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DOJ's Pursuit of Hedge Fund SAC Raises Interesting Legal Issues, Expert Says

Friday, August 16, 2013
By Yin Wilczek

SAN FRANCISCO--The Department of Justice's recent indictment of SAC Capital Advisors LP and its separate action seeking civil forfeiture are based on “very unusual facts,” and raise interesting legal questions, Stanford law professor Joseph Grundfest said Aug. 11.

Grundfest--a noted securities law expert and a Securities and Exchange Commissioner from October 1985 to January 1990--noted for example that the case marks the first time DOJ has used money laundering as a strategy for pursuing insider trading.

“How does civil forfeiture actually work under these circumstances?” Grundfest asked. Although DOJ obviously will receive more from the hedge fund through civil forfeiture than through the civil mail or wire fraud provisions, “nobody knows how you go about doing the calculations” for civil forfeiture in insider trading situations, he said.

Grundfest participated on an insider trading panel at the American Bar Association's annual meeting.


Indictment
DOJ July 25 indicted SAC and its affiliates in the U.S. District Court for Southern District of New York on wire fraud and securities fraud charges alleging institutional practices that made it possible for numerous employees to engage in insider trading (144 SLD, 7/26/13).

U.S. Attorney for the Southern District of New York Preet Bharara also named SAC in a separate civil action seeking forfeiture of property involved in laundering insider-trading proceeds and the imposition of money-laundering penalties.

In another observation, Grundfest noted that “SAC so far has beaten the odds” by still being in business despite the indictment. DOJ is proceeding with a “clear strategy” of not putting the hedge fund out of business, the academic said. Commenters had speculated that an indictment would spell the end of SAC, as has happened to other hedge funds, including convicted insider trader Raj Rajaratnam's Galleon Management LP.

Grundfest referenced the protective order jointly filed by the parties and approved by the court Aug. 9 in which SAC must preserve around 85 percent of its assets--reportedly around $5 billion--in case the government prevails on the forfeiture action. In exchange, the hedge fund may go about its legal business during the duration of the action.


Potential Settlement Terms
The $5 billion amount is a “public disclosure” of what the government wants in this case, Grundfest said. “You can smell the dimensions” of a potential settlement from the protective order: forfeiture in an amount less than $5 billion, an agreement from SAC to put a monitor in place, and perhaps negotiation on whether to limit SAC founder Steven Cohen's participation in the securities industry, he said. “You can see the parameters of how this case might settle.”

However, the calculation changes if any of the individual defendants “flip” and admit to facts that allow the government to link Cohen directly to the alleged insider trading scheme, Grundfest added.

Cohen was not charged by DOJ. However, the SEC July 19 named the hedge fund founder in an administrative proceeding over his alleged failure to supervise two senior employees who engaged in insider trading under his watch. The employees--Michael Steinberg and Mathew Martoma--currently are facing related civil and criminal charges.

Grundfest criticized the SEC's case against Cohen, describing some paragraphs of the commission's order instituting administrative proceedings as “remarkable.” He cited specifically paragraph 69 for its “use of the conditional.”

The paragraph reads: “Cohen encouraged Martoma to speak with the doctor who Cohen had been told may have seen Phase II Trial results--information that any reasonable hedge fund manager should have known might be material and nonpublic. Cohen also knew, based on his communications with the Analysts, that Martoma possibly had another inside source on the Phase II Trial.”


Defense of SEC Order
However, other panelists defended the commission's language. Carmen Lawrence, a partner at Fried, Frank, Harris, Shriver & Jacobson LLP in New York, argued that the paragraph was pointing out red flags, which “don't need to be definitive.”

Lawrence, among other former SEC roles, was director of the commission's Northeast Regional Office from 1996 until June 2000.

Kenneth Bialkin, of counsel at Skadden, Arps, Slate, Meagher & Flom LLP, New York, also suggested that the paragraph was an “understatement” that Cohen should have known what was going on.

The only SEC official on the panel--Jina Choi, an assistant Enforcement director in the SEC's San Francisco Regional Office--said she thought the paragraph was “brilliant,” and urged the defense bar to review it. She added that the entire SEC order, when read “as a narrative … tells quite a story.”

Grundfest responded that if the SEC had a case, it should make it. “That's not making a case.” He said there were other “problematic” paragraphs in the commission order that “raise questions about the strength of the SEC's case.”

In other observations, Karl Groskaufmanis, a Fried Frank partner from Washington, told the audience that the SAC case has caused buy-side investing entities to “rethink” their activities. “People on the buy side” are trying to develop good research practices, reviewing their controls and procedures, and “putting in place advanced detection systems,” he said.

“The government to a great extent with buy-side investors has been on a roll,” Groskaufmanis said. “Eight of these insider trading cases have gone to trial,” and the government has won all of the cases.

Michael Mann, a partner in Richards Kibbe & Orbe LLP, Washington, added that the government's message to the hedge fund community is that “it's not just about building systems and spending money.” Instead, “it's the substance” of the funds' internal controls that matters, he said.

 


The parties' protection order is available at http://www.bloomberglaw.com/public/document/United_States_Of_America_v_SAC_Capital_Advisors_LP_et_al_Docket_N.

The SEC's administrative order against Cohen is available at http://www.sec.gov/litigation/admin/2013/ia-3634.pdf.

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