Executives at the $14 billion firm have spoken to some of their largest clients after a former portfolio manager was arrested Nov. 20, the sixth time a current or former employee was linked to insider trading while working at the firm. The Stamford, Connecticut-based firm is telling investors that compliance procedures are robust and the hedge fund is cooperating with the government, said two clients, who asked not to be named because the fund is private.
“Patience will be wearing thin among some investors after this latest accusation,” said Vidak Radonjic, managing partner at Beryl Consulting Group LLC in Jersey City, New Jersey, which advises clients on investing in hedge funds. “There is a pattern of potential compliance breaches and the money involved is getting bigger.”
Prosecutors say SAC, one of the best-performing hedge funds, reaped $276 million in profits and averted losses after Mathew Martoma, a former portfolio manager at a unit of SAC, used inside information from a clinical trial to trade in shares of two health-care companies in 2008. The investors said they are much more concerned about last week’s charges than previous ones because Cohen, according to a criminal complaint, traded those shares in his own portfolio and discussed them with Martoma.
Neither Cohen nor SAC have been accused of any wrongdoing. While Cohen wasn’t mentioned by name in last week’s complaint, he is the hedge-fund owner and investment manager referred to in the criminal complaint and a related civil case filed by the U.S. Securities and Exchange Commission, according to people familiar with the matter.
“Mr. Cohen and SAC are confident that they have acted appropriately and will continue to cooperate with the government’s inquiry,” Jonathan Gasthalter, a spokesman for the firm, said last week.
SAC has 125 teams of traders and analysts who manage their own portfolios and vie for attention from Cohen, who runs his own account and solicits ideas from other managers. The portfolio managers and analysts submit their stock picks to Cohen and his team, and if he uses them in his account and they make money, they get paid for their idea.
Noah Freeman, a former SAC portfolio manager who pleaded guilty to securities fraud last year, told the FBI it was “understood” that giving Cohen your best ideas included providing insider information, according to an agent’s December 2010 notes of the conversation. Freeman wasn’t quoted as saying Cohen knew the information came from illegally obtained tips, ordered him to provide them or traded on the data.
Even if Cohen wasn’t aware that information had been obtained unlawfully, the SEC could opt to pursue claims that Cohen failed to supervise employees who traded on inside tips, according to securities lawyers. Such claims, which have typically been limited to abusive sales practices at brokerages, may not be applicable to trades that occurred before SAC Capital registered as an investment adviser with the SEC earlier this year.
“SAC has an obligation to have reasonable procedures in place to prevent insider trading, and Cohen would be at risk of a failure to supervise or aiding and abetting claim, even if he wasn’t directly liable for the insider trading,” said Donald Langevoort, a securities law professor at Georgetown University in Washington.
James Cox, a professor at Duke University School of Law in Durham, North Carolina, said the SEC could use a provision that Congress created in 1988 that introduced liability for managers who fail to maintain a system to discourage and detect insider trading by subordinates. That provision, known as control-person liability, doesn’t require the SEC to prove Cohen knew about the trades, just that the compliance system broke down, Cox said.
Still, the SEC would be unlikely to pursue control-person claims without being able to prove that Cohen deliberately circumvented SAC Capital’s safeguards or directed Martoma to make illegal trades, said Jacob Frenkel, a former SEC attorney. As a matter of policy, the agency has typically avoided cases that second-guess supervisors without evidence they were acting in bad faith, he said.
“In the SEC arena, which is civil, it’s possible but also unlikely to see a control-person case because anyone charged under such a theory would be able to argue good faith,” he said. “It’s more than proving he had the power to control somebody. It has to be the actual exercise of that control.”