Black Edge

by Sheelah Kolhatkar

  On the other side of a glass wall, Aizer’s options group kept going for a few more years, then shut down. His no-risk trades were disappearing as the market became more sophisticated. Aizer didn’t like the way the trading business was changing, so he moved to Florida. Cohen and the mentor who gave him his first job on Wall Street never really spoke again.

  —

  Beginning in the mid-1980s, the American stock market came to be dominated by mergers and acquisitions. Every day, the stock prices of large corporations like Carnation, Union Carbide, and Diamond Shamrock were sent on wild swings as rumors of takeovers surged across Wall Street. Like most everyone else trading stocks at the time, Cohen got caught up in the rumors. He had a hard time pulling himself away from his desk. According to one of his former traders, he almost missed the birth of his son Robert because he was on the phone at the hospital, giving out trade orders for Schlumberger while Patricia shrieked with labor pains in the background.

  “Our job was to play,” said the former trader. “You buy, man. It was deal mania, and every rumor was true.”

  Cohen loved to engage in market chatter as he watched his screens, exchanging stock ideas with his friends. He also had a habit of sharing stock ideas with his brother Donald, who administered Cohen’s books from his office in Miami.

  One morning in December 1985, Cohen phoned Donald and recommended that he buy shares of RCA, the parent of the NBC television network. “I heard there might be a restructuring going on,” Cohen said. “These TV stocks are pretty hot.” He then added, “If NBC is spun off, it could run up 20 points.”

  After studying RCA’s stock chart over the weekend and looking through a few back issues of Forbes, Donald bought twenty March call options in his personal trading account at Fidelity. It gave him the right to buy RCA shares three months later at $50, an aggressive bet that its stock price was going to increase. Cohen had already made a similar investment in his own account. Patricia later said that he’d been telling people that a Wharton classmate had told him about an impending takeover offer for the company.

  The movement of RCA’s stock looked like the skyline of the Andes, a zigzag of dramatic spikes as investors kept buying more shares in response to rumors of the takeover. Six days after the conversation with Donald, General Electric announced a takeover of the broadcaster for $66.50 a share, which sent its stock price shooting up even more. Cohen made $20 million in profits on the trade.

  Three months later, an envelope from the SEC arrived at the office of Gruntal’s legal counsel. It contained a subpoena. The agency had launched an investigation into possible insider trading in RCA before the takeover. It seemed obvious to the regulators looking at the stock activity that some traders in the market had known about the deal in advance. The SEC wanted Cohen to come in and testify.

  In fact, the agency was looking at a handful of other stocks, too—Warner Communications, General Foods, and Union Carbide, all of which had recently been targets of takeover offers. Trading on material nonpublic information that was leaked by an insider who was supposed to keep it confidential was a violation of securities laws. The SEC noticed that a group of people connected to Cohen had accumulated shares of all three stocks, as well as RCA, right before public announcements had driven the prices higher. The agency suspected an insider trading ring of some sort.

  Donald got a subpoena, too. Trying to stay calm, he called Steve demanding to know what was going on.

  “Don’t worry,” Cohen reassured him. “Everyone that bought RCA at the time is being questioned.”

  Privately, though, Cohen was panicking. Days before, he and his traders had all watched in horror as Drexel’s top mergers and acquisitions banker, Dennis Levine, was arrested and charged with orchestrating a massive insider trading scheme by paying off lawyers and bankers to leak him information about takeovers and other deals. The Levine arrest was just the beginning of the unraveling of Michael Milken’s junk bond empire, an unprecedented series of prosecutions that would dominate news headlines for months. The SEC accused Levine of accumulating $12.6 million in illegal profits and froze all his assets, preventing him from paying his legal bills.

