Do you remember the May issue of SBM, the one with The Biggest Insider Traders of All Time? At that time we decided to include Steve Cohen and his firm SAC Capital along with big names like Ivan Boesky, Michael Milken, and Raj Rajaratnam. We foresaw the rope tightening around “Stevie” as the Feds rounded on SAC in an attempt to build the largest insider trading case ever.
There have been numerous spats between the SEC & various SAC employees in recent years, with some former portfolio managers taken into custody. Just recently however, SAC agreed to pay $602 million in civil penalties to settle the insider trader case against the company. That was the largest payment an entity ever made to settle inside trading irregularities. Set against the $16 billion in assets that the company holds though the figure pales into insignificance and many are asking, has Cohen got away with the biggest insider trading haul ever?
Since its inception in Connecticut in 1992, SAC Capital has been dedicated to the “information arbitrage” business, collecting private non-material information, mixing it with material public information and, in the process, hanging its hat on so called ‘mosaic theory’ in building a strong rationale to trade stocks in a very successful way. The model was so good that they recorded a profit averaging 30% per year until recently.
The consistent returns are an aberration – less than a fraction of a percent of fund managers can maintain these types of returns year in year out and many asked, including the Feds, whether they were in fact a consequence of an illegal boost. The odds on those returns happening each year would be far superior to those of England winning the World Cup next year against Brazil with a hat trick from Joe Hart! With this in mind, the Feds investigated the “network of experts” that SAC’s fund managers were using to obtain their non-public non-material information and came to the conclusion that the timing of SAC trades was in fact too good to be true.
Under the direction of Mathew Martoma, SAC opened a long position worth $700 million in two pharmaceuticals (Wyeth and Elan) which appreciated substantially as the first developments from clinical trials of an Alzheimer drug came in better than expected. After some time, in July 2008, SAC quickly closed the whole position on both companies and, in what was likely Martoma’s undoing, reversed his position and opened a short one. Can you guess what happened? Yes, the next clinical trials were awful and Elan and Wyeth ended up plunging 42% and 12% respectively. In a mix of loss avoidance and real profit, SAC reaped $276 million out of this trade, but the Feds discovered this wasn’t because they are enlightened biotech analysts, but because a doctor connected with those companies and part of the network of experts told them about the clinical trials in anticipation!
Even though he’s no longer a SAC employee, Mathew Martoma has, somewhat oddly, been lucky enough to enjoy his legal fees being paid by his former company and so he pleaded not guilty to anything. The case is still in court and, if he is found guilty, his plea is likely to act to his detriment in any sentencing.
The Feds have been trying to nail Cohen for some time now and so far have been unable to prove that he has engaged in insider trading – I guess with several billion dollars of profits at your disposal you can engage the finest legal brains on the planet? Several SAC employees received subpoenas in May to appear before a grand jury and Michael Steinberg was arrested in May, but for now there’s no formal accusation against Steve Cohen.
It has been said that besides paying the record $602 million fee, SAC also agreed on a deferred prosecution, which, in all but description, admits wrongdoing. At the same time, the Feds were said to be forcing the company into being a privately managed one and returning funds to outside investors although until now that hasn’t happened. However, outside investors are withdrawing their funds anyway, fearful of what else may be coming down the pipe with Stevie’s name on it…
A few days ago Steve Cohen was summoned to appear at a grand jury but he quickly made use of the Fifth Amendment to excuse himself from testifying. As he knows, the Feds are trying to get their big scalp and by saying nothing, he is looking to save himself from self-incrimination. The story of SAC and the insider trading scandal rolls on and it will be interesting to see whether he does finally end up behind bars.