SAC charges challenge hedge fund model
By Richard Beales
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
Steven Cohen seems to have escaped criminal charges, but his billionaire and millionaire hedge fund peers shouldn’t rest easy. Not only does a U.S. government indictment threaten the existence of Cohen’s roughly $15 billion SAC Capital Advisors firm, but the 40-page rap sheet could change the rules of the game.
The government says that SAC tried to hire traders “with proven access to public company contacts,” as if that were a bad thing. But that is what equity trading shops like Cohen’s do. The government also criticizes the lack of a process to ensure that still-to-be-employed portfolio managers wouldn’t use their networks to obtain illegal inside information. That suggests giving compliance a much larger role in hiring than is normal in any business – never mind a hedge fund.
Then there’s the “edge.” The search for special insights into what’s happening is the lifeblood of many hedge funds. There are lots of legitimate ways to get it, including clever number-crunching, close observation of companies’ supply chains and attentive schmoozing. But the indictment conveys suspicion about the whole idea of taking advantage of networks of contacts.
Hedgies often talk of creating a “mosaic” – an insightful picture of a company or industry made up of little tiles of information and analysis. If traders have to think twice about every phone call, the art could suffer.
The SAC indictment is part of its own small mosaic. Convicted Galleon Group founder Raj Rajaratnam argued that his trading was based on too many data points to be tainted by an isolated bit of inside information. The jury was not persuaded and the appeals court said that mere “knowing possession” of material non-public information when trading crossed a legal line. In other words, guilty unless demonstrably innocent.
If the SAC case goes to trial, the verdict will give U.S. hedgies some dots to connect. They may have to recruit more carefully and change other longstanding habits. Cohen’s record of 25 percent annual net returns already looks beyond the dreams of today’s funds. Additional restrictions could leave such returns – and the fees they have justified – even further out of reach.