If the past is any guide, the U.S. Securities and Exchange Commission will probably hold off on its threat to sue SAC Capital Advisors LP until prosecutors determine whether they can build a criminal insider-trading case against the hedge fund’s founder, Steven A. Cohen.
U.S. Attorney Preet Bharara in Manhattan took a step closer to the billionaire on Nov. 20, when former SAC Capital portfolio manager Mathew Martoma was arrested on charges of using inside information to trade the stocks of drugmakers Elan Corp. and Wyeth LLC. Cohen sold the stocks after speaking with Martoma, according to prosecutors and an SEC complaint, the first time they had linked him to trades at the center of an insider case.
The same day the SEC notified Stamford, Connecticut-based SAC Capital that it’s considering pursuing civil fraud claims against the $14 billion firm related to Martoma’s trading, three people with knowledge of the matter said two days ago. It was another example of how the SEC and U.S. Attorney Preet Bharara have cooperated in their probe of insider trading that has led to more than 80 people, with prosecutors often going to court first.
“The U.S. attorney brought a case against Martoma to try to force him to cooperate against Cohen to the extent that there is a case against him,” said Marc Powers, the leader of Baker & Hostetler LLP’s national litigation and regulatory enforcement practice in New York. “The SEC is likely waiting to see if the U.S. attorney’s office is able to flip Martoma against Cohen before they provide Cohen with a Wells notice.
In addition to fraud, the SEC’s so-called Wells notice to SAC Capital also outlined claims related to the firm’s responsibility for overseeing CR Intrinsic Investors LLC, the unit that employed the Martoma, said one of the people, who like the others asked not to be named because the information is private. The regulator may extend the fraud and oversight claims to Cohen himself, the person said.
John Nester, a spokesman for the SEC in Washington, declined to comment on whether or how the agency would proceed against SAC Capital. Ellen Davis, a spokeswoman for Bharara, declined to comment.
Cohen, 56, told investors two days ago on a conference call that he acted appropriately when he sold shares of Wyeth and Elan on the advice of Martoma. Neither Cohen nor SAC Capital was accused of wrongdoing in last week’s criminal complaints.
‘‘Mr. Cohen and SAC are confident that they have acted appropriately and will continue to cooperate with the government’s inquiry,” a spokesman for SAC Capital said last week in an e-mailed statement.
The complaint against Martoma said that the 38-year-old portfolio manager had a 20-minute phone call with Cohen, who in court papers is described as the “hedge fund owner” and not identified. The next day, the billionaire ordered his head trader to start selling the firm’s $700 million position in the two companies. The sale was done through dark pools, which conceal the identity of the buyers and sellers, to hide it from other investors both inside and outside of SAC Capital, according to the complaint.
The SEC sends a Wells notice to a company or an individual after its staff has determined that sufficient wrongdoing has occurred to warrant civil claims being filed. The notice gives the recipient a chance to try to dissuade the SEC from taking action. In some cases, the SEC has decided to refrain from filing a complaint after sending a Wells notice. Under a provision of the Dodd-Frank bill, the SEC must bring an action within 180 days, though the director of enforcement can extend the deadline with agreement of the recipient of the notice.
The SEC, which is a civil enforcement agency, typically coordinates with federal prosecutors who pursue criminal claims in insider-trading cases, said former SEC lawyers and prosecutors. While the SEC often brings insider-trading claims using circumstantial evidence, criminal prosecutors face a higher burden of proof at trial, which can prolong investigations as they seek to pin down needed corroborating witnesses.
“The Justice Department’s interest is keeping its cards close to its chest, said David Gourevitch, a former SEC attorney now practicing securities law and white-collar defense in New York.
Civil cases allow broad discovery of depositions and documents that could give defendants a preview of the evidence for the government’s potential criminal case, Gourevitch said.
