Risks his $15 billion hedge fund to avoid a huge loss
They were SAC Capital’s largest equity positions when Stevie Cohen sold $700 million and shorted $260 million of Elan and Wyeth stock in July 2008, just before the two pharmaceutical companies announced disappointing results in the Phase II clinical trial of bapineuzumab, their jointly-developed Alzheimer’s drug.
Cohen had been accumulating Elan and Wyeth stock for several months on the advice of his top health care portfolio manager, Mathew Martoma, who suddenly and radically changed his view of the Phase II trial outlook the week before its results were to be announced. Martoma then persuaded Cohen to immediately unload his entire position in both stocks which, for SAC, was a bold and dangerous move since its sales constituted 20% of Elan’s trading volume that week and 11% of Wyeth’s.
When the Phase II trial results were publicly announced, Elan and Wyeth shares fell 42% and 12%, respectively. SAC saved and made a combined total of $276 million on its trades.
Cohen, however, didn’t hesitate for a minute dismissing that regulatory risk in order to avoid a potentially huge loss, probably not realizing that his big bet could have fatal consequences.
Given their size and timing, Cohen must have known that his Elan/Wyeth trades would undoubtedly catch the attention of the regulators and he also knew that Martoma had been receiving advance intelligence on bapineuzumab. Cohen, however, didn’t hesitate for a minute dismissing that regulatory risk in order to avoid a potentially huge loss, probably not realizing that his big bet could have fatal consequences.
As it turns out, Martoma’s bearish reversal on bapineuzumab was based on confidential information he elicited from a doctor – Sidney Gilman at the University of Michigan – who was monitoring the drug trial for Elan/Wyeth. Dr. Gilman, 80, was paid a total of $108,000 by SAC for 49 expert consultations with Martoma, in at least one of which he concededly tipped Martoma that the Phase II trial results were going to disappoint the market.
Thanks to his Elan/Wyeth trades, Cohen, 57, now faces a civil lawsuit brought by the SEC against him personally for failing to properly supervise Martoma and certain other investment staff. Based on a long list of equally suspicious transactions, SAC now also faces a criminal prosecution for allegedly fostering a culture of insider trading.
The Civil Suit
In the civil suit, Cohen is accused of intentionally ignoring ‘red flags’ that Martoma1 and other portfolio managers were basing their investment decisions and recommendations to him on confidential information on which neither they nor he should have traded2. Cohen’s lawyers have defended him on the ground that none of the e-mails or deposition testimony against him in regard to the Elan/Wyeth and Dell trades on which the SEC’s case is based support his encouraging or tolerating trading by himself or his staff on the basis of material non-public information.
In a white paper submitted to the SEC, defense counsel assert that Cohen had more than ample justification from price movements and public research sources to sell Elan/Wyeth and Dell stock when he did and that, as a practical matter, he was so busy trading every day that he could not possibly have delved into the information sources relied on by his staff in making their investment recommendations3. If Cohen loses the case, he could be barred from managing other people’s money forever.
The Criminal Case
The allegation in the criminal prosecution against SAC is that, from 1999 through 2010, it sought out portfolio managers and research analysts who had inside connections at public companies and then rewarded them handsomely for successfully ascertaining and exploiting confidential corporate information in advance of public announcements. Such inside dope was dubbed ‘black edge’ by SAC staffers, five of whom have already pled guilty to its illegal use and three more are currently under indictment.
The criminal prosecution against SAC could result in Cohen’s losing a good portion of his entire personal fortune. The U.S. Attorney, Preet Bhahara, is asking for SAC to forfeit as much as $10 billion of illicit gains, which is roughly what Cohen (and his employees) have in the fund.
Single Family Office
In addition to the felony convictions, new indictments and recent lawsuits, SAC has lost the early investment magic that earned it its stellar reputation. Founded in 1993, SAC averaged returns of almost 50% a year through 2000, almost tripling the average annual return of the S&P 500. From 2001-08, its average annual performance plummeted to 14.8%, which still outstripped the S&P by 15.5 percentage points. Since 2009, however, SAC has actually underperformed the S&P’s average annual returns of 14.9% by 600 basis points.
Because of its regulatory troubles, SAC is likely to lose most if not all of its outside capital by the end of this year and, by default, become a single family office. If things do turn out that way, Stevie Cohen may decide it’s not worth mounting a technical defense to clear his name in the civil suit which he should be able to settle by agreeing to disbarment and a hefty fine, thus bringing another illustrious Wall Street career to an ignominious end.
1Mathew Martoma, 39, has been criminally charged by the U.S. Attorney for securities fraud to which he has pleaded innocent and for which he is scheduled to stand trial in November of this year.
2The SEC complaint also highlights the 2008 sale of $12.5 million and shorting of 167,000 shares of Dell stock allegedly based on an illegal tip from a Dell investor relations insider regarding a disappointing quarterly earnings announcement that knocked the price of the stock down by 13% and netted SAC a combined $2.7 million in avoided losses and profits.
2In their white paper, Cohen’s counsel actually claim that he did not even read key e-mails from Martoma and other SAC staffers on which the SEC case is largely based.