July 25, 2013 / 2:05 PM / 4 years ago

U.S. charges SAC Capital with insider trading crimes

United States Attorney Preet Bharara speaks during a news conference in New York, July 25, 2013. REUTERS/Mike Segar

NEW YORK (Reuters) - Federal prosecutors came down hard on billionaire hedge fund manager Steven A. Cohen on Thursday, unveiling criminal fraud charges against his SAC Capital Advisors LP that could end the career of one of Wall Street’s most successful investors.

Cohen stands accused of presiding over a broken business where employees were encouraged to push the envelope to get that extra investing edge, with little regard for whether they were acting honestly and within the law.

The result was “insider trading that was substantial, pervasive and on a scale without known precedent in the hedge fund industry,” the government said.

Thursday’s indictment, and a related civil case seeking an asset freeze and money laundering penalties, imperils the future of SAC, a roughly $15 billion hedge fund that has posted some of its industry’s best returns and established Cohen as one of the best traders of his generation.

While not personally charged criminally, Cohen joins Drexel Burnham Lambert chief Michael Milken and Galleon Group hedge fund founder Raj Rajaratnam among prominent Wall Street executives associated with insider trading.

The rare move by the U.S. Department of Justice to indict a powerful financial firm could end Cohen’s career managing outside money. It reflects what prosecutors and the FBI see as pervasive wrongdoing at SAC that hurts investors generally.

“SAC not only tolerated cheating, it encouraged it,” FBI assistant director George Venizelos said in a statement.

The charges also cap a seven-year investigation of SAC, amid a broader crackdown on insider trading resulting in more than 70 convictions and guilty pleas.

The case is as much a forceful reproof of an era of free-wheeling trading by hedge funds, as it is a condemnation of SAC’s culture as an alleged breeding ground for traders and analysts angling for that extra edge by trafficking in illegal tips about corporate earnings and buyouts.

SAC in a statement said it will continue to operate as it works through the criminal case.

WITHDRAWALS

Launched in 1992 with just $25 million, SAC became the most successful hedge fund to rely on the so-called mosaic theory of investing, which builds investment theses on stocks by gathering information from multiple sources.

Cohen has been able to generate average annualized returns of 25 percent, far outpacing most rivals. It’s because of that performance that many outside investors have stuck with him despite years of speculation about improper trading.

It was only in recent months that this changed, as investors requested $4 billion in withdrawals, after it became clear that investigators were closing in on SAC and Cohen.

Several lawyers, including former federal prosecutors, said a decision to charge SAC, but not Cohen, might signal an admission that there was a lack of evidence to charge him personally.

But the indictment also does not preclude the government from later criminally charging Cohen.

By reaching back to activities dating from 1999, the government signaled it has found a way to sidestep the five-year deadline to bring insider trading charges.

Many Wall Street firms that lend money to and trade with Stamford, Connecticut-based SAC are likely to return money to investors and cease operations because of the criminal case. SAC, however, might stay in business because more than half its assets belong to Cohen and employees.

Cohen is also known for his collection of expensive art and real estate holdings. He paid casino mogul Steve Wynn $155 million for Pablo Picasso’s “Le Rêve” and owns properties valued well into eight figures.

SECURITIES FRAUD, WIRE FRAUD

The indictment accused SAC and various affiliates of four criminal counts of securities fraud and one count of wire fraud.

It accused SAC of “systematic insider trading” in a scheme that ran roughly from 1999 to 2010, was designed to boost returns and fees, and enabled SAC to generate hundreds of millions of dollars of illegal profits and losses avoided from timely trades.

Prosecutors said Cohen “financially incentivized” portfolio managers to share their very best ideas and encouraged them to relentlessly pursue an “information edge.”

But they said this activity overwhelmed SAC’s “limited” compliance systems, which lacked the ability to police whether recommendations and trades were made properly.

“There was no meaningful commitment to ensure that such ‘edge’ came from legitimate research and not inside information,” the indictment said. “The predictable and foreseeable result ... was systematic insider trading.”

SAC had in March agreed to pay $616 million to settle two U.S. Securities and Exchange Commission cases over alleged illegal trading.

Neither required an admission of wrongdoing, and the larger $602 million settlement was held up by the presiding judge for that reason.

Last week, the SEC went a step further, civilly charging Cohen with failing to supervise two employees, Mathew Martoma and Michael Steinberg.

Both have pleaded not guilty to charges of criminal insider trading and are scheduled to go on trial in November.

The indictment suggested as well that the government probe into insider trading is far from over, alluding to Cohen’s having hired an employee from a fund despite a warning that the person was part of that fund’s “insider trading group.”

That employee was Richard Lee, according to two people familiar with the matter. The fund is Kenneth Griffin’s Citadel Investment Group, according to a person familiar with the matter.

Citadel managed roughly $13.3 billion at year end. A spokeswoman, Katie Spring, said Lee was fired in 2008 for breaching company rules, but that his dismissal was unrelated to insider trading. “There is no insider trading group at Citadel,” she added.

‘UGLY SITUATION’

Prosecutors built their case against SAC with help from several former employees - including Noah Freeman, Jon Horvath, Donald Longueuil and Wesley Wang - who pleaded guilty to charges of criminal insider trading.

Lee, meanwhile, pleaded guilty on July 23 to securities fraud and conspiracy related to trades in Yahoo Inc and 3Com Corp. His plea was disclosed in the SAC indictment.

Other suspect SAC trading included nearly $1 billion of stock sales and short sales by Martoma and Cohen in 2008 in Ireland’s Elan Corp and Wyeth, which is now owned by Pfizer Inc.

Prosecutors said these transactions were based on tips about a trial for a drug to treat Alzheimer’s disease, and generated about $276 million of illegal profits and avoided losses.

Another suspect trade was Cohen’s August 2008 sale of a $12.5 million stake in Dell Inc, which began within 10 minutes after he was forwarded an email in which Horvath told Steinberg, based on a “2nd hand read from someone at the company,” that the computer maker’s earnings would disappoint.

Lawyers for Cohen earlier this week said their client never read that email.

It is unclear how much SAC will need to retrench, or how many of its nearly 1,000 employees might be affected.

Cohen charges a 3 percent management fee and keeps 50 percent of SAC’s investment profits, making him far pricier than typical hedge fund managers who collect a 2 percent fee and 20 percent of the profits.

SAC also generates more than $300 million annually in trading fees for Wall Street brokerages large and small, such as JPMorgan Chase & Co and Jefferies & Co.

Three trading counterparties on Thursday said their dealings with SAC remain normal for now. SAC is sitting on $6 billion to $8 billion of cash, people familiar with its finances said, easing potential worries about its ability to post collateral.

Concerns still remain, however.

“Having them as a counterparty when you don’t know that they’re going to be there tomorrow is a problem,” said an executive at one counterparty. “It’s an ugly situation.”

One recent example of the government indicting an entire firm was the 2002 case against Enron Corp’s accountants Arthur Andersen. That firm was forced to close shortly after the indictment, although it had lost much of its business even before that occurred. The case was later thrown out.

The criminal case is U.S. v. SAC Capital Advisors LP, U.S. District Court, Southern District of New York, No. 13-00541. The civil case is U.S. v. SAC Capital Advisors LP in the same court, No. 13-05182.

Reporting by Emily Flitter, David Henry, Lauren Tara LaCapra, Jonathan Stempe, Bernard Vaughan and Katya Wachtel in New York; Svea Herbst-Bayliss in Boston; Peter Rudegeair in Stamford, Connecticut; and Sarah N. Lynch in Washingotn, D.C.; Editing by Matthew Goldstein and Grant McCool

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