[Congressional Record Volume 153, Number 127 (Friday, August 3, 2007)]
[Senate]
[Pages S10889-S10894]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]
REPORT OF SEC INVESTIGATION
Mr. GRASSLEY. Mr. President, today along with Senator Specter, I
present the findings of a joint investigation by the minority staffs of
the Committees on Finance and the Judiciary. It will be posted today on
the Finance Committee Web site. I urge all my colleagues to read this
important report.
Together, our committees conducted an extensive investigation of
allegations raised by former Securities and Exchange Commission
attorney Gary Aguirre concerning the SEC and insider trading at a major
hedge fund.
During the course of this investigation, the staff reviewed roughly
10,000 pages of documents and conducted over 30 witness interviews. The
Judiciary Committee held three related hearings. Our joint findings
confirm a series of failures at the SEC: (1) Failures in its
enforcement division, (2) failures in personnel practices, and (3)
failures at the Office of Inspector General.
There was, however, one bright spot. The Chairman of the Securities
and Exchange Commission cooperated fully with our inquiry. I would like
to take a moment to thank Chairman Christopher Cox for recognizing the
value of congressional oversight instead of resisting it like most
other agencies do. In my years in the Senate, I have overseen many
investigations of Federal agencies. I am happy to say that Chairman
Cox--who inherited these problems in 2005--was a model of transparency
and accountability.
I also thank Senator Specter for his hard work on this issue, and for
the way our committees were able to work together so effectively.
Our investigation focused on three allegations: (1) The SEC
mishandled its investigation of a major hedge fund, Pequot Capital
Management. (2) The SEC fired Gary Aguirre, the lead attorney in the
Pequot investigation, after he reported evidence of political influence
corrupting the investigation. (3) The SEC's Office of Inspector General
failed to thoroughly investigate Aguirre's allegations.
In 2001, Pequot made about $18 million in just a few weeks of trading
in advance of the public announcement that General Electric was
acquiring Heller Financial. Pequot accomplished this by buying over a
million shares of Heller Financial and shorting GE stock. The New York
Stock Exchange highlighted these suspicious and highly profitable
trades for the SEC.
When the SEC finally got around to investigating the matter 3 years
later, the only full-time attorney working on it, Mr. Aguirre, was up
against an army of lawyers from Pequot and Morgan Stanley.
Those lawyers could easily bypass the commission staff and go
directly to the Director of Enforcement. In other words, attorneys from
Wall Street law firms had better access to SEC management than the
staff attorney working on the case, and they used it.
When Aguirre wanted to question Wall Street executive John Mack, his
supervisors blocked his efforts and delayed the testimony as long as
they could. Mack was about to be hired as the CEO of Morgan Stanley.
This raised a critical question in our investigation: Did Mack get
special treatment, and if so, why? Gary Aguirre was told by one of his
supervisors that it was because of his ``political connections.''
Our investigation uncovered no evidence that Mack's special treatment
was due to partisan politics. However, internal e-mails do show that
SEC
[[Page S10890]]
managers cared about something else: prominence--not partisanship.
They put hurdles in the way of taking Mack's testimony because he was
an ``industry captain'' and well-known on Wall Street. His lawyers
would have ``juice,'' according to SEC management--meaning they could
easily pick up the phone and talk to senior officials three and four
layers above Aguirre. Mack's prominence protected him from the initial
SEC inquiry, protection that would not have been afforded to him had he
been from Main Street rather than Wall Street.
Our investigation also found that Mr. Aguirre's firing from the SEC
was closely connected to his objections to the special treatment
afforded to John Mack. Unfortunately, that was not the only retaliation
we found at the SEC. Another employee was also penalized for objecting
to problems similar to Aguirre's. This sort of retaliatory firing of a
whistleblower is not acceptable, and must be stopped.
Finally, our investigation found failures at the SEC's Office of
Inspector General. When Mr. Aguirre presented the Inspector General's
office with serious allegations, there was no attempt to conduct a
serious, credible investigation.
The Inspector General merely interviewed SEC management, accepted
their side of the story, and closed the case. This is unacceptable. It
is the role of the inspector general to be an independent finder of
fact, not a rubberstamp for agency management. I understand that the
current inspector general is retiring, and his last day is today. I
hope Chairman Cox chooses the next inspector general very carefully.
