The thing is that when you run a hedge fund and "At least nine current or former ... employees have been linked to insider trading while working at the firm, including four who have pleaded guilty to crimes," the SEC really ought to charge you with “fail[ing] reasonably to supervise" your employees, no? At least? Whether or not you were insider trading yourself, you weren't exactly "continuing to maintain a first-rate compliance effort woven into the fabric of the firm."
So my first reaction to the SEC's case against Steve Cohen was "what took so long" but then I read the complaint and it is worth the wait, full of information that we haven't seen before and that is ... awkward. Here is the best of it, emphasis added for Steve's own words:
61. Within CR Intrinsic, [SAC accused insider trader Mathew] Martoma claimed to have unique insight into the Phase II Trial [of Elan's Alzheimer's drug]. In the words of [two other CR Intrinsic Analysts], Martoma claimed to have “black edge” — illicit, nonpublic information.
62. The Analysts grew frustrated with Martoma’s claims that he had information about the outcome of the Phase II Trial. They believed it was impossible for anyone, even an insider, to have such information before the trial concluded.
63. The Analysts exchanged a number of emails and instant messages with Cohen about whether Martoma’s advice on Elan and Wyeth was sound. On March 28, 2008, one of the Analysts told Cohen in an instant message that he did not think anyone could yet know the Phase II Trial data, because the trial was not over yet. Cohen responded by saying he would follow Martoma’s and Hedge Fund Manager A’s advice, because “they are closer to it than you.” Later in the same message, the Analyst asked Cohen: “[I] don't know if [Hedge Fund Manager A] or mat [Martoma] will answer, but do you think they know something or do they have a very strong feeling.” Cohen replied: “[T]ough one . . . i think mat [Martoma] is the closest to it.” The Analyst responded: “[T]he question that I would ask is if it[’]s possible to know the data yet – i could be wrong, but i don't think it is yet.”
64. A few days later, on April 6, 2008, Cohen exchanged instant messages with the other Analyst about the Drug. Cohen remarked that it “seems like mat [Martoma] has a lot of good relationships in this arena.”
65. On April 11 and 12, 2008, the Analysts relayed to Cohen their conversation with another doctor, who according to the Analysts, implied that he had seen some confidential Phase II Trial data. Like Gilman, this doctor was a paid consultant to SAC, through an expert networking firm, and simultaneously participated in confidential clinical trials conducted by Elan and Wyeth. The Analysts informed Cohen that this doctor had told one of them that the Drug did not have a statistically significant effect on patients and that the Phase II Trial data were not as good as Elan’s public statements might suggest. The Analyst summarized this conversation in an email to Cohen and dismissed Martoma’s claim that he had informational “edge” on the Phase II Trial data. The Analyst told Cohen that if Martoma really had “edge,” it contradicted the Analyst’s conversation with this doctor. ...
67. ... Cohen wrote to one of the CR Intrinsic Analysts that it “[s]eems strange that [the doctor] would have seen the [interim] data when other investigators haven’t.” The Analyst responded, “Some small # of [people] have seen the data, otherwise they would not have been able to design the phase 3s. Was [the doctor] one of those ppl, I have no idea…. But he said he saw the data before agreeing to be in the study, which isn’t totally unreasonable….”
Martoma's edge was, of course, extensive conversations with Dr. Sid Gilman, the neurologist supervising Elan's trials, which as edge goes would seem to be pretty black.
There's some other good stuff,1 and also some disappointing lack-of-stuff. In particular, the SEC never found a way in to the pivotal conversation where Martoma told Cohen that he had doubts about Elan, after which SAC quickly flipped its Elan position from very long to slightly short and saved itself $275 million. The SEC has only Cohen's version, which is unsurprisingly unincriminating.2 But those IM exchanges are the main new news.
So: what do you make of them? Two immediate sources of delight are:
- Wow did everyone at SAC hate each other! Those two analysts didn't trust Martoma so they went out to get illegal inside information to prove him wrong. "Hey boss, we committed a crime for you, to prove that that other guy isn't as good at committing crimes for you as we are." What a nutty place.
