U.S. investigators have subpoenaed a 2011 deposition of SAC Capital Advisors LP founder Steven Cohen, whose sworn statements on insider-trading compliance may hurt him as he tries to persuade regulators not to file a lawsuit with the potential to shut his $14 billion firm.
The SEC told the hedge fund Nov. 20 that it planned to sue SAC for securities fraud and so-called control-person liability for failing to supervise employees. The same day, the agency accused an ex-SAC portfolio manager and his hedge-fund unit of insider trading for persuading Cohen, 56, to make $700 million in illegal trades. Prosecutors also indicted the manager.
Cohen’s testimony, reviewed by Bloomberg News, establishes his personal control over the unit, CR Intrinsic, and records his unfamiliarity with his firm’s compliance and ethics policies on insider trading.
“I’ve read the compliance manual, but I don’t remember exactly what it says,” Cohen said.
John Coffee, a securities-law professor at Columbia University Law School said, “That’s a dangerous statement. The fact that he doesn’t know what’s in his compliance manual is useful to the SEC’s case.”
Also unhelpful was a statement that no employee had ever been punished for violating the firm’s compliance policy. In a six-year investigation of insider trading by Wall Street firms, federal prosecutors or the SEC have accused the former portfolio manager, Matthew Martoma, and six other SAC employees of trading on illegal tips while at SAC.
Cohen’s deposition answers helped Stamford, Connecticut- based SAC win its dismissal from the underlying lawsuit, filed by Fairfax Financial Holdings Ltd. over short-sale damages. In new light, they provide fodder for regulators seeking to establish he was a negligent manager.
Before the SEC sent SAC its litigation threat in a so- called Wells notice, it had Cohen’s testimony in hand as a result of a subpoena, as did prosecutors who charged Martoma, according to a person familiar with the matter. The Wells notice process gives SAC a chance to talk the agency out of suing. The SEC is considering adding Cohen to the suit, a person familiar with the matter has said.
The SEC might not pursue Cohen for some of his opinions about the vagueness of insider trading laws, Coffee said, because he’s “a layman, not a lawyer.”
Cohen said in his testimony in the Fairfax case: “The way I understand the rules on trading on inside information, it’s very vague.”
Cohen enumerated several circumstances in which he would make trades while in possession of material, nonpublic information about a company — core elements of any insider- trading case. He also characterized his firm’s compliance policy as just “guidelines” that employees could ignore by substituting their own judgment on whether a trade was illegal.
Michael Bowe, the lawyer with Kasowitz Benson Torres & Friedman LLP who conducted the deposition, had this harsh take on Cohen’s answers: “In my opinion, no judge or jury looking at that testimony would believe compliance was taken seriously.”
The threatened SEC suit may prove the gravest threat Cohen and his firm face from the U.S. government, which is also investigating whether he and SAC violated criminal laws.
An automatic e-mail deletion policy in effect at the time of the $700 million in trades left scant electronic evidence for SAC to turn over when U.S. investigators subpoenaed the firm for relevant information about possible insider trading.
Martoma’s indictment and the SEC complaint against him and his SAC unit contain no allegations of wrongdoing by Cohen. Martoma pleaded not guilty and isn’t cooperating with federal prosecutors in their investigation of SAC.
In a control-person liability suit, however, the SEC doesn’t have to prove Cohen engaged in insider trading — it need only show that he failed to properly supervise Martoma or the other accused SAC employees by turning a blind eye to what they did, or by being grossly negligent in not catching them.
The SEC has the power to ban Cohen and his firm from the securities industry should it prove he failed to supervise his employees adequately when it came to insider trading.
Cohen hasn’t been charged or sued for wrongdoing regarding the trades, which netted SAC $276 million in profits and avoided losses on shares of pharmaceutical companies Wyeth LLC and Elan Corp. in July 2008, according to prosecutors and the SEC.
SAC declined to comment on the deposition. A spokesman, Jonathan Gasthalter, has said that Cohen acted appropriately and that SAC maintains rigorous compliance standards.
The Cohen deposition in the Fairfax case took place over two days, in February and April of 2011. The SEC monitored the case closely, issuing a subpoena in early 2011 demanding access to internal SAC e-mails produced through discovery, according to the person familiar with the matter. Later, the agency and prosecutors subpoenaed the deposition transcript.
The proposed SEC lawsuit against SAC relates to the criminal charges in Martoma’s indictment. He allegedly learned July 17, 2008, that test results of an experimental Alzheimer’s treatment from Dublin-based Elan and Madison, New Jersey-based Wyeth were worse than the market anticipated, and that those results would be made public at the end of that month.
On Sunday, July 20, Martoma e-mailed Cohen and said it was “important” that they talk. He said he was no longer “comfortable” with CR Intrinsic’s long position on the two stocks. The men spoke for about 20 minutes, according to the SEC’s complaint against Martoma.
Cohen was asked about CR Intrinsic’s status in 2006 during the Fairfax deposition and said: “Intrinsic was a division of SAC and essentially it was me and a guy named Matt Grossman who was running that division.”
The purpose of setting up the unit was “essentially that we would have a group of analysts that would work solely for us as opposed to relying on portfolio managers and analysts in the firm to ferret out ideas.”
Grossman left SAC Capital before the alleged illegal trades and started his own fund, Plural Investments, in 2008. Martoma was hired in 2006 and was a portfolio manager for CR Intrinsic through 2008, according to the SEC complaint.
Whether trading through CR Intrinsic or other units, Cohen said it was “a judgment call” deciding whether buying or selling was legal if the firm had material, nonpublic information.
For example, if he learned that a negative report about a particular stock was about to come out, with the probable effect of driving the share price down, he wouldn’t hesitate to buy shares prior to that report.
“If you are buying stock into a sell recommendation,” Cohen said, “then I would have no problem with that.”
A few pages later, Cohen elaborated: “If I’m buying stock into a sell recommendation, there is nobody on the other side that gets hurt.”
Coffee said he agreed with Cohen on that point.
Cohen testified he would even allow his traders to take the same side of a position articulated in material, nonpublic information if, in his own judgment, the information wouldn’t have any effect on share prices.
“I can think of circumstances where if you believe that even if you were trading on the same side as a — as a recommendation, if you felt or if you knew that would have no impact on the stock, then I can theoretically suggest that trading on that stock, even — while I might refrain from trading on that stock, if you believe that would have no impact on the stock, that therefore, I — theoretically, you might be able to trade on that stock if you knew that was coming out.”
Coffee said he also agreed with Cohen on that issue.
At a different point, Cohen described the difficulties of defining hard-and-fast rules regarding insider trading.
“It’s my belief that the rule is vague, and therefore, you can interpret the rule any way — you know, with — as a lawyer, you can probably interpret it in lots of different ways.”
By Greg Farrell
Courtesy of Bloomberg News