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NYBob

08/03/06 12:31 AM

#58 RE: Telephonics #56

allege fraud by the world's largest "prime brokers" in securities lending practices -

San Gabriel Valley Tribune
July 19, 2006

Two class-action lawsuits filed in Manhattan federal court
in April allege fraud by the world's largest "prime brokers"
in securities lending practices.

Goldman Sachs, Bear Stearns, Lehman Brothers, Morgan Stanley,
Merrill Lynch, Citigroup, Banc of America Securities, Credit
Suisse, Deutsche Bank Securities, UBS Financial and
Bank of New York allegedly charge high fees to lend
securities for short selling, but fail to deliver the securities
sold short by hedge funds.

On June 28, the Senate Judiciary Committee held a hearing in
Washington, D.C., on hedge fund relations with independent
research firms. That hearing's star witness was Gary Aguirre.
Until September 2005, Aguirre was the Securities & Exchange
Commission's senior counsel leading its most important
investigation of illegal trading by a hedge fund.

Aguirre told the Judiciary Committee that SEC's investigation of
Pequot Capital Management (a $7 billion hedge fund) began after
18 reports of suspected insider trading from self regulating
organizations (SROs), such as NASD or NYSE.
After he interviewed dozens of witnesses, Aguirre says,
his SEC superiors allowed him to take the evidence to
the U.S. Attorney for criminal prosecution, and to
subpoena the central target of insider trading cases -
the "tipper."

But Aguirre testified that his attempt to take sworn
testimony of the "tipper" was derailed after he revealed
the primary suspect to be John Mack. At the time, Mack
was being recruited as the CEO of Morgan Stanley.

Aguirre says his SEC superiors told him Mack's political
connections were so powerful he should not be subpoenaed.
When Aguirre persisted in contacting SEC's higher officials,
he was fired. Aguirre's firing occurred within weeks after
he received a two-step pay increase and an award for
excellent performance.

Upon firing Aguirre, the SEC informed Morgan Stanley the
agency had no interest in Mack. Mack was hired as Morgan
Stanley's CEO, and was pictured in a June 28 Wall Street Journal
feature as an icon of the investment world.

Morgan Stanley is a named defendant in the two class-action
suits against prime brokers alleging intentional failure to
deliver shares sold short by its clients.

Aguirre says hedge funds tend to flock, or "swarm," to
profitable trading tactics, including illegal insider
trading and naked short selling.

The SEC warned Aguirre against testifying at the Judiciary
Committee hearing and demanded return of all documents
relating to his work at the agency, threatening civil
suit and criminal prosecution.

Revealing a contest of Senate authority, the Senate Banking
Committee delivered a letter to the Judiciary Committee
asserting exclusive jurisdiction over the SEC.
Charles Schumer, New York's senior senator and a member
of the Banking Committee, appeared at the June 28
Judiciary hearing to deliver the same message.

Judiciary chairman Arlen Specter encouraged witnesses at the
June 28 hearing to bypass the SEC by filing complaints of
illegal trading activities directly with a U.S. Attorney's
Office of the Justice Department. Two witnesses said they
will do so.

Aguirre told Specter that a high-powered attorney for Morgan
Stanley went over his head in seeking SEC clearance of John
Mack. That attorney was Mary Jo White, who served as U.S.
Attorney in the Southern District of New York during the Clinton
administration.

As U.S. Attorney, White was responsible for investigating
Clinton's pardons of felons, including tax evader Marc Rich,
at the end of his second term as president. White closed
those investigations without indictments.

When prime brokers and hedge funds fail to deliver shares
sold short, buyers ordinarily are unaware they receive
only electronic entry of shares for their money paid. Depositary
Trust & Clearing Corporation (DTCC) allows
the funds to be cleared to the seller without actual
delivery of shares.

The suits filed in federal court by Electronic Trading Group
and Quark Fund LLC allege this illegal practice has occurred
widely since at least April 2000.
The SEC has been ineffective in stopping the unlawful
practices, and Aguirre's testimony indicates why that may be the
case. At a public hearing July 12, the SEC voted to consider
minor changes in its Reg SHO,
a regulation adopted in 2004 that has been ineffective in
eliminating or punishing failures-to-deliver shares sold short.

The Senate Banking Committee appears reluctant to remedy risks
to investors arising from millions of "phantom" shares sold
but not delivered. So far, financial press reports of the
June 28 Judiciary Committee hearing have downplayed concerns
that hedge funds are causing investor risks in the markets.


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