Hedge Funds – The Good and the Bad
If you find value in this project, please consider supporting our efforts through our Patreon page. Contributions go to paying for site maintenance, supporting writers and staff that are in school, and 15% will go to Cornerstone Financial Education to improve financial literacy across the country. Check out our supporters here.
“Guess who’s back, back again”. Nope, not Slim Shady, but billionaire hedge fund manager Steve Cohen. After four years of SEC sanctions from the SAC Capital trial, the Wall Street titan hinted at plans to open a $20-billion-dollar hedge fund. The hardest part of this venture? Regaining the trust of his investors.
A hedge fund uses high-risk strategies to generate returns for high-wealth individual and institutional investors. The “hedge” is derived from the most notable investing methods used: long and short. A long play is investing in a stock with the sentiment that the share value will increase. A short play is a little more complicated, it involves borrowing shares from a broker, selling them with the hope of the share value decreasing and then buying them back at a lower price and returning them to the original owner.
SAC Capital Advisors was one of the world’s largest and most reputable hedge funds, and only started out with visionary Steven Cohen and $25 million in assets under management (AUM) in 1992. Only 21 years later, SAC Capital had over $14 billion AUM and 29% annual returns, that’s 18% higher than the average S&P 500 return in the same time span. But, like Icarus, SAC Capital flew far too close to the sun. Back in 2013, SAC Capital pleaded guilty to the largest case of insider trading within a hedge fund.
It all started in 2008, when Dr. Gilman, an Alzheimer scientist, made a thirteen-minute presentation in Chicago for the International Conference on Alzheimer’s Disease. The presentation, not of good news, confirmed that the Alzheimer’s drug developed by Wyeth and Elan had not performed well at clinical trials. After this presentation, SAC Capital’s position in Wyeth and Elan was sold and flipped into a short. Before the presentation, SAC held its largest position in Wyeth and fifth largest in Elan, totaling a near $700 million dollars. All these trades were made by Mathew Matorma, a portfolio manager at CR Intrinsic Capital owned by SAC Capital and run by Steve Cohen. All it took to tip off the SEC was a 20-minute phone call with Cohen and then the immediate dump of $700 million in shares.
The repercussions: Mathew Martoma, portfolio manager at CR Intrinsic Capital spending 9 years in federal prison, a mere $1.8 billion fine, and Steve Cohen becoming unable to manage outsider capital for two years. Martoma used inside information on pharmaceutical companies Elan and Wyeth, which were collaborating on a break through Alzheimer’s drug. This classified information he was receiving for over two years allowed Martoma to make over $275 million for SAC Capital’s investors. A federal court found Martoma guilty of insider trading and Cohen guilty of failure to supervise an employee. Although Cohen did not get prison time, he was unable to manage the wealth of institutional and individual investors. Instead he had to settle for managing his own $11 billion fortune through his new firm Point72 Asset Management.
The fines in total were massive and as follows: CR Intrinsic was fined $600 million along with an additional $1.2 billion to both SAC Capital and CR Intrinsic, but that’s not it. SAC Capital had to then reimburse shareholders in both companies for their losses. Cohen paid $135 million to shareholders in Elan Corp. and $10 million to Wyeth shareholders. To cap things off, Mathew Martoma was forced to hand over his recent $9 million bonus he received, even from the better side of prison bars he would be unable to pay his mortgage for his $2 million Miami home.
For all my fellow Billions fanatics, this may sound familiar. For those unfamiliar, Billions is a Showtime original series about a hedge fund manager, Bobby Axelrod, and his rivalry with U.S. Attorney Chuck Rhoads. Axelrod runs a multi-billion-dollar fund, Axe Capital, out of Westport, Connecticut making similar noise in the investment world as SAC Capital. In the first season, Axe Capital’s alpha portfolio manager, “Dollar Bill” Stearn, is accused of insider trading for paying for a girl’s medical bills in return for exclusive company information from her father. Now in Billions, the two made it out a little better off than SAC Capital did; Axelrod had no repercussions and “Dollar Bill” was found not guilty and merely got a slap on the wrist.
Anyway, now Cohen has to overcome a massive scandal to recoup large sources of capital for his new fund. This stain, equivalent to that of a $500,000 bottle of Screaming Eagle Cabernet, will follow him forever. He has lost the trust of institutional investors such as endowments and pension funds, the largest sources of capital received by hedge funds. In order to become the great hedge fund manager he once was he must be proactive in leading and supervising his employees as well as being ethical in all decisions he makes. The launch of a $20 billion hedge fund will put him under a microscope and he must be well prepared.
The moral of the story is to not misuse relationships or information to make ill-gotten gains for investors. It will come back to haunt you. With each passing scandal comes increasing scrutiny on investors. The SEC and other regulators will eventually catch you and the monetary punishment will be severe. We have seen this with Martha Stewart and Enron in the early 2000’s, leading to increasing SEC power and the Sarbanes Oxley Act: which regulates financial reporting. Once the fines are paid, the reputations scars remain. Time will tell if Steve Cohen will be able to recover from those scars.
Keefe, Patrick. “The Empire of Edge: How a doctor, a trader, and the billionaire Steven A. Cohen got entangles in a vast financial scandal.” NewYorker.com. http://www.newyorker.com/magazine/2014/10/13/empire-edge (accessed August 20, 2017)
Goldstein, Matthew. “Martoma, SAC Capital Ex-trader, Gets 9 Years in Prison.” Nytimes.com. https://dealbook.nytimes.com/2014/09/08/hours-before-sentencing-u-s-judge-says-cohen-trades-should-count-against-martoma/?mcubz=1&_r=0 (accessed August 20, 2017)
SEC. “Steven A. Cohen Barred From Supervisory Hedge Fund Role.” SEC.gov. https://www.sec.gov/news/pressrelease/2016-3.html. (accessed August 20, 2017)
Segal, Julie. “Would you invest with Steve Cohen?” CNBC.com. https://www.cnbc.com/2017/07/26/steve-cohen-needs-investments-to-launch-a-new-20-billion-hedge-fund.html (accessed August 20, 2017)
Shen, Lucinda. “Billionaire Steve Cohen’s New Hedge Fund May Be Even Bigger Than His Last.” Fortune.com. http://fortune.com/2017/05/30/steve-cohen-hedge-fund-point72/ (accessed August 20, 2017)
Van Voris, Bob. “SAC Capital’s $135 Million Insider Trading Settlement Approved by Judge.” Bloomber.com. https://www.bloomberg.com/news/articles/2017-05-12/sac-capital-s-135-million-insider-settlement-approved-by-judge. (accessed August 20, 2017)