It is a bit confusing, honestly.

Photographer: Ronda Churchill/Bloomberg

Senator Wants to Protect Investors From Steve Cohen

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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I don't get all that worked up about insider trading, but let's assume for a moment that it is bad and that Steve Cohen did it, or at least failed to supervise people who insider traded while working at his old hedge fund, SAC Capital.  What is the right punishment? Obviously prison, beheading, etc. might be options. But on this assumption, the basic bad thing that he did was trade, so we might want the punishment to be related somehow to his trading. (Or: The basic bad thing that he did was supervise traders, so we might want the punishment to be related to his supervising of traders.) One could imagine, for instance, banning him from trading for a while, or forever, because his trading was bad.

But that isn't what happened, because banning someone from trading is in practice, in 21st-century America, unthinkable. It is just not a remedy that is available to the Securities and Exchange Commission. How would you even do it? Buying and selling stocks is the all-American thing to do with your money; barring people from trading stocks would be like barring them from using the Internet, or owning guns.  

Instead, when the SEC settled its case against Cohen for allegedly failing to supervise an employee who was convicted of insider trading, he was "prohibited from serving in a supervisory role at any broker, dealer, or investment adviser until 2018, must retain an independent consultant and adopt consultant recommendations, and must submit to on-site SEC examinations of his registered or unregistered firms." This left him two key loopholes:

  1. He could be associated with a broker, dealer or investment adviser in some capacity other than a supervisory role -- as a receptionist, say, or more plausibly as a passive owner with no supervisory responsibilities.
  2. He could just trade stocks with his own money, or supervise people who traded stocks with his own money.

Loophole No. 1 has gotten a bit of a workout recently, because Cohen founded a firm called Stamford Harbor Capital and registered it with the SEC, which looked like a step toward managing outside money. "Steve Cohen owns the entity, but consistent with his January agreement with the SEC he will not supervise the activities of anyone working on its behalf," said a spokesman, and I expressed amusement and confusion:

Isn't that ... isn't that exactly what got him in trouble in the first place? The charges against Cohen boiled down to claims that he hired portfolio managers, set high profitability expectations for them, and then failed to supervise them when they insider traded. The upshot is not quite, as I had thought, that he was banned from managing outside money for a few years. He is still allowed to own a firm that manages outside money, that hires portfolio managers picked by him and pays him a portion of their profits -- as long as he doesn't supervise them at all. He didn't supervise his old fund carefully enough, so now regulators will require him to supervise his new fund even less.

Senator Elizabeth Warren, who takes a somewhat broader and less humorous view of securities fraud than I do, also expressed, in her words, "concern and disappointment," in a letter she sent to SEC Chair Mary Jo White:

The SEC's decision to approve Stamford Harbor -- and the January settlement terms that allowed this to happen -- make a mockery of the SEC's core mission to "protect investors." The Commission has permitted a recidivist hedge fund manager, well-known for his former company's willingness to evade and ignore federal law, to once again profit from -- and potentially exploit -- investors.

It does seem like kind of a weird loophole, honestly? But after Warren sent her letter, another Cohen spokesman said, in effect, never mind :

Cohen has no plans to “manage one dollar of outside money” until Jan. 1, 2018, said Mark Herr, a spokesman for the trader’s family office.

 “The SEC imposed clear conditions in the settlement,” Herr said in an e-mailed statement. “We are fully meeting and continue to meet the letter and spirit of the agreement.”

False alarm! The markets are still safe from the possibility that Steve Cohen might "profit from -- and potentially exploit" outside investors. Until Jan. 1, 2018, when he can exploit them to his heart's content.

Of course, Cohen has never actually been accused of exploiting outside investors. Outside investors love him! They lined up to fling money at him, even though he charged fees of 3 percent of assets and 50 percent of profits. Which sounds exploitative, actually, come to think of it, except that he made them so much money, with average returns of 30 percent for two decades. Then, once he kicked them out and turned his fund into a family office, he made so much money for himself. SAC Capital didn't shut down because of worries that it was exploiting its outside investors.

