It has been clear for years that the Securities and Exchange Commission has had Steve Cohen and his eponymous hedge fund, SAC Capital, squarely in its sights. Friday’s decision by regulators to levy charges against the billionaire trader and art collector, based on allegations that Cohen failed to supervise his employees, ignoring “red flags” that should have alerted him that they were taking trading positions based on illegal insider information, is simply the first attempt by the SEC to attack Cohen directly.
Cohen isn’t being charged with insider trading, and he may never be. The difficulty that regulators have had obtaining material to back up any allegations against Cohen is evidence of just how much trouble they may still have proving their case in court – and how important they believe it is to financial markets to demonstrate that SAC Capital and funds like it shouldn’t be doing business in the way the SEC believes they are. Clearly, regulators hope that winning the case and getting Cohen banned from life from the industry, part of which he has helped to create in its current form, will somehow make financial markets more transparent and equitable. And clearly they believe that they finally have enough information to push forward with a case against Cohen himself, even if it’s in the form of an administrative action rather than a lawsuit, which would require a different level of proof and, most significantly, convincing a jury of lay people in a federal court that Cohen is indeed culpable.
The roots of this action go back to the mid-2000s, by which time Cohen was already a force to be reckoned with not only in the hedge fund enclaves on 57th Street in Manhattan and Connecticut’s Gold Coast, but throughout Wall Street more broadly. When Cohen, a notable collector who has snapped up some of the priciest works of modern and contemporary art, spent $8 million to acquire a pickled shark in a tank by British artist Damien Hirst, rival traders and former employees, rolling their eyes, agreed that it was the perfect metaphor for Cohen himself. “In meetings, talking about ideas, he’s a bit like you’d expect a shark to be in the water – fast, predatory,” said one individual who has participated in such meetings with Cohen and his team members in the past. Cohen also is a demanding employer, that individual said: scathingly critical of anyone who doesn’t present fresh trading or investment ideas or whose previous ideas haven’t paid off in double-digit returns.
Of course, simply being a bit of a bully isn’t a federal securities offense. (If it were, at least half of Wall Street likely would be under indictment at any given time, along with large swathes of corporate America.) Nor is it – happily – illegal to make billions off of an employee’s bright ideas: Businesses of all kinds have been doing it for years, and if the “carry” is extraordinarily high – SAC takes as much as half of the profits in fees on some of its funds, while the industry average remains around 20 percent – well, that’s because he simply does better than his peers. Indeed, up until 2008, Cohen could point to the fact that he had generated an average return of 30 percent annually. (That long-term average now hovers closer to 25 percent.)
The problem now is that Cohen will be asked to defend how he has generated those returns. His lawyers have said he has “acted appropriately at all times” and will fight the SEC’s claims. The question lawyers for Cohen and SAC will have to address is just how much evidence – even indirect and circumstantial – regulators have accumulated since FBI raids on three other big hedge funds in late 2010 made it clear just how ambitious the crusade against insider trading was becoming. Two of those funds, Level Global and Diamondback Capital Management, were run by former Cohen employees, who had used their status as SAC alumni in order to raise billions of dollars in capital from investors. All three funds later closed their doors, even though in some cases charges were never brought.
Since then, the authorities have circled ever closer to Cohen himself. Last November, the SEC charged SAC money manager Mathew Martona with insider trading; trader Michael Steinberg was indicted in March on similar charges. Both are set to go to trial late this year. Two former SAC traders, whose activities and portfolios were supervised by Cohen himself, have pled guilty to similar charges.
The question at the heart of the Cohen case so far is increasingly key on Wall Street: At what point does inaction, or even a kind of passive encouragement, on the part of top execs translate into criminal culpability? Underlings can claim they were just doing whatever was necessary to obey orders: Cohen demanded performance, and in a market where proprietary information of any kind is hard to obtain, working for a fund that generates its profits by taking relatively short-term trading stakes in companies, the perception may well have come to be that the only way to obtain a real edge and hang on to your job (the average tenure at SAC is reported to be only around four years) was to dabble in illegally obtained information.
Whether or not the SEC succeeds in banning Cohen from the business, it has managed to make him at least slightly less influential and raise questions about his approach to the business. With about $15 billion under management today, SAC is smaller than it was at its peak, and more than half of those assets come from Cohen himself, and from his employees. As the level of scrutiny on SAC and Cohen has grown, investors have ramped up their redemptions. Some of those who work with hedge funds, helping them to raise new funds, have said that the level of scrutiny investors have devoted to funds with a similar approach to trading as Cohen’s is significantly higher. Meanwhile, being an SAC alumnus no longer means that a manager can raise big bucks out of the gate for a new hedge fund (as David Ganek did, bringing in $500 million for Level Global in 2003) or demand above-average fees.
Some of those who know Cohen saw his purchase of Damien Hirst’s shark as a way of telling Wall Street just how he wanted to be perceived. But the $8 million pickled shark, it turned out, was actually moulting in its own formaldehyde and required costly repairs. It remains to be seen whether this is a metaphor for Cohen’s current problems – and whether in a newly aggressive SEC, the ferocious trader has run into a bunch of even larger sharks, with freshly sharpened teeth.