SAC Capital Advisors LP is seeking to calm investor concern about founder Steven A. Cohen’s trading in two drug stocks and possible regulatory sanctions after prosecutors for the first time tied Cohen to a specific transaction at the center of an insider-trading investigation.
Executives at the $14 billion firm have spoken to some of their largest clients after a former portfolio manager was arrested Nov. 20, the sixth time a current or former employee was linked to insider trading while working at the firm. The Stamford, Connecticut-based firm is telling investors that compliance procedures are robust and the hedge fund is cooperating with the government, said two clients, who asked not to be named because the fund is private.
“Patience will be wearing thin among some investors after this latest accusation,” said Vidak Radonjic, managing partner at Beryl Consulting Group LLC in Jersey City, New Jersey, which advises clients on investing in hedge funds. “There is a pattern of potential compliance breaches and the money involved is getting bigger.”
Prosecutors say SAC, one of the best-performing hedge funds, reaped $276 million in profits and averted losses after Mathew Martoma, a former portfolio manager at a unit of SAC, used inside information from a clinical trial to trade in shares of two health-care companies in 2008. The investors said they are much more concerned about last week’s charges than previous ones because Cohen, according to a criminal complaint, traded those shares in his own portfolio and discussed them with Martoma.
Neither Cohen nor SAC have been accused of any wrongdoing. While Cohen wasn’t mentioned by name in last week’s complaint, he is the hedge-fund owner and investment manager referred to in the criminal complaint and a related civil case filed by the U.S. Securities and Exchange Commission, according to people familiar with the matter.
“Mr. Cohen and SAC are confident that they have acted appropriately and will continue to cooperate with the government’s inquiry,” Jonathan Gasthalter, a spokesman for the firm, said last week.
SAC has 125 teams of traders and analysts who manage their own portfolios and vie for attention from Cohen, who runs his own account and solicits ideas from other managers. The portfolio managers and analysts submit their stock picks to Cohen and his team, and if he uses them in his account and they make money, they get paid for their idea.
Noah Freeman, a former SAC portfolio manager who pleaded guilty to securities fraud last year, told the FBI it was “understood” that giving Cohen your best ideas included providing insider information, according to an agent’s December 2010 notes of the conversation. Freeman wasn’t quoted as saying Cohen knew the information came from illegally obtained tips, ordered him to provide them or traded on the data.
Even if Cohen wasn’t aware that information had been obtained unlawfully, the SEC could opt to pursue claims that Cohen failed to supervise employees who traded on inside tips, according to securities lawyers. Such claims, which have typically been limited to abusive sales practices at brokerages, may not be applicable to trades that occurred before SAC Capital registered as an investment adviser with the SEC earlier this year.
“SAC has an obligation to have reasonable procedures in place to prevent insider trading, and Cohen would be at risk of a failure to supervise or aiding and abetting claim, even if he wasn’t directly liable for the insider trading,” said Donald Langevoort, a securities law professor at Georgetown University in Washington.
James Cox, a professor at Duke University School of Law in Durham, North Carolina, said the SEC could use a provision that Congress created in 1988 that introduced liability for managers who fail to maintain a system to discourage and detect insider trading by subordinates. That provision, known as control-person liability, doesn’t require the SEC to prove Cohen knew about the trades, just that the compliance system broke down, Cox said.
Still, the SEC would be unlikely to pursue control-person claims without being able to prove that Cohen deliberately circumvented SAC Capital’s safeguards or directed Martoma to make illegal trades, said Jacob Frenkel, a former SEC attorney. As a matter of policy, the agency has typically avoided cases that second-guess supervisors without evidence they were acting in bad faith, he said.
“In the SEC arena, which is civil, it’s possible but also unlikely to see a control-person case because anyone charged under such a theory would be able to argue good faith,” he said. “It’s more than proving he had the power to control somebody. It has to be the actual exercise of that control.”
Pursuing criminal claims under that theory would be “extremely difficult” and “a stretch beyond elasticity,” Frenkel said.
The SAC investors said they are waiting to hear what the firm will say about the latest charges before deciding if they want to pull their money. One investor said it’s now becoming increasingly difficult for him to justify an investment in SAC to his clients.
Still, the fund has one of the best track records in the industry. While SAC Capital charges the highest fees in the industry, with 3 percent of assets and as much as 50 percent of profits, Cohen has produced average annual returns of 30 percent since starting two decades ago. He’s had just one money-losing year, 2008, when his main fund tumbled 19 percent.
This year the $9 billion flagship fund has returned about 10 percent through October, according to a person briefed on the returns, compared with the average 2.7 percent gain posted by rival stock hedge funds, according to data compiled by Bloomberg. The Standard & Poor’s 500 Index of large U.S. companies climbed 14 percent, including dividends.
SAC’s portfolio is in easy-to-sell stocks and it holds few large investments, so outside clients, who make up about 40 percent of the firm’s assets, could get their money back quickly. As of the end of September, SAC Capital’s biggest U.S. stock position was a $340 million holding in Sirius XM Radio Inc., which accounted for just 2.5 percent of the outstanding shares.
Clients can only pull 25 percent of their investment every quarter after giving 45 days notice, meaning it would take them a year to redeem in full. The next deadline for putting in a redemption notice is mid-February.
Another reason why investors may not want to pull their money immediately is that SAC Capital closed its main fund to new investments last year, so if clients flee, they may not be able to invest again.
SAC Capital also last year said it would indemnify clients against disgorgement of illegal profits and legal fees, according to a person familiar with the firm.
Cohen, who started SAC Capital in 1992 with 12 people and $25 million, made his name as a rapid-fire stock trader. The Stamford, Connecticut-based hedge fund today employs about 1,000 people working in offices from London to Hong Kong. Cohen, a billionaire and avid art collector who owns works by Damien Hirst, is an investor in the New York Mets.
SAC Capital first came into the probe-related headlines shortly after the October 2009 arrest of hedge-fund manager Raj Rajaratnam when former employee Richard Choo-Beng Lee was among those charged with insider trading at another firm. Six former or current SAC Capital employees have been tied to insider trading while working at the firm, including three who have pleaded guilty.
Cohen was deposed earlier this year by the SEC about trades made close to news that generated profits for his firm, people familiar with the matter said in June. Last year, prosecutors said they were looking at the trading account run by Cohen.
The increased scrutiny didn’t deter investors. Cohen’s main fund saw net deposits last year before he closed it, people with knowledge of the matter said at the time.