Black Edge: Inside Information, Dirty Money, and the Quest to Bring Down the Most Wanted Man on Wall Street

by Sheelah Kolhatkar

  Cohen, Klotz pointed out, also received a similar number of instant messages on a daily basis. Cohen’s desk had seven monitors on it. His Microsoft Outlook messages appeared on the far left one, behind multiple other screens, further increasing the likelihood that he never saw the Dell message. He would have had to “turn to the far left of his seven screens, minimize one or two computer programs, scroll down his emails, double-click into the ‘2nd hand read’ email to open it, read down three chains of forwards to read the ‘2nd hand read’ email, before issuing an order to shell shares of Dell.” All of it, according to Klotz, taking place in less than half a minute.

  This idea that Cohen could run his business in such a haphazard style didn’t seem plausible to most of the investigators in the room. They had been studying Cohen for six years and understood him to be a rapacious consumer of information. They believed that SAC had been structured to ensure that Cohen had access to every bit of trading data being gathered by his portfolio managers and their aggressive, ambitious teams. He was controlling and demanding. The suggestion that he ignored 80 percent of the messages from his own research trader, whose sole job was to alert him to critical market information, struck them as absurd.

  But as a glimpse into Cohen’s potential defense arguments, it was powerful.

  Klotz reminded everyone in the room of the convoluted journey the “2nd hand read” email had taken before being sent to Cohen. “Steve does not remember reading it,” Klotz said. “He may not have read it.”

  Klotz then revisited some of the facts surrounding the email’s transmission: On August 26, 2008, two days before Dell reported its earnings, Cohen owned 500,000 shares. Steinberg, on the other hand, was short Dell stock. As soon as Steinberg learned that Cohen was long Dell, he and Horvath started to debate whether and how to tell Cohen that they had the opposite bet. Steinberg spoke with Cohen about their opposing views on the stock on that morning, when the earnings release was still two days away. Then Steinberg urged Gabe Plotkin, who was also long Dell, to discuss his own research with Horvath via email. At 12:54 P.M., Plotkin and Cohen spoke on the phone for seven minutes. Shortly after, Horvath sent the “2nd hand read” email, which Plotkin forwarded to Vaccarino, who then sent it to Cohen.

  Vaccarino had then called Cohen, a call that lasted around a minute. At 1:39 P.M., right after hanging up the phone, Cohen started selling. By the time the market closed that afternoon he had gotten rid of all 500,000 shares of Dell that he owned.

  Shortly after 4 P.M. on August 28, Dell made its earnings announcement. The stock went way down. Cohen averted losses of $1.5 million.

  Klotz then started attacking the legal underpinnings of the case. It was far from clear that a trade made by Steve after he received the “2nd hand read” email would even constitute insider trading, he argued. The Dell information had passed from a Dell investor relations employee to another trader named Sandeep Goyal, to Jesse Tortora to Horvath to Steinberg to Plotkin to Vaccarino to Cohen. Klotz and his colleagues from the defense bar believed that Cohen was too far from the original source of the information, and too ignorant of the circumstances, to be criminally liable for any securities fraud.

  “A number of people I’ve spoken to say that isn’t a legitimate extension of insider trading,” Klotz said.

  “Are any of these people federal judges?” Rich Zabel, the most senior member of the Justice Department at the meeting, asked. “Give me a break.”

  Zabel, who had a gray goatee that made him look a bit wolflike, had grown up in the shadow of the hedge fund industry. He was the son of William Zabel, the founder of the law firm Schulte Roth & Zabel, which had a huge number of hedge fund clients. He understood how rich hedge fund guys operated, and he wasn’t afraid to express his cynicism about their motives. But where his bluntness would normally have sparked laughter, there was only awkward silence. Much as they didn’t want to admit it, the government attorneys knew that Cohen’s distance from the Dell leak was a serious weakness.

  Klotz then launched into a hypothetical story about his son-in-law, an employee of Best Buy, the electronics chain. “You could ask him, ‘How are the flat screen TVs selling?’ and he’d tell you how they were doing,” Klotz said. “That would be a ‘2nd hand read from someone inside the company.’ And that would be totally legitimate. There’s nothing in this Dell email to distinguish it from me talking to my son-in-law.”

