The Pequot Capital insider trading blow-up can be traced back to Karen Zilkha, the ex-wife of 41-year old Pequot trader David Zilkha. Zilkha is the loose-cannon employee who apparently fed insider information to Arthur Samberg (of Pequot Capital) about his former employer, Microsoft.
Almost every piece of material evidence in the SEC’s case against Pequot and Samberg stemmed from the Zilkhas’ ugly divorce case, in which Karen requested supervision rights every time David visited the children because she believed (and the court agreed) that he could not control his anger.
Thanks to the divorce filings, the SEC discovered that Pequot had agreed to pay David Zilkha $2.1 million in 2007, even though he had been employed with the hedge fund for just 7 months way back in 2001 (from April to November, according to the SEC filing).
Karen had asked that evidence of the payments Zilkha received from Pequot be presented to the court in 2004. The SEC started investigating Pequot’s payments in 2005. According to Bloomberg, the FBI questioned Zilkha twice that year but determined that there was no foul.
Then in 2006, the case re-opened and again, no action was taken. But apparently there had been foul.
Back in 2001, as rumours swirled that Microsoft wouldn’t hit its 3Q earnings estimates, Samberg had sought information from Zilkha, then a Microsoft employee, who had just (that same month) interviewed for an analyst job at Pequot, the SEC alleges in its suit.
According to the filing, Samberg emailed Zilkha while he was still at Microsoft:
im not as impressed with our research on msft. do you have any current views that could be helpful? Might as well pick your brain before you go on the payroll!!
I own some msft… despite recurring indications from knowledgeable people that the company will either pronounce or take guidance down. Any tidbits you might care to lob in would be appreciated
[As an aside, we should note that this is possibly the stupidest email we have ever seen written by an experienced senior executive. If the SEC is representing the email accurately, Samberg was clearly asking for material non-public information, which he then received. And after reading the emails, we are not surprised that Pequot Capital had to close and Samberg had to pay $28 million to settle the case.]
Upon receiving Samberg’s email, Zilkha then asked a Microsoft colleague about the March quarter earnings. The colleague told him that the company would meet or exceed the earnings estimates.
“Any ideas on how the quarter shaped up,” Zilkha asked in one of those emails, according to the filing. And in another email he asked: “Have you heard whether we will miss estimates? Any other info?”
One colleague replied:
march was the best march of record. made up shortfall in us sub. w2k pro major contributor. on track for revised forecast (MYR).
Samberg soon wrote an email to Zilkha congratulating his new hire. It said: “I shouldn’t say this, but you have probably paid for yourself already!” according to the Wall Street Journal. [The second-dumbest email ever written.]
But then, just 6 months later, Zilkha says he was fired.
It’s not clear how much he made during those months, but we suspect it wasn’t enough. Because six years later, in 2007, Zilkha filed an employment-related civil claim against Pequot. That‘s where the $2.1 million payment came from. And that’s why the SEC got suspicious again and began re-pursuing the Pequot case in January 2009.
The SEC discovered, again from evidence found through Zilkha’s divorce proceedings, that Pequot paid Zilkha $1.4 million and planned to pay him the remaining $700,000 at a later date.
They also discovered further evidence, from David Zilkha’s former therapist.
Zilkha had been consulting with therapist Peggy Thomson in order for her to testify about his mental health at his divorce hearing. In her testimony, the therapist had said that when Zilkha stopped providing insider information to Samberg, Samberg fired him.
Much of the divorce case, meanwhile, rested on Zilkha’s ability to control his anger.
In court, his wife had argued that his visitation rights had to be “enjoined” because of perceived dangers, inadequate food, lack of parenting skills and poor judgment. The court ruled that indeed, the behaviour they saw in court indicated that David could not control his anger.
The defendant’s inability to channel his anger resulting in an increased propensity for violence was amply demonstrated in the October 30th incident at the scheduled supervised visitation at the bookstore.
In any event, were it not for Zilkha’s divorce, Pequot’s insider trading might never have been discovered by the SEC.
When the SEC first told Samberg that they planned to pursue charges, Samberg vowed to fight, according to the Wall Street Journal. But he’s since decided to settle. The SEC announced yesterday that Samberg would pay $28 million to settle the case. Having read the emails he wrote to Zilkha, we’re not surprised.