Circle of Friends

by Charles Gasparino

  An SEC spokesman said in response that Rosenfeld was just alerting people “to be careful,” as was his boss Khuzami, who in interviews with reporters explained how the SEC was cracking down on this vice “that is baked into the business model of many hedge funds.” Khuzami has made a good case that the SEC, being a government agency, has limited resources, so it can only file insider trading charges for activities that are clearly illegal.

  Still, an even bigger perceived threat came in March 2011 during congressional testimony, when Khuzami appeared to set his own standard for what might prompt an investigation of suspicious trading. “We’re now doing things like canvassing all hedge funds for aberrational performance.”

  Khuzami had ordered his troops to be “proactive” in looking at fraud including suspicious trading after all the screwups in recent years, from Aguirre to Madoff. As a result, he defined such performance as when funds beat “market indexes by three percent and [are] doing it on a steady basis.”

  He might as well have said, “Note to Stevie Cohen: That means you.”

  CHAPTER 14

  STEVIE IS WORRIED

  I’ve had a rough six months,” Steve Cohen told Vanity Fair magazine in a lengthy July 2010 piece written by veteran business writer Bryan Burrough, the author of Barbarians at the Gate. The best-selling book is considered a classic. It chronicled the epic takeover battle of RJR Nabisco, and the insanity of the 1980s takeover mania in all its gory details.

  But Burrough was also the author of one of the worst business articles ever written about the 2008 financial collapse, a long Vanity Fair feature on the demise of Bear Stearns, the first firm to implode during the crisis. He pinned the firm’s collapse not on its CEO, James Cayne, who spent much of his time playing golf, attending bridge tournaments, and smoking weed, nor on the firm’s hyper-aggressive, risk-taking culture, or even its senior management team, regarded as the weakest on Wall Street.

  In Burrough’s opinion, Bear’s implosion was the result of media bias: reporters (this author included) who were only too willing to report all the bad stuff about Bear, and none of the good things, until a market frenzy developed that crushed the firm’s stock price, caused lenders to pull lines of credit, and drummed a once-great firm out of business.

  This odd critique (Joe Nocera of the New York Times called it an “apologia” for Bear’s feckless management) may have been the reason why SAC’s media adviser Sard Verbinnen welcomed the news that Burrough wanted to do a profile of Cohen. Finally, Cohen’s flacks had found someone who might accept the most positive spin on an increasingly difficult set of circumstances faced by the SAC chief.

  Sard Verbinnen was no stranger to media challengers. The firm, and its top executive George Sard was Martha Stewart’s press adviser when she was charged and stood trial in 2004 for lying to investigators about her suspicious trade of ImClone stock. Based on the facts at hand, it was a pretty open-and-shut case. At least that’s what the jury thought, convicting Stewart after a relatively short deliberation. But Sard’s aggressive counterattack had much of the media coming to her defense, describing Martha as a successful businesswoman battered by prosecutors looking for some cheap headlines in the aftermath of the tech meltdown in 2000 and 2001.

  It would be hard to make Steve Cohen a victim of a sexist vendetta, but the firm’s advice to Cohen was along the same lines: Go on the offensive, start making some public appearances, and open up to a friendly reporter. Burrough became that reporter.

  The PR problem Cohen had was pretty obvious. People who had heard of Cohen—including average people who sit on juries—would know the characterization of him mainly from what 60 Minutes reported back in 2006: He was a shadowy, secretive multibillionaire who lived in a secluded mansion, collects art, and does sleazy things to make a buck.

  The reality was somewhat different. He wasn’t quite the recluse the media made him out to be, and he was far from greedy. He and his second wife, Alexandra, raised tens of millions of dollars to fund a pediatric wing for New York Presbyterian Hospital in the immigrant-heavy Manhattan neighborhood of Washington Heights, where Alexandra grew up. He has given millions more to the North Shore-Long Island Jewish Hospital to fund another pediatric care center.

