Why SAC Capital's Steven Cohen Isn't in Jail
Ten thousand dollars an hour worth of lawyers filed into a courtroom in lower Manhattan on the morning of Nov. 8. The legal team represented Steven Cohen’s hedge fund, SAC Capital Advisors, which had agreed to pay $1.2 billion to settle criminal charges that it had engaged in securities fraud. The hearing was the culmination of a long legal struggle between SAC and the government that has dramatically altered what was once one of Wall Street’s most powerful firms. Eight former or current SAC employees have been charged with insider trading. Six of them have pleaded guilty; one, Mathew Martoma, is due to go on trial on Jan. 6, and another, Michael Steinberg, was convicted on Dec. 18 of insider trading in two technology stocks. Separately, Cohen was charged in a civil case with failing to supervise his employees by the Securities and Exchange Commission, which is seeking to bar him from the securities industry. Cohen’s company is transforming itself into a much smaller operation that manages only Cohen’s money. SAC had fostered an unprecedented “culture of corporate corruption,” U.S. Attorney Preet Bharara said when the criminal charges against the company were first unveiled.
The man who was conspicuously absent from the courtroom that day was Cohen. After seven years of investigations, wiretaps, unearthed documents, and undercover informants, the government had not been able to assemble enough evidence to charge Cohen criminally with insider trading—though people familiar with the investigation say the pursuit of the billionaire hedge fund founder continues. It’s becoming increasingly apparent, however, that Cohen was just clever—or lucky—enough to avoid the harshest penalties levied against some of his own employees. The reasons why may trace back to his actions during a few pivotal weeks in the summer of 2008.
SAC, at the beginning of 2008, was at its peak, with close to 1,200 employees and more than $16 billion in assets. The firm had just gone through several years of rapid expansion, moving into areas beyond its specialty as a short-term stock-trading shop, having launched a private equity group in 2007, a Hong Kong office the year before, and other new funds and divisions in the preceding years. There were lavish holiday parties, three in-office masseuses, and the occasional cigarette boat stashed outside the firm’s headquarters in Stamford, Conn. The collection of cars in the parking lot was legendary: a portfolio manager’s Mercedes with gullwing doors, Maseratis, Ferraris, a brown Bentley just like Justin Bieber’s. Few at SAC could have imagined what was to come during the next 12 months, when the firm’s “edge” would evaporate and two portfolio managers would commit acts that would have them facing prison five years later. The year 2008 was, and remains, SAC’s only down year, when the firm’s flagship fund lost almost 28 percent.
Both Jon Horvath and Martoma had been with SAC for more than a year. Martoma, now 39, had grown up in Florida, graduated from Duke University, and had an impressive collection of degrees and residencies, including a stretch at Harvard Law School, a Stanford MBA, and time logged at a Boston hedge fund called Sirios Capital Management. Horvath, 44, a Swedish native who’d been raised in Toronto, graduated from Queen’s University in Kingston, Ont., with a degree in Commerce. He had shaggy hair and a slightly dazed expression that made him perpetually look as if he’d been up partying the night before. He’d worked at Lehman Brothers in San Francisco analyzing computer stocks at its Neuberger Berman asset management group before joining SAC’s Sigma Capital Management unit in New York in September 2006, following a vetting process that lasted six months.
SAC was structured like a bicycle wheel, with the spokes consisting of about 100 portfolio managers with their own teams of analysts and traders working in competition with the other teams. Camaraderie in SAC’s offices was low. At the center was Cohen, 57, the only connector between the different groups, who would take the best ideas from each and trade on them himself. Aside from losing money, there was nothing Cohen hated more than a portfolio manager who didn’t communicate vigorously and often.
Horvath’s job was to provide research ideas to Michael Steinberg, who had been at SAC since 1996 and was one of its most senior portfolio managers. Steinberg, 41, had attended the same high school as Cohen—Great Neck North in Long Island, N.Y.—and the two were close. Horvath tracked companies including Dell, Apple, Microsoft, IBM, Hewlett-Packard, and many others. He traveled constantly between California—where he had an apartment in San Francisco and a ski share at Lake Tahoe—and New York, as well as to conferences and company visits in places such as Boston, Arizona, and Taiwan.
If Horvath was sure of one thing after his first year at SAC, it was the unforgiving nature of the place. If your ideas didn’t make money, you were out. His investment recommendations to Steinberg had done reasonably well in the first half of 2007, generating $7 million to $10 million dollars in profit to the Steinberg portfolio. But after two Bear Stearns hedge funds collapsed that July and the market started to shudder, Horvath’s stock picks lost most of those gains. One stock in particular, Network Appliance, a data-storage company that Horvath had urged his boss to buy, plunged and caused losses of $2 million. Sometime later, after the Sigma offices on Madison Avenue had emptied out, Horvath later testified in court, Steinberg called him over to his desk on the trading floor.
