SEC Tries Last Ditch Move

In the end, billionaire Steven Cohen, one of the most successful hedge-fund managers of his generation, could end up getting banned from the business he dominated for an error of omission, not commission.

In an administrative action that constitutes its first formal salvo against Cohen, the U.S. Securities and Exchange Commission alleged he failed to supervise two wayward portfolio managers and ignored “red flags.” The agency stops short of accusing the owner of SAC Capital Advisors LP of insider trading. While the proceeding may result in his being barred from managing other people’s money, it won’t carry the potential penalties available if the SEC had sued him. It also pales in comparison to a grand jury indictment for securities fraud, and the 20 year prison term a conviction could bring.

Instead, the SEC claim that Cohen should have known two of his subordinates were using material, non-public information to rack up hundreds of millions of dollars in trading profits will be easier to prove. The regulator will have a lesser burden of proof and won’t have to deal with all of the protections afforded a defendant in a lawsuit, real time Location system.

“They are using an Al Capone-style tactic,” said John Coffee of Columbia Law School, referring to the prosecution of the Chicago gangster in 1931 on charges of tax evasion. “The SEC is aiming at his kneecaps, not his jugular,” he said. “This is a little like catching John Dillinger entering a bank with a submachine gun and charging him with double parking.”

The SEC, which seeks to ban Cohen from the financial industry for life in the non-court action, alleged he received “highly suspicious” information that should have caused any reasonable hedge-fund manager to investigate the basis for trades by subordinates Mathew Martoma and Michael Steinberg.

Cohen may find some guidance in how to respond to the agency from Rajat Gupta, the former Goldman Sachs Group Inc. director charged in the Galleon Group LLC insider trading probe.

Gupta sued the SEC after it filed an administrative action against him, saying he wanted the SEC to sue him so he could fairly defend himself. After both sides dropped their actions, agreeing any SEC matter would be in a federal court, Gupta was indicted by a federal grand jury. The SEC sued him, too.An SEC administrative proceeding is held before an administrative law judge, not a U.S. district judge or federal jury. The administrative law judge, in Washington, will hear testimony and issue a determination, without a jury present, said Tom Gorman, a former lawyer with the SEC’s Enforcement Division who is now in private practice.

After the administrative judge issues a ruling, the SEC makes the final determination, evaluating the facts supporting the allegations. Cohen may appeal to the federal appeals court in Washington, which handles such regulatory matters.But unlike if he were sued by the agency, Cohen won’t be entitled to evidence collected by the government, a distinct advantage if its only goal is to put him out of business.

SAC spokesman Jonathan Gasthalter has said the agency’s action against Cohen “has no merit.” Kevin Callahan, a spokesman for the SEC, didn’t return calls seeking comment. The administrative law judge will rule “no later than 300 days” from the date which the order was served, the agency said.SAC oversees $15 billion, about 60 percent of which is money from Cohen and rtls. Cohen, whose net worth is estimated at about $9 billion by the Bloomberg Billionaires Index, has returned 25 percent a year in his funds since founding his firm in 1992, after taking half of the profits in fees, a record unsurpassed by other equity hedge-fund managers.

Both men, who were also sued by the SEC for insider trading, have pleaded not guilty in the criminal cases brought by Manhattan U.S. Attorney Preet Bharara, and are scheduled to go to trial separately in November.
Regulators alleged Cohen, 57, ignored the suspicious actions of his subordinates and signs that pointed to malfeasance, in a failure to properly supervise that allowed the alleged illegal trades to take place.

In the administrative action, the agency for the first time described Cohen’s alleged personal involvement in trading activities with the two subordinates, including a claim that Cohen sold off hundreds of thousands of shares of Dell in August 2008. The SEC said the sale came after Steinberg sent Cohen an e-mail that the U.S. alleged included nonpublic information about the company’s disappointing earnings set to be reported days later.

The agency doesn’t allege that Cohen knew that the information was illegal, a prerequisite to any prosecution of Cohen for insider trading. Instead, the SEC said he failed to supervise the men after receiving information that should have caused a “reasonable” hedge fund manager to investigate the basis for the trades.

The nature of the agency’s action against Cohen, in effect a disciplinary action that occurs internally, caught many by surprise, since it comes after years of scrutiny by federal authorities, both civil and criminal.

The government’s six-year insider-trading crackdown on fund managers, analysts and insiders at technology companies has resulted in charges against more than 80 people and convictions against 73 people.Prior to last week’s filing, the government’s major actions against alleged inside traders and their associates have largely been tandem federal enforcement efforts -- pairing simultaneous charges by Bharara’s office with a lawsuit by the SEC.

Earlier this month, the Wall Street Journal, citing unidentified sources, claimed federal prosecutors had concluded they didn’t have enough evidence to charge Cohen by the end of this month for crimes related to Martoma’s tips.

“This matter has been investigated for months,” said Tom Gorman, a former lawyer with the SEC’s enforcement division, now a partner at Dorsey & Whitney LLP in Washington. “Clearly the SEC does not have the facts to bring an insider trading case or they would have brought it.”Gorman said the SEC’s action was based on two criminal insider-trading cases that have yet to go to trial. Should either Martoma or Steinberg be acquitted, it could damage the SEC’s proceeding, he said.

While he wouldn’t address the Cohen case specifically, Bharara took the unusual step in a speech last week of pointing out that prosecutors have other statutes, including conspiracy, that can push back any statute of limitations deadlines.