Our investigation has uncovered real failures at the SEC, and fixing
these problems will take real reform. We have proposed six
recommendations. These recommendations include the creation of a
uniform, comprehensive manual of procedures for conducting enforcement
investigations along the lines of the U.S. Attorney's Manual. If the
SEC had such a manual, there would have been clear guidance regarding
the standard for issuing a subpoena to any suspected tipper, whether
John Mack or John Q. Public.
Other recommendations include the reform of the SEC's Office of
Inspector General, firmer ethics requirements, and standardized
evaluation procedures to prevent the sort of retaliatory personnel
practices that took place with Gary Aguirre. By implementing real
reforms such as those our report outlines, the SEC can begin to regain
public confidence, and I look forward to working with the SEC as these
reforms are implemented.
Mr. President, in closing, I ask unanimous consent to print in the
Record, the report's executive summary and list of recommendations.
There being no objection, the material was ordered to be printed in
the Record, as follows:
II. Executive Summary
Pequot's trades in advance of the GE acquisition of Heller
Financial were highly suspicious and deserved a thorough
investigation. In the weeks after a conversation with John
Mack and prior to the public announcement of GE's acquisition
of Heller, Pequot CEO Arthur Samberg purchased over one
million shares of Heller Financial stock, and also shorted GE
shares. On the day the deal was announced, Samberg sold all
of the Heller stock. He also covered the short positions in
GE shortly thereafter, for a total profit of about $18
million for Pequot in a matter of weeks.
The SEC examined only a fraction of the other suspicious
Pequot trading highlighted by Self-Regulatory Organizations
(SROs). GE-Heller represented just one of at least 17 sets of
suspicious transactions involving Pequot brought to the SEC's
attention by organizations like the NYSE and NASD. However,
SEC managers ordered the staff to focus on only a few
transactions. In addition to GE-Heller, the SEC investigated
trades involving (1) Microsoft, (2) Astra Zeneca and Par
Pharmaceutical, and (3) various ``wash sales.''
Staff Attorney Gary Aguirre said that his supervisor warned
him that it would be difficult to obtain approval for a
subpoena of John Mack due to his ``very powerful political
connections.'' Aguirre's claim is corroborated by internal
SEC e-mails, including one from his supervisor, Robert
Hanson. Hanson also told Aguirre that Mack's counsel would
have ``juice,'' meaning they could directly contact the
Director or an Associate Director of Enforcement.
Attorneys for Pequot and Morgan Stanley had direct access
to the Director and an Associate Director of the SEC's
Enforcement Division. In January 2005, Pequot's lead counsel
met with the SEC Director of Enforcement Stephen Cutler.
Shortly thereafter, SEC managers ordered the case to be
narrowed considerably. In June 2005, Morgan Stanley's Board
of Directors hired former U.S. Attorney Mary Jo White to
determine whether prospective CEO John Mack had any exposure
in the Pequot investigation. White contacted Director of
Enforcement Linda Thomsen directly, and other Morgan Stanley
officials contacted Associate Director Paul Berger. Soon
afterward, SEC managers prohibited the staff from asking John
Mack about his communications with Arthur Samberg at Pequot.
Seeking John Mack's testimony was a reasonable next step in
the investigation. Several SEC staff wished to take Mack's
testimony because they believed he: (1) had close ties to
Samberg, (2) had potential access to advanced knowledge of
the deal, (3) had spoken to Samberg just before Pequot
started buying Heller and shorting GE, and (4) was an
investor in Pequot funds and was allowed to share in a
lucrative direct investment in a (5) start-up company
alongside Pequot, possibly as a reward for providing inside
information.
SEC management delayed Mack's testimony for over a year,
until days after the statute of limitations expired. After
Aguirre complained about his supervisor's reference to Mack's
``political clout,'' SEC management offered conflicting and
shifting explanations for blocking Mack's testimony. Although
Paul Berger claimed that the SEC had always intended to take
Mack's testimony, Branch Chief Mark Kreitman said that
definitive proof that Mack knew about the GE-Heller deal was
the ``necessary prerequisite'' for taking his testimony. The
SEC eventually took Mack's testimony only after the Senate
Committees began investigating and after Aguirre's
allegations became public, even though it had not met
Kreitman's prerequisite.
