NEW YORK (Reuters) - Until recently, having an “edge” was a coveted trait on Wall Street. After the federal indictment on Thursday of billionaire investor Steven A. Cohen’s hedge fund for insider trading, it is becoming a four-letter word.
In painting a picture of a cutthroat culture at SAC Capital Advisors LP, U.S. prosecutors used the word “edge” 14 times to describe the way traders and analysts allegedly went to great lengths to obtain inside information and insights that no one else on Wall Street had about publicly traded companies.
In one particularly rueful battle between competing portfolio managers at SAC, the indictment talks about two underperformers jealously questioning whether a third really had the “black edge” - parlance for inside information.
The Department of Justice’s rare move to indict an entire organization instead of a few individuals could sound the death knell for one of Wall Street’s most successful hedge funds and end Cohen’s career of managing outside money.
But other fund managers and a Wall Street historian said it could have far-reaching effects beyond SAC, and may change how hedge funds do business forever — especially funds that rely on getting an information to buy and sell stocks.
“This truly is the end of an era in that the days where a manager could say ‘give me your money and trust me’ are gone,” said Peter Rup, chief investment officer at Aretmis Wealth Advisors.
Charles Geisst, a financial historian and professor at Manhattan College, said the indictment was “a very big deal, as big as Arthur Andersen or Drexel,” referring to the accounting firm and the investment bank that went out of business after being indicted.
“This is going to be a nail in the coffin of hedge funds, whose glittery, glossy reputation is starting to slowly erode,” Geisst said. “Hedge fund guys were viewed as smarter than everyone else, but now it doesn’t seem like they were performing smarter analysis; it seems like they were just getting access to inside information.”
SAC Capital has not been convicted of a crime and denies any wrongdoing. Cohen may yet be able to stay in business because more than $8 billion of the fund’s roughly $15 billion of assets belong to him and his employees.
Cohen is also no doubt counting on his employees, who are known to be fiercely loyal, to stick with him. Even now, Wall Street headhunters say they aren’t seeing a flood of resumes from SAC Capital traders and analysts.
In a statement on Thursday, the firm said it “has never encouraged, promoted or tolerated insider trading and takes its compliance and management obligations seriously.” It added that the individual employees who admitted to wrongdoing are not representative of the firm as a whole.
In marketing materials, SAC Capital has described its information edge as being a totally lawful one and the by-product of the so-called mosaic theory of investing, which involves gathering information from multiple sources to build an investment thesis.
However, just how Cohen, who launched SAC Capital in 1992 with just $25 million, managed to generate some of the best returns in the $2.2 trillion industry always has remained a bit of a mystery. Over its history, the firm has provided investors a 25 percent return on average annually, even after charging some of the industry’s highest fees.
The mosaic theory of stock-picking is becoming something of a relic, with computer-driven quantitative trading replacing the need for knowing whether a company’s earnings will be worse or better than expected or whether it would be taken over. The use of industry consultants to gather bits of information to build an investment thesis has also fallen into disgrace with prosecution of traders who used so-called expert networks to build investment theses.
“I hardly know Stevie Cohen, but he was a great money manager for a long time. How he did it, I really don’t know,” said hedge fund pioneer Michael Steinhardt on Wednesday, as word of the imminent indictment of SAC Capital was spreading across Wall Street.
Cohen has said he is no fan of the term “edge.” In a 2011 deposition related to a separate lawsuit by a Canadian insurer, Cohen said, “I hate that word” when an opposing lawyer asked him whether it was used at SAC to describe having an advantage over other investors.
Yet, prosecutors said employees were hired for their network of contacts and then expected to come up with million-dollar trading ideas in stocks. Compliance and legal worries were often ignored, they said.
SAC’s computer and phone systems had designated inboxes and voicemails set up for traders to deliver their edgiest ideas, prosecutors said. Cohen also held ”semi-regular“ Sunday evening calls and in-person conversations” with traders to hear their best trading ideas.
Some examples cited by prosecutors: an SAC job candidate who shared a house in the Hamptons with the chief financial officer of a large publicly traded industrial company; a portfolio manager who allegedly traded on inside information he said he had received from “a friend of my cousin” who worked in the finance department of Dell Inc; and an analyst who had a “buddy” who happened to be a “senior guy at Microsoft.”
Representatives for Dell and Microsoft Corp did not immediately comment on the indictment.
Howard Ross, a financial recruiter with BOC Staffing Solutions, said the scandal has changed what job candidates have to highlight in their resumes.
In the indictment, prosecutors alleged that SAC’s due diligence reports on candidates had no reference “to ethics, integrity, compliance.” On one occasion, SAC even hired a candidate despite his reputation for insider trading.
Ross said, “Compliance, regulatory controls and risk - those are the three hottest areas that we’re dealing with these days.”
“There’s definitely been a huge shift because managers are now accountable not just for the bottom line but for making sure they’re running cleaner, safer operations,” he said.
Additional reporting by Katya Wachtel and Jennifer Ablan in New York and Svea Herbst-Bayliss in Boston; editing by Paritosh Bansal and Richard Chang