Black Edge

by Sheelah Kolhatkar

  Berke thrived on situations like this. The first one in his family to go to college—to Duke, followed by Harvard Law School—Berke had grown up middle-class in Philadelphia, where he watched his father lose his small linen supply company after a series of tax audits that Berke didn’t understand at the time but seemed profoundly unfair. The family had lost nearly everything, and the experience had left him wary of the government. Berke took pride in this kind of fight.

  “He can’t make a deal,” Berke told Apps. “He didn’t do anything wrong.”

  —

  The day of Steinberg’s arrest, the SEC’s Dell team found themselves back inside 1 St. Andrew’s Plaza to meet with their counterparts at the U.S. Attorney’s Office. Everyone involved in the Dell case, both the prosecutors and the SEC investigators, had been summoned for an urgent meeting. George Canellos, the acting head of the SEC’s enforcement unit, was in New York for only half a day. The meeting had been arranged in part to accommodate his schedule.

  The purpose was to discuss how the investigation would move forward in light of the new information the government had about Cohen receiving the “2nd hand read” email about Dell. Securities fraud had a five-year statute of limitations. The Elan trade had happened in July 2008, the Dell trade in August of the same year. That gave them three and four months, respectively, to charge Cohen—or anyone else—with crimes in those cases. They had no time to waste.

  Canellos role-played the white collar defense lawyer, pointing out weaknesses in their cases. He loved doing this, playing the role of the contrarian. It had earned him a reputation outside of the SEC as an enforcer who was at times reluctant to file aggressive cases because he empathized a bit too much with the defendants. Still, his colleagues found his argumentative style to be helpful. There was nothing worse than walking into a settlement meeting or a courtroom only to find that your opponent had a defense worked out that you hadn’t seen coming. George could always be counted on to show them exactly what their defense-lawyer opponents were likely to focus on.

  Just because someone sent Cohen an email didn’t mean that he actually read it, Canellos pointed out, let alone acted on it. And what does “2nd hand read” mean, anyway? In all likelihood, yes, whoever got that email from Horvath understood exactly what it was referring to. It was all about context. But in isolation, the phrase was open to multiple interpretations, and you could be sure that Cohen’s lawyers would exploit this to the maximum.

  They made a list of everyone they wanted to talk to, every person at SAC who had any connection to the Dell email, as well as SAC’s upper management and compliance staff. Because they had so little time, they needed to establish priorities. They needed to know more about how things worked at the firm, who had the authority to green-light a trade, who made sure that Cohen was kept apprised of important stock news. They discussed the benefits of sending subpoenas to the various executives versus asking them to submit to interviews. They went over all the evidence they would need to prove a case in a trial.

  For the criminal prosecutors, the debate was an exercise in frustration. In spite of the extensive amount of evidence they had connecting SAC to insider trading, they were afraid it would be next to impossible to successfully prosecute Cohen himself without evidence that was more specific, ideally a witness who could testify that Cohen knew exactly what he was doing. Preet Bharara, along with other top prosecutors around the country, had become increasingly sensitive to the possibility of losing big cases, especially ones that attracted a lot of news media attention. Ambitious young prosecutors from Ivy League law schools did not want to be associated with high-profile failures, especially when they were trying to build their careers and reputations. Bharara had watched prosecutors in the Eastern District lose a closely watched fraud case against two Bear Stearns hedge fund traders a few years earlier, in 2009, a case that had similarly seemed to be a surefire winner. It was one of the first major criminal cases to arise out of the financial crisis, and the two fund managers were acquitted after just six hours. The government was harshly criticized for choosing the case in the first place and for the way it was handled. It was a disaster, and it sent a message to the Justice Department that when it came to pursuing crime on Wall Street, it was much safer to file cases that were close to a sure thing, rather than risk losing after a big trial. To make a criminal case against Cohen that would be unbeatable in court, Bharara’s prosecutors felt they needed a witness or a wiretap linking him explicitly to the Dell or the Elan trade, something that clearly, irrefutably, showed Cohen knew he was trading based on inside information. Basically, they needed Steinberg, or Martoma, to flip.