The SEC fired Gary Aguirre after he reported his
supervisor's comments about Mack's ``political connections,''
despite positive performance reviews and a merit pay raise.
Just days after Aguirre sent an e-mail to Associate Director
Paul Berger detailing his allegations, his supervisors
prepared a negative re-evaluation outside the SEC's ordinary
performance appraisal process. They prepared a negative re-
evaluation of only one other employee. Like Aguirre, that
employee had recently sent an e-mail complaining about a
similar situation where he believed SEC managers limited an
investigation following contact between outside counsel and
the Director of Enforcement.
After being contacted by a friend in early September 2005,
Associate Director Paul Berger authorized the friend to
mention his interest in a job with Debevoise & Plimpton.
Although that was the same firm that contacted the SEC for
information about John Mack's exposure in the Pequot
investigation, Berger did not immediately recuse himself from
the Pequot probe. Berger ultimately left the SEC to join
Debevoise & Plimpton. When initially questioned, Berger's
answers concerning his employment search were less than
forthcoming.
The SEC's Office of Inspector General failed to conduct a
serious, credible investigation of Aguirre's claims. The OIG
did not attempt to contact Aguirre. It merely interviewed his
supervisors informally on the telephone, accepted their
statements at face-value, and closed the case without
obtaining key evidence. The OIG made no written document
requests of Aguirre's supervisors and failed to interview SEC
witnesses whom Aguirre had identified in his complaint as
likely to corroborate his allegations.
III. Recommendations
The controversy over allegations of improper political
influence and the firing of SEC attorney Gary Aguirre
garnered considerable media attention. The public airing of
evidence in support of those allegations undoubtedly had an
adverse impact on public confidence in the SEC. The damage to
public confidence in the SEC as a fair and impartial
regulator must be repaired if the agency is to be effective
and able to fulfill its mission.
However, the controversy is more than merely an issue of
perception. Our investigation uncovered real failures that
need real solutions. Our recommendations focus on improving
the Commission's approach to the management of complex
securities investigations, personnel problems, the handling
of ethics issues, and the role of the Inspector General. A
more standardized, professional system for dealing with these
issues could have averted much of the controversy. It could
also improve employee morale and confidence in management by
ensuring more consistent, documented, transparent, and
careful internal deliberations.
For these reasons, we offer the following recommendations
for consideration:
1. Standardized Investigative Procedures: The SEC should
draft and maintain a uniform, comprehensive manual of
procedures for conducting enforcement investigations, along
the lines of the United States Attorney's Manual. The manual
should attempt to address situations or issues likely to
recur. It should set a consistent SEC policy where possible
and provide general guidance for complex issues that require
individual assessment on a case-by-case basis, so that
inquiries are handled as uniformly as possible throughout the
Enforcement Division.
2. Directing Resources to Significant and Complex Cases:
The SEC currently lacks a set of objective criteria for
setting staffing
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levels and has no mechanism for designating a case as
critically important. The SEC should set standards for
assessing the size, complexity, and importance of cases to
ensure that significant cases receive more resources. The
Enforcement Division should develop and apply objective
criteria for determining how many attorneys, paralegals, and
support personnel should be assigned to a particular case.
3. Transparent and Uniform External Communications: The SEC
should issue written guidance requiring supervisors to keep
complete and reliable records of all outside communications
regarding any investigation. The need for a clear record and
transparency is especially acute regarding any communications
by supervisors that exclude the staff attorney assigned to
the case. The SEC's guidance should generally discourage
supervisors from engaging in such communications without the
knowledge or participation of the lead staff attorney. The
SEC needs to present one, consistent position to parties
involved in its investigations.
4. Greater Office of Inspector General (OIG) Independence
and More Thorough Investigative Procedures: The hallmarks of
any good Inspector General are independence and integrity.