  Klotz glanced at the faces of the government lawyers around him. They appeared unmoved. Inside, though, the prosecutors knew he had a point. It would be difficult to convict Cohen on the basis of the email alone.

  Three hours in, Klotz finally turned to Elan, the smallest portion of the binder, a reflection of the level of threat that Cohen’s lawyers evidently felt the trade represented, given that Martoma wasn’t cooperating. The core of Klotz’s argument was that there were multiple reasons why it made sense for Cohen to sell his Elan shares, none of which had anything to do with any inside information that Martoma might have obtained. He showed a chart of Elan’s stock, which had gone from about $19 in March to over $30 in July. On that alone, he said, it was a good idea to sell. Several analysts had issued reports that month arguing that the stock had peaked and that it was time to get out. SAC was sitting on an unrealized profit in the stock of around $80 million. Then, Klotz said, Cohen got a call from Martoma, who said that he was “no longer comfortable” being long the stock. Selling was the only prudent thing to do.

  When Klotz finished, Zabel just shook his head. “I’m sorry, I just don’t buy it,” he said, reflecting the thoughts of many people in the room.

  Typically, defense lawyers presented their strongest arguments in meetings like this, and to Zabel it all sounded weak. Klotz’s arguments were abstract, not built on actual assertions of anything. Cohen may not have read the email. He might not have had time to react to it. In Zabel’s view, it was a bit like saying, “I might have been in the bank, and I might have had a mask, and I might have had a gun, but that doesn’t mean I robbed the bank.”

  Still, hearing Klotz lay it all out, much the way he would in front of a jury, was a hard dose of reality. After years of agonizing work, they didn’t quite have the evidence they felt they needed to convict Steve Cohen. Not in a criminal case, anyhow. More than a dozen people at the FBI, the SEC, and the U.S. Attorney’s Office had worked for almost a decade to line up a row of pins, and Klotz had just kicked them all over. Their only remaining hope was that Steinberg or Martoma would cooperate.

  Klotz gathered his materials and stood up. He was going to sleep comfortably that night.

  “Thanks very much for giving us this time,” he said.

  Zabel rushed to Bharara’s office to tell him what had happened.

  —

  The two groups departing the meeting had different impressions of what had just transpired. Cohen’s lawyers felt that they had made a powerful case against a criminal indictment of their client. Their confidence was not misplaced. The criminal prosecutors who attended the meeting were more convinced than ever by the time it was over that they didn’t have the evidence they needed to charge Cohen with securities fraud. Instead, they turned their attention to their Plan B, indicting Cohen’s firm rather than Cohen himself. Legally, when any employee acting within the scope of his employment committed a crime, that crime could be attributed to the company he worked for. Charging SAC wasn’t the most satisfying outcome, but the prosecutors could do it and still leave open the possibility that Martoma would flip and give them a case against Cohen later.

  The U.S. Attorney’s Office was often criticized for not penalizing Wall Street firms that committed fraud, and Bharara could point to the prosecution of SAC as a response to that. It would send a strong message to Martoma, too, that time was running out for him to change his stance. A few days later, Apps and Devlin-Brown started sending out grand jury subpoenas. One was sent to Cohen, others to SAC’s top executives. These were not signs of an investigation being quietly wrapped up.
Rather, the case had gathered force and veered into a new, more serious phase. The prosecutors were hoping that they’d have two historic cases in the end, one against Cohen and another against his company.

  Klotz called the head of the securities unit at the Southern District to say that Cohen would be taking the Fifth in response to the subpoena. They were going to war.

  With news of the grand jury summonses being reported in the newspaper, SAC’s investors, after years of ignoring the signs, finally started withdrawing their money, and a torrent of capital flowed out the door. Since the beginning of the year, almost $2 billion had been redeemed out of the roughly $6 billion the fund managed that didn’t belong to Cohen and his employees. SAC’s largest outside investor was the Blackstone Group, a giant private equity fund run by the billionaire Stephen Schwarzman. Blackstone had $550 million with SAC. Executives at the firm had been watching as the investigation developed, debating what to do. Schwarzman had strong views about the government. He felt that the Obama administration was going out of its way to vilify Wall Street, and he didn’t want to abandon Cohen just because the government was going after him, but this new indication that Cohen was preparing for battle with the Justice Department pushed Blackstone to submit a redemption notice. The risk of their money getting tied up in litigation was now too high to ignore.

