Even after pleading guilty, fessing up to his crimes, and telling a judge “I’m sorry,” John Kinnucan received more than four years in a federal prison—one of the longer sentences given during Operation Perfect Hedge.
The government based its case against John Kinnucan not only on the facts found in the wiretaps, but also on the extremely low odds of someone betting right with such astounding frequency as Kinnucan appeared to have done. The government believes such odds are low unless you’re cheating, or, as David Makol told Kinnucan when they first met, “You know something is happening before it happens.”
Government investigators shared a similar disbelief over the legitimacy of some of the trading at SAC even as the fund’s legal team maintained it was all in a hard day’s work. The debate about where SAC got its famous “edge” was a daily one—between federal investigators and Cohen’s legal team, and among rival traders.
And it occurred even over practices that had nothing to do with insider trading, or any illegality for that matter, but underscored the firm’s ability to get an advantage over the competition. Such was the case in June 2010, when a drug company named Vivus went before an FDA panel that was ready to approve its new treatment for obesity, known as Qnexa.
Investment bankers packed into a room at the Hilton in Gaithersburg, Maryland, where the FDA advisory committee on endocrinologic and metabolic drugs met for an eight-hour session to decide whether to recommend approval of the weight-loss pill for public consumption. The market sentiment among traders was positive. In the days going into the event, shares of Vivus rose 32 percent to nearly $13 in anticipation that the panel would give the drug its blessing. During the day of the hearing, shares rose as well on what traders perceived to be positive comments from the panel.
SAC, however, was betting that the panel would reject the drug—and that it could profit handsomely. The firm had built up what people close to SAC say was a short position in shares of Vivus, meaning if the panel rejected the move and share price declined—as SAC believed it would—the fund would earn millions of dollars.
Did traders at SAC know something the market didn’t? Part of the reason for the broader Wall Street optimism was the favorable research on Qnexa. The FDA had compiled a packet of studies and data about the drug and distributed it to the advisory board members just before the vote. The research was for the most part positive, according to Wall Street executives, showing side effects in the normal range of what the FDA often allows for drugs it eventually approves. In the words of one investment banker who attended the meeting, the panel’s approval “seemed like a slam dunk.”
It didn’t turn out that way. Wall Street, of course, hates surprises, so when the panel issued a 10–6 vote against approving Qnexa, Vivus’s shares tanked 64 percent, to under $4 in the coming days. SAC, meanwhile, was counting its winnings—reportedly in the millions of dollars. The decision was widely covered in the media since anti-obesity drugs were becoming increasingly popular. The market impact alone made it a compelling story, with so much wealth being wiped out of the stock in a matter of days.
Cited among the reasons for the panel’s decision were lingering concerns among certain members of the panel that the combination of drugs used to create Qnexa showed incidences of heart disease, depression, and cleft lip, a form of birth defect. But that only tells part of the story, at least according to some bankers who followed the trading.
Norbert Gottesman had been a healthcare analyst at SAC for four years. He was an analyst for SAC’s CR Intrinsic unit specializing in pharmaceutical stocks, and in the past year he landed a position with broader responsibilities at the giant hedge fund. Gottesman was part of a new breed of SAC professional who had been making a mark inside the firm; analysts who, instead of reading the tape, spent their time crunching numbers and analyzing data. As Wall Street began to bet that Vivus would get approval to bring Qnexa to market, Gottesman saw other stuff in the data concerning the drug’s side effects. He hired an “expert” statistician from Gerson Lehrman Group, the network firm that specializes in healthcare-related issues, to help with his research. Based on some data he and his expert had discovered in the weeks leading up to the vote, Gottesman recommended to a portfolio manager in SAC’s healthcare group to begin shorting shares of Vivus.
It was a risky strategy—a “scary” one, was how one former SAC analyst with knowledge of the matter described the trade. But Gottesman appeared determined and confident. His numbers showed that the research the market was relying on understated the possible connection between Qnexa and birth defects. Based on his numbers, the incidence of cleft lip was significantly higher than most people realized. In fact, a recent updated study from the North American Antiepileptic Drug Pregnancy Registry shadowed his own analysis.