However, the reputation of the Inspector General within the
SEC appears to be that of an office closely aligned with
management, lacking independence. In addition to the facts of
the Aguirre case, we received numerous complaints about the
OIG from both current and former SEC employees. The OIG
should develop a plan to ensure independence from SEC
management and the General Counsel's Office, and to ensure
that its future investigations of allegations against
management are thorough, fair, and credible. The SEC needs to
implement a directive requiring its Office of Information
Technology to provide thorough and timely responses to SEC/
OIG document requests. Since the purpose of the OIG is to
ensure integrity and efficiency, a document request in
connection with an SEC/OIG investigation should be among the
highest priorities.
5. Timely and Transparent Recusals: The SEC should review
its guidance to employees regarding their obligations to
recuse themselves immediately from any matter involving a
potential employer with whom the employee has had contact,
either directly or indirectly through an agent. Recusals
should be communicated in writing to all SEC staff who have
official contact with the recused individual, and a record of
the recusals should be centrally maintained by a designated
ethics officer. The appearance created by having undisclosed
contacts with potential employers while still participating
in an enforcement matter involving that potential employer
undermines public confidence in the fairness and impartiality
of the SEC.
6. Standardized Evaluation Procedures: Employee evaluations
should be submitted in a timely manner, according to an
established schedule. Evaluations should not be prepared
outside or apart from the established procedure. Although it
is appropriate to document performance issues and to discuss
them with the employee as the issues arise, submitting a re-
evaluation with substantive changes after the regularly
scheduled evaluation is submitted can raise questions. Where
the re-evaluation occurs just after an employee reports
alleged wrongdoing by a supervisor, it tends to suggest that
retaliation is driving the process rather than an honest
attempt to evaluate employee performance.
Mr. SPECTER. Mr. President, I seek recognition, along with my
colleague from Iowa, Senator Grassley, to inform the full Senate of the
conclusion of our joint investigation into allegations of abuse of
authority at the Securities and Exchange Commission and of the
availability of our findings and recommendations. On January 31, 2007,
Senator Grassley and I came to the floor and submitted the ``Specter-
Grassley Interim Findings on the Investigation Into Potential Abuse of
Authority at the Securities and Exchange Commission.'' Senator Grassley
and I did not want to delay in expressing our concerns about, No. 1 the
SEC's mishandling of the investigation of potential massive insider
trading by a hedge fund which we recommended be reopened; No. 2, the
circumstances of the termination of SEC attorney Gary Aguirre, who was
leading the investigation; and No. 3, the manner in which the SEC's
Inspector General's Office handled Aguirre's allegations that he was
terminated for improper reasons, including pressing too hard to
interview a witness in the investigation. We were concerned about what
appeared to be managerial interference with the independence and
doggedness of an SEC attorney who was determined to follow the evidence
wherever it might lead.
Today, we file our comprehensive report and recommendations--
comprising nearly 100 pages of annotated findings and recommendations--
with the Senate Judiciary and Finance Committees. Before I summarize
the key findings and recommendations, I must commend the SEC for two
aspects of its response to Congress. First, the SEC, despite some
initial disputes and letters relating to document production and
privilege, ultimately cooperated fully with Congress by producing all
requested documents and permitting all witnesses to be interviewed
under oath and with a transcript. Second, Chairman Cox, the other
Commissioners, and SEC Director of Enforcement Linda Thomsen have
clearly been listening to concerns we raised about insider trading in
general and in particular suspicious trading ahead of mergers on the
part of hedge funds and others with access to material nonpublic
information as a result of the intertwined relationships in our
financial sector. Since the Judiciary Committee began holding hearings
on insider trading and related fraud in June 2006, the SEC has filed a
number of substantial civil cases--often in coordination with the
Department of Justice, which handles criminal matters. Linda Thomsen
testified at the Judiciary Committee hearing on September 26, 2006 that
``[r]igorous enforcement of our current statutory and regulatory
prohibition on insider trading is an important part of the Commission's
mission.'' This appears to be the case.
In February 2007, the SEC charged seven individuals and two hedge
funds with insider trading ahead of announcements by Taro
Pharmaceuticals Industries regarding earnings and FDA drug approvals.
Four of the individuals were in their early thirties or younger and
worked at major accounting and law firms.
