• a cease-and-desist order; disgorgement;
• a third-tier civil money penalty of $120,000; and
• investment adviser and investment company bars.  

Cast of Characters 

David E. Zilkha

After earning an MBA in 1998, Zilka worked at Microsoft from 1998 to until May 7, 2001. Interested in employment in the investment advisory field, Zilka interviewed at several firms, including Pequot. Pequot extended him an offer of employment on February 28, 2001, and Zilkha gave notice to his manager at Microsoft on Friday, April 6, 2001. 

Zilkha began employment at Pequot on April 23, 2001, where he remained until his termination by Samberg in November 2001. After sporadic employment until March 2004, Zilka has not been employed in the financial industry since then.

Arthur J. Samberg

Samberg was the chairman and chief executive officer of Pequot. Samberg and Pequot entered into settlements of charges arising out of a civil action brought by the Commission and an administrative proceeding. SEC v. Pequot Capital Mgmt., Inc., No. 3:10-cv-00831-CFD (D. Conn. June 2, 2010) ; Pequot Capital Mgmt., Inc., Advisers Act Release No. 3035 (June 8, 2010).

 In the court proceeding, the court:

• enjoined Pequot and Samberg against violating Exchange Act Section 10(b) and Rule 10b-5,
• ordered them to disgorge over $15 million plus prejudgment interest, and
• fined each $5 million.

 In the administrative proceeding:

• Pequot was censured
• Samberg was barred from association with any investment adviser, with the proviso that he could participate in the wind down of Pequot. 

Mark Spain

Mark Spain (Spain) was a regional technology specialist in Microsoft’s U.S. Sales and Services division, and was Zilkha’s neighbor. Microsoft fired Spain when the events at issue came to light. Spain was not called as a witness; he advised that he would assert his Fifth Amendment privilege against self-incrimination and decline to answer any questions.

Pequot

Since 1998, Pequot is an SEC-registered investment adviser. 

Microsoft

Microsoft is a public company that trades on the NASDAQ under the symbol “MSFT” and its fiscal year ends on June 30.

 Job Hunting

During January 2001, Zilkha had employment interviews with:

• Goldman Sachs,
• Fidelity Ventures,
• Alliance Capital,
• Galleon Group,
• Lazard Asset Management (Lazard), and
• Pequot

On February 28, 2001, Samberg offered Zilkha a vice presidency at Pequot, at a salary of $250,000 plus a minimum 2001 bonus of $250,000 and various benefits and moving expenses. Although Zilkha was considering a similar offer from Lazard and another offer from Alliance Capital, he accepted Samberg’s offer on March 4, 2001, with an April 23, 2001 start date.

Employment Overlap

Oddly, there was an overlap in Zilka’s employment at Pequot and Microsoft, and he was mutually employed from April 23 through May 7.

Although Zilka was on vacation from Microsoft from December 2000, followed by various forms of leave, and ending on his termination date of May 7, 2001, he:

• had access to Microsoft’s premises;
• used the company’s e-mail server during that time
• had his Microsoft laptop and cell phone;
• was able to use his Microsoft e-mail account and access Microsoft’s intranet; and
• was receiving e-mails related to Microsoft business activities

Talk To Me About Microsoft

During the Pequot interview process, Samberg specifically sought information from Zilkha about Microsoft.  On February 28, the same day he extended the offer of employment, Samberg e-mailed Zilkha, expressing the view that tech stocks were oversold and that might be a buyer of Microsoft – and then asked “do you have any current views [on Microsoft] that could be helpful? might as well pick your brain before you go on the payroll!!”

Notably, Microsoft’s third quarter ended on March 31, and Zilkha knew that Microsoft would announce its third quarter earnings in the middle of April.  Shortly thereafter, Zilkha contacted Microsoft colleagues Edison Yu (“Yu”)and Spain from his Microsoft e-mail address. Zilkha’s claimed that neither he, nor the two colleagues, nor any employee at their level in the company, had material non-public information — a position that the SEC did not accept and views as what I would characterize as absurd, if not preposterous.

Yu did not reply to Zilkha’s question about Microsoft but, rather, congratulated Zilkha on his new job and suggested they have lunch.  Spain replied the next morning that “march was the best march of record. made up the shortfall in us sub. w2k pro major contributor. on track for revised forecast.”

One question. Two responses. The proverbial fork in the road. Yu turns right to safety. Spain turns left to his own nightmare. 

Update

Subsequently, Zilkha told Samberg to buy more Microsoft. Further, after visiting his offices at Microsoft, where he still had his badge and access, Zilkha supplemented his prior response with “I heard this afternoon from the MSN finance controller that our CFO has been much more relaxed before this next earnings release than he has been in the last year. Augurs well.” 

On April 19 Microsoft issued its earnings announcement, reporting unexpectedly strong quarterly revenue and growth, in large part due to  Windows 2000 Professional.

Ca-Ching!

Between Monday, April 9, and Friday, April 20, 2001, (the day after Microsoft’s earnings announcement), Samberg engaged in a series of Microsoft transactions that netted him, Pequot, and Pequot funds more than $14 million in gains. On April 20 Samberg e-mailed Zilkha, “i shouldn’t say this, but you have probably paid for yourself already!” 