Prosecutors say Martoma received illegal inside information on the trial of an Alzheimer’s drug being conducted by Elan and Wyeth from Sidney Gilman, 80, a doctor involved in the tests. Gilman has reached a non-prosecution agreement with the government and will testify against Martoma, prosecutors said. Gilman earlier this week quit his neurology research position at the University of Michigan, Pete Barkey, a spokesman for the school in Ann Arbor, said in an e-mail.
‘‘It appears they’ve got substantial evidence against Martoma, so he would be looking to cut as good a deal as he can, and that’s through cooperation,” said William Mateja, a former federal prosecutor who is now a principal at law firm Fish & Richardson P.C. in Dallas. “There’s always been smoke around Cohen,” he said, referring to the involvement of former SAC Capital employees in other cases. “But there’s never been the direct link. Criminal prosecutors need that direct link.”
Cohen was deposed by the SEC earlier this year about trades in Elan and Wyeth that he and the firm made, Tom Conheeney, SAC president, told investors on Wednesday’s call. Cohen answered all the SEC’s questions, he said.
“Mathew Martoma was an exceptional portfolio manager who succeeded through hard work and the dogged pursuit of information in the public domain,” his lawyer, Charles Stillman, said last week in an e-mailed statement, adding that he expected Martoma to be fully exonerated.
The current case with Cohen and SAC Capital may end up mirroring the cooperation that took place between the two agencies in the case involving Rajat Gupta, the former Goldman Sachs Group Inc. board member who was convicted this year for passing confidential information to Galleon Group founder Raj Rajaratnam.
The SEC moved first, filing an administration proceeding against Gupta. Gupta then sued the SEC, claiming that an administrative proceeding, which doesn’t allow the same amount of discovery as a lawsuit in U.S. court, would deprive him of multiple rights, including a jury trial. The SEC dropped the administrative case and waited for prosecutors to charge Gupta before filing its suit in federal court.
Donald Longueuil, a former junior portfolio manager at SAC Capital, was arrested in Feb. 8, 2011, for insider trading and was sued by the SEC on the same day. While he pleaded guilty a month later, it wasn’t until September of that year that Longueuil settled the SEC’s civil suit.
If the U.S. attorney doesn’t make a criminal case against Cohen, the SEC can continue with a civil action.
In insider-trading cases, the SEC can seek disgorgement of illegal profits, as well as three times that amount in penalties. It alleges that SAC Capital reaped $276 million in profit and losses averted as a result of trading on material, nonpublic information. The agency can also file administrative actions to bar offenders from the securities industry.
James Cox, a professor at Duke University School of Law in Durham, North Carolina, said Congress in 1988 expanded a provision regarding oversight, called control-person liability, to insider trading. It exposes managers who fail to maintain a system to discourage and detect insider trading to action by the SEC. The provision wouldn’t require the SEC to prove Cohen knew about the trades, just that the compliance system broke down, Cox said.
CR Intrinsic employed Martoma from 2006 to 2010, was named last week as a defendant in a civil complaint by the SEC, along with Martoma and Gilman.
SAC Capital first was linked to the government’s investigation of insider trading on Wall Street shortly after the October 2009 arrest of Rajaratnam, when former SAC Capital 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.
Previous insider cases involving former SAC employees haven’t deterred investors. Cohen’s main fund saw net deposits last year before he closed it to new money, people with knowledge of the matter said at the time.
One investor, who asked not to be named because the fund is private, said he wouldn’t feel compelled to pull out his money unless there was a criminal indictment against Cohen.
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.
If enough people wanted to pull their money, Cohen could turn SAC into a family office, said Brad Balter, head of Boston-based Balter Capital Management LLC, which invests client money in hedge funds. About $8.4 billion, or 60 percent, of SAC’s assets belong to Cohen and his employees.
“If the owner gets sued by the SEC, what’s the rationale to stay?” said Balter, who has never invested in SAC or in any of its spinoffs. “You know your investors will ask you why you have that in your portfolio.”
The criminal case is U.S. v. Martoma, 12-mj-02985; and the civil case is SEC v. CR Intrinsic Investors LLC, 12-08466, U.S. District Court, Southern District of New York (Manhattan).