Circle of Friends

by Charles Gasparino

  And the feds had a lot to work with, including numerous suspicious trades, multiple witnesses, and cooperators. A separate case involving suspicious trading in Dell and Nvidia shares was also taking shape. The case developed by agent David Makol began with low-level cooperators flipping on their supervisors at various hedge funds, including Level Global and Diamondback Capital. Before long, the trail led to a familiar place: SAC Capital and specifically to Jon Horvath, a former technology analyst who agreed to cooperate. Horvath then told the feds that whatever inside information he received, he shared with Michael Steinberg, one of the firm’s top money managers and himself a confidant of Cohen.

  The SAC bodies were now piling up. Steinberg had been waiting nervously for his status as an “unindicted co-conspirator” to change for the worse through a chunk of 2012 and well into 2013. He moved into a hotel room alone off and on so his wife and kids didn’t have to witness him being handcuffed and led off to jail. His lawyer, Barry Berke, offered to have his client turn himself in, but the request was denied. What Berke didn’t know was the behind-the-scenes drama between Bharara’s people and FBI agents, mainly Chaves, over how to handle the pending arrest and how to get the maximum publicity for it.

  A little more than a year earlier, lawyers for Anthony Chiasson offered the government the same deal, which was denied just before a team of FBI agents, accompanied by a camera crew, showed up one morning at Chiasson’s Manhattan apartment. One witness said the feds appeared to dramatize the scene. After the camera was in place, the FBI car sped around the block once more and came to a screeching halt. That’s when five agents in FBI windbreakers jumped out, entered the building, and accompanied the doorman to Chiasson’s apartment so they could lead the moneyman out in handcuffs in full view of the camera.

  There was just one problem: Chiasson had already moved to a hotel and when he got word that the FBI was looking for him, his attorney simply brought him to the government so he could be arrested, albeit privately.

  Fast forward about a year, and Bharara’s people didn’t think the shock-and-awe approach was necessary. Steinberg, after all, wasn’t a terrorist. FBI officials, apparently still stinging over the Chiasson flop, argued that there was a deterrent value in letting fat-cat traders know the consequences of their alleged crime, particularly those like Steinberg who were refusing to cooperate. In any event the FBI argued, agents do the arresting and they’ll do it as they see fit.

  With that, Steinberg’s wait came to an end early one Friday morning, just before the Easter weekend and during Passover, when FBI agents showed up at his Manhattan apartment and placed him under arrest for five counts of securities fraud involving insider trading. His wife and kids were out of town for the ensuing media circus. Yet another leak to the Wall Street Journal had allowed a reporter to show up and film the arrest on her iPhone. A few hours later, no longer handcuffed, Steinberg pleaded not guilty and was released on $3 million bail.

  He is regarded as the highest-ranking SAC employee to be snared during the inquiry, and immediately SAC’s public relations team at Sard Verbinnen began spinning the least harsh interpretation of the move, its impact on the fund and on Cohen himself. “Steinberg is not a top adviser to Cohen,” said Gasthalter, who described him as a long-time SAC portfolio manager, albeit a very good one.

  What Gasthalter couldn’t deny was Steinberg’s personal relationship with Cohen. They are close friends, and Cohen had in the past used him as a sounding board on trading strategies, which is why the feds are eager to cut a deal with Steinberg for information that could help build a case against the man at the top of the SAC food chain.

  Cohen’s legal team viewed the situation as difficult, but not disastrous. The government had a perfect record in trying cases. But legal experts quickly concluded that the one against Steinberg could be difficult. One of the defenses used by targets is that even if they traded on inside information they didn’t know it was inside information. In other words, they didn’t intentionally break the law.

  So far that defense hadn’t worked, but in Steinberg’s case it might. The insider tips Steinberg allegedly used were filtered through several different layers. They began with a hedge fund manager at a different shop, who passed along the information to Jon Horvath, the SAC analyst who passed the information to Steinberg, the government alleges. Even with Horvath’s cooperation, the government may face difficulties proving that Steinberg knew what he was trading on was inside information because whatever came his way was passed along through so many sources he could have plausibly believed it was public.

