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Hedge Fund's Puzzling Payments to Former S.E.C. Target

Documents filed in a Connecticut divorce case disclose that Pequot Capital Management C.E.O. Arthur J. Samberg or his hedge fund is making so-far-unexplained payments of $2.1 million to a former Microsoft employee who figured in a now-closed insider-trading investigation of Samberg.

The Securities and Exchange Commission closed its investigation of Samberg in 2006 without filing any charges, although the Senate Judiciary Committee a year later faulted the S.E.C. for the way it conducted the investigation and allegations that a related case had been influenced by politics.

Records obtained from Connecticut Superior Court in Stamford show that Samberg or his firm has paid the former employee, David Zilkha, $1.4 million in two equal installments since April 30, 2007, and has promised an additional $700,000 in April 2009.

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Zilkha's lawyer and a Samberg spokesman declined to explain the payments or to answer any questions from Condé Nast Portfolio about them, and so far neither Zilkha nor Samberg have provided an explanation in court.

The Senate Judiciary Committee has obtained the documents from the divorce case and is monitoring developments in court to see if there is any evidence that the payments to Zilkha are related to the insider-trading investigation.

In a 2007 report, the Judiciary Committee and the Finance Committee criticized the S.E.C.'s investigation of suspicions that Samberg had inside information when he made particularly profitable trades in several companies' securities.

One part of the S.E.C. investigation centered on suspicion that Zilkha had given Samberg insider information about Microsoft which he used to make a quick $12 million profit in April 2001, according to commission records.

A separate facet of the S.E.C. investigation looked into whether Morgan Stanley C.E.O. John Mack had fed inside information to Samberg about a planned General Electric acquisition of Heller Financial, a lender to businesses. Samberg's hedge fund had bought Heller shares and shorted G.E. stock in advance of the announcement, and made $18 million on the trading, the S.E.C. said.

The Mack aspect of the case hit the headlines because the S.E.C. fired the government lawyer investigating the allegations, Gary Aguirre. Aguirre claimed he was fired for insisting on subpoenaing Mack, a move which he said higher-ups at the S.E.C. overruled because of Mack's connections and political clout.

The S.E.C. denied that, but a joint investigation by the Senate judiciary and finance committees in August 2007 sided with Aguirre and sharply faulted the S.E.C. for failing to pursue the case, including the evidence concerning Zilkha and Samberg’s Microsoft trading.

In a report issued in October 2008, the S.E.C.'s own inspector general recommended disciplining senior S.E.C. officials for their handling of the case. A month later, however, an S.E.C. administrative law judge ruled against any disciplinary measures.

The trading investigated in the case occurred in 2001. Zilkha had been working as a product manager at Microsoft when Samberg that year offered him a job as an analyst of technology stocks at Pequot.

Records made public in the investigation show that in February 2001, in the same email in which he offered Zilkha a job, Samberg pressed him for information about Microsoft. Zilkha then was still employed by Microsoft. The email said "might as well pick your brain before you go on the payroll!"

On April 6, 2001, Samberg in an email pressed Zilkha for any "tidbits" about Microsoft. Zilkha responded the next day that he would get back to Samberg "ASAP."

Three days later, Samberg, who had been betting that Microsoft's stock would go down, reversed course and began amassing 30,000 Microsoft options in a bet the stock would go up, according to S.E.C. records from the case.

On April 17, Zilkha reported in an email to Samberg that Microsoft's chief financial officer had been unusually upbeat in advance of the company's pending quarterly earnings announcement. The email appears in S.E.C. files.

Microsoft announced its earnings on April 19, beating analysts' expectations. The stock rose, and a day later Samberg closed out his positions, reaping that $12 million profit. That day, Samberg emailed Zilkha that "I shouldn't say this, but you probably have paid for yourself already," investigators found.

Samberg fired Zilkha months later in 2001, after Zilkha's contacts inside Microsoft evidently had stopped talking to him, according to records from the S.E.C. investigation.

After that, Zilkha had no known personal or financial dealings with Samberg or Pequot.

Not "material" information, but payments continue

S.E.C. records made public in the case show that at one point in the investigation the S.E.C. enforcement division, which can only file civil lawsuits, had brought its evidence to the Federal Bureau of Investigation and federal prosecutors in an attempt to interest them in opening a criminal investigation.

No charges were ever filed, although F.B.I. agents did interview Zilkha, according to a 2006 S.E.C. memo written just before the investigation concluded. After talking to him alone, the F.B.I. joined with the S.E.C. and the U.S. Attorney's office to grant Zilkha limited immunity from prosecution and jointly questioned him under oath.

The S.E.C. memo and other records, though, show that investigators considered the information Zilkha gave them to be of little use. "Zilkha proffered that he had obtained information from Microsoft employees and provided it to Samberg, but did not believe the information was either material or confidential," the memo said.

Samberg, when he was questioned by the S.E.C. in 2006, testified that he couldn't remember why he had made the Microsoft trades, but denied that he had received any inside information on Microsoft.

Information about the recent payments by Samberg or Pequot to Zilkha surfaced in a long-running, fiercely contested divorce case between Zilkha and his former wife, Karen. Their marriage was dissolved in 2005, but Zilkha was required to continue filing regular financial statements with the court.

One of those statements show that in January 2008, Zilkha for the first time disclosed that he had received payments totaling $1.4 million, and expected to receive an additional $700,000 in 2009.

Karen Zilkha's lawyers moved to question both David Zilkha and Samberg under oath, to find out if an agreement to pay the money had been made before the divorce was made final.

Court records show that Samberg and Zilkha recently filed separate motions asking the judge in the divorce case to seal—that is, keep from being disclosed publicly—any testimony they will give about the payments.

In one motion, David Zilkha's lawyer asserted that "any release of this confidential information would potentially cause irreparable financial harm to the defendant [Zilkha]."

In a separate motion, Samberg's lawyers asserted that sealing information about payments to Zilkha is "necessary to protect Pequot's private financial information and business affairs."

A hearing on the motions is set for December 22.

The payments are curious because Zilkha isn't known to have filed any court claim against Samberg or Pequot. People familiar with the case said it's possible that Zilkha believes he was unfairly fired from Pequot in 2001 and the payments were in response to a request for compensation. But so far it isn't clear why any such payments would be deferred until six years after he had left the firm.

Jonathan Gasthalter, a spokesman for Samberg, said he wouldn't have any comment on the payments. Norman Pattis, a Connecticut lawyer representing Zilkha in the divorce case, said "I don't know anything about it" and hung up when Portfolio called him for comment. He didn't respond to subsequent email and phone messages.

Telephone numbers listed for Zilkha reached recordings saying the numbers aren't in service, and efforts to locate Zilkha for comment weren't successful. In 2006, Henry Putzell III, a lawyer who had represented Zilkha in the S.E.C. investigation, was quoted as saying that "David Zilkha never obtained and did not communicate any material, nonpublic information, nor did he attempt to do so."

An S.E.C. spokesman said the agency had no comment on whether it was aware of the payments to Zilkha.