For some reason the prosecution by the U.S. Attorney for the Southern District of New York, Preet Bharara, of the S.A.C. Capital hedge fund group of companies isn’t getting the attention it deserves from financial firms.
It should – it’s an extremely important case for numerous reasons, not the least of which is the fact that if it proceeds to trial, the battle will be over the simple but often elusive concept of the adequacy of a compliance regime for financial institutions (banks, brokers, custodians and funds), and the extent to which a CEO must supervise the compliance function. Wall Street and indeed, Bay Street, should be paying close attention to that.
There isn’t just 1 case against SAC – there are several so the penalties paid to the DOJ will be huge
There are several prosecutions and actions underway against SAC, not just one. And several ongoing or settled against employees or former employees of SAC.
The main action is a criminal complaint against the four SAC entities that manage the hedge fund, namely Sigma Capital Management, LLC, S.A.C. Capital Advisors, L.P., S.A.C. Capital Advisors LLC, and CR Intrinsic Investors, LLC (collectively, “SAC“). They are charged with securities fraud and wire fraud for the trading of shares based on material undisclosed information.
The second is a civil forfeiture action involving money laundering in which the DOJ is seeking the forfeiture of an unidentified sum of money and of corporate assets located in the U.S. and in places know as tax havens, as proceeds of crime. Pursuant to that complaint, SAC allegedly laundered money by co-mingling illegal profits from insider trading with other assets, using those profits to promote additional insider trading and pay bonuses.
The are also several more indictments of employees of SAC charged with insider trading making their way through the system, or that have settled.
Penalties, fines, settlements, disgorgements and forfeiture amounts, as the case may be, will be huge, including from SAC employees for huge bonuses paid to them that are alleged to be partially proceeds of crime. SAC has already paid the SEC a record US$616 million to settle two civil insider trading lawsuits. As with the Rothstein case, prosecutors will likely pursue the return of employee bonuses, regardless of the outcome of the SAC case.
The corporate entity, the hedge fund, has been criminally indicted & DOJ says this case is meant to “get your attention” if you’re a CEO
What is also different about this prosecution is that the corporate entity, the hedge fund, has been indicted criminally. And while criminal prosecution of a corporate entity may prove fruitless in terms of the ultimate deterrence (i.e., prison), such a prosecution may spell the demise of SAC. It did for Arthur Anderson, the last corporate entity to be criminally indicted in the U.S.
But there is another reason why the corporate entities were indicted – the U.S. Attorney is using this case to get the attention of other firms with apparent regulatory compliance issues – he has said as much – that firms will reap what they sow and he also said this: “To all those who run companies, and value their enterprises but pay attention only to the money their employees make and not how they make it, today’s indictment hopefully gets your attention.”
The reference to valuing the enterprise is a cue to CEOs of financial institutions on the business risks of not having an adequate compliance regime, namely civil forfeiture of corporate assets and huge penalties. It’s also a reminder of the perils of failing to comprehend the implications of money laundering law, which ironically is required to be part of the compliance regime for financial institutions.
A number of defendants have already caved
At least 10 current or former SAC employees have been tied to allegations of insider trading while working at the hedge fund. Several of them have pled guilty or admitted wrongdoing in connection with the SAC case including Noah Freeman who pled guilty to conspiracy and insider trading in connection with trades of several companies such as Research in Motion; Jon Horvath who pled guilty to conspiracy and securities fraud for insider trading for mining a network of people for the information and passing the information along for trade; and Wesley Wang who pled guilty to conspiracy to commit securities fraud for passing illegal tips about QLogic, Cirrus eBay and Cisco.
Then there is Richard Lee, a US$1.25 billion portfolio manager at SAC, who pled guilty to conspiracy to commit securities fraud and wire fraud for trades made based on insider information he provided while employed at SAC. He was hired by SAC despite reservations expressed by SAC’s legal counsel over his reputation for insider trading at a previous firm.
Two others, Matthew Martoma and Michael Steinberg, have been charged and both have pleaded not guilty.