  Even before Steinberg’s arrest, Martoma had pleaded not guilty, and his lawyer Stillman vowed to fight the charges to the end. That was also good news for Cohen, legal experts said, since the circumstances surrounding the trades were now running up against the statute of limitations.

  And the feds still didn’t know exactly what had been said during that twenty-minute call between Cohen and Martoma. In fact, Martoma could have told Cohen plenty of stuff without revealing the source of his information. “Conviction levels” hardly make criminal insider trading cases, particularly when you’re going up against Steve Cohen.

  They’re going to pay a large fine like Goldman did and put this to rest,” Anthony Scaramucci began assuring his clients in early 2013. “And Steve is protected.”

  Scaramucci was one of Cohen’s closest friends on Wall Street, which is why he now called Cohen “Steve” instead of the more common “Stevie,” which Cohen’s wife and now Cohen himself had come to detest. He also ran a “fund of funds” with substantial holdings in SAC, and he wasn’t pulling out. For Scaramucci, staying with SAC was a no-brainer. The fund didn’t beat the 13 percent return in the S&P (one of the few years it didn’t beat the market), but after fees, Cohen still earned a respectable 12 percent return, which wasn’t bad considering his growing legal distractions.

  If only there were more people like Scaramucci, Cohen must have thought, as his troops began to dial for dollars and beg investors to give them another chance. If the history of these investigations were any guide, investors would soon be running for the exits with their money in hand—or, in hedge fund speak, “redeeming their shares.” But SAC held a better hand than most; so much of the fund’s assets were made up of Cohen’s own money—now around $9 billion out of the $14 billion SAC managed. Even if all the money from outside investors were redeemed, Cohen would still be trading one of the largest portfolios in the world.

  SAC, of course, wasn’t just any hedge fund. Its investor base was incredibly loyal after having dined on Cohen’s massive returns for so long. But the reality of the hedge fund business is that law trumps loyalty. SAC manages a significant amount of money from pension funds, which under charter cannot be associated with an outfit under regulatory scrutiny. Money supplied by so-called funds of funds—hedge funds that invest in other hedge funds—was perhaps more stable, but some of that would certainly flee as well because it was just easier to simply pull the money out than to take the risk that the feds would close SAC and lock away its assets. Big banks like Citigroup and private equity firms like Blackstone would face similar choices as they weighed an uncertain future.

  That is why Scaramucci’s support was so vital. It was one thing for Cohen’s own people to assure clients that all is well inside SAC. It was something else for someone outside SAC to do it.

  The Goldman-like fine was a reference to the $550 million that the Wall Street firm paid the SEC to settle charges that it failed to disclose the risk in several pools of bonds it sold to its clients at the time of the financial crisis. But more than that, it was a talking point among Wall Street lawyers for the best way to handle a crummy situation. The settlement sounded like a lot, which made the feds sound like they were punishing the evil Wall Streeters—that is, until you consider it was being paid by a multibillion-dollar, deep-pocketed company that just wanted the bad publicity of the case to go away. That’s exactly what happened, as shares of Goldman Sa
chs surged after announcing the settlement.

  Indeed, Scaramucci’s predictions proved amazingly accurate. SAC never bothered to respond to the Wells Notice from the SEC, a move that would have delayed the proceedings for months. It just decided to settle the case, offering to pay a Goldman-like penalty that ultimately came to $616 million. The SEC took its victory lap, as was expected, hawking the deal as the “largest insider trading settlement ever.” (Michael Milken paid $1.1 billion back in 1991, but that was to settle both civil and criminal charges over a multitude of securities fraud charges that ended up not including insider trading.)