Back to the Well

On April 24 and thereafter, Samberg e-mailed Zilkha asking for further guidance on the Microsoft position. Zilkha continued to contact Microsoft employees during April, May, and June and provide updates on ongoing launches of the Windows product and possible acquisition of Internet Service Provider Earthlink, which he thought was not being viewed favorably. Zilkha used his Microsoft email address and laptop for some of these queries. In June, Zilkha was advising that Microsoft managers were confident of a blow-out quarter.

The Cold Shoulders

Around mid-June or July, Zilkha’s Microsoft contacts stopped returning his calls. Also around that time, Samberg stopped asking for Zilkha’s input and essentially turned his back on him. On September 25, Samberg informed Zilkha that he would be let go, and he was terminated on November 16 with a prorated salary of $173,000 and an agreement to pay him a $250,000 bonus.

Not Going Quietly

It appears that Zilkha believed that he was hired to provide legitimate research analysis about software companies and to report to and be mentored by Jerry Schendel, Pequot’s technology portfolio manager. However, on Zilkha’s first day at Pequot, Schendel told Zilkha that he was not consulted on Zilkha’s hiring and had no interest in him, preferring to hire his own software analyst. While at Pequot, Zilkha received no mentoring or training and worked directly for Samberg.  According to the SEC, Samberg’s sole purpose in hiring Zilkha was to obtain material non-public information on Microsoft, and that he was fired when he could no longer further that illegal goal. 

At the time Samberg notified Zilkha that he would be terminated, Zilkha prepared a spreadsheet containing all of the recommendations he had made concerning various securities and calculating the profits that would have resulted. Although in November 2001, Zilkha started searching for litigation counsel to bring suit against Samberg and Pequot for fraudulently inducing him away from his offers at Alliance Capital and Lazardin November 2001, it wasn’t until 2003 or 2004 he retained a lawyer. but through the machinations of his ex-wife, a court ordered the legal retainer turned over to her divorce attorneys. Consequently, on advice of counsel, Zilkha suspended his plan to sue Samberg during the 2005-2006 investigation of Pequot; however, after that investigation was closed, he pursued his lawsuit. 

According to a 2007 draft complaint alleged, Zilkha’s lawsuit alleged that Samberg had failed to live up to his representations that Zilkha would be trained, mentored, and integrated into a software analyst team. There were additional allegations that Samberg “continued to ask Zilkha to obtain information from his contacts at MSFT and to ask Zilkha for his opinion of MSFT stock based on this information. Zilkha observed that Samberg acted on his MSFT recommendations only when they appeared to be based on information obtained from MSFT employees.”

Settlement

On April 30, 2007, Zilkha entered a confidential settlement for $2.1 million, to be paid in three annual payments. Samberg paid the first two payments, totaling $1.4 million, but refused to make the final payment. Zilkha is pursuing the final $700,000 in arbitration. 

Hell Hath No Fury Like . . .

In approximately January 2009, the SEC received material made available by Zilkha’s ex-wife, including April 7-8, 2001e-mails with Spain.  Zilkha was asked whether he currently had a copy of the April 8 Spain e-mail, whether he had a copy during 2005 and 2006, and whether he tried to keep that document from being produced to the SEC.  On the advice of counsel, he invoked his Fifth Amendment privilege against self-incrimination and did not otherwise answer those questions, among others.  

SIDE BAR: As testimony apparently confirmed, in August 2003 a computer forensics examiner was hired by Zilka’s wife’s attorneys to examine their home computer for e-mails related to possible infidelity.

The forensics examiner made a copy of the hard drive to examine at his office, and, at her request made a second copy on a new 30 gigabyte hard drive. The new 30 gigabyte hard drive was installed in the computer, and she retained the original 12 gigabyte hard drive in her possession.

In January 2004 a new operating system was installed on the computer, which had the effect of removing e-mails that were on the hard drive from retrieval by the lay computer user.

In January 2009, during continued legal proceedings related to the divorce, Zilkha’s ex-wife made the original 12 gigabyte hard drive available and it came into the hands of SEC staffers. The 30 gigabyte copy, which had been in Zilkha’s possession, was examined by the two experts in 2009 and 2010, and no trace of the Spain e-mails was found by either (except for the hiberfil.sys file that noted the previous location on the 30 gigabyte hard drive of e-mails and e-mail profiles that were found on the original 12 gigabyte hard drive). 

SIDE BAR: At this late date, it is impossible to determine whether the e-mails were available to Zilkha during the 2005-2006 investigation so as to conclude that he intentionally withheld them. The e-mails could have been effectively deleted by the installation of the new operating system in January 2004, or intentionally deleted before or after that time and then overwritten such that it would be impossible for a forensic expert to find evidence of their existence several years later. 

Initial Decision

Based upon the above issues and others, the Division sought a

• cease-and-desist order,
• disgorgement of $2,523,000 plus prejudgment interest,
• a civil money penalty of $120,000, and
• investment adviser and investment company bars.

On April 13, 2011, SEC Administrative Law Judge Carol Fox Foelak issued an initial decision (now pending review by the SEC) In The Matter Of David E. Zilkha (Initial Decision #415, Administrative Proceeding File No. 3-13913, April 13, 2011, ALJ Carol Fox Foelak).  The Initial Decision ordered that Zilkha:

• CEASE AND DESIST from committing or causing any violations or future violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder;
• DISGORGE $250,000 plus prejudgment interest