After Billionaire Steven Cohen’s Hedge Fund Turned Focus to Market-Moving Info to ramp up “Deep Value” Investing, Regulators Grew Wary

July 24, 2013, 6:40 p.m. ET

For SAC, a Shift in Investing Strategy Later Led to Suspicions

After Steven Cohen’s Hedge Fund Turned Focus to Market-Moving Info, Regulators Grew Wary


As SAC Capital Advisors LP was preparing for the 2004 launch of a new division,Steven A. Cohen had a number of portfolio managers and traders driven up from the firm’s New York offices in private cars for a gathering at SAC’s Stamford, Conn., headquarters. At a catered dinner, Mr. Cohen explained his desire to ramp up the firm’s “deep value” investing, according to people familiar with details of the gathering. He floated ideas, and traders asked questions about how money would be allocated and research teams organized. The gathering led to the formation of a new unit within SAC called CR Intrinsic—and marked the continuation of a striking shift in the firm’s investing style.Mr. Cohen had delivered stellar returns from the time he opened his hedge fund in 1992, but as success compelled him to change his investing style, something else changed, too: His firm began drawing what turned into a decade’s worth of suspicion from regulators that it was trading on illegal inside information.

When Mr. Cohen opened SAC, the little-known technical-trading whiz blew away competitors, with returns nearly triple the industry average, by reading obscure patterns in short-term stock-price movements. An intense “tape reader,” he traded in bursts and had little interest in what the companies behind the shares actually did, according to a number of former traders at his firm.

But, as the traders and Mr. Cohen have described it in interviews, he changed his approach in the late 1990s and early 2000s as he fought to maintain the impressive returns with far more assets under management. Many hedge funds make similar adjustments to growth, said Andrew Lo, director of the Laboratory for Financial Engineering at the Massachusetts Institute of Technology’s Sloan School of Management.

“Once your footprint is more sizable, you have to adapt and diversify your styles to provide attractive returns,” Mr. Lo said.

SAC’s solution was to invest larger sums in each position, hold shares for longer periods and hire dozens of analysts to perform deep corporate research. The aim was in part to anticipate market-moving events such as takeovers or earnings shocks, according to investors and former traders.

That emphasis on digging up intelligence ahead of the market produced solid returns, but it also led to the years of regulatory scrutiny.

In 2006, for example, the National Association of Securities Dealers, a self-regulatory body, examined what it deemed “suspicious” trades in Red Robin Gourmet BurgersInc., RRGB -2.28% when SAC sold shares just before a disappointing earnings report. But what most concerned the regulator, according to the confidential report the NASD investigator prepared, was the fact that there were 38 other instances of SAC trading that the association found suspicious, all detailed in the document, which was reviewed by The Wall Street Journal. That list started with trades going back to 2000, around the time SAC began using the so-called event-driven strategy, according to several former traders. An SAC spokesman declined to comment on the report.

The list got longer over the years. The NASD and then its successor, the Financial Industry Regulatory Authority, flagged an additional 28 instances they examined and found “suspicious” through 2010, according to regulatory reports reviewed by the Journal. While most of those instances, as well as the suspicious trading referred to in the Red Robin report, were sent along to the Securities and Exchange Commission for further investigation, none resulted in an enforcement action. An SEC spokesman and a Finra spokeswoman declined to comment. An SAC spokesman said the firm wouldn’t comment on any of those regulatory inquiries.

The SAC spokesman previously has said of the referrals that, because of SAC’s high volume of trading, “it is not surprising that we would be included in a small percentage of Finra referrals.” Further, SAC noted that the referrals are “based on limited information” and don’t constitute allegations.

More recently, the firm and former employees have been hit with a wave of allegations, and SAC itself may face criminal charges as early as this week, according to people familiar with the matter. On Friday, the SEC accused Mr. Cohen in an administrative proceeding of failing to properly supervise employees who were allegedly trading using inside information. SAC and Mr. Cohen have said they acted appropriately and that they have strict rules prohibiting improper trading. On Monday, Mr. Cohen’s lawyers sent employees a 46-page rebuttal of the SEC allegations, arguing that supposedly questionable trades in Dell Inc., DELL +0.27% Wyeth andElan Corp., DRX.DB +2.32% were based on legitimate analyses and information about the companies and their prospects.

