In April 2008, three months before drug makers Elan Corp. and Wyeth were scheduled to release results of their Alzheimer’s drug trial, two health-care analysts for hedge-fund manager Steven A. Cohen warned their boss in an e-mail that a doctor, who implied he had seen inside information about the trial, said it wasn’t going well.
Cohen, who had bought shares of both companies on the advice of Mathew Martoma, one of his health-care portfolio managers, shot back with a question: How would any doctor know interim results? The analysts, who were bearish on Elan and Wyeth, replied that the doctor said he had seen the data before agreeing to be part of the trial. The information, the analysts said, was better than Martoma’s, according to an order filed last week by U.S. regulators against Cohen for what they said was failure to supervise his employees.
Cohen forwarded the e-mails to Martoma, who was bullish on the stocks, asking him to follow-up with the unnamed doctor. Martoma, who for the past year had been getting illicit tips from a second doctor involved in the drug trial, complied and a few days later answered that it was a “non issue,” according to the U.S. Securities and Exchange Commission order. For the time being, Cohen and Martoma stuck with their bets on the stocks.
This exchange, one of many detailed in the SEC’s administrative order, shows how the notorious eat-what-you-kill culture that Cohen created at SAC Capital Advisors LP may have led some of its traders to break the law. The 57-year-old billionaire, who pitted his employees against one another to come up with the best trading ideas, turned a blind eye to their use of illicit information, the SEC said. The agency seeks to bar Cohen from managing money for investors, which would put him out of business after producing the industry’s best stock-trading record over more than 20 years.
“The very nature of the culture at SAC led to his tremendous success in generating performance and raising assets for many years,” said Jay Rogers, president of Irvine, California based Alpha Strategies Investment Consulting Inc., which advises hedge-fund clients and managers. It appears “it also led some within the organization to take shortcuts.”
The SEC’s order, the first action against Cohen personally in the government’s multiyear insider-trading investigation, falls short of accusing him of securities fraud. The failure to supervise claims, which relate to Cohen’s oversight of Martoma and portfolio manager Michael Steinberg’s trading in Dell Inc., will be heard by an administrative judge within the SEC, not in a federal court like civil or criminal insider-trading allegations would. A criminal investigation by the U.S. attorney’s office in Manhattan and the Federal Bureau of Investigation continues, as does the SEC’s probe.
The SEC’s accusations have no merit and Cohen acted appropriately at all times, Jonathan Gasthalter, a spokesman for Stamford, Connecticut-based SAC at Sard Verbinnen & Co., said in a July 19 statement.
The SEC’s action is a damaging blow for Cohen, a trader who grew up in a middle-class family in New York’s Long Island and built his reputation as a genius “tape reader” able to sense the moves in stocks before they happen. His performance -- after taking as much as half the profits in fees -- has averaged 25 percent a year for the past two decades, far outpacing his hedge-fund rivals.
While he has never had a losing year in his own portfolio, investors have asked to withdraw billions of dollars from SAC, which managed about $6 billion for clients earlier this year, and $9 billion for Cohen and his employees.
$9 Billion Fortune
Cohen had risen to the pinnacle of the hedge-fund, philanthropic and art-collecting worlds. His roughly $9 billion personal fortune includes about $750 million in art, with pieces by Pablo Picasso, Andy Warhol and Jeff Koons. He lives in a 14-acre estate in Greenwich, Connecticut, with a basketball court and two-hole golf course. In 2011, he wrote a $13.35 million check to the Robin Hood Foundation, his charity of choice.
Speculation has long circulated within the hedge-fund world that SAC’s outsized returns could only be the result of insider trading, and the government has spent at least six years building a case against the billionaire.
The SEC’s July 19 order, which doesn’t identify the health-care analysts by name, alleges that Cohen failed to supervise Martoma and Steinberg, who have been charged with securities fraud. The agency presented new details that it said showed Cohen received “highly suspicious” information that should have caused any reasonable hedge-fund manager to investigate the basis for the alleged wrongdoing.
Martoma, 39, was arrested in November for alleged insider trading in Elan and Wyeth after receiving confidential information from Dr. Sidney Gilman in July 2008 that caused him and Cohen to abruptly abandon their bullish bets and sell their holdings. The trades earned SAC profits and avoided losses of more than $275 million, the government said. Steinberg was arrested in March for trading in Dell and Nvidia Corp. based on illicit tips given to him by his analyst. Martoma and Steinberg, 41, have pleaded not guilty.
