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Aguirre v. Securities and Exchange Commission

April 28, 2008

GARY AGUIRRE, PLAINTIFF,
v.
SECURITIES AND EXCHANGE COMMISSION, DEFENDANT.



The opinion of the court was delivered by: Ellen Segal Huvelle United States District Judge

MEMORANDUM OPINION AND ORDER

Gary Aguirre, who was formerly employed as an attorney at the Securities and Exchange Commission ("SEC"), has sued the SEC under the Freedom of Information Act ("FOIA"), 5 U.S.C. § 552 et seq. Plaintiff seeks documents relating to his employment, his termination, and the SEC's investigation of Pequot Capital Management ("Pequot") and John Mack. Some of the documents in question have been withheld in their entirety, while others have been released with redactions. The SEC is withholding information under FOIA Exemptions 3, 4, 6, and 7(C). Plaintiff also alleges that the SEC has failed to conduct an adequate search, and in particular, he challenges defendant's failure to produce his original personnel file. Before the Court are cross-motions for summary judgment.

BACKGROUND

The backdrop of this dispute has been thoroughly explored by the Senate Committee on the Judiciary and the Senate Committee on Finance. These Committees released a detailed report on August 3, 2007, based on an extensive joint investigation into "allegations of lax enforcement, improper political influence, whistleblower retaliation and related matters involving" the SEC. (S. Rep. No. 110-28 at 1 (2007) [hereinafter "Report" or "S. Rep. __"].) The Report contains the Committees' findings and recommendations based on their review of some 10,000 pages of documents, over 30 witness interviews and three Judiciary Committee hearings in July, September and December 2006.*fn1 This investigation was undertaken as a result of plaintiff's complaints that he was thwarted by his superiors in his investigation of Pequot and its relationship to the current Morgan Stanley Chief Executive Officer John Mack, and ultimately, that he was fired in retaliation for his whistleblowing activities. (Id.) Because of the importance of understanding the dispute between the parties, as well as plaintiff's legal argument that the public interest in disclosure of the withheld records outweighs any privacy interest under Exemptions 6 and 7(C), the Court must provide a detailed summary of the evidence presented to the Senate Committees and their findings, and to begin this story, it will describe the activities of Pequot, its Chairman and CEO Arthur Samberg and their relationship to John Mack.

I. Pequot

A. Suspicious Trading Activity Regarding General Electric and Heller Financial

Pequot, a large investment advisory firm that manages over $15 billion in assets, is run by Arthur Samberg, its Chairman and CEO. (S. Rep. 15.) Beginning on July 2, 2001, Mr. Samberg directed his traders to aggressively buy shares of Heller Financial stock. (Id. 15, 47.) In fact, from July 2 to July 27, he "attempted to purchase many more shares of Heller than his traders could safely execute without driving up the price." (Id.) On six days during this period, the number of shares sought by Pequot exceeded the total volume of Heller shares traded, and on two days, the number of shares sought was more than twice Heller's daily volume. (Id. 47.) Pequot had no position in Heller at the beginning of the month, but by July 27th, it was "long" 1,148,200 shares.*fn2 (Id.)

On July 25, 2001, at a time when Pequot had amassed a large long position in Heller, it began selling short General Electric ("GE") stock.*fn3 (Id. 47.) Pequot shorted over 1.5 million shares of GE during the three-day period from July 25 to July 27. By the close of business on Friday, July 27, Pequot was poised to profit if the price of Heller increased or if the price of GE decreased.

On the following Monday, July 30, GE announced its plan to acquire Heller. (Id.) As often happens when an acquisition is announced, the stock price of the acquiring company (GE) decreased while that of the target company (Heller) increased. (Id. 15.) Pequot was positioned to profit from the news of the acquisition: both its long position in Heller and its short position in GE increased in value. Mr. Samberg sold all of his Heller stock on the day of the announcement by GE, and on the following day, he covered his short position in GE. (Id. 47.) Pequot made approximately $18 million from its trades involving Heller and GE. (Id. 15.)