But it was unclear if the panel was up to speed on the new data. The packet of research distributed to the panel, for example, relied on a study conducted in winter 2009, which showed the occurrence of birth defects to be lower.
That was about to change. Early in the meeting, panelist Dr. Mary Roberts brought up the registry findings as part of her comments. Then, just before the committee’s final vote, Dr. Eric Coleman, the FDA’s deputy director of endocrine products, reminded the panel of Dr. Roberts’s comments about the registry study for “isolated cleft” and added that the information shows that the incidence of the birth defect was actually greater than it might appear.
“It’s just limited data,” Coleman said, “but there’s an odds ratio that you don’t generally ignore.”
And it wasn’t ignored, at least according to bankers who attended the hearing and saw firsthand the surprise results as the panel voted against the drug’s approval, and watched shares of Vivus get crushed with it. Such advisory votes are also nonbinding, meaning the FDA can ignore their outcomes, though that is rare. Moreover, there were several reasons cited by panelists for their no vote. Indeed, FDA panels rejected at least two other similar drugs around the same time.
But Coleman’s comments certainly stood out to bankers in the room. “They came out of left field,” said one banker who worked with the company. “And why was he alerting people to what he described as ‘limited data’? It made no sense.”
For the company’s financiers on Wall Street, and many small investors who owned the stock, the 2010 outcome was heartbreaking. But it was a cause of celebration at SAC. Speculation swirled that SAC had contacted the FDA before the vote—a perfectly legal action—on its way to victory.
An FDA spokeswoman says there was no communication with the firm and that both Coleman and Roberts brought up publicly available information. Meanwhile, the SAC edge had worked again, earning by one estimate tens of millions of dollars on the trade (the exact amount couldn’t be determined; an SAC spokesman wouldn’t comment on the matter). It would take two more years for the Vivus drug to receive final approval based on further data that showed the risk of birth defects to be less worrisome.
Investigators looking into the activities of SAC had come to believe that the fund’s “edge” came in several forms. For one, there was its ability to legally root out information overlooked by the market, as it did in the Vivus trade. There was also its organization of around one thousand employees (300 of them market professionals), who operated day in and day out like a machine, cranking out massive trades as well as investment ideas that were passed on to the man at the top of the pyramid, primarily through a series of buffers, that also shielded him from any impropriety below.
SAC’s vaunted “hub and spoke” trading model, where Cohen sat at the center of the information flow, was billed by SAC as the most creative way to maximize returns, with the world’s best trader weeding out bad ideas and trading off the good ones. To get a meeting with Cohen was a big event in any trader’s career. It meant the likelihood of a huge payday because, when Cohen used a strategy and it made money, he always shared the wealth. That’s why some traders would do almost anything—including possibly breaking
the law—to get in front of the big boss.
It also meant that Cohen had gained a certain level of comfort with that trader, which he didn’t necessarily have with most of the people on staff. That’s why flipping someone who was directly involved in insider trading and actually had direct dealings with Cohen became a key objective of government investigators as the investigations moved forward. So far most of the best witnesses were too removed: Jon Horvath and at times Noah Freeman, for example, dealt with Michael Steinberg, who was close to Cohen but not close enough for them to make a case against their ultimate target. Jonathan Hollander never spoke to Cohen directly at least about business. So the government’s strategy was to pick off someone with direct ties to Cohen—and pray he would flip.
In the summer of 2012, President Obama was locked in a tight race against his Republican challenger Mitt Romney, and the general feeling on trading desks across the banking sector was that a president who had made class warfare his campaign theme wasn’t above making a high-profile arrest of a fat-cat Wall Street figure. It would be done, at least according to the trading desk chatter, as an “October Surprise,” that is, something big enough to prove to a skeptical public that the Obama Justice Department was tough on Wall Street crime and coming close enough to election day to have an impact on the result.
