SEC’s pitiful Pequot war

May 27, 2010

How’s “better late than never” as the new motto for the Securities and Exchange Commission?

The SEC on Thursday brought civil insider trading charges against Pequot Capital Management and its CEO Art Samberg. Samberg and the firm agreed to pay $28 million to settle allegations that they made $14 million on illicit trades of Microsoft stock nine years ago.

“The cases have two particularly troubling aspects,” said Robert Khuzami, director of the SEC’s Division of Enforcement. He pointed to “a hedge fund manager trading on illegal insider information, and his tipper source who withheld crucial information about the scheme during an SEC investigation.”

But there is a third troubling aspect to the case, which is that it took the SEC nine years to bring charges -- by which time Pequot, once the world’s biggest hedge fund, was but a shadow of its former self.

That isn’t exactly a recipe for scaring the miscreants on Wall Street straight.

“This case shows how badly enforcement failed over the past decade,” said James Angel, a professor at Georgetown. “Pequot has been a high-profile embarrassment for them -- they had to do something. I guess it's a case of better late than never.”

David Bergers of the SEC's Boston office disagrees. He says the case sends the message that “holding hedge fund managers who trade on inside information accountable is one of our top priorities.”<!-- more -->

But there’s no mistaking the SEC’s failure in this case. It was pursuing a much bigger investigation of Pequot before the investigator leading that effort was fired and the inquiry disbanded. A Senate report chastised the agency for its handling of that episode.

“The investigation of Pequot Capital Management could have been an ideal opportunity for the SEC to develop expertise and visibility into the operations of a major hedge fund while deterring institutional insider trading and market manipulation through vigorous enforcement,” according to the 2007 report by Senators Charles Grassley, R-Iowa, and Arlen Specter, then a Pennsylvania Republican. “Instead, the SEC squandered this opportunity through a series of missteps.”

That failure allowed market abuse to proceed unabated until the economy nearly collapsed in 2008, says Gary Aguirre, the former SEC lawyer who was fired in 2005 as he investigated Pequot.

Aguirre said that when the SEC abandoned his probe of Pequot in 2006, it dropped 16 trading cases involving insider trading and other illicit practices. Most famously, it gave up on questions about former Morgan Stanley  chief John Mack’s role in another deal on which Pequot made big profits, General Electric’s 2001 purchase of Heller Financial.

That case seems to have been dropped for good. But Aguirre says other cases were just as important to what he contends was the growing business of hedge funds pursuing insider trading as a business model.

Had the agency vigorously pursued some of these cases, it and other law enforcement authorities could have brought cases -- perhaps including criminal charges -- that would have cut down on the speculation and abuse that he says flourished in the late stages of the credit bubble.

Until regulators end their revolving door relationship with the big financial firms and show the courage to pursue timely cases against powerful players, Wall Street will continue to ignore them, Aguirre said.

“This isn’t just a case of closing the barn door after the horse has left,” said Aguirre, who is now a lawyer living in San Diego. “This is like burying the horse after it has been shot.”

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