Given this suspicious trading activity, there was reason to suspect that Mr. Samberg had inside information about GE's plan to acquire Heller. As noted in the Senate Report:

When an acquisition is announced, the price of the purchasing company typically falls, and the price of the purchased company typically rises. In this case anyone with knowledge of the deal before it was announced could purchase Heller and short GE for virtually guaranteed profits. (Id. 15.) If Mr. Samberg did have prior knowledge of the GE-Heller deal, he profited from material, non-public information in violation of federal insider trading laws.*fn4 (Id.)

In the eyes of the Senate, Mr. Samberg failed to adequately explain his motivation for these trades. When he first testified at a deposition at the SEC on May 3, 2005, Mr. Samberg cited several reasons why he purchased Heller stock in July 2001. (Id. 23.) However, the SEC soon learned that all of these purported motives had appeared in a Legg Mason analyst report, which Mr. Samberg had only reviewed in preparation for his SEC testimony. (Id.) During his second deposition on June 7, 2005, Mr. Samberg conceded that he had not read the Legg Mason report, or any other analyst materials, prior to ordering the trades. (Id.) In addition, this conduct was contrary to Pequot's regular decision-making practice of relying on a "research driven approach" prior to making trades. (Id. 16, 23.) Yet, as explained in more detail below, the SEC cut short its investigation into this matter.

B. Pequot's Other Suspicious Trades

The incident involving Heller and GE was not the first time that Pequot had engaged in suspicious trading activity. Three months earlier, in April 2001, Mr. Samberg had a series of e-mail exchanges with Microsoft employee David Zilkha, who was about to leave Microsoft to join Pequot. (Id. 20.) Mr. Samberg asked Mr. Zilkha if he had any "tidbits" about Microsoft, and Mr. Zilkha replied, "I heard this afternoon from the MSN finance controller that our CFO has been more relaxed before this next earnings release than he has been in the last year. Augurs well." (Id. 21.) Two days later, Microsoft reported earnings that beat Wall Street's estimates, and the stock rose significantly. (Id.) Mr. Samberg, having realized a profit of $1.6 million from recent Microsoft trades, wrote Mr. Zilkha, "I shouldn't say this, but you have probably paid for yourself already!" (Id.) Despite the seemingly damning nature of this communication, the SEC closed its investigation into this incident, concluding that it was unworthy of an enforcement action. (Id. 44.)

Pequot also engaged in suspicious trading prior to a court ruling in a drug patent case. In October 2002, a federal district court ruled that Par Pharmaceutical had infringed the drug patents held by AstraZeneca. (Id. 19.) As a result of this decision, AstraZeneca's stock price rose significantly while Par Pharmaceutical's price fell. (Id.) The New York Stock Exchange ("NYSE") reported suspicious trading by Pequot in both stocks prior to the court's ruling. (Id. 20.) While the U.S. Attorney's Office in the Southern District of New York investigated whether a judicial law clerk had leaked the outcome of the case (id.), the SEC declined to investigate the situation (Id. 45).

In yet another instance of possible improprieties, the SEC's Office of Market Surveillance investigated Pequot's use of wash sales in 2005. (Id. 18.) A wash sale occurs when an investor both buys and sells the same security at the same price within a short period of time. (Id.) While wash sale trades are not per se illegal, they are sometimes used for "illegitimate accounting, tax, or market manipulation purposes." (Id.) After reading a memorandum describing Pequot's wash sales activities, an Associate Director at the SEC noted, "This memo describes some wild and troubling trading. The wash sales may be manipulative or fraudulent. . . . Either case involves potential SEC or [NASD]*fn5 rule violations." (Id. 19.) Despite these concerns, the SEC closed the case without action. (Id.)