  This reality, and little else, is what Cohen’s media handlers wanted portrayed in the article. Burrough is, of course, a smart and gifted writer, and his long piece contained a rare interview with Cohen as well as a few interesting revelations about SAC. Cohen’s trading desk operates without telephones that ring (which would distract his traders) and the room is kept at a temperature of 68 degrees so traders remain alert. He also said that investors shouldn’t expect those blowout years they had in the past, where SAC cranked out returns above 50 percent. “We’re not going to generate those larger numbers now that we are bigger,” he said. After all, it’s hard to crank out such large numbers when you’re managing $14 billion in assets.

  Maybe the biggest takeaway: Burrough made it clear that Cohen believes he has been made a scapegoat by a media gone mad over insider trading. Cohen told Burrough he hated being put in the same category as crooks like Rajaratnam, and rightly pointed out his fund’s pristine regulatory record. If individuals at SAC have been responsible for bad conduct, that’s because they violated company policy. The firm itself hasn’t been touched.

  “I could not understand it,” Cohen said, referring to the media interest in his firm’s trading. “What the hell was going on. It was like a circus, a fucking circus.”

  The article, however, was short on new details about the firm and how the various investigations were circling around SAC and the simple fact that regulators kept coming up with suspicious trades flagged out of the hedge fund, or even how Cohen’s returns defied their logic—namely because it’s impossible to beat the markets that consistently. Warren Buffett doesn’t do it year after year, so why should Stevie Cohen?

  Speaking about “Stevie,” Burrough quoted Cohen saying he hated the name by which he’s been known during his nearly thirty-year Wall Street career. “I mean, they still call me ‘Stevie,’ and I’m fifty-four years old. It drives my wife crazy.” The article also said that Cohen was thinking about getting out of the hedge fund business sometime soon—something that his PR people would later retract.

  “There’s a lot of other things I can do,” Cohen told Burrough. “I’ve been to the top of the mountain, and there’s not much there. My dream is to liberate myself. So is that a midlife crisis? Or is it just being fucking smart? I don’t know. But it’s exciting.” It was a bizarre statement coming from a man known equally as a control freak and as obsessed with investing, somewhat reminiscent of the weird comments he made the last time he opened up to the press during his brief and unfortunate career in tabloid TV about twenty years earlier.

  But if the intent of the article was to humanize Cohen enough to give regulators second thoughts about pursuing him, it failed miserably. In fact, it only whetted their appetites. The media only cared about Cohen and SAC because reporters’ sources in the SEC and the Justice Department had made the hedge fund a priority in the insider trading crackdown.

  His remark about returns now falling back to earth only suggested to prosecutors in the Southern District that SAC knew it had problems and was taking steps to ensure complete compliance with insider trading laws after years of ignoring them. The increased compliance meant fewer dirty and profitable trades.

  The “circus” Cohen complained about would only get crazier in the coming months. In fact it got so crazy that Sard couldn’t possibly find any reporter whom he could get to bite on even a semi-positive yarn about the trader and the company that had so obviously become a leading figure in the eyes of the federal insider trading police.

  Of course there were other players in the ever-unfolding enforcement drama, which the government agencies were fighting to take credit for no matter how lowly the analyst being arrested and charged. Some, of course, weren’t so lowly. By October 2011, Rajat Gupta was
finally arrested in what the feds were calling the most significant insider trading bust since the 1980s crackdown yielded junk bond king Michael Milken. Signing his indictment papers was one of the last major things Streeter did before going into private practice. Gupta’s lawyer, Gary Naftalis, a former assistant U.S. Attorney in Manhattan and longtime white-collar attorney, proclaimed his client’s innocence. Rather than antagonize the prosecution, he immediately reached out to his adversaries and promised a professional fight.

  Gupta wasn’t without his friends in high places, and they could, Naftalis promised, all testify to his unblemished record in the private sector and his substantial charitable acts during his long career, he told prosecutors. Unlike Rajaratnam, his client wasn’t obsessed with making money. He received not a dime from Rajaratnam no matter how much talking they did. Gupta was a good man, and juries generally like good people.