The names most bandied about included Lloyd Blankfein, the CEO of Goldman and a favorite whipping boy of congressional investigators looking at financial crisis excess, and Dick Fuld, the former Lehman Brothers chief. But Blankfein ran a too-big-to-fail bank and had already outmaneuvered a Justice Department referral made by Senator Carl Levin over statements he had made during a hearing into Goldman’s behavior during the banking collapse. And for all the excesses of Lehman, the SEC labored to bring a case against Fuld, coming up with lots of smoke but little or no evidence of intent to break the law.
Another possibility: a high-profile arrest in an insider trading case that would garner fairly big headlines. The list of possibilities seemed endless given the success already achieved in convincing targets to cooperate and cough up other targets. Indeed, the FBI had even investigated a financial journalist for taking part in the scheme, a case that seemed to stall in fall 2012.
But investigators were aiming higher—much higher.
Back in 2008 and into 2009 as federal investigators were putting the finishing touches on their investigation of Raj Rajaratnam, Steve Cohen wasn’t just on their radar screens, he was also on their tape recorders. That significant development remained confidential until early 2012. According to the Fox Business Network, Kang and his colleagues had been listening to calls Cohen had made from his home telephone in an effort to expand the probe of insider trading to include Cohen and SAC. Again, it was hardly news at this point that the feds had a passing interest in SAC and its founder; what was news was the feds’ very direct interest in Cohen and its desire to do whatever it took to make a case.
Senior executives at SAC said they knew nothing about the matter and demanded that Fox clarify the report because it was still unclear whether the wiretap was placed on Cohen’s phone or whether an outside cooperator, with a listening device on his telephone, had called Cohen.
It was a crucial difference, Jonathan Gasthalter, the Sard Verbinnen flack who worked most directly for SAC, argued. A wiretap on an outside cooperator didn’t mean that the feds had gone to a judge and produced evidence of illegal behavior at SAC, a necessary step to get a court order for a listening device. If the feds merely taped a cooperator’s calls, Cohen certainly wasn’t the subject of the probe.
But before long, SAC received its clarification: Senior government officials with knowledge of the wiretaps said Cohen might be innocent, but he wasn’t a complete bystander. The FBI had received a court order to wiretap his telephone. The tapes were said to have produced relatively little that could be used to build a case against either Cohen or the fund he ran, but that hardly ended the government’s interest in Cohen.
SAC remained on edge, and friends said Cohen could feel the heat from the investigations growing around him.
Much was at stake, including billions of dollars of clients’ money that might be redeemed if Cohen did become an official suspect. Fearing massive redemptions, Sard Verbinnen worked overtime to build the impression that it was business as usual in Stamford. Cohen, ever the master chess player, began to increase his political giving, embracing Mitt Romney over Obama for president in 2012.
Cohen’s history of political giving (including the history of underlings at SAC) reflected a bias in favor of Democrats. But as usual Cohen was looking to gain an edge any way he could. With Romney in and Obama out, that would also mean walking papers for one of Cohen’s chief antagonists, the Southern District chief, Preet Bharara, as well as the appointment of a new SEC chairman, possibly one less inclined to make insider trading the crime of the century.
Cohen had made his political trade—and did so in a fairly public manner. At one point in 2012, dressed uncharacteristically in a suit and tie, he was spotted dining with New Jersey governor Chris Christie at the popular Manhattan restaurant Quality Meats. Christie was one of Romney’s top fund-raisers and a former prosecutor holding the functional equivalent of Bharara’s post in New Jersey. It’s unclear what was said during the conversation (neither would comment about it) but people in the restaurant say both men were engaged in intimate, quiet discussion over expensive steaks and at least one bottle of three-hundred-dollar Sassicaia wine.
Cohen’s political maneuvering didn’t end there, as the alleged recluse from SAC held a fund-raiser for Romney at his Greenwich estate, attempting to appear as if he had not a care in the world. Reality, however, was far different.
