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For example, on or about July 29, 2009, a recently hired SAC PM (the “New PM”) sent an instant message to [Steve Cohen] and relayed that, due to some “recent research,” the New PM planned to short Nokia when he started work 10 days later. The New PM apologized for being “cryptic” but noted that the head of SAC compliance “was giving me Rules 101 yesterday – so I won’t be saying much[.] [T]oo scary.”
Possibly the weirdest part here is that new hires got compliance lectures two weeks before they showed up at the firm? But maybe not; the DOJ takes a pretty dim view of SAC’s hiring process generally, and if you believe the DOJ that SAC’s main hiring criterion was “is good at insider trading” then you could imagine the need for a little pre-start-date warning about email etiquette:
E-mails from the business development [i.e. recruiting] team to [Cohen] and others reflected an emphasis on hiring personnel with company contacts in their respective sectors. For example, a brief write-up of a SAC PM candidate specializing in the industrial sector forwarded to [Cohen] on or about November 16, 2008, described the candidate as “the guy who knows the quarters cold, has a share house in the Hamptons with the CFO of [a Fortune 100 industrial sector company], tight with management.”
I hope the share house was on his résumé. Or:
[I]n or around the summer of 2008, [Cohen] received a warning from an employee of another hedge fund (“Hedge Fund A”) that Richard Lee, who previously had worked at Hedge Fund A, was known for being part of Hedge Fund A’s “insider trading group.”
I hope that was on his résumé! SAC hired Lee anyway, and he proceeded to insider trade in 3COM and Yahoo, get indicted, and plead guilty this week.1 Good job everyone. Incidentally it seems Hedge Fund A was Citadel though perhaps they shut down their insider trading group when they were lopping off all those other businesses.
The meat of the complaint is really that, despite the euphemism training, people kept emailing Cohen saying “here’s a trade based on inside information” and he kept replying, in essence, “cool”:
[O]n multiple occasions the SAC PMs and SAC RAs communicated to [Cohen] trading recommendations sourced to information from a contact “at” a public company or with similar language. In these cases, the SAC Owner failed to inquire whether the contact was permitted to disclose the company information or to take other steps to ensure that the trade was not based on Inside Information. For example: …
[PM:] “I am very comfortable that this qtr is going to be solid vs current consensus and guidance. I am getting coffee on tues afternoon with the guy who runs north American generics business.” [Cohen]: “Let’s talk later.” …
Horvath wrote [to Cohen]: “My edge is contacts at the company and their distribution channel.”
And that the rigorous compliance program wasn’t. About that last email from convicted insider trader Jon Horvath – “My edge is contacts at the company and their distribution channel” – there is this:
Steinberg, who was copied on the e-mail, forwarded it to the SIGMA CAPITAL Chief Operating Officer (the “COO”) with the comment: “I suspect the line about contacts at the company may wake up some of our legal eagles.”
It did not! The COO rationalized it away – “my interpretation of his comment is just that he developed good relationships with mgmt. that enhance his comfort level” – without talking to Horvath (or compliance), and that was that. Also “wake up” is an unfortunate turn of phrase. But perhaps accurate:
[T]he limited number of internal investigations by the SAC compliance department of insider trading were generally weak, with a focus on “confirming” with a SAC PM or SAC RA in an interview that an e-mail implying access to Inside Information was an inartfully drafted e-mail. In fact, despite numerous documented cases of insider trading at SAC – established by, among other things, guilty pleas of six former SAC PMs and RAs who each committed insider trading on numerous occasions and over a substantial period of time while employed at SAC – SAC’s compliance department contemporaneously identified only a single instance of suspected insider trading by its employees in its history.
And when it did – a case where SAC analysts shorted Medicis stock on a tip from an outside analyst that he was going to release a negative research report the next day – SAC “imposed monetary fines on the two offenders, but allowed them to keep their jobs, and failed to report the insider trading to any regulatory or law enforcement personnel.”
Really it’s worth making an effort to understand where both sides here are coming from. SAC was a vast and voracious machine for digging up information about companies, and hired people who were good at, and enjoyed, finding out information about companies. The Journal had a good article this morning about SAC’s 2004-ish shift from tape reading into “deep value investing,” and its subsequent focus on hiring people who knew about companies. And really how do you get to know about companies except by reading about them, watching them, talking to people who work with and for them, and generally immersing yourself in their businesses? And share houses?
If that’s what you do then you understand that the lines between legitimate and illegitimate, and material and immaterial, information can be blurry. Is the CFO’s confidence a sign of strong management (great!) or a sign that they’ll beat consensus this quarter (illegal!)? Did that doctor see the Phase II drug trial reports because he was talking to the company about participating in Phase III (fine, somehow?) or because he was the supervisor of Phase II (illegal probably?). And because you’re human and basically a decent person you assume that you are behaving ethically and avoiding doing anything illegal – and that everyone around you is too. You read ambiguous emails charitably. You’ve met that guy, that guy’s no dummy, he’s not going around sending emails about how he’s committing crimes. He’s just developing relationships to enhance his comfort level.2
Meanwhile if you’re a U.S. Attorney who’s spent half your career investigating SAC Capital you would bring a different perspective to those emails.
Neither perspective is a priori right or wrong. Hedge funds really are allowed to do extensive research into the companies they invest in, talk to people in the industry, talk to people at the companies, and generally try to build a mosaic of information and insight that is better than everyone else’s. And then trade on it. That’s their job. On the other hand, there really are rules – fuzzier rules than many people assume, but still, rules – against certain kinds of research.
A lot of what’s in this indictment – “omg Steve Cohen got emails saying that his analysts talked to someone at the company!!!” – is less than it seems; investors talk to companies all the time and it’s not necessarily suspicious. Still, though. There’s just a lot in this indictment. Assuming the best about your colleague’s motives is a perfectly sensible human behavior, the first or second or tenth time they email you about their inside information. Eventually, though, you might draw more negative conclusions. And eventually the DOJ did.
Charging & Supporting Documents: U.S. v. S.A.C. Capital Advisors, L.P., et al. [SDNY]
SAC Capital Advisors Investigation Live [Reuters]
Document Trail of a Hedge Fund Investigation [DealBook]
For SAC, a Shift in Investing Strategy Later Led to Suspicions [WSJ]
1. Giving him the amazing distinction of being the second SAC Capital employee named Richard Lee to plead guilty to insider trading. A Richard Choo-Beng Lee, referred to as “CB Lee” in the indictment, did some insider trading for SAC in 1999-2004 and pled guilty in 2009. The ex-Citadel Richard Lee worked for SAC from 2009-2013 and pled guilty on Tuesday. See paragraphs 14(b) & (g) of the SAC indictment.
2. And, really, to be fair, there’s not a lot of “we got merger news a week in advance and bought a lot of call options” here. It’s all shades-of-gray insider trading: a stronger read on the drug trials than everyone else was assuming, a little bit of confidence around already disclosed earnings guidance, a third-party research report. You could easily rationalize it. It could even be legal, some of it.