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Hedge Funds

Institutions probably won’t lose investments in S.A.C.

Cohen promises full redemptions for firms

080513 martoma steinberg
Mathew Martoma, left, and Michael Steinberg will go to trial this year, charged with insider trading.

Institutional investors have survived another hedge fund blowup — this time S.A.C. Capital Advisors LP — with barely a bruise.

The Securities and Exchange Commission and U.S. Attorney Preetinder Singh “Preet” Bharara for the Southern District of New York have filed civil and criminal cases, respectively, stemming from their investigations - with the assistance of the FBI - of alleged insider trading by the S.A.C. complex of companies.

To date, six S.A.C. or affiliate company portfolio managers or research analysts have pleaded guilty to insider-trading charges. Portfolio managers Mathew Martoma and Michael Steinberg are scheduled to stand trial later this year on similar charges.

Even the smattering of institutional hedge funds-of-funds managers that until recently remained loyal to the high-octane hedge fund strategies of the secretive Stamford, Conn.-based firm hardly suffered a scratch.

Blackstone Alternative Asset Management, Lyxor Asset Management Inc., Ironwood Capital Management, Magnitude Capital LLC and Morgan Stanley (MS) Investment Management all expect to receive full redemption of investments in S.A.C. by the end of the year.

Executives at some of these firms said they have been answering a lot of questions about their investments from chief investment officers at institutional clients, but haven't lost clients.

Regardless of what comes next for S.A.C. and its iconic founder — majority owner, CEO and CIO Steven A. Cohen — sources said he soothed flaring tempers of external investors by not only agreeing to return all of their money, but also assuring them that S.A.C. would bear all fines and legal costs.

That S.A.C. would cover its costs, had liquid investments it could sell fairly easily and Mr. Cohen had so much of his own money invested reassured hedge funds-of-funds managers that their client assets could be easily accessed, sources said.

S.A.C.'s returns were always a huge draw for many institutional investors and their hedge funds-of-funds intermediaries, despite the unusually high fees — 3% management fee and 50% performance fee — Mr. Cohen charged.

“It's mystifying to me why any institutional investor or money manager would still be invested in S.A.C. after all the rumors that have been swirling around about Stevie Cohen for so long,” said Janet Tavakoli, president, Tavakoli Structured Finance Inc., Chicago, a derivatives and structured financial product consulting firm.

“But I guess that institutional investors are so desperate for performance that they — and their hedge funds-of-funds managers — stayed with S.A.C. because of the returns.”

The rumors of alleged insider trading at S.A.C. and affiliates were solidified into indictments and enforcement proceedings in 2012.

The start of 2013 was not a good time for S.A.C., and the rest of the year is shaping up to be even worse.

The SEC announced settlements on March 15 totaling $616 million by S.A.C. Capital Advisors and affiliates CR Intrinsic Partners LLC and Sigma Capital Management LLC over insider-trading charges. None of the parties admitted or denied the charges.

The settlements included disgorgement of $279 million of what the SEC termed “total illicit gains” in its complaint. Sources said that action precluded later attempts by federal authorities to claw back money from investors.

It wasn't until July 19 that Mr. Cohen himself was chargedwith failure to supervise Messrs. Martoma and Steinberg and stop them from insider trading within S.A.C.-affiliated hedge fund managers. Mr. Cohen faces potential financial penalties as well as disbarment from the financial services industry by the SEC.

Less than a week later, S.A.C. Capital Advisors and the three affiliates were indicted on criminal charges in connection with the alleged insider-trading scheme. A grand jury indictment unsealed in U.S. District Court in Manhattan on July 25 leveled four counts of securities fraud and one count of wire fraud against parent company S.A.C. Capital Advisors and affiliates S.A.C. Capital Advisors LLC, CR Intrinsic and Sigma.

The case, brought by Mr. Bharara, further alleged S.A.C.'s “institutional indifference” to the unlawful conduct of portfolio managers at the firm and its affiliates resulted in “insider trading that was substantial, pervasive and on a scale without known precedent in the hedge fund industry.” Mr. Bharara also seeks civil forfeiture of S.A.C.'s assets.

Maintaining its innocence

S.A.C. is maintaining its innocence. “S.A.C. has never encouraged, promoted or tolerated insider trading and takes its compliance and management obligations seriously,” said Jonathan Gasthalter, an S.A.C. spokesman, in an e-mailed response to a request for comment. “The handful of men who admit they broke the law does not reflect the honesty, integrity and character of the thousands of men and women who have worked at S.A.C. over the past 21 years. S.A.C. will continue to operate as we work through these matters.”

Mr. Cohen invoked the Fifth Amendment when summoned to testify before the grand jury about allegations of insider trading, according to Bloomberg.

S.A.C. Capital, on the other hand, likely will lose most of its external investors regardless of whether the firm, its affiliates and Mr. Cohenare found guilty of tolerating alleged insider trading.

At its peak at the end of 2007, S.A.C. managed $16 billion in a wide array of hedge fund strategies. Assets were down to $14 billion as of July 1, of which about $8 billion is Mr. Cohen's own money, said a source with knowledge of S.A.C. who asked not to be named.

The firm declined to provide the size of redemptions requests received to date.

Sources can't say how much in redemptions was requested by external investors in the first half of the year, but some estimated the total was just less than $5 billion. The actual figure might be higher because Mr. Cohen agreed to let investors take all their money from his hedge funds, but he is spreading the disbursal over the last three quarters.

This article originally appeared in the August 5, 2013 print issue as, "Institutions probably won't lose investments in S.A.C.".