In March 2007, the SEC and Federal prosecutors filed charges against
a dozen defendants, including a former Morgan Stanley compliance
officer who pleaded guilty in May 2007 to charges that she and her
husband sold information about four deals--including Adobe Systems
Inc.'s $3.4 billion purchase of Macromedia and the $2.1 billion
acquisition of Argosy Gaming by Penn National Gaming, Inc.--to
individuals who used the information in trading for hedge fund Q
Capital Investment Partners and other accounts.
In March 2007, the SEC charged a 41-year-old UBS research executive
with selling information about upcoming UBS upgrades and downgrades of
the stock of Caterpillar, Goldman Sachs, and other companies. The
information was then used in trading on behalf of hedge funds Lyford
Cay, Chelsea Capital and Q Capital Investment Partners.
In May 2007, a 37-year-old Credit Suisse investment banker was
charged with insider trading for leaking details of acquisitions
involving nine publicly traded U.S. companies including the $45 billion
takeover of TXU Corp by a private equity firm. He also leaked
information on deals involving Northwestern Corporation, Energy
Partners, Veritas DGC, Jacuzzi Brands, Trammel Crow Co., Hydril
Company, Caremark RX, and John H. Harland Co.
In May 2007, the SEC accused a former analyst at Morgan Stanley and
her husband, a former analyst in the hedge fund group at ING, of making
more than $600,000 by trading on companies advised by Morgan Stanley's
real estate subsidiary.
In May 2007, the SEC obtained a court order requiring Barclays Bank
to pay $10.9 million--including a $6 million penalty--for insider
trading based on material nonpublic information obtained by its head
trader, who served on bankruptcy creditors committees.
In June 2007, the SEC filed a complaint alleging that a former bank
vice president had traded in securities of a bank that he learned would
be acquired by another bank.
In June 2007, the SEC filed a complaint alleging unlawful insider
trading by the former managing partner of the Washington, DC office of
a large law firm who learned of an imminent acquisition from a job
candidate.
In July 2007, a court sentenced a corporate executive to a 6-year
jail term, and ordered him to forfeit $52 million, in a case involving
more traditional insider trading executed by a company executive in his
own company's stock.
These aggressive enforcement efforts send a strong message to the
public, and we commend the SEC for ensuring that action accompanies
their assurances to Congress and to the public. I point out the ages of
some of those charged because it strikes me that they may not have
lived through the insider trading scandals of the 1980s that resulted
in jail sentences for some very prominent businessmen. Though
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time has passed since those scandals, there continues to be a need to
reinforce that insider trading is a serious violation of the law.
Following our hearings and investigation, the SEC appears to have
reasserted itself.
On March 1, 2007, in announcing charges against 14 individuals in a
brazen insider trading scheme, Chairman Cox stated: ``Our action today
is one of several that will make it very clear the SEC is targeting
hedge fund insider trading as a top priority.'' Linda Thomsen, Director
of the SEC's Division of Enforcement, recently stated that the SEC has
made insider trading ahead of mergers and acquisition one of its top
priorities. Peter Bresnan, Deputy Director of the SEC's Division of
Enforcement, stated in a CNBC interview on May 11, 2007: ``Hedge fund
managers are under enormous pressure to show profits for their clients.
. . . Not every hedge fund manager can get those kinds of returns
through legitimate trading.'' Bruce Karpati, an Assistant Regional
Director in the SEC's New York office stated in May 2007 that the SEC
is ``actively studying the relationships that hedge funds have both
inside the hedge funds and outside'' to see how information flows
around financial markets and that the SEC is also looking at ``more
complex trading strategies'' at hedge funds. Also in May 2007, when the
SEC filed charges against a Hong Kong couple and alleged that they had
illegally traded ahead of News Corp.'s offer to buy Dow Jones, Cheryl
Scarboro, SEC Associate Enforcement Director, stated: ``Cases like
this, insider trading ahead of mergers, are a top priority and we will
continue our pursuit of it, no matter where it occurs.''
Finally, in early 2007 it was widely reported that the SEC had begun
a factfinding study of the relationships that hedge fund advisers have
with brokerages to determine if those contacts could have led to
insider trading. The SEC had specifically requested information about
stock and options trading by major firms. It is encouraging to see that
the SEC's rhetoric is increasingly matched by real cases against those
who subvert our capital markets through insider trading.
