One hopes “black edge” wasn’t on the list. Anyway today’s indictment against SAC, for wire fraud and securities fraud, is a hoot:

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.

37 comments (hidden to protect delicate sensibilities)
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Comments (37)

  1. Posted by batmansion | July 25, 2013 at 11:46 AM

    "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."

    Ordinarily a fine premise, but something you cannot assume with regard to Wall Street. I hope the defense doesn't rely on something like this, because guess how a jury will react?

  2. Posted by Only if legal | July 25, 2013 at 11:50 AM

    It's about time the fucker got taken down.

  3. Posted by PermaGuestII | July 25, 2013 at 11:52 AM

    The CFO of a Fortune 100 company is in a Hamptons *share house* in the summer?!?

    -guy who's used to the c-suite being better compensated (and/or classier)

  4. Posted by Guest | July 25, 2013 at 12:02 PM

    Matt – I think a distinction you're missing is that the sort of info-gathering you're talking about would be much less above question on the sell-side (that is, an analyst working at a brokerage), who finds out info, distributes it publicly (like through a research report), and then if it's previously undisclosed, the company in question has the option of confirming it publicly (within 24 hours, per Reg FD [fair disclosure]) and everybody's in the clear.

    SAC gets in trouble because it got the info for its own purposes, hoarded it, effectively, and traded on it. Their primary role (at least, I would argue, regulatorily) is stock-picking. Aggressive research in-house is an uneasy fit – - and one reason most firms pay the sell-side is so it can be a clearinghouse for information, and for building those mosaics. It keeps the hedge fund at arm's length from the info gathering process, and that acts as a sort of buffer against the accusations that SAC is getting. So, by trying to do it all himself, Cohen essentially gave away that margin of safety and deniability that comes from relying more on intermediaries like the sell-side or external research shops.

  5. Posted by NotAGreatIdea | July 25, 2013 at 12:10 PM

    If you're pitch to investors is that you're research process consists of browsing a bunch of sellside reports and just going with how you feel about those methinks you're going to have a hard time gathering much in the way of assets.

  6. Posted by Guest | July 25, 2013 at 12:20 PM

    Yeah, I'm not saying you just want to sit back and wait for stuff to come to your inbox, and have that be all you do for researcuh. I think it's like the difference between buying something (in this case, info) from a traditional store vs. scaring it up yourself on the black market. Do you pay more in the store, and get stuff that's not garden variety when you get it on the black market?

    Sure. But you have that untidy side effect of being accused of being up to no good. // So it partly comes down to, what lengths do you go to, to keep yourself above suspicion. // Having a real compliance department with some teeth would be a good start!

  7. Posted by SMU Insecure | July 25, 2013 at 12:27 PM

    You stupid Yankees, WTF does having teeth have to do with having competent employees? Down here a full set of teeth is most definitely not a prerequisite for employment as a high flying stock broker.

  8. Posted by Garden 101 | July 25, 2013 at 12:39 PM

    Matt,

    How is the garden coming along this year? Good? Bad? Better than last, but doesnt hold a candle to what you had going on in that yard back in 09?

  9. Posted by Hobbes | July 25, 2013 at 12:44 PM

    But I thought insider trading was black and white?

    - Bewildered CFA Level I candidate

  10. Posted by PermaGuestII | July 25, 2013 at 12:46 PM

    It depends on what you mean by sellside. If you're saying "we rely on Goldman, BAML and JP for our research," sure, you sound like a moron. If on the other hand you're using ISI, Strategas, Ned Davis et al– either pure research places or shops w a small b/d inhouse- I'd say you're going to do just fine.

  11. Posted by Guest | July 25, 2013 at 12:51 PM

    Which is why they went out and paid for third party expert networks. . .which they are now in trouble for

  12. Posted by Homer Simpson, CFA | July 25, 2013 at 12:58 PM

    What about Ned Flanders?

    -Springfield Pension Board Member

  13. Posted by UBS MD / Tired Joke | July 25, 2013 at 1:01 PM

    Hey, I'm pretty stoked on my summer share on the jersey shore! Although I've got to say, when clients keep asking if I'm going to Jersey on business / to help them find a place for their assets, I'm kind of confused, are NJ community banks especially secretive or something?

  14. Posted by quant me maybe ... | July 25, 2013 at 1:13 PM

    Shouldn't your avatar be Hobbes CFA II ? I mean really, if you have it flaunt it.

    – Guy who seems to remember you thinking you were ready to go toe-to-toe with Matt Levine with that first comment on CFA Results a couple of days ago.

  15. Posted by What's a euphemism? | July 25, 2013 at 1:23 PM

    Best SAC euphemism: "I'll be in Conference Room A sticking sharpies up my analyst's ass."

