It would take a stronger man than me to resist making fun of the SAC Capital white paper responding to the charges against Steve Cohen, as you can tell from the post I wrote before I read it. But now that that’s out of our system I suppose we ought to actually talk about it? Having read it now, I find it creepily compelling.
The first trick in reading it is to understand that neither the SEC’s complaint nor the white paper is really about what they say they’re about, which is “failure to supervise.” The SEC throws in a few “failed to reasonably supervise”‘s for show, but never talks one way or the other about SAC’s procedures and systems to stop insider trading – it’s all “Steve Cohen saw red flags and ignored them and then traded on that red-flag-draped inside information.” And the white paper has a rousing defense of SAC’s compliance procedures,1 but spends the bulk of its energy on second-by-second timelines to refute those supposed red flags. Nobody’s really that into the supervising or lack thereof. This is an insider-trading-lite case: the SEC is charging Cohen with insider-trading-but-we-can’t-prove-it, and SAC’s response is “you can’t prove it because it wasn’t insider trading.”
So was it? I dunno but the white paper provides some useful context around the alleged Elan insider trading, in which Mathew Martoma, who was getting inside information from the doctor supervising Elan’s Alzheimer’s-drug testing, told SAC to buy and then abruptly reversed course. SAC’s arguments for why it sold in July 2008 – that SAC was sitting on a big unrealized gain, that analyst consensus was turning against Elan, that Elan’s own announcements were negative, and that “macro considerations argued against outsized long positions in anything in July 2008” what with it being July 2008 – seem pretty reasonable; “also we had inside information that their results would be bad” would be a perfectly consistent additional reason to dump the stock but hardly a necessary one.2
The California Physician incident is much ado about nothing. To begin with, there is no reason to believe that the California Physician actually saw interim Phase II data, as distinct from having them described generally to him or surmising for himself what they likely showed. Healthcare PM 1 tells Cohen that the California Physician “implied, though he did not say outright” that he asked to see the interim data, and Healthcare PM 1 adds, in a follow-up email to Mr. Cohen, that “I have no idea” whether the California Physician was actually shown the interim data. Healthcare PM 2, who was apparently not present for the portion of the conversation that related to the Phase II bapineuzumab study, has stated unequivocally: “I don’t think that [the California Physician] had access to blinded data.” Mr. Cohen himself was plainly skeptical that the California Physician had seen non-public data: “Seems strange tha[t] he would have seen the data when other investigators haven’t.”
Second, if the California Physician was shown interim Phase II data, or if officials at Elan or Wyeth described to him what these data showed, there is no reason to believe the California Physician was under any obligation to keep this information confidential. He was not a Phase II participant, had not yet become a Phase III participant, and would not have been signatory to a standard participant’s confidentiality agreement. There is no suggestion that Elan or Wyeth, which had a legitimate commercial interest in sharing the data, or a description of that data, with the California Physician, asked him to maintain the information in confidence. Indeed, the California Physician appears to have volunteered the information to Healthcare PM 1, suggesting he felt completely free to share it: Healthcare PM 1 emphasizes that “I didn’t call [the California Physician] on Alzheimer’s, was talking to him about migraine drugs.”4
Is that true? Doesn’t it not matter? I mean, it matters for this lawsuit, but, like, for the world? Here:
- SAC, through an expert network firm marketed to hedge funds, hired a doctor whom it believed to be close to Elan and to have had private conversations with the company about its drug trials.
- If the California Physician hadn’t signed a confi with Elan, if he wasn’t a study participant, if he wasn’t being paid by SAC for the Alzheimer’s-drug data (but only for the migraine stuff), if he volunteered it, etc., etc., then SAC could freely use it.
- If he signed a confi and was being paid to breach it, then that’s insider trading.
I mean sure whatever but come on. Is this not silly stuff for grown-ups to care about? SAC is in the business of doing very extensive and very expensive research into companies and then deciding whether to buy their stock. That research involves lots of talking to people who know stuff about companies, and some of the stuff they know comes from talking to companies and working on drug trials and so forth. That’s the whole company. That’s what they do every day. Of course they have information that other people don’t have, and that is hard to come by. They work hard for it. And they pay well.
Whenever the SEC brings charges like this they say things like “legitimate research is okay but SAC crossed the line into illegal insider trading boooooooooooooo,” but this is the line. The line is “the California Physician would not have been signatory to a standard participant’s confidentiality agreement,” since Elan “had a legitimate commercial interest in sharing the data, or a description of that data, with” him. I mean the SEC would agree with that!5 That’s a stupid line. You want a level playing field for all investors? Okay, fine, prevent SAC from talking to the doctors who’ve seen Elan’s test results and signed a confi. Let them keep talking to the other doctors who’ve seen Elan’s test results and not signed a confi. Level playing field! What?
Or take Dell. A lot of the Dell stuff is about whether Steve Cohen read the email being like “here is inside information on Dell,” and that’s amusing, but the white paper also makes a case that the email didn’t contain inside information on Dell. Or rather – it obviously did, but not in a bad way:
The email also does not give any details about the identity of the ultimate source of the information, other than that it is “someone at the company.” The information could have come from any number of lawful sources, such as a low-level employee at Dell, who did not have access to the quarterly results and was simply guessing or surmising as to what the numbers would be (which might explain why, rather than containing precise gross margin numbers, the “second hand read” email provided a range). Or it could have lawfully come from an authorized person in Dell’s Investor Relations group. Indeed, we now know that the person who in fact was the source of the information was a Dell Investor Relations officer, who, to this day, maintains he did nothing wrong and was simply doing his job. That person has never been charged with wrongdoing by the SEC or any other governmental agency. And Dell appears to have routinely made selective disclosures of precisely the kind of information contained in the “second hand read” email.
