Here’s a simple model of Steve Cohen:
- He is really really really really good at making money in the stock market.
- He generously shared those skills and used them to make money for pension funds, university endowments and other investors, in exchange for a modest 3 percent management fee and a 50 percent cut of the profits.
- Now, due to circumstances, he has stopped doing that, and is making money only for himself and his employees.
- That is somewhere between a misallocation of resources and a national tragedy.
In this cold dark time of year, when hedge funds are constantly being criticized, losing money and shutting down, it is heartening to remember that there’s at least one hedge-fund manager with a multi-decade record of consistent outperformance, and frustrating to remember that no one can invest with him. Come back, Steve Cohen! An embattled industry needs you.
You could have an alternate model, which goes something like: “Steve Cohen is just good at insider trading and should stop.” But I think events of the past few years have — well, not disproved that model, necessarily, but at least shown that Cohen is good at trading even without the insider part. In 2013, the last year he managed his hedge fund SAC Capital Advisors, it was up 20.1 percent (versus 6.5 percent for the average hedge fund).1 The next year, he closed SAC and shifted to a family office, Point72, which ended the year up … a lot? Something on the order of 30 percent gross, though that’s before fees and expenses, versus 3.3 percent (net) for the average hedge fund. Through October 2015, the latest performance numbers I could find, Point72 was up about 12 percent, versus basically flat for the average hedge fund. That all happened after the intensive investigations by the Securities and Exchange Commission and the Department of Justice were announced, and some of it happened after Cohen started hiring a fleet of former prosecutors and FBI agents, paying bonuses for compliance tips, banning instant messaging and generally turning his firm into a compliance operation that does the occasional stock trade. If people at SAC/Point72 were insider trading in the last three years, they had to be incredibly sneaky about it.
Of course, SAC had a fairly astounding two decades before those investigations, but you could always doubt the legitimacy of those results, and plenty of people — not least at the SEC and DOJ — did. You can interpret Cohen’s last few years in the wilderness as a carefully proctored test of his ability to make money without cheating.
And he passed! On Jan. 8 Cohen settled the SEC’s case against him for “failing to supervise” SAC appropriately. Cohen will be banned from managing outside money until the end of 2017, but starting on New Year’s Day 2018, he’s back in business.2 (If he wants to be.) But ”Before Cohen can handle outside money again, an independent consultant will ensure there are legally sufficient policies, procedures, and supervision mechanisms in place to detect and deter any insider trading”; it seems that the consultant is likely to be one Bart Schwartz, a former prosecutor who previously did compliance monitoring at SAC as part of its 2013 guilty plea agreement to insider trading.
It strikes me as a reasonable compromise in a case that both sides might feel nervous about taking to trial. On Cohen’s side, I mean, I like to emphasize that four SAC entities and seven former SAC employees have been convicted of insider trading, including two named Richard Lee.3 Cohen has fancy lawyers, and I am sure that they would have been able to make sophisticated arguments at trial, but at the end of the day if seven of your employees insider traded then it is hard to argue that you did a great job of supervising them. Also, the actual SEC allegations against him, as contained in the Jan. 8 settlement agreement, are both less wide-ranging and more troubling than that simple counting exercise suggests. The SEC case only touches on one of those convicted insider traders, Mathew Martoma, but it is full of suggestive evidence that Cohen at best failed to look into stuff that looked like insider trading, and at worst was complicit in Martoma’s insider trading.4
On the SEC’s side, though, the legal landscape for insider trading has shifted a lot since it first brought its case against Cohen in 2013.5 In the 2014 Newman decision, a federal appeals court ruled that to prove illegal insider trading prosecutors have to show that the person providing the inside information received a “personal benefit” for doing so, and that the person trading on it knew about that benefit. That’s a big deal for insider trading law, but it is a particularly big deal for insider trading law at hedge funds, where analysts are employed to build relationships with knowledgeable people in their industries, including at the companies they cover. And it is an even bigger deal for insider trading law at hedge funds like SAC Capital, a decentralized operation made up of ”groups of individual funds that are managed separately and compete against one another.” Under Newman, it seems virtually impossible that the manager of a fund like that could commit insider trading.
Of course, Cohen was charged with failure to supervise, not insider trading. But similar principles apply. In 2013, you could read messages from Cohen to his subordinates saying things like ”i think mat [Martoma] is the closest to it” or “seems like mat [Martoma] has a lot of good relationships in this arena” and interpret them as suspicious. In 2013, it was easy to argue that phrases like “closest to it” and “good relationships” were red flags, and when combined with the fact that Martoma was actually getting material nonpublic information from a doctor involved in confidential drug trials (and paying that doctor), meant that Cohen knew Martoma was up to no good. But in 2016, the law of insider trading is much more tolerant of hedge-fund analysts who build relationships with people who are close to situations. It’s only illegal now if the people providing the information are benefiting, and if the analysts know about it — a common situation in sloppy amateur insider trading, but a rare one in high finance. Those relationships are no longer the red flags that they were in 2013, and a hedge fund analyst’s ”good relationships” are again a sign of diligence rather than one of illegality.6