Corporate Governance

Communicating with the Division of Enforcement (Part 1)

By J. Robert Brown

We have been slow in digesting the reports issued by the Inspector General at the SEC.  Today we look at the report on Gary Aguirre, the staff attorney who was working on an insider trading investigation centering around purchases of shares by Pequot Capital Management, a hedge fund.  The fund bought shares of Heller Financial just before its acquisition by General Electric.  The investigation included the role played by John Mack, who, in 2005, became the Chairman and CEO of Morgan Stanley. 

The Inspector General examined whether John Mack received preferential treatment and whether Aguirre was fired in retaliation for his complaints about the preferential treatment.  In addition, however, the Inspector General also examined whether the senior enforcement officials "improperly" provided Morgan Stanley with nonpublic information about the Pequot investigation.  This is the portion of the report that we will examine in a number of posts.

During the course of the investigation, Mack was under consideration to become the CEO of Morgan Stanley (he was then the CEO of CSFB).  As part of the investigation, a subpoena had been issued that requested emails from Mack, suggesting that his behavior was under scrutiny.  This apparently caused concern at Morgan Stanley and resulted in calls to the Commission to try to uncover the status of the investigation with respect to Mack.

In late June 2005, Aguirre received a call from Eric Dinallo, the managing director for regulatory affairs at Morgan Stanley.  With Mack under consideration as CEO, Dinallo was trying to find out whether Mack was a target and if so, the seriousness of the claims.  Aguirre told Dinallo nothing about the investigation and informed his superiors about the call. Discussions occurred among Aguirre's branch chief, assistant director, and associate director.  According to some of the testimony set out in the Report, Paul Berger, the associate director, "was adamant in saying absolutely not [to say anything to Dinallo] and instructed [the assistant director] not to do that."  Report, at 73.

Despite the apparent instructions, Dinallo in fact received a call from the SEC, with the call coming from Paul Berger.  According to the Report, Berger denied informing Dinallo about the investigation.  "Berger was asked if he implied that the SEC did not presently have evidence of any wrongdoing by Mack, and replied 'no,' and that he 'was specifically trying to stay away from conveying anything that would suggest that they take from the conversation that they can make a business decision based on what the SEC is doing." 

The Report, however, also quoted a presentation prepared by Mary Jo White, the former US Attorney from the Southern District of New York and a partner at Debevoise, for the Morgan Stanley Board, apparently based upon conversations with Dinallo.  "The response [from Paul Berger] was that the SEC was looking at Mr. Mack, among others, as part of their investigation, primarily based on what they had seen in e-mail traffic, but implied that they did not presently have evidence of any wrongdoing by Mr. Mack."  When reading the language in the presentation, Dinello stated:  "I think that's exactly what my conversation with Paul Berger was about."

The exchange contains a number of issues.  There is obviously a dispute about what was transmitted during the conversation.  The disagreement is understandable.  Clearly Berger didn't come out and say that Mack wasn't a target.  The issue seems to be one of tone, something that can easily be misread.

The more serious concern are the hints at a possible conflict of interest.  The communications between Morgan Stanley and the Commission took place in June 2005.  The Morgan Stanley Board had retained Debevoise to engage in due diligence on the hiring of John Mack.  See Report, at 75.  The Report noted that in September 2005, Berger "authorized the friend to mention his interest in a job with Debevoise," Report at p. 3, and lists Berger as a partner at Debevoise. See Report at p. 8. 

The Report does not, however, address these circumstances.  As the Report notes:  "allegations regarding former Associate Director Paul Berger's improper contacts with the law firm of Debevoise & Plimpton and the failure to recuse himself from the Pequot investigation were not addressed because Berger no longer works for the Commission." 

Full post as published by The Race to the Bottom on November 03, 2008 (boomark / email).