Martoma was given a bonus of US$9.3 million one year, allegedly derived from illegal trades. Martoma is likely being advised by counsel to settle – the reality is that judges and juries are judgmental – in fact that’s their function – and, regardless of the facts, human nature being what it is, they will have difficulty being sympathetic to a trader who earned a US$9.3 million bonus in one year. Martoma faces another problem too – because he allegedly made so much money, if he is convicted, his prison sentence under U.S. law will be stiffer because it’s tied to the amount of illegal profits garnered.
The civil forfeiture of SAC and the allegation of money laundering is problematic
The civil forfeiture case is against all the SAC corporate entities (there are over 25 of them) incorporated in the U.S., and in places like the Cayman Islands and Anguilla, who are alleged to have been used as corporate vehicles for money laundering. It’s an in rem and in personam claim.
According to the complaint, profits from the illegal trades were allegedly paid to employees as bonuses through financial institutions (hence the laundering of funds if true) and were co-mingled with clean money and reinvested.
Under the U.S. money laundering statute, a person commits a crime if he (or it) attempts to conduct or does conduct, a financial transaction involving the proceeds of unlawful activity, and any property involved in that transaction may be forfeited to the government. The unlawful activity in this case is the alleged securities fraud and wire fraud. It is also a crime to engage in a monetary transaction with criminally derived property of value over $10,000. There does not need to be a conviction in the criminal case against SAC for the assets to be forfeited to the government and as a result, the DOJ will likely get at least some part of the assets by civil forfeiture, or by settlement of the claim.
The sting of a money laundering complaint is often insurmountable for financial institutions who are expected to be at the forefront of anti-money laundering compliance. Switzerland’s oldest bank, Wegelin Ltd., was similarly the subject of a civil money laundering forfeiture complaint in the U.S. this year. It shut down after 272 years of operation after clients fled when news of the U.S. action against it emerged.
It’s the first criminal indictment against a firm purely as a result of alleged regulatory compliance failures
The case against SAC is really one of compliance and if it proceeds to trial, the battle will be won or lost on the issue of whether or not SAC’s regulatory compliance regime was adequate. And that has implications for financial institutions globally, including banks, brokers, custodians and funds, including foreign mutual funds, funds of funds, exchange-traded funds, private equity and venture capital funds, other managed funds, commodity pools and hedge funds. They all grapple with that issue constantly.
According to the U.S. Attorney General, SAC’s compliance system ‘talked the talk’ of compliance but almost never ‘walked the walk’, hence the criminal indictment against the firm for wire and securities fraud. The criminal compliant alleges, in fact, that SAC suffered from systemic compliance failure. The FBI, which undertook the investigation in the SAC file, has said that SAC’s regulatory compliance was “woefully inadequate.”
Allegedly, the compliance people at SAC never undertook any real compliance – they are alleged to have ignored red flags or other warnings associated with numerous trades; failed to have reviewed electronic communications by SAC employees when they contained suspicious trading terms; failed to have detected any insider trading by the indicted or charged employees; and on the one occasion when they became aware of suspected insider trading, they allegedly failed to report it to authorities.
Attorneys for Stephen Cohen prepared and published what they term a “white paper” in which they address the regulatory compliance efforts of SAC.
According to the white paper, SAC paid “tens of millions of dollars” for the preparation of a compliance plan and not only did it install surveillance systems for compliance, it routinely undertook reviews of emails, texts and other communications by traders to monitor for compliance. And moreover, there was, according to the white paper, a strong culture of compliance at the hedge fund and if anything, SAC was more aggressive in implementing a compliance program than was the industry standard for Wall Street firms.
And so it seems that the case will ultimately come down to matters of regulatory compliance including the tricky issue of the extent to which CEOs of financial institutions have a responsibility to inculcate an organizational culture of compliance, and supervise institutional compliance efforts.
SAC has already lost billions of dollars in assets under management since the indictment two months ago. If the facts in the indictment prove to be accurate, the entire $14 billion fund may collapse over something as simple, but often overlooked, as adequate regulatory compliance.