II. John Mack

John J. Mack is currently the Chief Executive Officer and Chairman of the Board of Morgan Stanley, one of the world's largest financial services firms. Mr. Mack has spent most of his career at Morgan Stanley, rising up the ranks to the position of President and COO in May 1997. He left the firm in March 2001, and became CEO of Credit Suisse First Boston in July of that year. He stayed at Credit Suisse until June 2004, and in June 2005, he briefly served as Chairman of Pequot. Mr. Mack returned to Morgan Stanley in June 2005 to assume his current title of Chairman and CEO. See Morgan Stanley, Annual Report (Form 10-K), at 12 (Jan. 28, 2008).

A. John Mack's Connection to the GE-Heller Acquisition

Mr. Mack had strong ties to the two firms that were handling the GE-Heller acquisition --Morgan Stanley and Credit Suisse First Boston. (S. Rep. 24.) At the time that Mr. Samberg ordered the Heller stock purchases, Mr. Mack had recently left Morgan Stanley, and he was being considered for the position of CEO at Credit Suisse First Boston. (Id.) Both of these firms would have possessed material, non-public information about the transaction prior to its public announcement. (Id.)

B. John Mack's Connection to Pequot

John Mack was a "close associate" of Mr. Samberg and an investor in Pequot. (Id. 24.) On May 11, 2001, Mr. Samberg wrote an e-mail describing Mr. Mack's interest in making additional investments in Pequot: "John Mack would like to put $5mm into Partners [a Pequot fund] at the 1st available opening. He'd also like to put more $into Scout [another Pequot fund], if that's possible, and would like a recap of what he has where." (Id. 25.) On June 20, 2001, less than two weeks before Mr. Samberg started buying Heller stock, Mr. Mack lobbied Mr. Samberg for the opportunity to invest in a start-up company with the code name "Fresh Start." As Mr. Samberg noted in an e-mail to a Pequot employee, "I'm sitting here with John Mack and . . . John is busting my chops cuz he hasn't gotten the Fresh Start material yet." (Id.)

C. John Mack's Phone Call to Arthur Samberg

John Mack was meeting with senior officials at Credit Suisse (Credit Suisse First Boston's parent company) in Switzerland from June 26 to June 28, 2001. (Id. 11.) Upon his return, on June 29, 2001, Mr. Mack called Mr. Samberg. (S. Rep. 25.) Two things happened after this telephone conversation. First, Mr. Mack was allowed to invest $5 million in Fresh Start. He was the only individual investor to be given this opportunity. (Id.) Second, on the following Monday Mr. Samberg made large purchases of shares in Heller. Mr. Mack's investment in Fresh Start proved to be very profitable; he more than tripled his money in less than a year. (Id. 25-26.) Mr. Mack later claimed that it was Mr. Samberg who solicited his investment in Fresh Start because Pequot had reached the maximum limit that it could invest in the company. (Id. 41.) However, several Pequot principals, including Mr. Samberg's own son, were unhappy about sharing the deal with Mr. Mack, and according to Mr. Samberg's e-mails, Mr. Mack had been lobbying aggressively for the opportunity to participate in Fresh Start. (Id. 25.)

D. SEC's Slow Response in Pursuing John Mack's Testimony The Senate Report determined that there were several convincing reasons to suspect that John Mack told Arthur Samberg about the GE-Heller deal before that information became public:

Mack was a close associate of Samberg and an investor in Pequot funds. Mack was thus in a position to share in any profits the funds might make by trading on inside information. Mack also had been in employment negotiations with a firm working on the deal at the time of the trades, which meant he might have had an opportunity to learn of the GE-Heller acquisition before the public announcement. Moreover, an e-mail from Samberg indicated that he had spoken to Mack on June 29, 2001. Samberg began directing large purchases of Heller stock on the next trading day. (Id. 24-25.) Nevertheless, as explained in more detail below, the SEC resisted plaintiff's efforts to take Mr. Mack's testimony. (Id. 26.) In fact, it was not until this matter was publicly exposed in a front-page New York Times article on June 23, 2006,*fn6 that the SEC began to re-evaluate Mr. Mack as a potential tipper. (Id. 39.) Nonetheless, the SEC did not depose Mr. Mack until August 1, 2006, five days after the statute of limitations for civil and criminal penalties had expired. (Id. 41.)

