US calls hedge fund a magnet for cheating

New York: Federal authorities, under fire for treating Wall Street with kid gloves, have delivered a crippling blow to one of its most successful firms, SAC Capital Advisors, whose outsize trading profits have drawn government scrutiny for more than a decade.

Calling SAC "a veritable magnet of market cheaters," federal prosecutors announced criminal charges against the hedge fund Thursday, a rare move against a large company that could threaten its survival. Authorities argued that the firm and its units permitted a "systematic" insider trading scheme to unfold from 1999 to 2010, activity that generated hundreds of millions of dollars in profit for the firm, owned by its founder, the billionaire stock picker Steven A. Cohen.

The indictment offers the most detailed account yet of SAC's inner workings, citing emails indicating that Cohen and other top executives failed to prevent possible insider trading.

In one email about the technology company Sun Microsystems, a SAC analyst informed Cohen that, "My edge is contacts at the company and their distribution channel." In an instant message, an employee informed Cohen that he planned to bet against Nokia's shares and then apologized for being "cryptic," explaining that SAC's compliance chief "was giving me Rules 101 yesterday - so I won't be saying much." (Cohen never responded to the message.)

SAC, the indictment says, also recruited employees who possessed what the fund called "an edge," including one trader who was fired from another hedge fund on suspicion of insider trading.

The US attorney's office in Manhattan and the FBI, which brought the charges, have spearheaded the largest and most prominent securities fraud cases in the nation's history, including those against Ivan Boesky, Michael Milken and Raj Rajaratnam. Yet federal prosecutors on Thursday portrayed the "rampant insider trading" at SAC as having no equal, pointing to more than a decade of abuses that took place while managers turned a blind eye.

The scheme at SAC, said Preet Bharara, the US attorney for the Southern District of New York, was "substantial, pervasive and on a scale without known precedent in the history of hedge funds."

Cohen, 57, was not charged, but the 41-page indictment is a stinging attack on him nonetheless, declaring that he "fostered a culture that focused on not discussing inside information too openly, rather than not seeking or trading on such information in the first place." Last week, the Securities and Exchange Commission filed a civil action against Cohen, accusing him of failing to supervise his employees.

The criminal indictment lists eight former SAC employees who the government said engaged in misconduct while at the fund; six of them have already pleaded guilty to individual criminal charges and are expected to testify in a trial against SAC.

One of the cooperating employees emerged publicly for the first time in Thursday's indictment. Richard Lee, 34, pleaded guilty this week to insider trading charges, according to the indictment. It was Lee whom Cohen hired despite a warning from a previous employer that he was part of an "insider trading group."

The earlier employer was Citadel, a large fund based in Chicago. Citadel, which has not been accused of wrongdoing, said "it does not have, and never has had, an 'insider trading group.'"

"Richard Lee has accepted responsibility for his prior conduct," said Lee's lawyer, Richard D Owens of Latham & Watkins.

In response to Thursday's developments, a spokesman for the SAC hedge fund said, "SAC has never encouraged, promoted or tolerated insider trading." He added, "The handful of men who admit they broke the law does not reflect the honesty, integrity and character of the thousands of men and women who have worked at SAC over the past 21 years."

Despite the onslaught, SAC was open for business Thursday with Cohen at the center of the firm's cavernous trading floor in Stamford, Conn., sifting through information, buying and selling stocks, and trying to make money for his investors.

Banks including Goldman Sachs and Morgan Stanley continued to trade with SAC and finance its operations, although several are discussing the implications that the indictment will have on their relationships, said people with knowledge of those conversations. SAC is also wrestling with how to stanch an exodus of its investors, which is expected to accelerate after the indictment.

For its part, the government signaled that it could pursue hefty penalties, staking claim to "any and all assets" of SAC.

SAC, which has about 1,000 employees, managed about $15 billion at the beginning of the year, but the government's investigation has buffeted the firm; investors have withdrawn about $5 billion from the fund in recent months. Cohen's fortune and employee money accounts for about $9 billion of SAC's assets under management.

While prosecutors could theoretically pursue all of SAC's money, they have no plans to do so, a person briefed on the matter said. Instead, they are likely to demand that SAC forfeit money that is traceable to any illicit trading, a sum that could reach several billion dollars.

By filing the indictment under the theory of corporate criminal liability, the government is wielding a potent weapon. If prosecutors can show that SAC traders were acting "on behalf of and for the benefit of" SAC when breaking the law - and six such traders are likely to testify to that - then the theory allows the government to impute liability to the firm itself.

To avoid charging corporations every time an employee commits a crime, the government often relies on deferred prosecution agreements, which suspend an indictment so long as the company improves its behavior. Prosecutors seized on this cautious approach after the Justice Department indicted Enron's accounting firm, Arthur Andersen, in 2002, leading the firm to collapse and terminate 28,000 jobs. This practice has drawn ire from critics of Wall Street who have complained that no Wall Street banks faced criminal charges after the financial crisis.

But in the case of SAC, which five offices across the globe, the government rejected that more cautious measure.

"In the corporate criminal world, avoiding indictment is the key battleground," said Alan Vinegrad, a former federal prosecutor now a partner at Covington & Burling. "Once you have the indictment, either it's a deferred prosecution agreement or you have your work cut out for you."

At the heart of the government's case is an attack on SAC's pursuit of an edge in stock trading. Although it has pushed into other investment strategies, at its core SAC has traditionally been an information-driven hedge fund, aggressively trading stocks around market-moving events like earnings releases and merger announcements.

At the height of SAC's powers in 2006 and 2007, Cohen is reported to have earned about $900 million each year, helping to give the firm a certain mystique. But it also generated whispers about whether the fund routinely crossed the line.

The indictment paints Cohen and his staff as promoting a culture of lax compliance and crooked morals. In one example, an SAC employee forwarded an email to Cohen in which a prospective hire was praised for his access to industrial companies. The message described him as "the guy who knows the quarters cold, has a share house in the Hamptons" with a senior executive at a big industrial company.

In another instance, prosecutors quote internal emails from two SAC analysts saying that a third colleague had a "black edge," secret information about a company so good that it almost guaranteed an investment's success.

SAC used the word "edge" in a marketing document to summarize the fund's investment strategy in 2008, a year that much of the activity at the center of the indictment occurred. But by 2011, in a deposition for a private lawsuit, and at a time when the investigation was heating up, Cohen said, "I hate that word."

The charges will not necessarily destroy SAC. One option for Cohen would be to shut down SAC and open up a family office that manages his own personal fortune. But the SEC could seek to have him barred from stock trading for other investors for life.

The government will face off against an army of lawyers from two of the world's most sophisticated law firms: Willkie Farr & Gallagher and Paul, Weiss, Rifkind, Wharton & Garrison. Martin Klotz at Willkie and Daniel J. Kramer at Paul Weiss have headed the SAC representation. For the criminal case, the fund has also enlisted Mark F. Pomerantz and Theodore V. Wells Jr., both at Paul Weiss and two of the country's most renowned criminal defense lawyers.

Paul Weiss finds itself in a familiar position. Two decades ago, it represented Milken.