SAC agreed in March to pay a record $616 million to settle SEC charges regarding Martoma’s and Steinberg’s trades. After the agreement, Cohen bought a $60 million vacation home in the Hamptons on Long Island. SAC has said it would indemnify clients against disgorgement of illegal profits and legal fees.
The pudgy, balding Cohen, an unassuming dresser who favors half-zip sweaters and nondescript shoes, may never have attracted the attention of the government were it not for a decision, in the early 2000s, to go from managing mostly his own money to building a global firm with more than a thousand employees working in offices from London to Hong Kong.
SAC’s red-brick headquarters are in Stamford, on the other side of Long Island Sound from where its founder grew up. Its lobby and corridors are lined with Cohen’s extensive art collection, while a scrolling electronic stock ticker wraps the walls of the hush-tone trading floor. There, he and his fleece-clad traders buy and sell hundreds of millions of dollars of shares a day, generating lucrative commissions for Wall Street’s brokerages. Cohen likes to keep his trading room cold to stay alert.
SAC -- an acronym of its founder’s name -- boasts an ultra-Darwinian structure rare in the $2 trillion hedge-fund industry, one which a former employee described as shark tanks within a shark tank.
The competition at the firm exists on three levels.
SAC’s 130 teams of portfolio managers and their analysts vie for the firm’s roughly $45 billion in assets, including borrowed money. Less than 10 percent of the teams manage more than $1 billion, and the average ranges from $200 million to $550 million. Most of SAC’s teams trade stocks, although a few focus on macro-economic and quantitative trading.
More unusual in the industry is that at SAC multiple groups compete against each other by trading in the same industries. There are 12 teams trading technology and 11 handling health care. Senior portfolio managers can measure their performance against internal rivals throughout the day because all profits and losses can be seen in real time. Technology and health-care stocks tend to move dramatically on news about earnings, new products and drug trials, and most of the former SAC employees entangled in the government’s insider-trading probe traded these two industries.
The biggest difference between SAC and its rivals is that each of its 350 investment professionals also battle to get Cohen’s attention, as Martoma and the health-care analysts did in 2008, in the hopes that their best ideas will be picked by Cohen for the portfolio he personally manages, known as the Cohen Account. They are paid handsomely for their winning trades -- Martoma earned a $9.3 million bonus in 2008 for his Elan and Wyeth investments.
Cohen doesn’t tolerate losing trades and will cut money from a manager whose portfolio declines 5 percent from its peak. Drop 10 percent and you are shown the exit, according to marketing documents.
He generally holds trades for six days to 20 days, and he constantly looks for the catalyst that will send shares soaring or tumbling. In addition to the Cohen Account, SAC magnifies its profits by using an algorithm to track and mimic the trades of its best-performing portfolio managers, adding even more money to their stock picks.
The environment at SAC can be harsh, according to former employees. Cohen is known to belittle employees who don’t meet his standards.
If a portfolio manager or analyst can’t answer a question about why a stock is moving, Cohen is likely to lash out. “Do you even know how to do this f---ing job?” is a standard barb. Cohen is unapologetic. He’s said that employees need only worry if he yells at them after 4 p.m. when the market is closed.
Sunday conference calls with Cohen to discuss week-ahead trades, which initially started out as meetings at his mansion, are also part of life at SAC. He also held one-on-one calls with some employees, sometimes abruptly ending conservations by hanging up on them, according to the former employees.
SAC’s above-average fees -- 3 percent of assets and as much as 50 percent of profits -- allow Cohen to pay his employees generously. Portfolio managers take home about 15 percent to 25 percent of profits they generate; star traders get 30 percent.
The big rewards and the fear of losing one’s livelihood had pushed some managers to break the law. Noah Freeman, a former SAC portfolio manager who was charged and pleaded guilty to securities fraud in February 2011 and is cooperating with the government, told the FBI that it was “understood’’ that those picked to give their best ideas to Cohen would provide him with insider information.
The SEC also alleged in its July 19 order that Cohen speculated that Martoma may have had access to inside information to the Elan drug trials. Cohen told the two unidentified health-care analysts that Martoma “had a lot of good relationships in this arena,” and that he was “closer to it than you,” according to the SEC’s order.
Cohen’s passion for the markets and competitive drive dates back to his days at Great Neck North High School. As a teenager he started following stocks, combing through the tables listed in the New York Post newspaper that his father, a dress manufacturer, brought home each night.
It was also during this time that he started playing poker, a card game he has said helped him learn about taking risks. He was good at it, sometimes coming home at 6 a.m. after an all-night game with hundreds of dollars in winnings.