On the other hand, we agree with Peter Bresnan, who recently
expressed dismay over the number of Wall Street professionals involved
in these cases, from investment bankers and advisers to lawyers and
accountants. ``When we see Wall Street professionals engage in insider
trading, it is particularly reprehensible because we rely on them to
keep the markets fair and clean.'' As I stated during the Judiciary
Committee hearings, although disgorgement and civil penalties in these
cases are a good start, I will continue to press for jail terms for
those who engage in fraudulent conduct that harms other investors,
especially when those who commit fraud are in positions of trust.
With respect to our investigation and final report, Senator Grassley
and I were primarily concerned about three aspects of a single case of
insider trading: First, the handling of the investigation of what some
at the SEC believed was one of the largest insider trading cases in
recent history; second, the timing of the firing of Gary Aguirre, one
of the lead investigators on the case; and third, the worse-than-
cursory inspector general investigation of Mr. Aguirre's claims of
improper discharge. All of this presented a troubling picture that
centers on apparently lax enforcement by the SEC.
The alleged insider trading occurred in July 2001, several weeks
before the public announcement that GE would purchase Heller Financial.
During the lead-up to the announcement, Pequot CEO Arthur Samberg began
purchasing large quantities of Heller Financial stock while also
shorting GE stock. Two years later, the SEC began an investigation.
Despite several promising leads, the investigation was left to wither
when the lead attorney, Gary Aguirre, was abruptly fired with little
explanation. When Aguirre complained to Commissioner Cox about the
circumstances of the termination, Chairman Cox instructed the inspector
general to investigate. The inspector general's staff, however, did so
with the stated view that they were not going to ``second guess''
Aguirre's managers. Perhaps for this reason, the inspector general did
not interview Aguirre or the other employees named in Aguirre's letters
to Chairman Cox, choosing instead to accept the managers' explanations
at face valueeven the explanations that were inconsistent with SEC
procedures and some of the documentary evidence submitted by Aguirre.
What was Gary Aguirre investigating? As explained at our hearings,
when an acquisition like the GE-Heller deal is announced, the price of
the purchasing company typically falls and the price of the purchased
company typically rises. This is an opportunity for guaranteed, quick
and easy profits. Samberg directed the purchase of ``a little over a
million shares'' of Heller stock. On several days, the shares he sought
to purchase exceeded the total volume of trading that day. On January
30, 2002, the NYSE ``highlighted'' these trades for the SEC as a matter
that warranted further scrutiny and surveillance. Yet it was not until
2004, when Gary Aguirre joined the Commission, that an investigation
began in earnest. Mr. Aguirre became the driving force behind the
investigation of the GE Heller trades.
Aguirre's immediate supervisors were initially enthusiastic about the
investigation and the identification of John Mack as the possible
tipper. On June 14, 2005, Mr. Aguirre's supervisors authorized him to
speak to Federal prosecutors concerning the trades. His immediate
manager, Robert Hanson, wrote in an e-mail on June 20, 2005, ``Okay
Gary you've given me the bug. I'm starting to think about the case
during my non work hours.'' But the enthusiasm quickly waned at some
point after newspapers reported on June 23, 2005, that Morgan Stanley
was considering hiring John Mack as its new CEO. Aguirre testified that
the timing was no coincidence and that his supervisor, Robert Hanson,
would not let him take Mack's testimony because of his ``powerful
political contacts.'' Hanson later sent Aguirre e-mails that mentioned
Mack's ``juice'' and ``political clout.'' Hanson, for his part, later
explained that he simply wanted to make sure that the SEC had gotten
``their ducks in a row'' before taking drastic action.
Although reasonable minds may disagree on an appropriate
investigative strategy, the SEC's stated rationale for delaying the
taking of Mack's testimony runs counter to the normal approach
described to the committees' staff by insider trading experts at the
SEC. Hilton Foster, an experienced former SEC investor with knowledge
of the Pequot matter, stated that ``as the SEC expert on insider
trading, if people had asked me when do you take his testimony, I would
have said take it yesterday.'' The explanation offered by Aguirre's
supervisors--that without direct evidence that Mack had knowledge of
the GE transaction, the deposition would consist simply of a denial by
Mack--is not at all convincing since the SEC eventually did question
Mack for over 4 hours in August 2006 without such direct evidence.