  “Happy, relieved, excited about the future” was how one investor described the mood inside SAC. Even if he had to pay the settlement from his pocket, Cohen was still left with his $9 billion net worth largely intact. He appeared to celebrate days later, according to the New York Post, by shelling out $155 million to purchase Picasso’s Le Rêve from another billionaire “Stevie”—casino mogul Steve Wynn—and purchasing waterfront property in the Hamptons for $60 million. The general feeling among key clients like Blackstone was relief as well; if the SEC had a case against Cohen they would have brought it. The firm’s PR flacks told reporters that the “settlement is a substantial step toward resolving all outstanding regulatory matters and allows the firm to move forward with confidence.” The redemptions did come in February, but at $1.7 billion it was far less than what was feared, even if another redemption date looms as this book goes to press.

  While SAC traders exhaled, government investigators went back to building a case against Cohen, beginning with an unusual statement that, despite the settlement, Cohen remained a suspect. That warning shot came from George Canellos, now the acting head of the SEC’s enforcement division after having taken over for Robert Khuzami. During a briefing with reporters, Canellos said the settlement wouldn’t “preclude the future filing of additional charges against any person, including Steve Cohen, who is not named as a defendant in these cases.”

  It’s difficult to recall a similar instance of an SEC official referring to a suspect by name. Still, as this book goes to press, government investigators continue to press Martoma into agreeing to cooperate against his old boss. One reason they are confident about Martoma as a potential witness against Cohen is the timing of their telephone conversation about the drug-stock sales in question. It occurred in 2008, before news of the wiretaps had been disclosed, when traders talked more freely on the phone about why they were buying and selling stocks.

  With “each and every day that he doesn’t cooperate, that’s got to be a good day for Steve Cohen,” one former prosecutor involved in the investigation said, referring to the statute of limitations that runs out in the summer. And, the theory goes, without Martoma cooperating the government has relatively little on Cohen beyond hearsay from emails and Martoma’s self-professed level-nine conviction.

  All of that sounds good if you’re a Steve Cohen fan (or Cohen himself), until you consider the following: Prosecutors generally don’t walk away from cases (unless of course you run a bank that is “too big to fail”). Eric Holder, the attorney general of the United States summed up the double standard during testimony in early 2013. “I am concerned that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if you do prosecute, if you do bring a criminal charge, it will have a negative impact on the national economy, perhaps even the world economy, and I think that is a function of the fact that some of these institutions have become too large.”

  Holder’s remarks, of course, underscored the irony of Perfect Hedge and the entire insider trading crackdown: For all the hard work of people like Wadhwa, Kang, Makol, Chaves, and their supervisors, the country remains somewhat unimpressed that the government went wild on insider trading while the banking fat cats—who took such outrageous risks that they brought the global financial system to its knees—continue to walk around free. Average people don’t like insider trading, but many of these same average people believe it is beside the point. Holder was merely providing an awkward rationale for why the government seemed neutered when it came to busting the crime that brought down the U.S. financial system as opposed to the one that may have made some hedge fund traders a bit richer.

  Holder would have probably done better to say nothing so as not to further demoralize the investing public. Even as the Dow cruised to new record highs, small investors remained wary. They certainly don’t feel it’s safer to invest because Raj Rajaratnam is in jail and Steve Cohen may be next. The best evidence for this is the fact that investor money still remains largely on the sidelines of the stock market, tucked away in gold or bonds, which eke out minuscule returns. To be sure, some investors are jumping back into the market, but only because they feel they’re missing out on the party. Talk to financial advisers and they’ll tell you that their clients have bigger concerns than SAC’s market edge. Flash crashes, the botched Facebook IPO, and the belief the Fed has artificially inflated the market has scared many retail investors out of stocks.

  But that has hardly deterred our insider-trading police from their mission. Cohen’s spending spree on expensive art and the Hamptons home didn’t go unnoticed by the feds, even if the purchases were in the works for a while, as Cohen’s PR handlers say they were. Still, news of the sale suffered from very poor timing. It came as SAC was looking for a deal to end all the investigations through a settlement with Bharara’s Manhattan US Attorney’s office—a deal that would have “deferred” the prosecution of Cohen, possibly shuttered SAC in its current form, but allowed Cohen to restart the hedge fund at some later date.

  When Scaramucci heard about the possible deal, he was ecstatic, remarking, “I’ll even help Steve raise money.”

