SAC Capital Advisors LP employees gathered in the hedge fund’s cafeteria on July 21, 2008, for a seminar by former Securities and Exchange Commission Chairman Harvey Pitt on compliance and how to prevent insider trading.
Yet the U.S. government has alleged that the hedge fund’s portfolio managers and analysts were busy trading that very day, and in the weeks that followed, on inside information. Two of the trades, on drug and technology stocks, were at the heart of cases brought against some of the firm’s top traders: cases that unraveled an alleged 14 year-scheme to reap hundreds of millions of dollars in illegal profit.
That scenario, Pitt said in an interview, reminded him of the baptism scene from “The Godfather,” in which a duplicitous Michael Corleone swears to reject evil on behalf of his godson as his henchmen busy themselves executing rival bosses.
“Here I was going over the fundamentals about insider trading and you’ve got people at SAC who apparently on the day or nearly the same day were doing the business equivalent of what the Godfather did,” Pitt said.
Today, SAC Capital faces a final reckoning in Manhattan federal court for its alleged culture of criminality. U.S. District Judge Laura Taylor Swain is set to decide whether to accept the fund’s guilty plea and agreement to pay a $900 million penalty, the largest ever for insider trading.
“The indictment against SAC reads like it was drafted to hammer home what a compliance failure looks like,” said Daniel Richman, a Columbia University Law School professor and former federal prosecutor.
The $900 million fine the firm faces is half of the overall $1.8 billion resolution of U.S. government charges and civil claims against the Stamford, Connecticut-based firm. While it has awaited today’s hearing, SAC Capital changed its name to Point72 Asset Management LP and agreed to manage mainly the personal funds of its founder, Steven A. Cohen.
The 57-year-old billionaire fund manager has never been charged with a crime, though he is the subject of an SEC administrative proceeding for allegedly failing to properly supervise his firm. He has denied any wrongdoing. His spokesman, Jonathan Gasthalter, declined to comment.
“There are only two sorts of people who cheat under circumstances like this,” said Pitt, who headed the SEC from 2001 to 2003, of the day he was lecturing on compliance. “The first can’t do it honestly and the second are sufficiently arrogant to believe that none of society’s rules apply.”
The alleged scheme involved more than 20 companies and went back as far as 1999. Indicted in July, the hedge fund agreed in November to plead guilty to four counts of securities fraud and one count of wire fraud, and to shutter its investment advisory business.
Cohen’s firm managed about $11.9 billion in assets as of Feb. 1, according to regulatory filings. Executives at the hedge fund had expected to start this year with only $9 billion after returning capital to investors.
The grand jury indictment of the fund outlined criminal conduct by at least eight former SAC Capital employees. Noah Freeman, Donald Longueuil, Wesley Wang, Richard Choo-Beng Lee, Richard Lee and Jon Horvath have all pleaded guilty. Two portfolio managers, Mathew Martoma and Michael Steinberg, were convicted separately after trials in Manhattan federal court.
The government said SAC Capital encouraged its employees to obtain an informational “edge” over competitors, and hired people specifically for their contacts with insiders at publicly traded companies.
Manhattan U.S. Attorney Preet Bharara, whose office has pursued SAC Capital and its employees for more than six years, described the hedge fund as a “firm with zero tolerance for low returns but seemingly tremendous tolerance for questionable conduct.”
When the hedge fund’s legal department raised concerns that Richard Lee, then a prospective SAC Capital employee, had been part of an “insider trading group” at another hedge fund, Cohen agreed to hire him as a portfolio manager anyway, the government said.
“At SAC Capital you were expected to provide your trading ideas to Cohen,” Noah Freeman told FBI agents, according to a Dec. 16, 2010, memo written by FBI Special Agent B.J. Kang. Kang wrote that “Freeman and others at SAC Capital understood that providing Cohen with your best trading ideas involved providing Cohen with inside information.”
At Mathew Martoma’s trial, jurors heard that the fund manager had received nonpublic information in July 2008, on the day before Pitt’s presentation. A doctor had told Martoma about an Alzheimer’s drug trial involving Elan Corp. and Wyeth that showed disappointing results. Martoma then had a 20-minute telephone conversation with Cohen, according to evidence presented at the trial.
The next day, SAC Capital began selling its entire $700 million position in the drugmakers.
Martoma and Cohen worked together to keep the sell-off quiet, according to testimony. They used dark pools and algorithmic trades in a process so secret that Martoma’s former trader testified he knew nothing about it until it was completed.
A few days before Pitt's talk, SAC Capital analyst Ron Dennis obtained and passed a tip to an unidentified fund manager at his firm, according to the SEC. The tip, that Foundry Networks Inc. was about to be acquired by Brocade Communications Systems (BRCD:US) Inc., was followed by SAC Capital’s decision to obtain 120,000 Foundry shares, according to the regulator.
Foundry’s acquisition was announced as Pitt concluded his compliance presentation. The next day, Foundry’s stock price climbed 32 percent, and SAC reaped a profit of more than $550,000, the SEC alleged.
Dennis, who settled a lawsuit by the SEC last month without admitting or denying any liability, couldn’t be immediately reached for comment on today’s plea hearing.
In the month following Pitt’s visit to the hedge fund, Michael Steinberg, using what prosecutors said were illegal tips provided to him by Horvath, shorted Dell Inc. ahead of news the company was going to miss earnings estimates, allowing SAC Capital to net more than $1 million.
Cohen, who owned about 500,000 shares of the computer maker, began liquidating his entire position within minutes of receiving an e-mail from Horvath and Steinberg, the U.S. said in an SEC administrative proceeding. Cohen avoided losses of more than $3.5 million in two portfolios, according to the government.
Following his 2008 compliance lecture, which all SAC Capital employees attended in person or via closed-circuit television, Pitt said he was asked whether he wanted to meet Cohen, whom he later found at his desk.
“Virtually everyone was required to show up to my lecture except one single person: Steve Cohen,” Pitt said.
Pitt said compliance needs to be in a firm's ``DNA.''
“It has to permeate the culture of a firm, and if it doesn’t, it’s going to lead to a slew of disasters,'' he said.
“Cohen has lost, and lost big,” the former SEC chairman said. “It’s a very sad commentary.”
The case is U.S. v. SAC Capital Advisors LP, 13-cr-00541, U.S. District Court, Southern District of New York (Manhattan).
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