  It was as if the country’s biggest investors, its wealthy individuals, its major pension funds, and its educational endowments, had regained their senses. By taking their money out, they acknowledged that perhaps SAC’s enormous returns year after year had been too good to be true.

  —

  Inside the SEC, the staff attorneys and their bosses within the enforcement division were debating what to do about their own case. The agency’s renowned enforcement division was being co-managed by Andrew Ceresney, a former partner at Debevoise & Plimpton who was new at the job, and George Canellos, a longtime enforcement official. Klotz and the rest of Cohen’s legal team came in with their binders and put on the same presentation for both of them that they had at the U.S. Attorney’s Office, arguing that the agency should not file charges.

  The SEC lawyers who had investigated the Dell case for the previous three years felt they had enough evidence to charge Cohen with insider trading. The burden of proof that the SEC had to meet was lower than that for the criminal prosecutors, who had to prove guilt beyond a reasonable doubt. For a civil case, the SEC only needed to prove the facts by a preponderance of the evidence—essentially, that it was more likely to be true than not. The task ahead of them was convincing their bosses, Canellos and Ceresney, that they should move forward. If those two agreed, then the staff needed to go to the SEC’s five-person commission and persuade a majority that they should proceed.

  Ceresney’s instinct was that they should file the case. Canellos was more circumspect, arguing that they didn’t have the evidence to win. Ceresney was like an excitable puppy, while Canellos was the cautious one who worried about how an embarrassing loss against the most famous hedge fund manager in the world might damage the agency. Two SEC trial lawyers, the ones who would actually present the case in court if it went that far, pointed out the problems with the evidence they had, which was largely circumstantial. They said that Cohen’s lawyers would surely argue that the sequence of events—the forwarding of the “2nd hand read” Dell email, the phone call between Cohen and his research trader—hadn’t left him enough time to go through all the steps to sell his shares.

  Klotz and his partner Schachter repeated the same points they had raised to the U.S. Attorney’s Office: Cohen hadn’t necessarily read the email. Cohen would fight. It would go to trial. The SEC wouldn’t have one single witness to put on the stand to contradict Cohen’s position. Schachter also attacked the legitimacy of the AT&T phone records the SEC possessed showing that Cohen had spoken with Vaccarino right before he sold his Dell; he insisted that there was no way to prove that Cohen had actually answered the phone. The SEC had spent months consulting with phone company experts proving that he had answered the phone, but Schachter still managed to consume precious hours drawing them into a debate about it.

  The SEC staff spent the Memorial Day weekend locked in a tense debate with their supervisors about how to proceed. Sanjay Wadhwa had driven to Providence, Rhode Island, with his wife and three-year-old son. Matt Watkins was in West Virginia visiting his relatives. Justin Smith passed the long weekend in Massachusetts. All of them spent a good portion of the time on the phone or trying to locate pieces of evidence that the higher-ups wanted to see. Long emails flew back and forth, followed by heated phone calls.

  Slowly, the SEC staff attorneys started to detect a shift in Ceresney’s view. He was starting to waver.

  No one wanted to acknowledge it, but the arguments made by Cohen’s lawyers over the previous few weeks seemed to be having an effect. By the end of the Memorial Day weekend, Ceresney suddenly didn’t think they had a strong case anymore. The heads of the SEC’s vaunted enforcement division had gone from robust confidence in their case to a state of retreat.

  The SEC staff attorneys were in despair at the prospect of not filing any charges against Cohen. They couldn’t believe that after all this, their bosses were on the verge of backing down. They started trying to research other ways they could penalize Cohen. They believed his company was corrupt and that they had to get him out of the market. There were other types of violations besides insider trading, ones that could spring from negligence or recklessness in managing your employees. There had to be some mechanism to shut SAC down.

  —

  One after the other, black SUVs pulled up on Centre Street in lower Manhattan to drop SAC’s senior executives in front of the U.S. Attorney’s Office. Half a dozen of them had come for interviews with Arlo Devlin-Brown and Antonia Apps, in which they answered detailed questions about how the firm worked. Everyone to whom the prosecutors had sent a subpoena came in to talk. Everyone, that is, but Cohen.