“I can day-trade these stocks and make money by myself, I don’t need your help to do that,” Horvath says Steinberg told him, speaking slowly and deliberately. “What I need you to do is go out and get me edgy, proprietary information that we can use to make money in these stocks.” Steinberg added: “You need to talk to your contacts at the companies, bankers, consultants. And leverage your peer network to get that information.” Horvath says he understood this to mean that he should try to get nonpublic information they could use to make money—or he’d lose his job. During his trial, Steinberg vigorously disputed that this conversation ever happened.
Horvath took home a relative pittance of $416,084 of compensation in 2007, compared with Steinberg’s $5.1 million. He rang in the New Year vowing to do better. He cultivated a relationship with Jesse Tortora, an analyst at a hedge fund called Diamondback Capital, whom he’d met through a former roommate in San Francisco. Tortora was well connected and started funneling him inside information about Dell, which, Horvath later testified, he passed up to Steinberg.
With the financial crisis bearing down on them, it was getting harder and harder to make money. On Jan. 11, 2008, Bank of America announced it was buying Countrywide Financial, saving the mortgage lender from bankruptcy. On Jan. 15, Steinberg sent out an e-mail to all of the analysts in his group: “Time to retrench,” read the subject line. “Risk avoidance is the new maxim for us on the long side, until this market settles out,” he wrote. “We will not own 1 share of anything where we don’t have a qualitative, proprietary edge. Please do not propose any ideas without it.”
At the time, Martoma was juggling a different set of challenges as a portfolio manager focused on health-care stocks at CR Intrinsic, an elite research-driven unit that was walled off with glass from the rest of the trading floor in Stamford. Known as a polite, quiet fellow who never ran afoul of SAC’s compliance department, Martoma had been drawn to the firm by a guarantee that he’d take home a large chunk of the profits of his own portfolio and a portion of the proceeds in the Cohen and CR Intrinsic accounts, to the extent that he contributed to them. No other hedge fund offered such a direct gateway to potential riches. Martoma had been married for three years to Rosemary, a physician (they eventually had three children); he had studied biology at Duke and worked after college at the National Human Genome Research Institute. It was only natural he’d be drawn to stocks such as Elan and Wyeth, which, during 2008, were testing a new potential blockbuster Alzheimer’s drug called bapineuzumab that seemed like it might yield a windfall.
Martoma spent the first half of 2008 aggressively pitching Elan and Wyeth to Cohen because he expected the trial results to be good. Not everyone agreed. That spring, dissent festered over the investment, which was becoming a source of gossip within the SAC offices. Two analysts in particular, David Munno and Benjamin Slate, tried to dissuade Cohen from building such risky exposure to two volatile drug companies. “ELN, (important, please read) negative reads from company and other buysiders,” they wrote to their boss in one March 2008 e-mail. In April, at Cohen’s urging, the analysts consulted with another doctor who had some familiarity with the Alzheimer’s drug trial, who also contradicted Martoma’s optimism. But Martoma felt he had the best source. According to the government, he’d been getting nonpublic information from an Alzheimer’s expert at the University of Michigan named Dr. Sidney Gilman, who was overseeing the clinical trial of the new drug. (Martoma pleaded not guilty to charges of insider trading. “Mathew continues to fight these charges and is preparing for trial,” says his lawyer, Richard Strassberg of Goodwin Procter.)
As the traders scrambled to not lose money during the shaky spring of 2008, a government crackdown on illegal trading was beginning to crystallize. After 12 months of digging by the SEC, federal prosecutors at the Southern District of New York, and the FBI’s securities unit, the first wiretaps were placed in the investigation of the Galleon Group hedge fund in March 2008. They would eventually lead to dozens of insider-trading convictions (Raj Rajaratnam, Galleon’s co-founder, is serving an 11-year sentence). Around the same time, a handful of the earliest cooperators in the government’s probe of the industry were approached, in secret, by FBI agents—and all of them flipped and decided to cooperate.
Horvath, meanwhile, continued his exhaustive research of his tech companies, building spreadsheets and chasing investor-relations contacts. He also continued feeding the SAC trading machine with data on Dell he was getting, he says, from Tortora, his contact at Diamondback Capital. In April, Steinberg sent an e-mail to Horvath with the subject line “Code.” In it, Steinberg said that he was going to start referring to one of his contacts, a former SAC analyst named Richard Choo Beng Lee, who was often called “CB” by his friends, as “BC” from then on. The timing was uncanny—the government was just launching its investigation, and months later, in 2009, Lee would be approached by the FBI and persuaded to cooperate, providing evidence of wrongdoing involving SAC and other firms. But the flipping of initials started for internal competitive reasons, to hide information from other portfolio managers at SAC. Horvath started referring to Tortora, the source of his Dell intelligence, as “TJ” rather than “JT,” and another SAC trader began referring to Galleon as “lag” rather than “gal.”
