularly scrutinized by the SEC that preceded an earnings announcement by Microsoft. Pequot had a net positive result of over $2 million dollars in profit based on two trades in Microsoft that were theorized by the SEC to be the result of the email information received from Zilkha.

There were also several other examples of possible insider trades that the SEC investigated involving Pequot Capital and through these investigations Pequot provided 19.8 million pages of electronic mail to the SEC.

Based on the sheer volume of email presented by Pequot the SEC asserted on page three of Linda Chatman's presentation to the Senate that "our staff has become particularly adept at sifting through all available forms of evidence, including...emails."

Although originally Pequot Capital was cleared of insider trading, it now appears that the SEC is coming back and taking another look at this hedge fund but instead of facing the mounting investor scrutiny, Arthur Samberg has decided to scuttle the fund altogether. Yet what interested me most was the sheer volume of emails given to the SEC as well as the SEC's focus on email to not only look for evidence of wrong doing of Arthur Samberg but also to develop leads on other "tippers" of inside information.

This case is a good example of why companies need email management technology such as Estorian LookingGlass. As the SEC has shown, it is very adept at reviewing email documentation and having the ability to rapidly provide email information that can clearly show a company followed the rules will pay huge dividends in any investigation or information gathering exercise. An ability to provide transparency in any investigation or eDiscovery exercise can exonerate a business even if a government agency, such as the SEC, comes back to take a second look and help prevent taking such drastic measures as shutting down the business as Samberg obviously felt obligated to do.