NEW YORK -- A former lawyer at the U.S. Securities and Exchange Commission told a Senate hearing yesterday that his superiors at the commission blocked an insider trading investigation involving a major hedge fund when it threatened to involve the current chief executive officer of Morgan Stanley, John Mack.
In hearings at the Senate Judiciary committee, Gary Aguirre told the commission that he was fired from the federal regulatory commission after he refused to halt an investigation that pointed to a massive insider trading scandal at a $7-billion (U.S.) hedge fund, Pequot Capital Management.
The SEC, Morgan Stanley and Pequot have all denied Mr. Aguirre's version of events, which came as the committee launched a probe into the secretive $2.4-trillion hedge fund industry.
In other testimony, Connecticut Attorney-General Richard Blumenthal urged Congress to fashion new regulations governing the sector, saying Biovail Corp.'s allegations in a lawsuit against a Connecticut fund and an independent research firm highlight the potential for abuse.
Mr. Aguirre, who was a long-time trial lawyer before joining the regulator, slammed the SEC for its failure to rein in the hedge fund sector, which he said thrives as a result of client relationships and the regular flow of insider information from major investment banks.
"No legislation or regulation can protect market participants from hedge fund abuse unless the SEC does it job," he said. "By any measure, it has not."
He said he was part of a major probe into insider trading by Pequot Capital Management, which was halted when he suggested issuing a subpoena to Mr. Mack, who is a major Republican fundraiser. He said he was told Mr. Mack "had very powerful political connections."
In his opening statement, he said he believed Pequot had benefited from insider information on several deals, and that the "tipper" was the chief executive of a major investment bank. He later identified that executive as Mr. Mack.
In a statement released yesterday, Morgan Stanley stated: "No one has provided any evidence that Mr. Mack has engaged in any wrongdoing and Mr. Aguirre provided none today."
SEC officials denied Mr. Aguirre's claims of political interference but said it is against policy to discuss personnel matters.
The committee hearings were originally called to investigate short selling activities by hedge funds and the allegations that they are illegally profiting by commissioning negative research by supposedly independent companies.
Last week, federal courts ruled that, without explicit direction from Congress, the Securities and Exchange Commission has no authority to regulate hedge funds, a move critics claim will leave investors and other market participants more vulnerable to fraud.
Mr. Blumenthal, whose state is home to many of the country's top hedge funds, told Senators that the funds represent a "regulatory black hole." If Congress does not pass legislation empowering the SEC to regulate the investment pools, then the states will do the jobs themselves, he said.
"Federal action is profoundly preferable -- maximizing uniformity, expertise and resources, but the states will fill the void if Congress fails to act," he said.
The Connecticut Attorney-General noted that companies like Biovail and Overstock.com have sued hedge funds and an independent research firm -- Gradient Analytics Inc. -- with claims that the fund managers ordered false and negative reports from Gradient and then colluded in their release to profit from resulting declines in share prices. The allegations have not been proved.
Mississauga-based Biovail filed a $4.6-billion lawsuit in February against Gradient and SAC Management LLC, a major fund controlled by Stephen A. Cohen, and two investment analysts. Armed with affidavits from former Gradient employees, Biovail claimed fund managers worked with Gradient executives to drive down the value of its stock.
SAC and Gradient have denied those claims, arguing that the negative research was merely pointing out weaknesses in Biovail's business plan, and that they were not alone in reporting on those weaknesses nor in shorting the stock.
© 2007 The Globe and Mail. All rights reserved.
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