Elan and Wyeth announced initial results for the Alzheimer’s drug trial on June 17. They were positive, emboldening both Martoma and Cohen. By June 30, 2008, CR Intrinsic owned over $233 million worth of Elan shares and more than $80 million of Wyeth, comprising almost 14 percent of the fund’s holdings. Cohen also had $293 million of Wyeth and $95 million of Elan in his personal portfolio.
There are signs that the investment was generating considerable excitement around the office. As the positions ballooned, Cohen’s personal assistant, Kate Mattox—who listened to practically every conversation her boss had every workday via the famous Steve-cam, which broadcast Cohen’s movements across the trading floor—asked senior management for permission to open a personal trading account. There were only two stocks she wanted to buy: Elan and Wyeth. The firm said no. (Mattox has since left SAC; a SAC spokesperson declined to comment.)
On July 17, almost two weeks before the final drug trial results were due to be released, Dr. Gilman, the overseer of the trial, received a 24-page PowerPoint presentation from the companies containing the results. They were not good. Later that afternoon, the government alleges, he and Martoma talked for almost two hours by phone, and then again the next day. On the morning of Sunday, July 20, Martoma sent a message to Cohen saying that it was important that they speak. No one, aside from Cohen and Martoma, knows what was said during the 20-minute phone call that followed, which Cohen conducted from his home. The following day, Cohen’s head trader started liquidating SAC’s Elan and Wyeth shares, ultimately selling their entire holding and then shorting millions of shares of each. On July 30, after the negative bapineuzumab results became public, both Elan and Wyeth’s share prices dropped, yielding profits and avoided losses to SAC of around $275 million, according to the government. Martoma earned a $9.3 million bonus that year.
Horvath was sitting on a bombshell of his own. He learned that Dell’s August quarter was going to be a disappointment. In late August, Steinberg started shorting Dell based on Horvath’s advice. By Aug. 25, three days before the company was due to report earnings, Steinberg had amassed a short position of more than $3 million.
That day, Horvath received an e-mail from firstname.lastname@example.org, an address where analysts were supposed to send their best ideas so Cohen could trade on them. “Cohen Sector Position Alert,” read the subject line. “Please reply with any comments or updates you have on the Cohen Account positions below.” The accompanying chart showed that COHE, Cohen’s personal SAC trading account, owned Dell. Horvath felt a pit in his stomach. He and Steinberg were betting that Dell would go down, while Cohen was betting it would go up.
“Steve didn’t like losing money,” Horvath said later—something of an understatement, as Cohen was known for rages prompted by losing trades. “You were kind of in the bad books if you lost him money.” He forwarded the e-mail to Steinberg with the note: “steve is long DELL…”.
Steinberg replied, “Interesting… I have not mentioned anything to him yet. I would like to express our view to him, but we need to properly weigh the r.r. [risk-reward] of doing so. How high is your conviction here, scale of 1—10, 10 being maximal conviction?”
Horvath went and checked again with Tortora to see that his source was still predicting a disappointing quarter. He also called Dell’s investor-relations department to see what he could glean from the company’s “body language.” Both Horvath and Steinberg e-mailed back and forth with another SAC portfolio manager, Gabriel Plotkin, who had an enormous, $60 million long position in Dell and who had been “tagged” in Cohen’s portfolio as the impetus behind his trade, which meant that he would earn a share of Cohen’s Dell profits, if there were any. Around 12:30 p.m. the next day, Steinberg e-mailed Plotkin and Horvath: “I was talking to Steve about DELL earlier, and he asked me to get the two of you to compare notes before the print, as we are on opposite sides of this one…”. Horvath, who was in Cabo San Lucas, Mexico, wrote back to both of them what later became an infamous e-mail:
“I have a 2nd hand read from someone at the company—this is 3rd quarter I have gotten this read from them and it has been very good in the last two quarters,” he said, before enumerating Tortora’s gross margin, revenue, and earnings predictions, which showed a sharp disappointment for Dell. “Please keep to yourself as obviously not well known.” Steinberg added a postscript: “Yes normally we would never divulge data like this so please be discreet. Thanks.” To a savvy trader, what Horvath was saying was clear: A reliable source inside Dell had tipped him off about the earnings in advance.