It shut down because of all the insider trading.  

On the other hand, Loophole No. 2 is still going strong. The reason Cohen bothers to employ multiple spokesmen is that he right this very minute supervises a giant investment management firm, Point72 Asset Management, up in Stamford, Connecticut. That firm has 1,000 employees and offices in New York, London, Hong Kong, Tokyo and Singapore.  It has a program called "Point72 Academy" to train the next generation of Point72 employees. And it has $11 billion under management, enough to make it one of the 50 biggest hedge-fund firms in the world. Except that it's not a hedge fund. It's "a family office and as such is not required to register as an investment adviser with the U.S. Securities and Exchange Commission." It's just a pile of Steve Cohen's money. It's his money, he's allowed to invest it, and he's even allowed to hire 1,000 people on three continents to help invest it for him.

Senator Warren is worried about Cohen exploiting outside investors, so for her Loophole No. 1, allowing Cohen to profit from investing outside investors' money, is an outrage, while Loophole No. 2, allowing Cohen to trade his own money, isn't even worth commenting on. But if you are worried about Cohen running a giant organization that engages in all-but-impossible-to-detect insider trading -- which after all is what he was actually accused of doing -- then Loophole No. 2 is the troubling one.  Cohen is free to trade stocks with his own $11 billion, free to hire hundreds of people to help him, free to compensate and supervise those people however he wants, and there's nothing the SEC can do about it.  Family offices like Point72 are the Wild West; basically none of Point72's internal affairs are subject to the SEC's jurisdiction.

Except that the SEC made Point72 subject to its jurisdiction, because the settlement agreement requires Cohen to submit to SEC supervision -- including his "consent to any onsite examination of any Cohen Entity that the Commission staff elects to conduct" -- and hire an independent consultant to monitor Point72's compliance practices. Technically Point72 is a family office, subject to more or less no regulation at all, but the SEC has negotiated a deal in which Point72 is regulated and examined even more than a hedge fund would be. (Not that hedge funds are all that regulated, compared to, say, banks or mutual funds, but the SEC does have power to examine them for suspicious trading and bad compliance practices.) As the SEC put it:

“As the only law enforcement agency to charge Steven Cohen, the SEC imposed important restrictions, including a supervisory bar plus the additional oversight requirements in the settlement that are even stronger than typical remedies available under the securities law,” Andrew Ceresney, the director of the SEC’s Division of Enforcement, said in a statement.

“Under the settlement’s significant requirements, the SEC will scrutinise his trading activity closely going forward to protect investors.”

This only lasts until the end of 2017, though, after which Cohen will be free to do whatever he wants with his family office. Or he can turn it back into a hedge fund, and take outside money again. In which case the SEC will continue to have authority over him. Perhaps you are not worried about future insider trading at Point72/Stamford Harbor/whatever. I tend to think that Point72's much-publicized investments in compliance are genuine, and that Point72 is less likely to engage in insider trading than most other equity-focused hedge funds. But if you do think that Cohen's firm is a hopeless recidivist -- as Warren seems to! -- then you'd probably prefer that it be a regulated hedge fund than a totally unregulated family office.

It seems to me that Warren's letter is an unusually clear example of what you might call the Bad Things Are Bad school of financial regulation. In this theory, insider trading is bad, so Steve Cohen is bad, so bad things should happen to him, and he shouldn't be able to avoid those bad things. The conceptual fit between the misconduct and the consequences isn't of much importance in this line of thinking; what matters is that bad things happen to people who do bad things. Obviously this is an important strand in American political thought. But the SEC seems generally to take a more nuanced view of its role as a regulator; in particular, it tends to prefer to tailor the consequences of misconduct to minimize the risk of similar misconduct in the future.  Elizabeth Warren thinks that the consequence of Steve Cohen's alleged insider trading should be a ban on managing outside money, not so much because that punishment fits that crime, but because that's what the SEC said would happen, and she doesn't want Cohen to get a win by avoiding it. The SEC doesn't care so much about giving Cohen a win. It just wants to keep him where it can see him.