  While they waited, and hoped, for that to happen, they were considering filing a corporate fraud case against SAC. The prosecutors had two high-ranking employees—Steinberg and Martoma—and all of the other evidence they’d gathered that they could use to argue that SAC’s whole culture was rotten.

  The debate was very different at the SEC. With the agency’s lower standard for proving a civil case, they had a viable argument for charging Cohen. They wanted to put him out of business. The SEC investigators knew that Cohen had the “2nd hand read” email in his in-box at the time he sold his Dell shares. That, on its own, was practically enough. SEC rules expressly bar someone from trading a stock while in possession of inside information. Wadhwa felt certain they could persuade a jury once they put the whole story together. “We’re going to get him,” he thought.

  —

  Steven Cohen’s lawyers had been immersed in subpoenas, document requests, memos, and strategy sessions for four years now. In early spring, they embarked on an urgent new project, putting together a defense presentation they intended to make to the U.S. Attorney. They organized the presentation, approximately 130 pages long, into a black binder. They were going to use it to build a life raft.

  On the morning of Thursday, April 25, 2013, men and women in dark suits began filing into a large conference room on the eighth floor of 1 St. Andrew’s Plaza. The jockeying that went on for the chairs at the table closest to the action was a reflection of the hierarchy of those attending the meeting. Richard Zabel, Preet Bharara’s deputy, sat at the center of the “government” side of the long table. Surrounding him were the prosecutors, the securities unit chiefs, the head of the asset forfeiture unit, and the leader of the office’s criminal division. Several FBI agents were there as well as the SEC lawyers working on the Dell and Elan cases. There were so many government attorneys, seventeen in all, that someone had to get extra chairs from down the hall.

  A couple of weeks earlier, in anticipation of this moment, Bharara had asked his prosecutors to prepare a detailed memo outlining all the evidence the government had against Cohen. The memo was to include any evidence of knowledge that Cohen had about the trades in Dell and Elan, as well as any evidence from other cases that could be used against him. Antonia Apps and Arlo Devlin-Brown locked themselves up for a week putting it together. In addition to the evidence from the Dell and Elan cases, the memo contained example after example of Cohen receiving what seemed to be inside information from his traders and analysts and doing nothing to find out if the information was clean. Clearly, the prosecutors felt, Cohen’s employees felt comfortable giving him inside information. Some had told the FBI that they regarded it as part of their jobs. And Cohen had never, that the prosecutors found, referred an instance of suspicious trading by an employee to the SEC.

  When the memo was finished, it went to Bharara, who reviewed it carefully. Then he and Zabel spent hours with Apps and Devlin-Brown going over it. They outlined possible defense arguments and asked the prosecutors what their responses to those arguments would be. There was a mountain of evidence they could use to make a case against Cohen, everyone agreed, but it wasn’t enough to be certain of a victory at trial. Their chances of winning might not even be fifty-fifty. The evidence was too circumstantial.

  A criminal charge against SAC, on the other hand, was a case they could ea
sily win. They would start putting that case together while they waited for Martoma to come to his senses and decide to cooperate. Martoma had a young family and a long prison term in his future. As his trial date approached, they hoped that the benefits of working with the government would become clearer and he would give them the evidence they needed against Cohen.

  The next step was to request a meeting with Cohen’s lawyers. It was important to hear their point of view and give them an opportunity to talk the government out of moving forward. It was also a chance to get a preview of what Cohen’s defense would be. This was the moment when Marty Klotz and the rest of Cohen’s $10,000-an-hour legal team would prove just how clever they were.

  Klotz showed up looking slightly disheveled, as usual. Michael Schachter, his partner from Willkie Farr & Gallagher, took the seat next to him. Daniel Kramer, Michael Gertzman, and Mark Pomerantz, all partners at Paul, Weiss, sat next to them. Ted Wells, star trial lawyer at Paul, Weiss, was also in attendance. He didn’t speak, but the message was clear: If this case reached a courtroom, Wells, who was known to cry during his own closing arguments, would be their adversary.

  Klotz led the presentation. His mission was straightforward: He was there to keep Steve Cohen from going to jail. He took the assignment as seriously as he would have if Cohen had been a member of his own family.

