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Friday, 26 July 2013

A hedge on the edge: SAC Capital’s insider trading scandal - and Investors May Face Clawbacks -

A hedge on the edge: SAC Capital’s insider trading scandal - and Investors May Face Clawbacks - 

After causing the collapse of the Galleon Group hedge fund in 2009, insider trading enforcements have once again shaken the hedge fund industry. Late last week, the US Securities and Exchange Commission (SEC) charged Steven A. Cohen, CEO of SAC Capital Advisors LP, one of the world’s largest hedge funds, with failing to supervise two of his managers, Mathew Martoma and Michael Steinberg, who traded on material non-public information concerning three US listed companies in 2008.

As a result of these illegal insider trades, SAC Capital Advisors earned profits and avoided losses of almost $300 million. If the high-profile administrative suit of the SEC proves to be successful on August 26, Cohen could face a permanent bar from the financial services industry, leaving the survival of SAC Capital on the edge and sending shivers through the entire hedge fund industry.

In general, insider trading refers to some investors (e.g. managers and directors of corporations) trading on proprietary information that is not yet available to the rest of the market. In the US, insiders are allowed to trade, as long as they meet two fundamental requirements: they do not trade ahead of information events – for instance, mergers and acquisitions and corporate announcements – where they have access to sensitive information prior to the rest of the market; and they report their trades by filing a Form 4 with the SEC.

In the 2012 fiscal year, the SEC brought 58 insider trading actions against 131 managers and entities accused of gaining profits – or avoiding losses – totalling approximately A$600 million. Between 2010 and 2012, the SEC has filed more insider trading actions — a total of 168 cases against nearly 400 individuals and entities — than in any three-year period in the SEC’s history. “[T]hese illegal practices impose a cost on law-abiding investors and the integrity of the financial markets,” said Robert Khuzami, director of the SEC’s division of enforcement, in a press statement.

At one time, investors tripped over themselves to become one of the "extractive elite" in SAC Capital Advisors LP, the hedge fund run by Stevie Cohen. According to mainstream financial media, he could do no wrong. But that may be due to weak-kneed editors, instead of lack of news of alleged wrongdoing.

After Cohen's ex-wife filed a lawsuit including allegations that Cohen engaged in insider trading in the 1980's, investigative journalist Matthew Goldstein dug further. In late 2009, he wrote a document-based expose that Reuters' lawyers approved.

According to an exclusive story by Chris Roush at Talking Biz News, "Cohen repeatedly called Devin Wenig, CEO of the Thomson Reuters Markets Division and the No. 2 executive at Thomson Reuters, to complain." The multi-billionaire claimed he was being persecuted. Editors at Reuters killed the story.

The SEC wants Cohen's "Assets"

Around 60 percent of the $15 billion SAC managed belonged to Cohen and his managers. Cohen charged investors 3 percent per year and took 50 percent of gains for SAC. Most hedge funds gouge investors for 2 percent per year and 20 percent of any gains. Now, all of Cohen's assets are up for grabs by the S.E.C.

Last week, the SEC brought civil charges against Cohen for "failure to supervise," and Cohen may face criminal charges.

Cohen's Investors: Blackstone, Funds of Funds, and Individuals

Matt Goldstein followed the saga of Cohen's investors as they abandoned ship. Cohen's largest outside investor was The Blackstone Group with around $550 million invested. Other investors included Citi's private bank, a fund of funds managed at Morgan Stanley, HSBC, Skybridge Capital, and high net worth individuals.

Fund managers that invested with SAC must be quaking in their Guccis. Investors paid them high fees and expected them to perform first-class due diligence before placing funds under Cohen's management. Yet serious questions have swirled around Cohen's trading practices for more than a decade.

SEC Slaps SAC with Insider Trading Charges: Investor Clawbacks Likely

Now that Stevie Cohen's "No. 1 goal is not getting personally indicted" for insider trading, where does that leave his investors?

If the SEC can prove its case and find that SAC's gains were the result of a criminal activity, investors will likely face clawbacks. If investors accessed SAC through a fund of funds or a multi-advisor fund, they will likely sue the managers of those funds.

The SEC alleges that insider trading resulted in "hundreds of millions" of dollars in illegal profits.

SEC: Where are the Other Indictments?

Unfortunately for SAC investors, the SEC's lawyers seem to vigorously pursue insider trading, because they can grasp it. But the SEC still has to prove its case. If the allegations are true, there's still a chance of acquittal due to incompetent lawyering: trial by email instead of doing the hard work of investigating and explaining facts to a jury, until it can grasp the essentials. The game's not over.

But the "smart money" made illegal gains by committing crimes that are difficult for the SEC's lawyers to understand: crimes related to credit derivatives, commodities trading, collateralized debt obligations, and much more. The SEC has yet to effectively investigate, much less prosecute, widespread massive fraud in the financial system.


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