- Wow is Cohen good at ambiguity! It's all "relationships" and being "closer," not "inside information"; when people ask "does Martoma know something" Cohen replies "tough one." And even if he did "know something": it's not illegal to know something.
It's not even illegal to know something when that something is nonpublic interim drug trial data that came from investigators on those trials. Because Cohen's IMs clearly suggest that he thought he was getting that data from those investigators - or at least that that's what the Analysts thought they had. And he was unruffled by the legal niceties there; as the SEC puts it:
During his email exchanges with the Analysts, Cohen displayed no concern about the apparent disclosure of nonpublic information by the doctor to the Analysts or about the Analysts’ use of such information to inform their investment decisions on the firm’s behalf.
So from the SEC's complaint it seems that Cohen knew that he was getting nonpublic information from someone - a drug trial investigator - with a duty to keep it confidential. And he thought it was material, or material enough to debate and trade on. And: he traded on it. So why not charge him with insider trading?
Remember the semi-porous wall?
Martoma had relationships. Those anonymous backstabbing analysts had a conversation with a doctor. How could Cohen know what those relationships entailed, or how that conversation came about?3 (Through a paid expert network, is how, as it happens.) The law might well be that "the recipient of a tip isn’t liable for insider trading unless he knew the person who provided the illegal information did so for a personal benefit." Cohen's IM debates about who had what kind of edge from whom might, as the SEC puts it, be full of "red flags of potentially unlawful conduct by employees under his supervision," but they don't prove that he insider traded. Just that he liked relationships. With people who knew a lot about ongoing nonpublic drug trials. Who wouldn't really.
The SEC "is seeking to bar Cohen from overseeing investor funds" and this complaint is ... I dunno, I'm gonna say it's a pretty strong first move, though not perhaps insurmountable. But, really. The charge is just "failure to supervise." How can they lose that? If there's one thing a financial services supervisor should do, it's make sure his employees keep incriminating conversations off IM. Even ambiguously incriminating conversations!4 At the very least, Cohen failed at that.
1.On Dell there is this:
130. Just minutes later, at 1:09 p.m., Horvath replied to Portfolio Manager A and copied Steinberg:
I have a 2nd hand read from someone at the company – this is 3rd quarter I have gotten this read from them and it has been very good in the last quarters. They are seeing G[ross] M[argin]s miss by 50-80 [basis points] due to poor mix, op[erating] ex[penses] in-line and a little revenue upside
netting out to an [earnings per share] miss. . . . Please keep to yourself as obviously not well known.
131. Four minutes later, at 1:13 p.m., Portfolio Manager A forwarded this email to a SAC employee whose duties included forwarding to Cohen trading-related information worthy of Cohen’s attention (the “Research Trader”).
132. At 1:29 p.m., this employee forwarded Horvath’s email to Cohen at two email addresses Cohen maintained at SAC, one designated “Office” and the other designated “Home.”
133. From 1:17 p.m. to 1:36 p.m., Cohen spoke on his cell phone to another SAC employee.
134. At 1:37 p.m., the Research Trader called Cohen on his cell phone. The call lasted 48 seconds.
135. At 1:39 p.m., Cohen began selling shares of Dell. By 3:49 p.m., Cohen had sold his entire Dell position.
So: Cohen got an email saying that someone at the company, a previously reliable source, had told said that Dell would miss, but that he should keep it quiet. Then he sold Dell.
81. Later that morning, Cohen and Martoma spoke for nearly 20 minutes. According to Cohen, Martoma said that he was no longer “comfortable” with the Elan investments that CR Intrinsic and SAC held. Despite being informed of Martoma’s abrupt change in view on the Elan investments and red flags that Martoma may have unlawfully been in possession of material nonpublic information, Cohen failed to take prompt action to determine whether an employee under his supervision was engaged in unlawful conduct and failed to take reasonable steps to prevent violations of the federal securities laws.
3.The Dell situation is similar - someone talked to a guy who talked to a guy who had a "2nd hand read from someone at the company." Who knows how that came about.
4.Like: remember when Tom Montag called a Goldman CDO a "shitty deal," and in response Goldman banned cursing on IM? Supervising!