SEC: Cohen failed to prevent insider trading
Steven Cohen, the billionaire manager of one of the largest and most successful hedge funds, was hit with a civil action by federal regulators Friday for allegedly failing to supervise two financial lieutenants accused of insider trading.
The action filed by the Securities and Exchange Commission stopped short of accusing the famed founder of SAC Capital and one of the nation's wealthiest individuals of insider trading himself. But it seeks to bar Cohen from handling investor funds, a penalty that could force him to shutter portfolios that the agency said until recently totaled more than $15 billion.
In a relatively rare legal step, the SEC also filed administrative charges against Cohen, rather than a federal lawsuit. That means the case will be handled by an SEC administrative law judge, an employee of the regulatory agency.
That gives the agency potentially valuable "home court advantage" because the rules of evidence are somewhat less strict than those in federal court, said John Coffee, a Columbia University law school professor with expertise in securities law.
The action came roughly one week before the legal statute of limitations would have expired for some of the alleged insider trading offenses. It also follows the record $615 million in penalties that SAC Capital and CR Intrinsic, another Cohen affiliate, agreed to pay the SEC to resolve insider trading charges against the firms.
In the new case, the SEC charged that Cohen received "highly suspicious" non-public information in 2008 from portfolio managers, Mathew Martoma and Michael Steinberg, who have pleaded not guilty to insider trading charges and face separate trials later this year.
Instead of heeding his supervisory responsibility to investigate, the SEC charged that Cohen "ignored red flags" and allowed trading on the information to proceed, earning profits and avoiding losses totaling more than $275 million.
"Hedge fund managers are responsible for exercising appropriate supervision over their employees to ensure that their firms comply with the securities laws," said Andrew Ceresney, co-director of the SEC's Division of Enforcement. "After learning about red flags indicating potential insider trading by his employees, Steven Cohen allegedly failed to follow up to prevent violations of the law."
"The SEC's administrative proceeding has no merit," said Cohen spokesman Jonathan Gasthalter, who said the agency had ignored SAC Capital's extensive compliance policies and procedures. "Steve Cohen acted appropriately at all times and will fight this charge vigorously."
According to the SEC, Cohen oversaw trading by Martoma and Steinberg and required them to give him updates and convey the reasons for their trades.
Martoma bought shares of two pharmaceutical companies, Elan and Wyeth, based on their joint involvement in clinical trials of a drug being tested for potential use against Alzheimer's disease.
"Cohen allowed this despite repeated e-mails and instant messages to Cohen from other analysts at CR Intrinsic advocating against it," the SEC alleged.
"The analysts questioned whether Martoma possessed undisclosed data on the results of the trial. Cohen responded by saying it was "tough" to know whether Martoma knew something, but that he would follow Martoma's advice because he was "closer to it than you,' " the SEC said.
The SEC alleged that Cohen also was told "about a doctor who had provided his portfolio managers with potentially non-public information about the clinical trial, but failed to express any concern about the use of that information."
"Instead, Cohen encouraged Martoma to talk further with a doctor familiar with the clinical trial," the SEC said.
On July 20, 2008, Martoma told Cohen he was no longer comfortable with the firm's investments in Elan, according to the SEC.
" Despite Martoma's abrupt change in view and red flags that he likely received confidential information about the clinical trials from a tipper, Cohen failed to take prompt action to determine whether an employee under his supervision was violating insider trading laws," the SEC alleged. "Starting the next morning, Cohen oversaw the liquidation of his and Martoma's positions in Elan and Wyeth and the accumulation of a short position instead."
The SEC also alleged that Cohen supervised Steinberg when the portfolio manager was involved in insider trading of Dell securities in August 2008.
"After being looped into a highly suspicious e-mail between Steinberg and other firm employees reflecting the clear possibility that they possessed material non-public information about an upcoming earnings announcement at Dell, Cohen again failed to take prompt action to determine whether Steinberg was engaged in unlawful insider trading," the SEC charged.
"Instead, Cohen liquidated his Dell shares based on the recommendation of Steinberg, who continued short selling Dell shares in his Sigma Capital portfolio based on the confidential information," the SEC said.
"Dell's stock price dropped sharply after its August 28 earnings announcement, and funds managed by Cohen's firms profited or avoided losses totaling at least $1.7 million. Three hours after the earnings announcement, Cohen e-mailed Steinberg: 'Nice job on Dell,' " the SEC alleged.
The absence of insider trading charges against Cohen himself appears to signal that neither Martoma nor Steinberg has given SEC or Department of Justice investigators any incriminating evidence against the hedge fund manager, said Coffee, the Columbia law professor.
"That's far less than they hoped for," Coffee said of the failure-to-supervise charges. "But that seems to be all they have" or feel confident of proving.
The SEC will have a potential advantage in presenting the case before an administrative law judge because it's easier to introduce hearsay testimony and some other types of evidence than in a court, said Coffee, who predicted an "intensely fought" legal battle.
"It's rare that the SEC proceeds administratively in an insider trading related case," said Coffee, who likened the agency's legal strategy against Cohen to "aiming at his kneecaps instead of his jugular."
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