Chair

A Hedge Fund Gets Indicted

Chair

To help us keep track of all the hedge fund scandals of recent years, we created IFA’s Hedge Fund Manager Hall of Shame. Note that we limited it to hedge fund managers, so today’s grand jury indictment of SAC Capital Advisors for insider trading puts us in a bit of a conundrum. This is the first time we recall that a hedge fund itself is facing criminal charges. Of course, the real intended target is the owner of SAC, billionaire Steven A. Cohen. Unfortunately, like the mafia dons who are never caught actually giving orders to their underlings, Cohen himself is untouchable except for a minor SEC civil charge for failure to properly supervise his employees. Of course, that may change should one of his confidants decide to turn state’s evidence. This criminal indictment comes on the heels of a record-setting $616 million settlement paid by SAC for insider trading, and many of SAC’s clients have voted with their feet by removing about $5 billion of the $6 billion in outside money from the firm. Given that they were paying an exorbitant 3% of assets plus 50% of profits, this was probably a wise move because even if SAC survives these criminal charges, it will be quite difficult to deliver a decent return after paying these expenses without having the benefit of trading on inside information. The majority of the remaining capital belongs to Mr. Cohen.

The full text of the indictment can be found here. The heart of the indictment is contained in this sentence: “Unlawful conduct by individual employees and an institutional indifference to that unlawful conduct resulted in insider trading that was substantial, pervasive and on a scale without known precedent in the hedge fund industry.” The indictment relates specific instances of insider trading such as the ones we covered in this article, and it repeatedly mentions not only the failure of the “SAC Owner” to address the illegal actions occurring inside his firm but his “incentivizing” of them. Underpinning the charge is the theory of corporate criminal liability, which allows the government to attribute certain criminal acts of employees to the employer.

If the government wins a conviction against SAC, the consequences will be dire for the firm. Its lenders and trading partners will likely disassociate themselves, leaving SAC dead in the water. Unfortunately for Mr. Cohen, the government’s record at winning these types of cases brought against companies rather than individuals is a perfect 100%. The most noteworthy one was the conviction of the accounting firm of Arthur Andersen for its role in concealing the accounting problems of Enron. Although this conviction was essentially a death sentence for the company, most of its 85,000 employees managed to find jobs elsewhere. The same would probably hold true for the approximately 1,000 employees of SAC, many of whom are independently wealthy. The federal prosecutor leading the case, Preet Bharara, has won convictions or guilty pleas on over 90% of the insider trading cases brought by his office. Four onetime SAC employees have pleaded guilty to insider trading funding while at the fund, and five others were implicated in illegal conduct while at SAC.

Since we have been following the SAC story since it first went public, we will track the progress of this new development and comment appropriately. Furthermore, we will continue to dissuade investors from becoming hedge fund suckers.