  Even without him, the process had been illuminating. The prosecutors had learned of many situations where questionable trading seemed to be happening at SAC. In one case, a trader was recommended for a job at SAC because he had rented a summer house with the CFO of a publicly traded company, and he had gotten good at predicting the company’s quarterly earnings. In another instance, a portfolio manager had learned about a negative research report that was about to be released about a company called Medicis Pharmaceutical and shorted it before the report came out. It was the only case the prosecutors had found where SAC’s own compliance department had sanctioned someone for insider trading. The internal punishment was a fine.

  Everything they had learned about how SAC operated made perfect sense to the prosecutors once they interviewed Steven Kessler, SAC’s head of compliance. The compliance department at a hedge fund was crucial, as it was tasked with enforcing the rules. Unlike Sol Kumin, Tom Conheeney, and the other SAC executives they met with, Kessler did not seem like a very sophisticated person. He was one of the last ones to come in, and when he did, he began the meeting with a scripted presentation about SAC’s compliance department and how robust it was. He boasted that SAC had launched a pilot program to catch inappropriate trading by searching firm emails for certain keywords, but it hadn’t started until four years after the trades the government was looking at had happened. Once he started answering questions, Kessler didn’t prove to be any more impressive.

  “How many times have you ever reported suspicious activity of insider trading at SAC to law enforcement?” Devlin-Brown asked.

  “Zero,” Kessler replied.

  The exchange revealed something about the way Cohen had chosen to run his company. Both Kessler and to some extent Peter Nussbaum, SAC’s general counsel, were quiet, low-energy guys whose voices could easily have been drowned out. The firm’s president, its chief recruiter, and the head of trading, on the other hand, were all big and broad-shouldered, jocular and confident, the kind of cool guys that Cohen probably wishe
d he was. Cohen seemed to the prosecutors like someone who had probably been picked on as a kid. Now that he was immensely wealthy, he could bully other people. As the prosecutors saw it, the people he was most likely to want to push around were in compliance and legal.

  —

  At the SEC, the teams working on Dell and Elan sat down together to see if they could combine the evidence they had gathered in both investigations into one charge that would shut SAC down. A few similarities between the cases stood out. Both the Dell situation and the Elan and Wyeth trades had happened under Cohen’s direct supervision. There was a clear pattern showing that Cohen was more than willing to ignore signs that information he was getting from his traders might be illegal.

  Wadhwa went to Ceresney and Canellos with an idea: Why didn’t they drop the idea of insider trading and instead charge Cohen with “failure to supervise,” with having neglected to properly monitor his traders? It was a weaker charge than insider trading, but in the end, if their goal was to bar Cohen from the securities industry, it could be enough. The evidence, Wadhwa’s staff thought, was definitely strong enough to support the charge. Plus, it didn’t carry the same risk of losing a trial. They could bring the case in an internal SEC court, where the stakes would be lower. At this point, the SEC leadership was leaning toward not filing any case at all, and failure to supervise was better than nothing.

  Much to the relief of the SEC staff, Ceresney and Canellos said yes.

  When Wadhwa called Klotz to inform him of the case they planned to bring, Klotz seemed relieved, too.

  “Okay, fine,” he said. He asked only that Cohen be given a day to inform his employees. Cohen didn’t want his traders reading about it on their Bloomberg terminals.

  The SEC’s enforcement chiefs arranged a phone call with Rich Zabel, the Deputy U.S. Attorney, to update him on their plans. Rather than congratulating them, though, Zabel seemed annoyed. He was exasperated that the SEC was pushing ahead with its own case without waiting for them, and he said so. As soon as the SEC filed something, Cohen’s lawyers could start to extract information about the government’s evidence. Bharara still planned to charge SAC Capital Advisors with insider trading. His prosecutors were working to get the papers ready. Cohen was hanging out there, and there was still a possibility that Martoma would flip. In the past, the criminal prosecutors and the SEC had tried to coordinate the timing of their filings to avoid interfering with one other. It was essential that they maintain a unified front. Not only was the SEC violating that implicit agreement to work together, they were racing ahead with a weak case—failure to supervise instead of insider trading.