Something big is coming,” David Chaves told his colleagues one afternoon in the late summer of 2012. He just received the latest briefing about an upcoming case that had captivated both the SEC and the FBI for the past year, and would emerge as the government’s best chance yet to finally harpoon the elusive white whale of a trader from Stamford.
It was only fitting that the case began with the investigative work of Sanjay Wadhwa over at the SEC. By now Wadhwa had earned the distinction of being the only investigator who had been working on the insider trading crackdown since the beginning. The wiretaps might have been the sexy part of the Rajaratnam conviction, but if Wadhwa hadn’t done all that legwork beforehand—beginning with his investigation into Rengan Rajaratnam, and then following the paper and email trails to Raj Rajaratnam, Roomy Khan, and others—B. J. Kang would never have known to show up at Roomy Khan’s home in the first place. Without the probable cause evidence Wadhwa developed, there would be no wiretaps. Without Wadhwa, Galleon would still be making money illegally and Rajaratnam would be a free man. And his institutional knowledge was instrumental in cracking the next big phase of the investigation. Nearly from the beginning Wadhwa and his closest associate at the FBI, B. J. Kang, had smelled something bad at SAC Capital.
Some prosecutors in the Southern District have always had their doubts about making any case against Cohen—and whether, given the time and effort required, it was worth it. They compared Kang and Wadhwa to Ahab in Melville’s Moby-Dick, with Cohen playing the part of the elusive white whale as the government obsessively hunts down a target of dubious worth, at least from a legal standpoint.
Wadhwa had heard the Moby Dick analogy and bristled at the suggestion because so much about SAC appeared to add up to trouble. What struck both Wadhwa and Kang about Cohen and the firm he ran was the simple fact that so many of the major targets and cooperators had some SAC connection. Like Goldman Sachs, you would expect a big, successful firm like SAC to have alumni everywhere in the financial world. But where the SAC diaspora differed from Goldman’s was in the white-collar-crime department. Since 2007, Goldman has had its brushes with scandal, of course. But its alumni just weren’t found on the lists of targets or suspected targets of securities fraud to the degree that the names of SAC’s traders, both pa
st and present, kept cropping up over that relatively short period of time.
Even Raj Rajaratnam’s younger brother Rengan—the initial focus of Wadhwa’s insider trading probe back in 2007—had worked at SAC. His firm, Sedna, was long closed down and he largely dropped off the radar, though not completely. Like Raj, he too would be indicted some six years later in the spring of 2013, just before the statute of limitations ran out—the same statute of limitations that Kang and Wadhwa would soon be racing to beat in their pursuit of the white whale from Stamford.
In the spring of 2009, Sanjay Wadhwa had just spent another grueling day at the office when he received a message from Cameron Funkhouser at FINRA about yet another batch of suspicious trades from SAC Capital. Wadhwa and B. J. Kang were at this point in the final stages of their Galleon investigation that in a few months would lead to Rajaratnam’s arrest. The probe of SAC was considered a secondary matter in the grand scheme of things.
But Wadhwa has told people that Kang made an interesting, almost cryptic, statement to him at this time. Kang continued to probe SAC simultaneous to his work on Galleon. He planted a wiretap on Cohen’s home telephone and unsuccessfully tried to plant a cooperator in SAC’s ranks.
Through his research he came across something that led him to believe that investigators should look at a cluster of suspicious trades that occurred around the same time a year earlier.
Wadhwa had worked long enough with Kang to know to trust the agent’s instincts, so he ordered FINRA to send him some of its red-flagged trading data from SAC. One set stood out. It came via the New York Stock Exchange surveillance system, and it involved massive amounts of trading at SAC—in both long and short positions—in shares of Elan and Wyeth in 2007 and 2008. After further investigation, he saw similar trading patterns the year before. The buying occurred right before key events, such as successful drug trials—the selling just before setbacks caused shares to drop.
Circle of Friends Page 31
