It all comes down to a computer hard drive.
That's what transformed Karen Zilkha v. David Zilkha from a messy divorce case into an insider trading investigation that led to the downfall of a major hedge fund.
Southbury, Conn., resident Karen Kaiser (her remarried name) made headlines last month when the federal government gave her a $1 million whistleblower bounty for finding evidence allegedly implicating her ex-husband and his former employer, the Westport, Conn.-based Pequot Capital Management Inc.
But less has been written about the emotionally charged child custody battle that led to the discovery of computer files, the continuing investigation by the Securities and Exhange Commission and the two attorneys who aided Kaiser.
"[The case] is unbelievable," said Jill H. Blomberg, a family law attorney at Schoonmaker, George & Colin in Greenwich, Conn. "You never know what will happen next."
Blomberg represented Kaiser from the beginning of the divorce proceedings in 2003 through the time the SEC evidence was found in 2008. Stamford, Conn. attorney Mark Sherman has also represented Kaiser, helping her obtain a protective order against her ex-husband, who was charged with assault, and guiding her participation in the SEC probe.
"It's rare that you stumble on [a case] like this accidentally," Sherman said. "It shows that when you get involved in a small criminal matter, it can really escalate into something more substantial."
Zilkha and Kaiser began their married life together in June 1998 after a wedding in Los Angeles.
Their twin children, a boy and a girl who are now 9, were born three years later, and the family lived in Washington state for a time when Zilkha worked for Microsoft. Then they moved to Connecticut, and Zilkha joined Pequot as a trader in 2001. By 2003, the marriage had fizzled and Kaiser commenced divorce proceedings.
In June 2004, there was an incident that complicated the child custody proceedings.
Zilkha was arrested for allegedly punching Kaiser and breaking a bone near her eye. Kaiser claimed that it was an example of the type of physical and verbal abuse that had marred their marriage. But Zilkha stated in an e-mail to the Stamford state's attorney's office that he had been wrongly accused and that their son had "whacked Karen in the face with the back of his head" and fractured the bone.
At this point, Sherman started representing Kaiser, who got a protective order against Zilkha.
Zilkha said Kaiser called police again in December 2004 to report an alleged threat "that I was going to kill her, the kids and myself." Zilkha said she made the statement in an attempt to get a protective order that would keep Zilkha from having contact with his children.
That information was part of an e-mail that Zilkha ultimately sent to Gov. M. Jodi Rell trying to explain what he considered to be unfair treatment in the legal proceedings.
In 2005, Kaiser was awarded a $750,000 settlement in the divorce.
Zilkha's e-mails are cited as evidence that Kaiser "has been subjected to numerous intentional and malicious smear campaigns" by Zilkha, according to a defamation lawsuit that Sherman, Kaiser's attorney, filed against Zilkha in August 2009.
ALERTING THE FEDS
Throughout the post-dissolution proceedings, Zilkha filed multiple financial affidavits so the court could determine how much money should be paid in child support. In January 2008, Zilkha listed a $2.1 million settlement that had never appeared before on any affidavits.
"We were trying to figure out how Karen was going to pay for the kids, and David had been out of work for several years," attorney Blomberg said. "We started to realize that it didn't make sense that David would have $2.1 million coming from anybody."
Thinking back over the course of her marriage, Karen Kaiser recalled that many years before "David had threatened a lawsuit against [Pequot Capital Management CEO] Arthur Samberg and Pequot," Blomberg said.
At this point, Blomberg enlisted the help of Sherman, the Stamford attorney. And Sherman began searching for the source of the $2.1 million on the family computer's hard drive, which was in his client's possession.
Kaiser had kept the hard drive because it contained family photos, according to her lawyers. "I had known [Kaiser] had the hard drive from working on the divorce for six years," Blomberg said. "It was one of the things she got when the house was sold. She didn't take the hard drive because she thought she'd need it for [any investigation]."
The SEC had its eye on Pequot as far back as 2005, investigating whether Zilkha had provided inside information about Microsoft to his bosses at Pequot, a multi-billion dollar hedge fund that became one of the largest in the world after its formation in 1998.