Mack's testimony was taken 5 days after the statute of limitations
expired. We note that shortly after Aguirre's termination, the SEC
Market Surveillance Branch Chief sought removal from the Pequot
investigation, stating that ``something smells rotten.'' We note that
this chief was a reluctant witness who came forward to the committees
to do the right thing. Despite a number of such SEC employees, with
Aguirre gone and a change in staff on the Pequot case, the trail seems
to have grown cold and any evidence likely lost.
With respect to our recommendations, we start by noting that the
committees adduced documents and testimony showing that Gary Aguirre, a
probationary employee while at the SEC, was an experienced, smart,
hard-working, aggressive attorney who was passionately dedicated to the
Pequot investigation. These attributes were noted in a June 1, 2005,
performance plan and evaluation. A more detailed ``Merit Pay''
evaluation written by Hanson on January 29, 2005, noted Aguirre's
unmatched dedication ``to the Pequot investigation'' and
``contributions of high quality.'' These evaluations were submitted to
the SEC's Compensation Committee, which approved a two-step salary
increase recommendation on July 18, 2005. After these favorable
reviews, Aguirre's managers wrote a ``supplemental evaluation,'' on
August 1 that included negative assessments. The document was
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never shared with Aguirre, who received a notice of termination exactly
1 month later, on September 1. To the extent that there was
contemporaneous documentation, little appears to support the assertion
that the decision to terminate was based on poor performance or
employee misconduct, which leaves open the possibility that the
discharge was for improper reasons.
More disturbing, however, is the cursory investigation of Aguirre's
allegations by the SEC's Office of Inspector General, headed by Walter
Stachnik. Chairman Cox referred the matter to Stachnik, who failed to
interview Aguirre or any of the other SEC employees mentioned in Mr.
Aguirre's letter. The IG's investigators repeatedly told staff that in
investigating Mr. Aguirre's allegations of improper motivation for his
termination that they ``don't second guess management decisions . . .
[and they] don't second guess why employees are terminated.'' These
statements are troubling. After speaking only to Aguirre's supervisors
about the facts and accepting everything they said at face value, the
IG staff reviewed only those documents identified by Aguirre's
managers.
This is not a recipe for an independent and thorough investigation.
Even after committee hearings, Stachnik insisted that his investigation
was ``professional,'' but he did reopen the IG investigation.
Unfortunately, as part of the reopened investigation, Stachnik sought
documents in Aguirre's possession, including documents that were
communications between Aguirre and the Senate. When Aguirre balked,
Stachnik asked the Department of Justice to petition a Federal court to
enforce the subpoena. If Chairman Cox had been able to obtain a timely,
objective, and thorough consideration of Aguirre's concerns, the Pequot
investigation may have been put back on track shortly after Aguirre's
termination. Because the Chairman did not have the benefit of a careful
review by the IG, we will never know what would have happened.
In light of this, and based on the committees' investigation, we make
certain recommendations intended to help the SEC remedy obvious
shortcomings in order for it to avoid an undermining of public
confidence in the agency. The reputation of the SEC as a fair and
impartial regulator must be restored. I note that through our
investigation, we determined that what we have is not merely an issue
of perception. There are real failures that need real solutions to
improve the management of complex securities investigations; the
handling of ethics concerns and issues; and personnel policies and
procedures to increase employee morale and confidence in management and
to ensure more consistency, transparency, and careful internal
deliberations.
The SEC should draft and maintain a comprehensive manual of
procedures for conducting enforcement investigations, along the lines
of the U.S. Attorney's Manual. The manual should address situations and
issues likely to recur, including a section outlining all SEC policies
related to the issuance of subpoenas. It should set a consistent SEC
policy and provide general guidance for complex issues that require
individual assessment on a case-by-case basis.
Among other policy changes, the SEC should begin to conduct regularly
scheduled, confidential employee surveys to measure confidence in
senior management. Such responses should be reviewed and evaluated by
the inspector general as potential predicates for audits,
investigations, or recommendations to senior management. The SEC should
also revise its policies on disclosing nonpublic information to third
parties.