What happened next represents something of a brush with the legal abyss for Cohen. Plotkin forwarded the “2nd hand read” e-mail to Anthony Vaccarino, another SAC portfolio manager who had been instructed to keep Cohen informed about how the others were trading Dell. Vaccarino forwarded the e-mail to Cohen, who was at his house in East Hampton, N.Y. Then Vaccarino called him on his cell phone. During the next two hours, the government has alleged, Cohen sold his entire long position of 500,000 Dell shares. After the earnings announcement, Dell dropped 14 percent, its largest selloff in eight years. Cohen denies that he sold the shares based on Horvath’s “2nd hand read” e-mail, and cites the actions of Plotkin and others as driving his decision to sell.
Later that evening, Cohen sent Steinberg a message that read: “Nice job on dell.” Steinberg’s response was, “Thanks… this ole dog can still hunt”.
Steinberg’s team tried to repeat their success three months later. Lehman Brothers had gone bankrupt on Sept. 15, and Washington Mutual had been seized by regulators 10 days later, becoming the largest bank failure in history. In early October, the head of the International Monetary Fund said that the global economy was on the “brink of systemic meltdown.” As Horvath would later put it: “The world seemed to be ending.” The SEC choked off one of the traders’ only remaining avenues for making money when it tightened the rules surrounding short selling after the Lehman collapse in an effort to stabilize the plunging market.
Cohen, once again, found his trading in conflict with that of Horvath and Steinberg, who had built a long position in Dell, Horvath says, based on information from Tortora. On Nov. 14, Cohen held an Instant Message chat with Steinberg:
AIM:mike72ms [Steinberg] dell rpts thrusday
AIM:cas— [Cohen] y …
AIM:mike72ms we like it…weve been good here if u remember
AIM:cas— call me… it’s a shame-cause I can be helpful to you too but that;s life
AIM:mike72ms steve I have an analyst that covers this stock… he has industry contacts… im not hiding anything from u
The exceedingly cautious Cohen replied: “I would prefer to talkon phone”.
Steinberg, concerned that the boss was angry, recounted the exchange to Horvath later, providing the strongest explanation yet of why Cohen was not charged for his Dell trades: “I told him not to be short and he got pissed, drilling me… who is telling me business is ok,” Steinberg wrote, describing his conversation with Cohen. “I said Jon has a number of industry contacts and that is what he has heard through supply datapoints and he was not pleased…total bulls- - -.” In other words, Horvath later testified, he and Steinberg had hidden from Cohen where they were getting their information.
Government investigators say that by the end of 2007, trading on inside information had permeated the hedge fund industry, fed by expert-networking firms which connected traders with insiders at public companies who could leak them valuable data. But the 2008 financial crisis threw sand on some of the government’s plans. The market became so volatile, and so many funds lost money, that it became pointless to try to press charges over trades that investigators were convinced were illegal but ultimately didn’t yield any profits, according to people connected with the investigation. If 2008 hadn’t happened, some of them believe, they might have actually captured their white whale—Cohen—and many other targets.
In 2010, Martoma was terminated by SAC for failing to replicate his success with Elan. A few months before that, he’d written an e-mail to Cohen and some of his top executives: “SAC is a special place to me. Having attended graduate and undergraduate programs at Harvard, Stanford and Duke; founded/sold my own healthcare company; and worked as a Director at the largest federally funded science initiative in the last 3 decades, I have a variety of experiences to compare against my time at SAC,” he said. “Through it all, it’s clear to me that I am in my element here at SAC.”
Perhaps the e-mail explains why, despite repeated invitations, Martoma has so far declined to cooperate with the government in its investigation of Cohen, leaving Martoma with the possibility of a long prison sentence and prompting conspiracy theories over what might be motivating him. Steinberg, a father of two small children, must wait until April to learn what his sentence will be; although guidelines suggest that he could get up to 85 years for the five counts on which he was convicted, the relatively small profits of $1.4 million he made on his trades mean that he’ll likely end up sentenced to a handful of years. He plans to appeal his conviction.
Despite the dogged efforts of investigators, Cohen appears to have avoided a comparably stiff punishment. Might things have turned out differently? If Cohen had engaged with Steinberg over instant message in November 2008, indicating some knowledge of where his employees’ illegal edge came from; if Martoma had told him about his alleged conversations with Dr. Gilman, which prompted SAC’s sales of Elan and Wyeth that week in July, and if Martoma went on to tell that to the FBI—it might be Cohen awaiting sentencing now rather than one of his top associates.
Instead, Cohen continues to live in a 35,000-square-foot mansion and buy and sell the high-priced art he’s become known for. He’s been telling people that he plans to rebuild SAC as soon as possible.