  Around 6 P.M. on June 5, 1986, the same day that Levine pleaded guilty to tax evasion, securities fraud, and perjury and agreed to help the Justice Department by providing evidence against others committing crimes on Wall Street, Cohen arrived at 26 Federal Plaza, at Broadway and Worth Street, wearing his best suit. He was about to be deposed in the RCA investigation. Gruntal had arranged for Cohen to be represented by Otto Obermaier, a former head trial lawyer for the SEC with a taste for expensive wine and Mozart. Obermaier was one of the most talented and well-connected defense attorneys in the field, and he was about to validate his reputation.

  An SEC staff attorney and a financial analyst who evaluated trading data for the agency’s enforcement division were waiting for Cohen in a conference room. After some awkward greetings, the staff attorney began the formal proceedings. “This is an investigation by the Securities and Exchange Commission entitled, ‘In the matter of trading in the securities of RCA Corporation,’ ” the staff attorney said. “We are here to take testimony in this matter to determine whether there have been violations of certain provisions of the federal securities laws.”

  The staff attorney asked Cohen to raise his right hand. Cohen did, and he was sworn in. The staff attorney then turned to Cohen, introduced himself and his colleague, and asked: “Have you seen the subpoena?”

  “He has,” Cohen said, gesturing in Obermaier’s direction.

  The staff attorney looked at Obermaier, then turned to Cohen again. “Have you seen the subpoena?”

  “I don’t think so,” Obermaier said, answering for Cohen. “It hasn’t been shown to him.”

  The agency had sent a separate subpoena to Cohen requesting trading records and other documents as part of its investigation. The staff attorney mentioned this and then looked at Cohen again. “No documents have been produced. Do you plan to produce any documents today?”

  “No,” Obermaier said, again on Cohen’s behalf. They had no intention of being helpful, although he didn’t say that to the SEC lawyers. Instead, Obermaier told them that they would “decline the invitation to produce documents” based on his client’s constitutional rights.

  “Which constitutional right is that?” the staff attorney asked.

  “The provision that no person shall be compelled to be a witness against himself,” Obermaier answered.

  “That’s his ‘Fifth Amendment right,’ ” the staff attorney said.

  Frustrated, the SEC attorney tried to insist that Cohen answer the question about the documents himself. During depositions there was usually a struggle over this point. It was always a goal of the SEC to get a witness to admit that he was “taking the Fifth” on the record when he was refusing to answer their questions; it could be used later as an inference of guilt. If you were innocent, the thinking went, why wouldn’t you use the opportunity to tell the SEC all about it? White collar defense attorneys were well aware of this, of course, so it was their job to resist and try to avoid letting the client say that he was “taking the Fifth,” even when he was taking the Fifth, for precisely the same reason. It was standard legal maneuvering.

  “He has to assert personally his right not to produce documents under the Fifth Amendment,” the SEC staff attorney said, trying again.

  “I don’t think he does,” Obermaier replied. He had no intention of letting Cohen say a word. “I’m responding as his lawyer.”

  The staff attorney and the financial analyst glanced at one another. Obermaier thought that he detected a slight look of resignation. They had already lost.

  “What is your date and place of birth?” the staff attorney asked, looking at Cohen.

  Cohen looked over at Obermaier. They had rehearsed this. “Upon the advice of counsel,” Cohen said, “I respectfully decline to answer the question on the ground that I’m being compelled to be a
witness against myself.”

  “Did you purchase securities on behalf of Gruntal & Co. in December of 1985 while in possession of nonpublic information concerning RCA?”

  “Same response,” Cohen said.

  They went back and forth. The staff attorney asked more questions: Did Cohen purchase RCA shares in his own account in December 1985? Did anyone tell him that RCA would be involved in a merger with General Electric prior to the public announcement? Did Cohen, in December 1985, recommend that anyone else buy RCA shares? Each time Cohen repeated the same answer, taking the Fifth without saying that he was taking the Fifth.

  Then the staff attorney asked, “Are you familiar with an entity known as J. Goldman & Company?” The attorney was referring to Cohen’s close friend Jay Goldman, a.k.a. “J-Bird,” who had formed his own trading firm after leaving Gruntal the previous year.