  By now the government team was touting Gupta as a bigger get than even Rajaratnam, who was a mere trader compared to one of the most prominent businessmen in the world. They would show that good people sometimes do bad things, and that juries don’t take too kindly to Wall Street crooks no matter how much moral support they can get from UN chiefs or prominent businesspeople.

  Gupta’s trial was set for early 2012, and based on the government’s record, the odds of a conviction were high. On Wall Street the question wasn’t conviction—that was largely a foregone conclusion. The betting involved whether Gupta would serve jail time (and how much), or whether the judge would show leniency to someone whose profit motive in sharing inside tips was having friends in high places rather than earning direct returns from his illegal activities.

  Meanwhile, the investigation was taking a much-needed break from its frenetic pace. Most of the bad guys from Perfect Hedge had been rounded up. The few who hadn’t wouldn’t make big headlines. The expert network business had been put on notice while Primary Global was shut down as its clients in the hedge fund business began to cut ties with dozens of experts under investigation.

  And with good reason: Several, such as Tony Longoria and Walter Shimoon, were cooperating with the government to avoid jail time and to implicate others. The independent analysts who used the experts and their access to inside information, such as John Kinnucan, were just waiting for their arrest.

  But that doesn’t mean the investigation came to a halt, particularly when it came to SAC and Cohen.

  “The way I understand the rules on trading on inside information, it’s very vague,” Cohen explained one afternoon in early 2011 during a deposition taken not by any one of the federal agencies now investigating his activities, but by lawyers for a public company that believed he had broken the law.

  Cohen was dressed uncharacteristically for him; gone were his trademark khakis and sweater. Today he was dressed in a dark suit and tie. He sat uncomfortably in the offices of his longtime outside counsel, Willkie Farr & Gallagher, flanked by his attorney Martin Klotz as the grilling began.

  The deposition involved a case brought against SAC by an insurance company named Fairfax Financial Holdings. The lawsuit, filed in New Jersey Supreme Court, alleged that SAC conspired with the other hedge funds to drive shares of Fairfax down through rumors and other types of market manipulation to profit off a massive short position on Fairfax stock.

  The details of the case were almost a second thought for officials at the SEC and the other regulatory agencies involved in the insider trading probe. They had already decided to drop an inquiry into Fairfax’s claims, and in a few months a judge would dismiss the lawsuit against SAC altogether.

  But what became must-reading among the government sleuths eyeing SAC and Cohen was his deposition and the parts where the SAC chief described his own belief system about what is or isn’t a dirty trade.

  In Cohen’s mind, it seemed insider trading is a lot like pornography: You know it when you see it.

  The questioning was being done by attorney Michael Bowe of the Manhattan law firm Kasowitz, Benson, Torres & Friedman. Bowe and the rest of the firm had by now made a small fortune representing companies that had a beef with SAC, namely Biovail and Fairfax. He and a PR handler named Michael Sitrick were behind the unflattering 60 Minutes portrayal of Cohen.

  Now they were ready for round two. Bowe knew of the feds’ long-standing interest in SAC and had met with both government cooperators and with B. J. Kang at the FBI to share what he had found in discovery. The case being alleged by Fairfax didn’t involve insider trading per se. But the company was ready to argue it was all part of a business model that makes money by playing dirty.

  Bowe interviewed a number of people with knowledge of SAC’s operations including Jonathan Hollander. Aside from their largely uniform description of how SAC was run like a money-making machine, with Cohen calling the shots either directly or through a few trusted people, what struck Bowe was how in awe they were of “Mr. SAC.” He was described in almost superhuman terms as a man who knew everything, and could do just about everything. Bowe had never met Cohen, but as the two shook hands just before the deposition began, he was completely underwhelmed at least by his physical appearance: The bald head, the glasses, and the pudgy physique hardly equated with his reputation as a master of the universe.