III. Plaintiff's Role in the Pequot Investigation

A. Plaintiff's Path to the SEC

In 1968, Gary Aguirre earned his law degree from the University of California, Berkeley.

(Id. 55.) After working as a public defender for several years, he embarked upon a long career in private practice and ultimately became a partner at Aguirre & Eckmann. (Id.) After a brief retirement, Mr. Aguirre enrolled in Georgetown University Law Center's LL.M. program in 2001. (Id.) Upon graduation Mr. Aguirre applied unsuccessfully for employment at the SEC twenty-three times. (Id.) Mr. Aguirre filed a complaint with the EEO office of the SEC alleging age discrimination. (Id.) Soon after the complaint was filed, the SEC extended a job offer. (Id.) Mr. Aguirre joined the SEC's Enforcement Division on September 7, 2004. (Id. 56.)

B. Plaintiff's First Disagreement with SEC Management Leads to a Branch Transfer

Mr. Aguirre initially worked under Branch Chief Charles Cain and Assistant Director Richard Grimes. (Id. 56.) One of his first assignments was to prepare a draft formal order memorandum for the Pequot insider trading investigation. (Id.) The formal order is significant because it is the document that authorizes the SEC to conduct a full-fledged investigation. (Id.) On October 6, 2004, Mr. Aguirre sent a draft order to Branch Chief Charles Cain with the following language: "over the past two years, SROs [i.e., self-regulatory organizations such as the New York Stock Exchange] have referred or 'highlighted' at least six matters involving possible insider trading by the Pequot Management and one or more of Pequot Funds to the Division of Enforcement." (Id.) Mr. Cain edited the draft by replacing Mr. Aguirre's language with the following: "subsequent investigation by the staff identified at least six transactions involving possible insider trading by the Pequot Management and one or more Pequot Funds." (Id.)

Mr. Aguirre told Mr. Cain that his revision was inaccurate because the SROs, not the SEC, had initially uncovered Pequot's suspicious activities. According to Mr. Aguirre, Mr. Cain responded that "the memorandum was not going to state that Joe Cella [The Director of Market Surveillance] had been informed but had failed to act." (Id. 56.) Mr. Aguirre expressed his concerns in an e-mail to Mr. Cain and Mr. Grimes:

The proposed revisions . . . [are] unsupportable. Neither I nor anyone on the staff has discovered an insider trading transaction involving Pequot. Yes, I have prepared a spreadsheet of suspected Pequot insider trading activity since 1999 . . . in each one of those 11 cases, an SRO identified the transaction and referred it to Enforcement (Market Surveillance), where it stopped. Under these circumstances, the quoted revision is not merely unsupportable; it could be the source of embarrassment or worse for each of us. (Id.) Mr. Grimes eventually accepted Mr. Aguirre's language, but this incident led plaintiff to request a transfer on January 10, 2005, to the section headed by Mark Kreitman, his former Georgetown Law professor. (Id. 56-57.) Mr. Aguirre was transferred approximately one week later. (Id.)

C. Plaintiff Encounters Resistance in Investigating

Pequot Senior management at the SEC narrowed the scope of the Pequot investigation during its early stages. In early 2005, SEC Enforcement Director Stephen Cutler met with Pequot's lead counsel, Audrey Strauss. (Id. 17.) The staff attorneys working on the case, including plaintiff, were excluded from this meeting. (Id.) Later, in early February 2005, Assistant Director Mark Kreitman ordered that the Pequot investigation be narrowed to two or three matters. (Id.) This was significant because the SEC had just obtained subpoena power, but subpoenas had yet to be issued. (Id.) Plus, the self-regulatory organizations ("SROs") had identified between 17 and 25 suspicious incidents involving Pequot. (Id.) Mr. Kreitman and his supervisor, Associate Director Paul Berger, defended the decision as a "triage" given the SEC's limited resources. (Id.) However, a retired SEC official testified before the Senate that a narrow scope makes it difficult to demonstrate an illicit pattern, which is particularly important in hedge fund investigations:

