[Congressional Record (Bound Edition), Volume 153 (2007), Part 16]
[Senate]
[Pages 22842-22847]
[From the U.S. Government Publishing Office, www.gpo.gov]




                      REPORT OF SEC INVESTIGATION

  Mr. GRASSLEY. Mr. President, today along with Senator Specter, I

[[Page 22843]]

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 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

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     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 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

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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 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,

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choosing instead to accept the managers' explanations at face value--
even 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 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

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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 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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