  Bowe began the deposition by trying to rattle Cohen, calling him “Stevie,” which prompted an angry outburst by Klotz, who called Bowie’s choice of words an “obnoxious, deliberate use of Stevie in addressing Mr. Cohen.” Bowe said it was a “mistake” before moving on to the heart of the case: SAC’s alleged manipulation of Fairfax stock.

  Bowe had reviewed SAC’s marketing material, boasting of the alleged SAC “edge” it has in the markets. SAC describes this edge in company marketing documents as the sum total of its ability to find talented traders, analysts, and portfolio managers to cover various industries, execute different trading strategies, and leverage its research.

  The marketing materials also didn’t hide the fact that SAC’s advantage is derived at least in part because the hedge fund is a “major commission generator” for Wall Street firms. As a result, it receives “priority treatment” from Wall Street. Being everyone’s biggest customer has its advantages in terms of market knowledge and insight.

  But regulators increasingly believed the edge also involved the use of inside tips to profit—and Bowe wasted little time pressing Cohen on what turned out to be a sore subject. “I hate that word,” Cohen explained, even as his spokesman conceded that he approved the use of the word for SAC’s promotional brochures. (The word edge, I’m told, no longer appears in such material.) Bowe pressed the obvious hot-button question, namely what does having an “edge” really mean. Does it mean SAC knows “something everyone else doesn’t”?

  “You know, I think that’s an over—I think that’s an incorrect characterization of the word.”

  In Cohen’s mind, at least during the deposition, having an edge is far less nefarious. It simply means “somebody believes that in a particular situation. . . that somehow their expectations are different than either investors’ expectations or Wall Street’s expectations.”

  For the remainder of the three-hour deposition Cohen appeared more annoyed than rattled, that is, until he explained that he wasn’t all that familiar with something every SAC employee is supposed to be familiar with: his firm’s own compliance manual and what it says about insider trading.

  “The answer is when you’re trading securities, it’s a judgment call,” Cohen explained, adding that “whatever the compliance manual says, it probably doesn’t take into account every—every potential situation.”

  Bowe, sensing an opening, pressed Cohen even further, and Cohen’s answers became more convoluted—and potentially more problematic. He said that while he had read the firm’s compliance manual, which strictly forbids insider trading, he didn’t “remember exactly what it says.”

  He explained correctly that there are times that legal trades can be made based on nonpublic information�
��and that he leans on his legal staff, not his compliance manual, for the final say. In Cohen’s view there are “circumstances” where utilizing information that some might consider confidential is perfectly legal, which is true given the murky nature of the insider trading rules.

  Cohen, who never went to law school, said one such instance occurs “where if you believe that even if you were trading on the same side as a—as a recommendation, if you felt or if you knew that would have no impact on the stock, then I can theoretically suggest that trading on that stock, even—while I might refrain from trading on that stock, if you believe that would have no impact on the stock, that therefore, I—theoretically, you might be able to trade on that stock if you knew that was coming out.”

  At bottom, he said that his understanding of “the rules on trading on inside information, it’s very vague.”

  It’s unclear if Cohen knew how his convoluted definition fit with what was being professed by the SEC or Justice Department or the FBI, where the use of any nonpublic information was at the very least something that might touch off alarm bells with the government.

  But the feds obviously picked up on the difference. The SEC subpoenaed the deposition as part of its ongoing investigation into trading at the hedge fund, and Bowe shared it with just about anyone else interested in SAC. Simultaneously, Senator Grassley was back on the insider trading trail, this time demanding an accounting as to how many referrals Funkhouser at FINRA had made to the SEC about suspicious trades, and how many were acted upon.

  The message to the SEC was direct: Get moving on an SAC case or be ready for more bad publicity. And the message was received. The SEC started to look deeper at nearly 100 SAC trades flagged by FINRA as suspicious. Investigators turned up the heat on Cohen as well. Within a year after Grassley began making noise about SAC, the commission decided to find out exactly what Cohen knew about some of the trades. For the first time in more than two decades, he was deposed.