A hedge fund is an entity that has a whole bunch of other people's money and invests in all kinds of different securities. So if you go in and say, I think, Hedge Fund A, you engaged in insider trading in IBM, they will open their files and say, we make two million trades a year, and so what if we got lucky on IBM? It's very difficult to prove a case where they've got that kind of trading history all over the board. So what you do, from an investigative standpoint, is you see whether there's a pattern there. . . . So hedge funds are different than the ordinary investigation. (Id. 16-17.) Nevertheless, the SEC declined to investigate many of the leads from the SROs, and instead, it limited its focus to the trades involving GE and Heller, Microsoft, and AstraZeneca and Par Pharmaceutical. (Id. 18-21, 42.)

D. Plaintiff Receives Positive Performance Evaluations and a Merit Pay Increase

On June 1, 2005, Mr. Kreitman evaluated Mr. Aguirre's performance from October 2004 to April 2005. The evaluation covered four areas: knowledge of field or occupation, planning and organizing work, execution of duties, and communications. (Id. 57.) There were two rating choices for each category: "acceptable" or "unacceptable." (Id.) Mr. Kreitman gave Mr. Aguirre an "acceptable" rating in each category, which qualified him for a merit pay increase. (Id.)

Branch Chief Robert Hanson, who reported to Mr. Kreitman, sent a separate evaluation of Mr. Aguirre to the Enforcement Division's Compensation Committee on June 29, 2005. (Id. 57.) This evaluation consisted of four levels of recommendations, in decreasing order of praise: "(1) made contributions of the highest quality, (2) made contributions of high quality, (3) made contributions of quality, and (4) made no significant contribution beyond an acceptable level of performance." (Id.) Mr. Hanson said that Mr. Aguirre "made contributions of high quality" and described Mr. Aguirre's performance in glowing terms:

Gary worked extremely hard on one investigation during his time in the group, a significant matter involving the trading by Pequot Capital, one of the nation's largest hedge funds. Gary has an unmatched dedication to this case (often working well beyond normal work hours) and his efforts have uncovered evidence of potential insider trading and possible manipulative trading by the fund and its principals. He has been able to overcome a number of obstacles opposing counsel put in his path on the investigation.

Gary worked closely with the Office of Compliance Inspections and Examinations to develop the case and worked with several self-regulatory organizations to develop a number of potential leads. He has consistently gone the extra mile, and then some. (Id.)*fn7 On August 21, 2005, Mr. Aguirre received a raise from $130,257 to $134,110. (Id. 58.)

E. SEC Management Resists Plaintiff's Efforts to Depose John Mack

On June 27, 2005, Mr. Aguirre wrote an e-mail to Mr. Hanson identifying John Mack as a potential tipper. (Id. 26.) Mr. Aguirre noted that Mr. Mack "likely had the GE-HF info sources, he had contacts with Samberg during the period, there was quid pro quo, mutual trust existed, and Samberg needed a huge favor." (Id.) Mr. Aguirre asked for permission to take "Mack's testimony [to] simply nail down whether he will admit that he knew about the GE/HF acquisition from any source." (Id.)

However, around the same time that Robert Hanson was praising Mr. Aguirre for his "unmatched dedication" to the Pequot investigation, he was resisting plaintiff's efforts to depose John Mack. In fact, Mr. Hanson's boss, Mark Kreitman, and his boss, Paul Berger, were also opposed to the idea. (Id. 26.) Mr. Kreitman wanted definitive proof that Mr. Mack had prior knowledge of the GE-Heller deal before proceeding with his testimony. Mr. Kreitman said that establishing when Mr. Mack first learned about the acquisition was "the necessary prerequisite to [issuing] a subpoena to Mack." (Id. 32.) When the Senate Committees asked a 30-year SEC veteran about Mr. Kreitman's position, he said, "[Y]ou're not going to prove your case and then go talk to these people. I don't understand the justification for waiting." (Id. 33.) The Senate Report determined that Mr. Kreitman's prerequisite requirement was "an arbitrary requirement, which (1) was not required ...


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