While studying at the University of Pennsylvania’s Wharton School in Philadelphia, he continued playing poker with this fraternity brothers and would skip class to go to a downtown brokerage firm where he taught himself to predict the direction of a stock by watching each tick of the price and the volume of shares traded.
After graduating in 1977 with a bachelor’s degree in economics, Cohen went to Gruntal & Co., a small New York brokerage firm where he thrived doing short-term trading. Two years later he married his first wife, Patricia, and they had two children before separating in 1988.
There were a few scrapes with regulators in those early years. A lawsuit Patricia filed years after their separation, accusing her ex of hiding money from her during their divorce, and said her husband had been questioned by the SEC in June 1986 about receiving inside information on the takeover of RCA Corp. by General Electric Co. During the interview, Cohen invoked his Fifth Amendment right against self-incrimination, the suit said. No charges were ever brought.
Then, in 1991, he bought 100 shares of a very thinly traded stock at the end of the month, enough to drive the share price up sharply, increasing the value of the firm’s holdings by more than $100,000. Four years later, a New York Stock Exchange panel sanctioned Cohen for the purchase, saying he “engaged in conduct inconsistent with just and equitable principles of trade” and barred him from working for a member of the exchange for four weeks. He neither admitted nor denied wrongdoing.
In 1992, he started SAC with $25 million and 10 employees, continuing the same short-term trading he had done at Gruntal. The same year he married his second wife Alex, who he had met through a dating service. The newlyweds appeared on a talk show that discussed men who can’t separate from their ex-wives even after starting new relationships.
In the early years, SAC was made up of a close-knit group of traders, with Cohen attending basketball games and going on vacations to the Caribbean with them. One former employee described the firm at that time as the Wild West because there was little oversight over trading.
Throughout the 1990s, Cohen accounted for around half the profits, and he has repeatedly said it was a great time to make money because his assets were relatively small and there were few other hedge funds competing with him. In 1999, he posted a return of 68 percent, and as the technology bubble burst he did even better, ending 2000 up 73 percent, his best year ever.
By then, SAC was managing more than $1 billion. Ninety percent of that money was Cohen’s, and he would routinely return client capital because he felt returns would suffer if he had to invest larger amounts.
As the hedge-fund industry’s assets approached $500 billion, five times what they were when Cohen started SAC, former employees said he started dreaming of joining the ranks of the big firms such as Julian Robertson’s Tiger Management LLC and George Soros’s Soros Fund Management, which had both briefly surpassed $20 billion in assets.
Cohen already had proved that he was an ace trader, now he wanted to build a hedge-fund empire. In 2001, he started a New York-based unit, Sigma Capital, to trade debt and equity, organized by industry group. Three years later he created CR Intrinsic Investors LLC -- the initials standing for Cumulative Return -- which emphasized research and longer-term trades to accommodate SAC’s growing assets.
Both units held their own meetings with corporate executives and brokerages, bolstering market information gathered by SAC as a whole and increasing competition. It also enabled analysts to be directly linked to their trade ideas and rewarded for the ones that paid off.
In 2005, with this structure in place, Cohen ramped up marketing efforts. In the next two years, SAC’s assets jumped $10 billion on performance and new clients, reaching $16.5 billion by the end of 2007.
As Cohen crossed into billionaire territory, he raised his profile. He started collecting art and in 2004 joined the board of the Robin Hood Foundation. Last year he bought a stake in the New York Mets baseball team and was elected to the 45-member board of trustees of the Museum of Contemporary Art, Los Angeles.
Cohen’s success attracted scrutiny from the government. From at least 2007, investigators have been making inquiries about his trades. At least nine current and former SAC employees, including Martoma and Steinberg, have been linked to insider trading at the firm. Four have pleaded guilty.
The SEC said in last week’s order that Cohen failed to determine whether employees were engaged in “unlawful conduct” and to take steps to prevent violations of securities law. Martoma and the health-care analysts didn’t follow rules governing interactions with doctors involved in clinical trials, the agency added.
SAC said in its July 19 statement that the SEC ignored SAC’s “exceptional supervisory structure, its extensive compliance policies and procedures, and Steve Cohen’s strong support for SAC’s compliance program.”
Yet just two months ago, Cohen told investors that SAC was strengthening its compliance procedures, including restricting the use of industry consultants, such as Dr. Gilman, and contact with public-company employees.
In the past two months, as the government investigation of Cohen intensified, he stopped updating his clients on the probe, and reduced his trading in the Cohen Account. He also spent time earlier this month vacationing on a yacht in the Mediterranean.
A trader who has always been skillful at cutting his losses, he’s now vowing to stand his ground.