Four former SAC employees have pleaded guilty to criminal insider-trading activity while there; another former trader and a current one have pleaded not guilty to criminal insider-trading charges. SAC in March paid a record $616 million penalty to settle civil insider-trading allegations with the SEC, without admitting or denying wrongdoing.

SAC and its founder are inextricably linked. Besides having his initials on the door, Mr. Cohen owns most of the roughly $8 billion in SAC assets belonging to employees, out of roughly $14 billion total, while also closely supervising its operations and overseeing billions of dollars of trading.

The Federal Bureau of Investigation and prosecutors have examined trades in a multibillion-dollar stock portfolio known as the Big Book or Cohen Account, overseen by Mr. Cohen, according to documents filed by prosecutors in cases against other SAC employees and people familiar with the firm.

SAC portfolio managers for years have funneled what they considered their most promising ideas to Mr. Cohen for his own trading account and have earned bonuses for generating big returns, the people said.

SAC initially produced average annual returns of about 50% from 1993, its first full year of operation, to 2000, even after subtracting its unusually hefty fees, according to documents reviewed by the Journal. Between 2001 and 2007, the average return slid to 21%, though that was still more than double the industry average, according to Hedge Fund Research Inc. data.

But as SAC’s assets rose from $60 million in 1993 to more than $3 billion in 2000, the firm morphed its style to counter rising competition and find ways to invest larger chunks of money.

The firm hired dozens of analysts to ferret out market-moving news about companies. They pitched their best ideas to Mr. Cohen, who grilled them to determine their conviction in their suggestions, according to a number of former traders at the firm.

Mr. Cohen once reportedly joked: “OK, we trade these stocks; now we should know what they actually do,” according to a former employee.

About a quarter of all hedge funds say they rely on a similar “event-driven” investing style, which is legal if it is based on public information. SAC dove deeper into this approach around 2003, before launching CR Intrinsic.

According to a marketing document SAC circulated to investors, SAC by 2009 had more than 90 research analysts covering two dozen industry sectors. The firm’s “edge,” the brochure added, included “Over 60 portfolio management teams with deep industry networks.”

That same year, in another report, Finra found what it said were “suspicious” trades by CR Intrinsic in the stock of ViroPharma VPHM +0.15% Inc.; it sold the shares short less than a week before the company announced poor test results for a drug used by bone-marrow-transplant patients, which sent the stock down. The document, reviewed by the Journal, said that the authority was especially concerned because it had found 18 other instances of suspicious trades by CR Intrinsic. An SAC spokesman declined to comment on the ViroPharma trading or the Finra report.

When the hedge fund agreed to settle insider trading-related charges with the SEC in March, the commission cited more trades in the CR Intrinsic fund, by a portfolio manager there named Mathew Martoma.

According to the SEC, Mr. Martoma and Mr. Cohen accumulated a large position in two pharmaceutical companies, Elan and Wyeth, based on inside information Mr. Martoma was receiving from a scientist involved in the trial of a new drug the two companies were developing for Alzheimer’s disease.

In late July 2008, when the scientist told Mr. Martoma that the drug trial had been disappointing, Mr. Martoma and Mr. Cohen liquidated their holdings before the news became public, the SEC said. While SAC settled that civil case with the SEC in March, Mr. Cohen has denied the SEC’s allegation that he personally failed to supervise Mr. Martoma’s trading properly and missed signs of wrongdoing.

Mr. Martoma was indicted on criminal charges related to the trades last November and has pleaded not guilty. He is scheduled for trial later this year. The doctor who provided the information, Sidney Gilman, a professor at the University of Michigan Medical School, consented to an injunction filed by the SEC and agreed that he can’t contest or deny the charges. The SEC also said he received a nonprosecution agreement from the U.S. attorney in Manhattan.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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