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From Securities Regulation Daily, July 19, 2013

SEC seeks to bar hedge fund manager Steven A. Cohen for failing to prevent insider trading

By John M. Jascob, J.D.

The SEC has announced charges against hedge fund adviser Steven A. Cohen for failing to prevent two portfolio managers he supervised from insider trading. Cohen, who founded and owns the SAC Capital Advisors firm (SAC) that bear his initials, has been charged with failing to supervise Mathew Martoma and Michael Steinberg, two senior SAC employees who face criminal charges for insider trading activity conducted in 2008 under Cohen’s watch. According to the Commission, Cohen’s hedge funds earned profits and avoided losses from the illegal trades totaling more than $275 million.

“Hedge fund managers are responsible for exercising appropriate supervision over their employees to ensure that their firms comply with the securities laws,” said Andrew J. Ceresney, Co-Director of the SEC’s Division of Enforcement in a news release. “After learning about red flags indicating potential insider trading by his employees, Steven Cohen allegedly failed to follow up to prevent violations of the law. In addition to the more than $615 million his firm has already agreed to pay for the alleged insider trading, the Enforcement Division is seeking to bar Cohen from overseeing investor funds.” The order instituting civil proceedings against Cohen indicates that SAC and its affiliates managed portfolios of approximately $15 billion in early 2013.

Failure to supervise. According to the SEC, Cohen’s supervisory role at SAC required him to oversee stock trading by Martoma and Steinberg. Although Martoma and Steinberg provided information to Cohen on at least two occasions in 2008 indicating their potential access to inside information, Cohen ignored the red flags and allowed them to execute the trades. Instead of scrutinizing their conduct, the SEC claims, Cohen praised Steinberg for his role in the suspicious trading and rewarded Martoma with a $9 million bonus for his work.

Elan and Wyeth trades. The SEC alleges that Cohen watched Martoma build a massive long position in two pharmaceutical companies, Elan and Wyeth, based on the two companies’ joint clinical trial of a drug with the potential to treat Alzheimer’s disease. Although speculating that Martoma might have access to material nonpublic information about the clinical trial, Cohen displayed no concern that Martoma might use the information to inform investment decisions at his firm. Instead, Cohen encouraged Martoma to talk further with a doctor familiar with the clinical trial.

After Martoma abruptly shifted his position on the two stocks and urged their liquidation, Cohen ignored the red flags and failed to take prompt action to determine whether Martoma was engaging in insider trading. Instead, the SEC alleges, Cohen oversaw the liquidation of the positions in Elan and Wyeth and the accumulation of a short position in those stocks. The trades ultimately netted the firm approximately $275 million in illicit profits and avoided losses.

Dell trades. The SEC also claims that Cohen supervised Steinberg while he was involved in insider trading of Dell securities in August 2008. Despite becoming aware of a suspicious e-mail exchange between Steinberg and other firm employees reflecting the possibility that they possessed inside information about an upcoming earnings announcement at Dell, Cohen again failed to take prompt action to determine whether Steinberg was engaged in unlawful insider trading. Instead, the SEC alleges, Cohen liquidated his Dell shares based on the recommendation of Steinberg, who continued short selling Dell shares based on the confidential information. After Dell’s stock price dropped sharply following the earnings announcement, funds managed by Cohen’s firms profited or avoided losses totaling at least $1.7 million.

Relief sought. The SEC has charged Cohen with failing to supervise Martoma and Steinberg with a view to preventing their violations of Exchange Section 10(b) and Rule 10b-5. The order states that the administrative proceedings instituted by the SEC will determine the specific relief that will be sought against Cohen, including financial penalties, a supervisory and financial services industry bar, and other relief.

The administrative proceeding is No. 3-15382.

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