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SAC `Eat-What-You-Kill' Culture Bred Hedge Funds Under Scrutiny

SAC Capital Advisors LP, the firm that spawned several of the hedge funds tied to investigations by U.S. regulators, encourages competition.

Its founder, 54-year-old Steven A. Cohen, hires traders and gives them some SAC money to manage on their own, according to former employees. If they do well, they get more money to manage and a green light to hire analysts to help research stocks. If they do poorly, they’re out. The result is a firm composed of fiercely competitive pods, with many of the best managers eventually leaving to start their own firms, the former employees say.

Now, part of SAC’s diaspora is under scrutiny by U.S. authorities because of an insider trading probe. Level Global Investors LP and Diamondback Capital Management LLC, two Connecticut firms founded by former SAC traders, were among funds raided by federal agents looking for documents for Manhattan U.S. Attorney Preet Bharara. SAC, based in Stamford, Connecticut, received a very broad request for information, according to a person familiar with the firm. None of the funds have been accused of wrongdoing.

“That eat-what-you-kill culture is highly competitive,” said Craig Lilly, an attorney at Greenberg Traurig LLP in East Palo Alto, California, whose clients include hedge funds. “A set-up where you have traders running their own portfolios instead of feeding into a centralized investment may make it more tempting for them to cut corners.”

Photographer: Anthony Behar/Getty Images

Steven Cohen, Chairman of SAC Capital Advisors LP. Close

Steven Cohen, Chairman of SAC Capital Advisors LP.

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Photographer: Anthony Behar/Getty Images

Steven Cohen, Chairman of SAC Capital Advisors LP.

Galleon Case

SAC spokesman Jonathan Gasthalter declined to comment on the subpoena. Steve Bruce, a spokesman for Diamondback, and Andy Merrill, a spokesman for Level Global, confirmed that the FBI had searched their offices and said their firms are cooperating in the investigation.

The raids follow testimony by a former UBS AG investment banker at a criminal trial in September that he “provided confidential information” to a friend who worked as an analyst at SAC.

Last year, Richard Choo-Beng Lee, pleaded guilty to insider trading at Spherix Capital LLC, a firm he co-founded after leaving SAC. Lee, a native of Malaysia, is cooperating with investigators in their probe of Galleon Group LLC, the New York- based hedge fund that shuttered after its billionaire founder run by Raj Rajaratnam was charged with insider-trading. Rajaratnam has denied any wrongdoing.

Another fund that was raided this week, Loch Capital Management in Boston, had no apparent ties to SAC.

‘Larger Agenda’

“It appears as if the government is pursuing a larger agenda,” said Peter Rup, chief investment officer at Artemis Wealth Advisors LLC, a New York-based firm that allocates money to hedge funds for clients. “The three firms raided are not necessarily a direct target of the investigation.”

Diamondback has a similar structure to SAC. The fund employs traders to run their own portfolios, while two of the founders, Lawrence Sapanski and Rich Schimel, both former SAC managers, oversee a central portfolio that takes trading ideas they deem to have the best chances of profiting, according to a letter sent to Diamondback investors.

A third Diamondback founder, Chad Loweth, left earlier this year. He had also worked at SAC. Schimel, 42, is Cohen’s brother in-law.

SAC hadn’t been subpoenaed as of Nov. 4 in relation to the government’s probe of Galleon, the firm’s lawyer, Martin Klotz, said that day. Klotz had been summoned as a government witness in the criminal trial of Milton Balkany, a Brooklyn rabbi who was convicted six days later of trying to extort $4 million from SAC.

Compliance Measures

Asked by a prosecutor whether “SAC or Mr. Cohen himself was under investigation in the Galleon case,” Klotz said no. “We did not receive subpoenas,” Klotz testified in Manhattan federal court. “We did not receive inquiries from anybody in the government in connection with that investigation.”

SAC investors say the firm takes strong measures to prevent traders from dealing on insider information. Cohen’s staff of 800 included 20 legal and compliance workers as of February, according to investors who spoke on condition of anonymity for a profile of Cohen and SAC that appeared in the April issue of Bloomberg Markets magazine.

Among other things, those workers monitor company e-mails, including those sent and received by Cohen. Harvey Pitt, former chairman of the SEC, and Stephen Cutler, former head of the regulator’s enforcement unit, have held workshops with SAC employees about complying with SEC rules.

One former SAC manager who started his own fund in New York said he never saw Cohen or anyone else at SAC trade on inside information or do anything else illegal. Speculation about illegal trading has dogged Cohen for years, the manager said, and that has made the firm extra careful, he said.

Sunday Quizzes

Cohen, sitting in the middle of a trading floor in Stamford, Connecticut, drives his groups hard, former employees said. One, who declined to be named, quit after working every Sunday for a whole summer. Cohen talked to his portfolio managers and analysts every Sunday, quizzing them on their stock holdings, to prepare for the coming week.

Should the Securities and Exchange Commission file a civil lawsuit alleging insider trading by the firm’s traders, SAC or Cohen would have difficulty defending themselves by citing only the structure of the firm, said Tom Dewey, a partner at Dewey Pegno & Kramarsky LLP in New York.

“It would not help that much because they would likely have a duty to supervise the traders,” Dewey said in an interview today. That defense would have a better chance of success in a criminal insider trading case against SAC or Cohen, where the government’s burden of proving that they knowingly broke the law is higher, Dewey said.

To contact the reporter on this story: Anthony Effinger in Portland, Oregon, at aeffinger@bloomberg.net

To contact the editor responsible for this story: Christian Baumgaertel at cbaumgaertel@bloomberg.net

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