November 28, 2012 / 9:07 PM / 5 years ago

SEC's written warning to SAC Capital means legal action soon

NEW YORK (Reuters) - It could be weeks, maybe months, before U.S. securities regulators move on their threat of filing civil fraud charges against Steven A. Cohen’s SAC Capital Advisors.

The $14 billion hedge fund now faces a period of meetings with SEC lawyers that could stretch on for some time, said lawyers familiar with the process.

At the end, SAC Capital could be dealing with a number of legal problems, the most serious of which would be insider trading allegations in civil court.

Cohen and SAC President Tom Conheeney told investors on a call on Wednesday that the SEC had sent the hedge fund a written warning, known as a Wells notice, according to two sources who listened to the call.

Wells notices describe the specific rule violations the SEC is planning to cite if it takes action. This gives target of an investigation a chance to respond with arguments or evidence that could affect the SEC’s decision about whether or not to act.

The announcement by the hedge fund came a week after the SEC and federal prosecutors charged a former portfolio manager at an SAC affiliate with operating a $276 million insider trading scheme.

“It suggests that the SEC has something more,” said Stephen Plotnick, litigation partner at Carter Ledyard & Milburn in New York.

The SEC and federal prosecutors accused Mathew Martoma, who worked at SAC’s CR Intrinsic unit, with selling shares in two drug companies based on information he obtained from Sidney Gilman, a doctor involved in a clinical trial for a drug the two companies were developing.

Both the criminal and civil complaints against Martoma describe a person who, though unnamed in either complaint, is widely understood by those following the case to be Cohen himself, personally signing off on trades in the stocks of drugmakers Elan and Wyeth, now owned by Pfizer.

“The missing link has been the connection between the discussions Martoma had with Gilman and Cohen knowing that that is where Martoma obtained the information,” Plotnick said.

“That’s really key to bringing any kind of insider trading charges against Cohen or SAC. So if that’s the direction that this is going in, it could be something like that — that they do have some sort of linkage or believe they have some sort of linkage.”

Insider trading is not the only violation for which the SEC could bring action. If the agency can prove a breakdown in the internal controls at SAC that should have prevented insider trading from occurring, the hedge fund could also face fines and an order to fix its systems. Some legal experts think the SEC could accuse Cohen of “failure to supervise” under a provision in the Dodd-Frank act.

Legal experts say to expect more news about the case in the coming weeks.

“It’s a period of intense activity,” said Stephen Crimmins, a partner at K&L Gates in Washington.

“When we see a financial services entity getting a Wells notice, often what happens next is we see an announcement of a negotiated resolution where the entity consents to remedies that the staff felt it could obtain if it did actually litigate the case — often without the entity admitting or denying liability.”

Crimmins said entities like hedge funds find it easier to settle with the SEC than individuals do.

For years, Cohen’s firm has been dogged by allegations that it has relied on insider information to deliver an average annual return of 30 percent since it was founded in 1992. The charges against Martoma are the closest authorities have ever come to implicating Cohen himself in the illegal activity.

Martoma is not the first ex-SAC employee to be accused of insider trading; he is the fifth. A sixth SAC employee was implicated but has not been charged.

The investigation of potential insider trading at SAC has been so wide-ranging that it is far from certain the SEC’s Wells notice pertained specifically and exclusively to the Martoma case.

Cohen’s stature on Wall Street makes it more unlikely that the SEC will try to bring a minor action against him, one legal expert said.

“I tend to think that if they’re going to bring an enforcement action against SAC Capital and Steve Cohen that they’re going to try to find something more substantial than failure to supervise,” said Thomas Gorman, a partner at Dorsey & Whitney in Washington.

“If you’re going to take on a target like SAC Capital and Steven Cohen, you’re probably going to look for the insider trading charge.”

Reporting by Emily Flitter; Additional reporting by Svea Herbst-Bayliss and Katya Wachtel; Edited by Matthew Goldstein and Dan Grebler

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