A story that we have been following for some time now is the SEC/FBI investigation of SAC Capital Advisors for insider trading. On March 15th, a shoe dropped when the SEC announced1,2 a record-setting $616 million settlement for affiliates of SAC Capital related to trades placed with the benefit of insider information. While Steven A. Cohen, the billionaire owner of SAC Capital, was not held culpable in these settlements, the SEC could still charge him in future enforcement actions, according to George S. Canellos, the SEC’s acting enforcement director. Since late 2009, six former SAC employees have been convicted of or pleaded guilty to charges related to insider trading, and four of them are cooperating with authorities. As noted in the Wall Street Journal on February 15th, SAC clients have so far moved to withdraw $1.7 billion which represents a quarter of outside investor’s money. We can expect to see more of the same after this announcement.
The bulk of the $616 million relates to a sale of $1 billion in shares of two pharmaceutical companies (Elan and Wyeth) after a portfolio manager illegally obtained confidential details about clinical trials for an Alzheimer’s drug jointly developed by the two companies. The chart below shows how the inside information flowed from Dr. Sidney Gilman, who was selected by the companies to present the final drug trial results to the public, to the funds affiliated with SAC Capital. The mechanism that facilitated Dr. Gilman’s transfer of information is the “expert network” which is supposed to be on the right side of the law, but just by a hair. The breakdown of the $602 million settlement is $275 million in disgorgement of ill-gotten gains, $52 million in interest, and a $275 million penalty.
The remaining $14 million of the $616 million derived from a run-of-the-mill scheme of obtaining advance knowledge of quarterly earnings releases (again, via an expert network) of Dell and Nvidia Corporation. Jon Horvath, a former analyst at SAC-affiliated Sigma Capital was specifically named in the complaint.
“Quarterly revenues and profit margins are fundamental drivers of stock prices. By illegally obtaining these vital financial measures in advance of their public announcement, Sigma Capital secured a crystal ball revealing where the stock would likely be trading in the near future,” said George S. Canellos. “However, the crystal ball failed to predict a costly settlement with the SEC.” Having our own genuine crystal ball on display in our conference room, we can somewhat identify with the humorous comments of Mr. Canellos.
According to Sanjay Wadhwa, Senior Associate Director of the SEC’s New York Regional Office, “Sigma Capital’s violations of the securities laws were blatant and recurring. The firm obtained key quarterly earnings information before it was public and exploited an unfair edge over the rest of the market to reap millions of dollars in unlawful gains.”
Normally, when somebody tells me that they have “beaten the market,” my first question is, “What risks did you take to achieve your above-market return?” However, in the case of SAC Capital, I would have to change that question to, “What laws did you break to get those returns?” Here is one final important consideration for any current or potential investors in SAC Capital: Considering that the fees charged are an astronomical 3% administrative and 50% of profits, the fund would need to have a healthy 23% return before fees for them to receive a 10% return. How likely is that to happen if they can no longer take advantage of insider information? Perhaps the crystal ball will tell us.
On March 29th, the SEC moved one step further up the ladder by charging Michael Steinberg, a portfolio manager at Sigma Capital, with trading on inside information ahead of quarterly earnings announcements by Dell and Nvidia Corporation. Mr. Steinberg traded on the information procured by Jon Horvath, the analyst mentioned above. What makes this even more interesting is that Mr. Steinberg is known to work closely with Steven A. Cohen.
Sanjay Wadhwa, Senior Associate Director of the SEC's New York Regional Office, added, "The SEC's aggressive pursuit of hedge fund insider trading, including this enforcement action against Steinberg, underscores its steadfast commitment to leveling the playing field for all investors by rooting out illicit conduct by well-capitalized traders."
In a separate action, the U.S. Attorney's Office for the Southern District of New York today announced criminal charges against Steinberg, who was arrested by the FBI.
On May 23rd, the SEC moved yet another step further up the ladder by issuing subpoenas to four senior executives of SAC Capital Advisors who are part of Steven A. Cohen's inner circle. The four executives are Thomas Conheeney (president), Steven Kessler (chief compliance officer), Solomon Kumin (chief operating officer), and Phillipp Villhauer (director of trading). The topic of discussion will be the flow of insider information within the firm. It will be interesting to see if one of them is willing to play a game of "Let's Make a Deal".