The SEC currently lacks a set of objective criteria for setting
staffing levels and has no mechanism for designating a case as mission
critical. The SEC should set standards for assessing the size,
complexity, and importance of cases to ensure that significant cases
receive more resources. The Enforcement Division should develop
objective criteria for determining how many attorneys, paralegals, and
support personnel should be assigned to a particular case. It may be
unavoidable that the SEC often will have fewer resources than the
entities the agency regulates, but effective staffing could help the
SEC avoid being outmatched when it matters most.
The SEC should issue written guidance requiring supervisors to keep
complete records of all external communications regarding any
investigation. As a starting point for drafting such a policy, the SEC
should review and consider adopting an approach similar to that of the
Food and Drug Administration in 21 C.F.R. section 10.65. The need for a
clear record and transparency is especially acute regarding any
communications by supervisors that exclude the staff attorney assigned
to the case. Allowing outside counsel and interested parties to
circumvent the staff attorney by dealing separately with higher level
officials may undermine the investigation and also undermine the goals
of consistency, impartiality, and professionalism.
The SEC Office of Inspector General should develop a plan to ensure
independence from SEC management and the General Counsel's Office. Such
a plan must ensure that the SEC's investigations of allegations against
management are thorough, fair, and credible. The OIG should submit its
plan to Congress for review and followup oversight.
Equally as important, employees should have confidence that they have
confidential alternate channels of communication through which both
real problems and misperceptions may be resolved early and without
public controversy. Personnel procedures should be regularly audited
and reviewed to ensure that they are fairly and consistently applied.
All SEC inspector general audit and investigation reports should be
available to Congress, on a confidential basis when appropriate. The
detail, quality, and volume of reports from the Inspector General's
Office need to be improved dramatically.
The SEC should review its guidance to employees regarding their
obligations to disclose any connections with potential employers and
recuse themselves from any matter involving those employers. The
appearance created by having undisclosed contacts with potential
employers while still participating in an enforcement matter involving
that employer undermines public confidence in the fairness and
impartiality of the SEC.
Employee evaluations should be submitted in a timely manner,
according to an established schedule. Evaluations should not be
prepared outside or apart from the established procedure. The process
should be audited regularly, and supervisors who fail to follow the
procedures should face meaningful consequences. Although it is
appropriate to document and discuss performance issues as they arise,
submitting a reevaluation with substantive changes after the regularly
scheduled evaluation is submitted can raise questions--especially when
it occurs just after an employee reports alleged wrongdoing by a
supervisor.
In conclusion, I will comment on an issue that was the subject of
much discussion during the investigation whether hedge funds should be
subject to greater regulation. With baby boomers beginning to retire,
pension funds are moving more of their assets out of fairly
conservative stocks and bond portfolios and increasing their
investments in hedge funds. This shift comes as hedge fund returns are
cooling. As just one example, the Amaranth fund, which made risky bets
on natural gas, collapsed in September 2006. On July 25, 2007, the
Commodity Futures Trading Commission charged the fund and its chief
energy trader with trying to manipulate the natural gas markets.
Hedge funds are fiercely protective of their trading strategies, and
they are hard to value because they are not actively traded. Unlike
mutual funds, they are not required to register with the SEC or
disclose their holdings. In addition, they may borrow as much as 10
times their cash holdings to execute their investment strategies. For
this reason, many say that there is an inconsistency between the high-
risk, high-return concept behind hedge funds and the low-risk,
guaranteed return goal of pension funds. Pension funds may have
consultants and sophisticated money managers, but even they can be
tripped up, as evidenced by the fact that Bear Stearns, a Wall street
firm known for its caution and its expertise in bond-treading, notified
clients this month that their investment
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in two prominent hedge funds were worth pennies on the dollar. Those
funds made bets on risky bonds backed by subprime mortgages.
Individuals, like managers of the pension funds of middle class
workers, have also begun to increase their investments in hedge funds.
Once limited to the wealthy, hedge funds are now available to retail
investors through funds of funds. By pooling money, funds of funds
allow investors who do not have the minimum investments or assets to
gain access to the hedge fund club.
Because of my concern for these investors, I will continue to study
the question of increased transparency and effective regulation of
hedge funds.
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