  Cohen barely registered any recognition. “Same response,” he said.

  The testimony was over in twenty minutes. Riding the elevator back down to the lobby, Obermaier couldn’t believe how painless it had been. He felt confident that he had done the best he could to save his client from prosecution.

  Cohen, however, was badly shaken by the experience. Refusing to answer questions before a law enforcement agency usually made people sound guilty, even if they weren’t. The RCA investigation was still ongoing. He felt he was now at risk of losing his livelihood. He was more irritable than usual during the day and spent most evenings at home, ranting about the SEC to Patricia. One weekend he could barely get out of bed. He was being unfairly persecuted, he complained, it wasn’t right. Patricia, for her part, was anxious. But she believed her husband’s assurances that he hadn’t done anything wrong.

  Then, one day, a letter arrived at their apartment from the phone company. It informed the Cohens that their phone records had been subpoenaed by the U.S. Attorney’s Office. It was a sign that there was a possible criminal investigation under way in addition to the SEC’s civil one. Patricia started screaming when she read it. The possibility of a criminal case went against everything Cohen had been telling her, that the worst that could happen was that he’d have to pay a fine. A criminal prosecution could result in jail time. Cohen assured her that he had learned the information indirectly, not right from the Wharton classmate who worked on the deal but from an intermediary, which meant that trading on it wasn’t illegal. Still, the uncertainty affected the whole family. Patricia and the children would cower when they heard Cohen’s key in the lock at the end of each day.

  The government’s RCA investigation was a source of constant embarrassment. “I’m just a stock trader, and I happen to have been trading in these stocks,” Cohen complained to his friend on the golf course. “It’s creating a lot of problems for my family, my children, and my personal life.”

  —

  On Monday, October 19, 1987, Cohen came into work before 8 A.M., earlier than usual. He had a bad feeling. In spite of the distractions of the SEC investigation, Cohen’s group had continued making money as the market, driven by hundreds of merger deals, climbed higher and higher. In the previous couple of weeks, though, fissures had started to appear, caused partly by the fact that lawmakers in Washington were debating the possibility of eliminating a tax loophole for interest payments on loans for financing hostile takeovers. If the mergers suddenly stopped, so would the ascent of the stock prices. Investors were nervous.

  There were also geopolitical tensions to worry about, including a long-running war between Iran and Iraq. On the previous Thursday, October 15, Iran had blasted an American oil tanker near Kuwait with a missile, prompting debate about how the United States would respond. The Dow fell over 100 points. By Monday morning, markets around the world were crashing. It seemed to be the result of a combination of fear about the Middle East, falling oil prices, the end of the M&A boom, signs of a recession, and some computerized stock selling. Cohen was aware of all of this when he got to his desk and saw how badly the overseas and Asian markets were doing. The Hong Kong index was down, and all the numbers on the European charts were red. He had many short positions in the portfolio, which would offset some of his losses. He tried to calculate how much money they might lose as he stared at his screen.

  When the market opened in New York, he started selling his holdings as fast as he could. The trouble was, with everyone else trying to do the same thing and a total absence of buyers in the market, stock prices lurched downward. Traders were rushing around the floor of the NYSE, knocking into one another. During the last hour of trading the selling accelerated, as investors panicked at the thought of holding shares overnight. Over the course of a single day that would become known as Black Monday, the Dow Jones Industrial Average fell 508 points, or 23 percent, the largest one-day decline in its history. Ten years of unrestrained borrowing was coming to a sudden, painful halt.

  Gruntal, along with many other firms, was practically put out of business. Cohen’s group lost almost half of its capital. Every one of its seven traders was nearly wiped out by losses.