There is a stellar footnote to that paragraph.6 There’s lots of legal ways for SAC to get advance information about Dell’s earnings! Like, for instance, that Dell routinely made selective disclosures of that information, including to journalists! Of course there are even more semi-legal ways for SAC to get that information, and tons of illegal ways. And good luck sorting them out.
Insider trading cases must be fun for the SEC precisely for these sorts of puzzles. Unlike sprawling weird unintuitive CDO cases, where you just sort of throw up your hands and say to a jury, well, what do you think about all this crap?, insider trading cases have a limited number of boxes to check – was it material? nonpublic? disclosed in breach of a duty? for a benefit? – with a certain amount of fun lawyery play in each of them. Meanwhile, lots of people like to get mad because Insider Trading Is So Unfair.
But you can’t really have both of those emotions at the same time. If your worry about insider trading is its straightforward intuitive unfairness, then SAC’s white paper will leave you cold. If your worry is that SAC, y’know, violated the law, then the white paper is highly relevant and not unpersuasive reading. But the fact that those worries are so different is itself troubling.
1. It is pretty rousing? This makes me feel a little bad for making fun of them:
For many years, SAC, at Cohen’s urging, has gone to great lengths to deter insider trading and to establish an appropriate compliance culture. As discussed below, SAC has spent tens of millions of dollars developing and implementing a robust and constantly improving compliance program. It has hired a staff of no fewer than 38 full-time compliance personnel (including compliance IT), in addition to legal department personnel who devote part of their time to compliance issues. The firm’s senior compliance personnel collectively have decades of compliance experience in the investment industry. They are supported by an infrastructure of compliance surveillance systems in which SAC has invested millions of dollars.
SAC’s compliance team, with Cohen’s full support, deploys some of the most aggressive communications and trading surveillance in the hedge fund industry. These include, among others, daily reviews of electronic communications (e.g., emails, IMs, Bloomberg messages, internal write-ups) and SAC trading using keyword- and concept-based search protocols; weekly reviews of randomly-selected portfolio manager teams; review of electronic communications between investment professionals and their former employers for a period after commencing work at SAC; review of trading made around market moving events and corporate access events; and regular reviews of the firm’s most-profitable trades. The firm has also adopted—at significant cost, and at the risk of putting itself at commercial disadvantage—numerous prophylactic measures, as well as restricting its employees’ use of expert networks.
Steve Cohen has strongly and consistently supported this compliance effort. Cohen regularly communicates with the firm’s senior compliance staff about improving the tools at their disposal, and has always provided the compliance department with the funding and support it has requested. Cohen has himself exemplified the firm’s expectation that compliance is the responsibility of all of its employees. As the firm’s emails reflect, Cohen has frequently forwarded to compliance staff communications he receives that caused him concern.
2. Though: there is rather less on why SAC originally got long the stock, on Martoma’s possibly tainted recommendation. But of course the SEC doesn’t really point to any red flags there either.
3. Those analysts, by the way, come off looking pretty hapless in all of this. This is not a good footnote:
The full record makes clear that Healthcare PM 1 and Healthcare PM 2 coined the term “black edge” as a joke and used it as part of a running humorous commentary between them on a wide range of trading activities.
Jesus. You just never never never never never never never never never never never never never never never never never never never want to be in a position where you’re explaining to regulators “oh yeah all those emails and IMs about committing crimes were a joke, see?”
4. There’s a third:
Third, the highly general impressions the California Physician conveyed were neither material nor non-public but were widely shared inferences among professionals, including Healthcare PM 1 and Healthcare PM 2, who followed bapineuzumab, and consistent with Elan’s and Wyeth’s own public statements. The California Physician apparently communicated to Healthcare PM 1 that the interim data were “interesting” and “warranted further study” but were not statistically significant. These were hardly novel observations. Most professionals assumed the interim data must have been in some measure encouraging, or Elan and Wyeth would not have elected to begin a large and expensive Phase III study before seeing the final Phase II results. At the same time, the Phase II study was so small that, from a statistical point of view, it was highly unlikely to achieve statistical significance.
6. It goes like this:
The public record contains multiple examples of information selectively disclosed by Dell Investor Relations officials. See, e.g., United States v. Newman Def. Ex. 798 (email from Jon Horvath to Jesse Tortora and Sam Adondakis asserting, “Apparently DELL IR saying offline that they will miss Oct ests ‘by a country mile’ is why stock is so amazingly weak.” Dell’s revenue missed by almost $1 billion that quarter, see Def. Ex. 8270, Gov’t. Ex. 1807.); United States v. Newman Def. Ex. 866 (email sent by Jon Horvath to Jesse Tortora during Dell’s quiet period quoting the head of Investor Relations at Dell, as saying, “We’ve pricing responsibly so even on a revenue miss GMs should be stable.” This prediction also turned out to be accurate: Dell’s revenues missed, and its gross margins were stable, see Def. Ex. 8270, Gov’t. Ex. 1807.); Shira Ovide, Dell to Miss Profit Estimates, Beat on Revenue, Wall St. J., May 14, 2013 (projecting, two days before earnings announcements, that Dell would report revenue of “roughly” $14 billion, operating income of $600 million, and earnings per share of 20 cents. That quarter, Dell reported revenue of $14.1 billion, operating income of $590 million, and earnings of 21 cents. See Dell Inc., Form 8-K (May 16, 2013)).
Citing the Journal article is a nice touch.