Summary
Highlights
In November 2010, a Wall Street Journal report on a government insider trading investigation caused panic for former SAC Capital trader Donald Longueil, who then attempted to destroy incriminating evidence. Both Longueil and his colleague Noah Freeman eventually pleaded guilty to charges related to insider trading, drawing attention to SAC Capital.
Steven A. Cohen, the founder of SAC Capital, was widely known on Wall Street for his exceptional trading success, but also his firm's reputation for insider trading. In a 2011 deposition, Cohen displayed a surprisingly vague understanding of Rule 10b5-1, the principal SEC regulation prohibiting insider trading, claiming the law was 'very vague'.
Cohen started his career at Gruntal, a brokerage firm described as a 'Wild West' environment where he learned to trade. In 1992, he founded SAC Capital, pioneering a new type of aggressive hedge fund. He charged exceptionally high fees (3% of assets and 50% of profits) due to his consistently high returns, often exceeding 60% annually. His strategy relied on obtaining an 'edge' – an information advantage through extensive contacts and paying exorbitant commissions to brokers for 'first call' information.
The government's investigation began with the Galleon Group and its CEO, Raj Rajaratnam. Former Galleon trader Turney Duff recalls a direct experience with an insider tip. Information from UBS Compliance officer John Moon, who flagged Rangan Rajaratnam's suspicious trading, led the SEC to Raj Rajaratnam. He maintained a vast network of informants, including Executives and individuals he knew from Wharton Business School, and even an IBM executive's lover.
The investigation uncovered Rajat Gupta, a respected businessman and Goldman Sachs board member, who allegedly tipped Rajaratnam about a '$5 billion investment from Warren Buffett' in Goldman Sachs. This information allowed Rajaratnam to make significant profits. The FBI's use of wiretaps, a first for insider trading cases, became a crucial tool in exposing these extensive networks. Rajaratnam was convicted and sentenced to 11 years.
The FBI's investigation expanded to 'expert networks,' firms that connect investors with industry professionals for information. While ostensibly legitimate, these networks became conduits for insider trading. Hedge funds paid substantial fees ($5,000 per hour, up to $1 million annually) for 'actionable information,' pushing experts to disclose proprietary data. James Fleschman of Primary Global Research (PGR) admitted it was 'bound to happen' that experts would disclose inappropriate information.
One key expert was Winnie Jiau, a well-connected Taiwanese-born consultant. She provided inside information to SAC Capital trader Noah Freeman, who used her tips about companies like Nvidia to make millions. Jiau, known for being 'high maintenance,' would demand lavish gifts like lobsters in exchange for her information. She served 4 years in prison while Freeman cooperated with the FBI.
Noah Freeman's cooperation led to the arrest of Donald Longueil after The Wall Street Journal's 2010 report. Freeman described SAC Capital's culture, stating it was 'understood' that traders needed to use material non-public information to succeed. Traders operated in independent 'pods' with little oversight, suggesting an environment where Cohen could be insulated from the source of illegal information.
The investigation also implicated Michael Steinberg, an SAC portfolio manager, for trading Dell stock based on illegal information. Separately, SAC portfolio manager Matthew Martoma was accused of using an expert network to obtain insider information about an Alzheimer's drug developed by Elan and Wyeth. Dr. Sydney Gilman allegedly leaked negative trial results to Martoma, allowing SAC to make $275 million by shorting the stocks. Greg Cappus, a private investor, lost over half a million dollars due to this alleged insider trading.
Cohen's 2011 deposition, where he showed a lack of knowledge regarding SAC's compliance manual, came back to haunt him. In 2013, the SEC filed a civil case against Cohen for failing to supervise his traders, and the Justice Department filed a criminal indictment against SAC, calling it a 'magnet for Market cheaters.' SAC Capital pleaded guilty to insider trading, agreeing to pay a record $1.8 billion fine and cease operating as a hedge fund. Steven Cohen himself was not charged with insider trading, prompting questions about the legal definitions of criminal negligence in finance.