It’s always been pretty clear that the SEC would charge Picasso-buying billionaire Steve Cohen with something.
After all, the agency has spent the better part of a decade investigating Cohen’s hedge fund, SAC Capital, for evidence that Cohen knew about and approved of the insider trading that was taking place among his stock-trading minions. And despite the fact that Cohen (a) has never been caught insider-trading, talking about insider-trading, or overtly encouraging his underlings to insider-trade, and (b) deliberately set up SAC as a decentralized network of feeder funds in order to create plausible deniability for just about anything, the agency wasn’t just going to let all that work go to waste. So it charged him with “failing to supervise” his firm — essentially, turning a blind eye to the insider trading happening under his watch.
“Failure to supervise” is a fairly weak charge, as these things go. In the context of Cohen’s case, it probably means the SEC has given up on finding a smoking gun linking Cohen directly to insider trading. The SEC’s allegation is basically: “Unless you were a complete idiot, you would have known that your traders were providing you with information that was acquired illegally, and you’re not a complete idiot.”
The SEC’s case against Cohen looks a little stronger than most failure-to-supervise cases. The agency has messages between Cohen and his analysts debating the possibility that Mathew Martoma, a trader who is going on trial for insider trading this fall, had gotten material, nonpublic information about the results of an upcoming drug trial. To quote from the complaint:
The Analysts exchanged a number of emails and instant messages with Cohen about whether Martoma’s advice on Elan and Wyeth was sound. On March 28, 2008, one of the Analysts told Cohen in an instant message that he did not think anyone could yet know the Phase II Trial data, because the trial was not over yet. Cohen responded by saying he would follow Martoma’s and Hedge Fund Manager A’s advice, because “they are closer to it than you.” Later in the same message, the Analyst asked Cohen: “[I] don’t know if [Hedge Fund Manager A] or mat [Martoma] will answer, but do you think they know something or do they have a very strong feeling.” Cohen replied: “[T]ough one … i think mat [Martoma] is the closest to it.” The Analyst responded: “[T]he question that I would ask is if it[’]s possible to know the data yet – i could be wrong, but i don’t think it is yet.”
A few days later, on April 6, 2008, Cohen exchanged instant messages with the other Analyst about the Drug. Cohen remarked that it “seems like mat [Martoma] has a lot of good relationships in this arena.”
“Has a lot of good relationships in this arena,” of course, isn’t necessarily the same thing as “gets a lot of inside information,” nor does “being close” to a drug trial mean “knowing exactly what’s going to happen.” Cohen’s saving grace, if he has one, may be that he’s always just mealy-mouthed enough to leave open the possibility that he thinks all of this information is coming to his desk legally. That’s the genius of being at the top of a huge, decentralized web of quasi-independent hedge funds — if you’re careful, you can almost always pass shady activity off as the work of your reports and claim you knew nothing about it.
That said, this is a situation in which SAC Capital’s decentralized structure could backfire. The SEC’s decision to bring a failure-to-supervise charge, rather than a regular old fraud charge, means they don’t have to prove that he definitively knew about insider trading, just that he should have known. That’s a much lower hurdle to clear. And it gives them a much better shot at a favorable verdict.
The SEC is seeking penalties up to and including barring Cohen from overseeing investor funds. That would effectively be the end of SAC Capital, and a pretty large black mark on Cohen’s legacy. It’s no wonder his spokesman is promising that he “acted appropriately at all times and will fight this charge vigorously.”