  1. To be absolutely clear, this is a hypothetical. Cohen has never been accused of insider trading. SAC did plead guilty to insider trading, though, and Cohen reached a settlement with the SEC for failure to supervise (without admitting or denying the charges). 

  2. Actually there is a reasonable case to be made that the essential illicit act in insider trading isn't the trading, but rather the misappropriation of material nonpublic information: that the harm isn't to the trading counterparty but to the issuer of the securities or whoever it is whose information you misappropriate. ("Insider trading," I sometimes say, "is not about fairness; it's about theft.") This isn't, though, how the SEC sees it. For instance, the SEC gave a chunk of its SAC insider-trading settlement to people who traded in the subject stocks, suggesting that they were the main victims.

  3. I am of course aware that both of those are in fact punishments that the U.S. justice system sometimes imposes.

  4. I know, I know, the answer to this is that someone else is supposed to supervise Stamford Harbor. But that is an insufficient response. Someone else was supposed to not insider trade at SAC Capital, too, but someone did. If Cohen is to be punished for setting up a big investment fund and rewarding people for achieving high returns without inquiring too closely into how they did it, surely letting him do that again is problematic?

  5. It is in fact explicitly included in the SEC's settlement with Cohen in January:

    Nothing in this Order shall be read to preclude or inhibit any Cohen Entity from applying to register as an investment adviser under the Advisers Act, provided that Cohen shall not be associated with such adviser in a supervisory capacity until December 31, 2017 and during such other period as provided for in paragraph 77. 

  6. I mean, I assume that's what he said. There's some way to parse that statement to suggest that Stamford Harbor might manage money before 2018, without Cohen's involvement, though that would be kind of a weird thing for those words to mean in context.

  7. Cohen's settlement with the SEC covers only one instance of failure to supervise an insider trader, Mathew Martoma, who is still in prison for insider trading. (The SEC's original case covered another instance of alleged insider trading, but that was ultimately thrown out by the courts.) But SAC Capital itself pled guilty to multiple insider-trading charges, as did six former employees other than Martoma. So it is not quite the case that SAC shut down due to one isolated instance of insider trading, though on the other hand prosecutors and regulators probably did overstate the pervasiveness of insider trading at SAC.

  8. That's according to its website. According to news reports, it also has a controversial East Hampton branch office, which inspired the television sitcom that I am currently developing

  9. That's not strictly true! The SEC's family office rules allow "key employees of the family office" to invest alongside the family, so Point72 can manage Cohen's money, his family's money, and at least some of his employees' money. 

  10. If he is insider trading, after all, that would be good for outside investors! It would make them money! You can hardly say that investors in SAC Capital were harmed by any of the actual and alleged insider trading that went on there, except insofar as it eventually caused the fund to close.

  11. I mean except catch him insider trading, if he's insider trading. But that option would be available if he had outside money too. If you care about any of this, you have to start from the assumption that the insider trading is hard to catch.

  12. In particular it is related to the idea of deterrence. (Warren complains that Cohen's loophole "is the latest example of an SEC action that fails to appropriately punish guilty parties, deter future wrongdoing, and protect investors" (emphasis added).) For myself I think in these circumstances that leaving Cohen with his $11 billion dollars and not letting him run outside money is not that much of a deterrent, but that is just an intuition that I have and it could be wrong.

  13. One maddeningly controversial example of this is that when big banks violate some securities rule, the SEC tends not to apply automatic bars from totally unrelated areas of securities law. There is some deterrence argument that the punishment for foreign exchange manipulation should be losing your well-known seasoned issuer status, but there's no actual investor-protection rationale for slowing down a bank's debt offerings just because it manipulated FX. That doesn't help the bank's debt investors, and the SEC is more concerned about investor protection than enforcing every possible consequence. Of course, this is controversial because some SEC Commissioners disagree.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net