  In 1988 Michael Milken’s lawyers, when faced with a similarly daunting set of legal pressures, had taken the cynical tack of arguing that Milken was an American hero whose junk bond empire provided fuel for the U.S. economy. They described Milken as a “national treasure,” a “genius,” and a “national resource” and publicly argued that Milken’s work building the junk bond market had created value for companies and communities around the country. This argument actually had some validity. Milken had ushered in new methods for companies to borrow money and expand, especially companies considered too small or too risky to obtain traditional loans; his innovations had contributed to economic growth in ways modern-day hedge funds never had. Milken also launched a public relations campaign, offering interviews to news outlets he was sure would be friendly. In many ways, Cohen was Milken’s equivalent, a financier who came from middle-class roots and rose up to embody the Wall Street of his time, partly through methods that regulators suspected were illegal. In Milken’s case, his defense had proved to be a colossal miscalculation, an expression of hubris that only hardened the prosecutors’ resolve to take him down.

  Cohen’s attorneys were smart enough not to follow that example. They didn’t suggest that Cohen was a saint or a creator of jobs or that he had somehow lifted up his fellow Americans. Rather, they focused on the government’s weak spot: its crippling fear of losing a big case. What Klotz wanted to do was create doubt. He and his colleagues were shrewd enough to know that, in the end, the government’s calculus was a matter of risk assessment and vanity as much as anything else. Klotz would get the prosecutors thinking hard about what it would be like to suffer a humiliating defeat at trial. As soon as that happened, the newspaper headlines about Preet Bharara would change from “This Man Is Busting Wall St.” to something much less flattering.

  A Willkie associate distributed the black binders they had prepared to everyone in the room. Inside was a presentation divided into three sections: “Plotkin,” “Cohen,” and “Elan.” Klotz looked out at the crowd of faces. “Thank you all for giving us this time to come and talk to you today,” he said in his gravelly voice. Then he started talking, and he didn’t stop for almost four hours. He walked them through page after page of trading records and emails. The government officials present had never endured anything like it.

  The argument Klotz made regarding Dell contained three elements: that it was highly unlikely Cohen had read the “2nd hand read” Dell email; that whether or not he had read it wasn’t relevant anyway; and finally, that even if Cohen had read the email and made a trade based on its contents, it was far from clear that it would constitute insider trading because Cohen knew so little about the original source of the tip.

  The argument Klotz was making was deceptively simple. He was not making the case that Cohen had his own, brilliant, reasons for selling his shares of Dell. Rather, Cohen’s own lawyer was saying that the most successful trader of his generation was winging it every single day. Maybe he read a critical email, maybe he didn’t. Who knew? Cohen lived in a swamp of information so deep that there was simply no way to prove that any single email was even read, let alone acted upon. He was making decisions independent of his own highly paid analysts and experts, based on his gut. There was basically no method to what he did; it was all chaos.

  “There is no evidence that Steve read the ‘2nd hand read’ email or that he spoke to anyone about the email,” Klotz continued. “There isn’t a single witness who would testify that they discussed the email with Steve.” He added, “Steve only reads a very small percentage of his emails.”

  He flipped to a printout of a screen shot of Cohen’s email in-box. Cohen had spam filters that diverted the junk messages from his overwhelming stream of communications—and even after that, he received at least twenty thousand emails a month, or almost a thousand emails per business day. He looked at just 10 percent of them. Cohen read only about 21 percent of the emails he got from his research trader, Anthony Vaccarino, who had forwarded the “2nd hand read” email to Cohen, Klotz added. The example Klotz showed of Cohen’s email box in Microsoft Outlook included a message from Wayne Holman about scheduling a golf game and dinner as well as research reports from various brokerage firms about oil prices and the Fed minutes.

  Halfway down, the message from Vaccarino was clearly visible: “FW: DELL,” it said in bold type.

  The government lawyers tried not to chuckle out loud when they noticed that the message directly above the Dell email was a marketing message from Amazon—“Up to 60% Off Art Magazines.” Apparently the spam filters didn’t always work.

  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 Hor
vath 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.