  When the financial stakes were high, though, Cohen demonstrated an almost inhuman ability to stay calm and make rational trading decisions. As the chaos continued around him, he saw an opportunity. After trading had closed for the day, according to a former employee, Cohen turned to his traders who were rubbing their faces and staring at their monitors in shock. “From now on, no one is trading but me,” he told them. “I’m the only trader, and you guys are my clerks.” No one quite knew what he was talking about, but they didn’t argue.

  It was a fraught time. Fortunes were lost and people’s lives were ruined. Two of their brokers at outside firms, including Kidder, Peabody, which was embroiled in the Drexel insider trading scandal, jumped out their office windows. The junk bond bubble was beginning to burst, as companies that had borrowed billions of dollars found they couldn’t pay it back. The savings and loan crisis was also getting worse, causing the collapse of more than a thousand banks around the country. Wall Street was in crisis.

  Cohen, however, remained in control. For the next month after the crash, as the NYSE floor specialists struggled to open trading in their securities every morning, Cohen’s “clerks” would call them before the market opened and get quotes for where they thought particular stocks would start trading. Due to the ongoing shock of the crash, the biggest trading opportunities often came at the start of the day, when nobody knew what was going to happen and fear ran high. Could this be the day it all went to zero? Cohen would get his “look” conveyed to him from the floor specialists, as in, “Gillette’s going to open up 2.” Then as soon as the stock opened he’d short as many shares as he could—selling shares he didn’t actually own and buying them back when the stock went down again. He did this over and over again for weeks, shorting nearly every stock in the Dow—DuPont, GE, IBM—making money almost every time as the prices went lower. It wasn’t a patriotic move, when the market was struggling to recover, but his colleagues marveled at his ability to turn off his emotions.

  Gruntal, and Cohen’s trading group, ultimately survived. Cohen’s marriage did not.

  He and Patricia had been fighting bitterly for months and had gone in and out of couples therapy. Things got so tense that on June 22, 1988, Cohen moved out of his family’s fifty-five-hundred-square-foot apartment on East End Avenue. It was the beginning of a year and a half of acrimonious divorce negotiations. While they were trying to come to a settlement, Cohen’s lawyer recommended that he move back into the apartment to give him a stronger negotiating position, which he did. With twenty-eight rooms, the place was enormous, and Cohen argued that he should be able to live there until the divorce was official, since it seemed to be taking so long. The move was the beginning of a new phase of conflict between them.

  The attorneys spent hundreds of billable hours arguing over a list of Cohen’s assets and trying to figure out exactly how much money he had been making each year. He had never shared this information with his wif
e. They made offers and counteroffers. Cohen finally produced a spreadsheet showing that everything he had in the world was worth $16.9 million. Around half of that, $8.75 million, had been invested in a real estate deal with his friend Brett Lurie. Cohen said that the deal had been unprofitable, though, and that the entire $8.75 million was gone—so he valued it at zero. The remaining $8 million or so had to be divided evenly. Cohen offered to give Patricia their apartment, which he said was worth $2.8 million, and an additional $1 million in cash. He also agreed to pay around $4,000 a month for expenses for Jessica and Robert, in addition to paying for their camp and private school tuition. Patricia planned to sell the apartment and move into something smaller, and she waived her right to spousal maintenance.

  Although Cohen made more than $4 million that year, he resented having to give any money to his former wife. He complained about her spending habits, her $80,000 in Bergdorf’s bills. The day after he signed the final spousal agreement he showed up at work in a petulant mood and turned to his traders.

  “I just got ripped off by my wife,” he said, according to a person who was there. “I’m going to make it all back by cutting your payouts.”

  His employees couldn’t believe what they were hearing. Cohen was taking 60 percent of the group’s profits. Out of that pool he was paying each of them 30 percent on the profits on their own trades, leaving him a full half of the cut on trades he hadn’t even made himself. Many of the traders had worked their way up from clerks’ salaries. Cohen wanted to reduce what they were getting by 5 percentage points.

  “You can’t do that,” one of the traders said.