  16. Posted by guest | July 25, 2013 at 1:44 PM

    I think you got 'SAC' confused with 'Doubleline', and 'euphemism' confused with 'interview'

  17. Posted by Guest | July 25, 2013 at 1:49 PM

    It's actually African American and White.

    – UBS Compliance Quant

  18. Posted by Hobbes | July 25, 2013 at 1:57 PM

    One is real, one is fictional. I'll let you guess which one.

  19. Posted by Raj Rajaratnam | July 25, 2013 at 2:04 PM

    Not all black people come from Africa

  20. Posted by Ping Pong | July 25, 2013 at 2:06 PM

    O rearry?

  21. Posted by Matt's Mom | July 25, 2013 at 2:36 PM

    Matty,

    Are you gunning for a job at SAC?

    Love,
    Mom

  22. Posted by WTF__k | July 25, 2013 at 2:41 PM

    And not all Africans are black.

    - Teresa Heinz Kerry

  23. Posted by Guest | July 25, 2013 at 2:51 PM

    I woke up in a new zamboni!

    -Ace SAC

  24. Posted by Jimmies | July 25, 2013 at 3:17 PM

    Do we have to call the spics "Hispanic Americans" now?

  25. Posted by hipster hater | July 25, 2013 at 3:19 PM

    Please tell me all of the words behind [Steven Cohen] and [Cohen] are "Stevey"

  26. Posted by Lloyd B. | July 25, 2013 at 3:24 PM

    This is amusing because SAC was foolish enough to actually break the laws as written(and leave copious amounts of evidence). The real trick is to manipulate the laws in your favor and act accordingly. Immoral >> illegal.

  27. Posted by Guest | July 25, 2013 at 3:38 PM

    Surely you meant "perhaps they accidentally shut down their insider trading group"

  28. Posted by Highlander Capital | July 25, 2013 at 3:48 PM

    Immortal > immoral > illegal

  29. Posted by Matt's Excel 2013 | July 25, 2013 at 3:51 PM

    Not if he's going to be using Excel 2007 over there.

  30. Posted by Danker_Banker | July 25, 2013 at 4:05 PM

    No, we call them 1/3 of your country, pendejo

    —Carlos Peligro

  31. Posted by W.E.B | July 25, 2013 at 5:21 PM

    “deep value investing”

    I don't think that phrase means what you think it means

  32. Posted by Bob Marley | July 25, 2013 at 11:05 PM

    If you are a Black Man, you are an African.

  33. Posted by Choo choo | July 26, 2013 at 3:42 PM

    WOW, if these are the stuff that is illegal: channel checks (distribution channel, middle management contact), getting color from management, what can buy side research analyst has left to do? The rule is that you don't get sensitive earnings number before the public gets it, but you accumulate circumstantial evidence to come to your own conclusion through circumstantial research…that's what EVERY buy side analysts' job description.

    If these insider trading guidlines look confusing to you, it IS confusing and it IS not well defined. Even our compliance trainer cannot explain it either therefore they ask all of you to be careful about communications in case anything can be "interpreted" as illegel. It IS scary because it is NOT WELL DEFINED.

    So now we are putting people in jail and crush companies for breaking the law that no one really understands in the first place.

    Maybe we should hold the regulators liable FIRST?

  34. Posted by Eric Peterson | July 28, 2013 at 1:49 PM

    Why are they focusing on one lame insider when Goldman's SACS is taking down countries via insider trading of Derivative gold-plated shitty loans to Greece, Spain,Italy and Portugal? FDR had it right when he outlawed Derivative trading and made it a felony to trade as such….Canada doesn't allow this kind of speculative gambling with Peoples lives why should the U.S.???

    Oh, thats right we don't use our founding fathers ideals the BANKSTERS are back with the BANK of ENGLAND style of ripping off everybody by burdening them with debt via unplayable loans and more taxation without representation…. .www.webofdebt.com

  35. Posted by Eric Peterson | July 28, 2013 at 1:54 PM

    Typical double speak, you pretend not to know what the law is because your buddies wrote it that was so they could wiggle they around insider trading laws. There hasn't been any real crack-down on fraud since William K. Black was a regulator during the saving and loan scandals….note he jailed over 2k banksters for fraud.

    Fraud always was and always will be a conspiracy. If you want the true insider info on debt goto: http://www.webofdebt.com a book by Ellen Brown.

  36. Posted by Industrial Plating | November 13, 2013 at 7:04 AM

    Hey Matt Levine, I am totally unknown regarding the Euphemisms insider trading. But reading out this post, I have got some plus point on trading. As though I am a successful businessman. Thanks and keep updating :)

  37. Posted by +śmieci+we+wrocławiu | March 31, 2014 at 6:30 AM

    Very nice blog. I hope that you will update it.