  The deal fell apart, and not just because the artwork purchase irked prosecutors. Bharara believes there is at least one major insider-trading case left, and all signs point to that case being SAC and Cohen. In May, it was learned that the US attorney’s office sent grand jury subpoenas to SAC officials, including Cohen, over the trades under scrutiny. Legal experts say Cohen is likely to exercise his Fifth Amendment right against self-incrimination to avoid the perjury trap that snared Martha Stewart. His lawyers have told clients that the hedge fund, which has continuously stated it was cooperating “fully” with any and all investigations, will no longer do so on an “unconditional” basis.

  SAC would not comment on the meaning of the announcement, released on a Friday afternoon in late May. But legal experts say it’s another indication of the ever increasing government scrutiny and that Cohen’s lawyers are taking steps to protect their man.

  The high-stakes chess game doesn’t end there. Bharara may have bristled at being compared with Rudy Giuliani when it comes to publicity seeking, but he isn’t above using Giuliani’s law enforcement tactics. In the late 1980s, Giuliani indicted the former junk bond king Michael Milken for securities fraud under the Racketeering Influence and Corrupt Organizations law, also known as RICO.

  One drawback to RICO is that prosecutors need to prove an ongoing multiyear conspiracy, and they need a sign-off from the Justice Department in Washington, presumably directly from Holder, to launch such a case. But the law is also among the most powerful weapons the government has in prosecuting criminal enterprises such as the Mafia and occasionally those that occur in the financial business, which is why in the spring of 2012, Bharara’s office began weighing a RICO case against SAC and possibly against Cohen.

  The major benefit to RICO is that there are ways around the five-year statute of limitations that prosecutors face in the Martoma-related charges. Another advantage is the enormous pressure RICO exerts on targets to settle. The penalties are so onerous (large fines, and as much as twenty years in jail per offense) that suspects end up cutting a deal with prosecutors rather than taking a chance in court. In Milken’s deal, he served twenty-two months in jail, agreed to pay the federal govern
ment more than $1 billion, and was barred from the securities industry for life.

  The government may be angling for a similar outcome for Cohen, legal experts say. Columbia University Law School professor John Coffee, one of the foremost experts on white-collar crimes, believes the government and Cohen’s lawyers have begun bargaining on a deal already, with the deferred prosecution agreement and the gesture to close SAC being just the opening salvo in the negotiations.

  Bharara’s hunt for more insider-trading targets, meanwhile, comes as he’s also thinking of leaving the office and has discussed ballpark figures with people about what his salary might be in the private sector. Wadhwa has also signaled that he might move to a private sector job, yet another indication that catching alleged bad guys often leads to a lucrative career defending them in the future.

  If Wadhwa leaves, there will be more than a few people looking to take his place to work on remaining cases, including the biggest prize of them all—the ongoing scrutiny of SAC and Steve Cohen. And if the government does finally get their man (Cohen, through a spokesman, continues to maintain his innocence), they won’t have to worry about the global economic ramifications as they would if, say, Citigroup, with its massive worldwide balance sheet, came under similar scrutiny.

  The problem for people like Steve Cohen is simple: even if he did nothing wrong, there is no such thing as a too-big-to-fail rule in the hedge fund business. An indictment of Cohen would likely lead to the liquidation of SAC. If SAC were forced out of business, it might mean lower profits for the firm’s trading partners on Wall Street, and many unhappy investors. But in the eyes of the federal government, the nation would survive, just like it did back in the early 1990s when Milken was sent to jail and Drexel Burnham Lambert, the firm he’d built into a powerhouse, was shuttered.

  All of this is probably why the federal government’s obsession with the white whale of Stamford continues. We don’t know if Moby-Dick will swim away, harpoons jutting from his skin but otherwise unharmed, or if the government will finally bring him to shore. One possible bad omen for Cohen: In early April, Martoma abruptly changed lawyers, firing Stillman and hiring a corporate law firm out of Boston, a sign he may now be willing to cooperate.