But the SEC had found no evidence of insider trading and filed no charges.
In 2006, the investigation was closed.
But while investigating the computer hard drive, Sherman discovered e-mail correspondence between Zilkha and former colleagues at Microsoft in which Zilkha asks if Microsoft would miss its quarterly earnings estimates. "What we found was the missing link to a closed investigation," Sherman said. "I knew we needed to get this over to the SEC."
The SEC claims the e-mails are proof that Zilkha provided insider information and that Pequot used that information to trade shares of Microsoft and earn Pequot $14 million in 2001. The SEC believes Zilkha received $2.1 million in compensation for that information.
The Pequot firm closed last year, and the company settled the insider-trading charges with the SEC this past May for $28 million without admitting or denying any wrongdoing.
But Zilkha doesn't buy that his ex-wife simply wanted the hard drive because of the family photos.
His attorney, Norman A. Pattis of Bethany, Conn., filed a motion last November to disqualify Blomberg from the case. In that motion, he laid out his theory on what has happened with the hard drive and the resulting SEC investigation.
Pattis said that when Zilkha filed a motion in late 2008 to increase visitation with his children, Blomberg "intimated" that Zilkha "would face difficulty with law enforcement" if Zilkha persisted with his efforts.
About that time, the contents of the hard drive were turned over to members of the U.S. Senate, the SEC and the Justice Department, according to Pattis' motion.
"The efforts to have the defendant charged [by the SEC] are part and parcel of a deliberate strategy to undermine [Zilkha's] will to fight for more time with his children and, if possible, to make it impossible [for him] to see his children," Pattis wrote.
Superior Court Judge Lynda B. Munro denied Pattis' motion to disqualify Blomberg.
Pattis told the Connecticut Law Tribune he couldn't discuss the case because of court-ordered restrictions that were part of a judge granting his motion to withdraw from the case earlier this year.
Sherman said any suggestions that Kaiser knew about the SEC evidence prior to 2008 "are pure fiction."
He added, "Karen never told anyone that she took the hard drive nor did she ever have any knowledge of the e-mails on it until we examined its contents in late 2008."
West Hartford attorney Joseph A. O'Brien now is serving as Zilkha's attorney in the ongoing post-divorce legal battle. The SEC's ongoing investigation into Zilkha's $2.1 million payment "has pretty much destroyed [Zilkha's] opportunity to be active in [trading and finance]," O'Brien said.
O'Brien, who is not involved with the SEC matter, said the $2.1 million payout from Pequot Capital had nothing to do with any information passed along about Microsoft. Instead, he said Pequot gave Zilkha the money so he wouldn't sue the hedge fund. Zilkha had been unhappy, said his lawyer, that promises made to him when he joined the fund had not been honored. Samberg, the CEO, "made promises of what role [Zilkha] would play in the company, and none of those occurred," O'Brien said.
New York City solo attorney Henry Putzel III is representing Zilkha before the SEC. Putzel did not respond to the Law Tribune's interview requests, but he told the Washington Post last month that Zilkha "will demonstrate he is innocent of any improper misconduct."
The bigger picture impact of the case involves the SEC's new approach to insider trading investigations. Its $1 million whistleblower payout to Kaiser comes after some SEC officials and U.S. senators had been critical of the SEC for not being receptive to whistleblowers' reports of alleged insider trading in the past.
Pequot's $28 million settlement with the SEC included $18 million in restitution plus $10 million in civil fines. From the $10 million fine, Kaiser was awarded a 10 percent whistleblower bounty, the maximum allowed under the old whistleblower laws that date back 20 years.
But people in Kaiser's position stand to reap even bigger rewards in the future.
A law signed by President Barack Obama last month now allows whistleblowers to collect much larger bounties for providing information to the SEC -- up to 30 percent of a penalty. "We missed the boat on a bigger payout," Sherman said. But the $1 million bounty "was a precedent and my client is happy."