The Early Years and SAC Capital’s Genesis
Steven Cohen had it all. He lived in a 35,000-square-foot mansion in Greenwich, Connecticut He flew to work by helicopter. And he amassed one the largest private art collections in the world — valued at $1 billion. Including this $8 million shark suspended in formaldehyde. Cohen has been jokingly referred to as the ultimate predator because of his keen trading instincts. His hedge fund, SAC Capital, managed $15 billion dollars and averaged returns of 30% a year for 20 years! It was almost as if Cohen had a crystal ball and could predict the future. Except perhaps his own. His world appeared to come crashing down when the FBI and SEC accused SAC Capital of insider trading: Getting confidential, insider information, trading on it, and making a profit. This is certainly the most lucrative insider trading scheme ever charged. After a seven-year investigation that began with the arrest of the founder of another prominent hedge fund, the feds targeted executives, traders, analysts, lawyers, and scientists connected to Wall Street, ultimately hoping to bring down Cohen. SAC Capital ended up pleading guilty to insider trading and Cohen’s henchmen went to prison. Yet Cohen managed to get away scot-free. With not a single criminal charge. How did he do it?
This is the story of how the Feds tried and failed to bring down the greatest trader who ever lived. Steven Cohen was born into a middle-class family on Long Island, the brightest of eight siblings. He mastered poker in high school which taught him the art of making money. He wasn’t as well off as his rich classmates at Wharton business school and felt a need to prove himself. It was clear very early on he had a knack for trading. “I never saw talent like that. It was just staring at you,” recalled a friend of Cohen’s who ran options at trading firm Gruntal, Cohen’s first job out of college. He had the instincts and acted quickly and made $5 to $10 million a year in commissions while still in his early 20s. But…he did get a scare that would affect him for the rest of his career. While at Gruntal, he bought shares of RCA just days before General Electric took over the broadcaster. When the SEC investigated him for insider trading, he pled the fifth and was never charged. Privately, his ex-wife Patricia said he panicked and feared ending up in prison. This close call taught him to be more careful… It wasn’t long before he went out on his own.
Foundation of SAC Capital
In 1992, he launched SAC Capital. At the time, few knew what a hedge fund was. In the simplest of terms, it was a way for rich people to diversify and get stable returns. A fund manager would identify the best companies and buy their shares while selling short the ones that were likely to perform poorly. Shorting involves borrowing a stock, selling it, and hoping to repurchase it at a cheaper rate to repay the loan. This dual strategy of buying some stocks (“long”) and betting against others (“short”) provides a “hedge” against market fluctuations, hence the term “hedge fund”. SAC focused on quick trades, reacting to market events rather than investing for the long term — the opposite of Warren Buffett’s strategy. Hedge funds make money off commissions. Usually a performance fee of 20% of profits each year. But SAC was so good at what they did that Cohen charged a whopping 50%! The tech boom of the ’90s benefited many hedge funds like SAC as they capitalized on the rapid growth in the technology sector and the stock market’s bullish sentiment. Faced with increased competition, how do you get an advantage over other hedge funds? You hire the best and brightest traders and analysts who could get the inside scoop. Technically, it’s illegal for them to get proprietary, nonpublic information and use it to make trades. Yet…because of the desire to get an edge over rivals, this was inevitable, as Sheelah Kolhatkar writes in “Black Edge”, the quest to bring down the most wanted man on Wall Street: “…black edge is like doping in elite-level cycling or steroids in professional baseball. Once the top cyclists and home-run hitters started doing it, you either went along with them or you lost.” Everyone was doing it. But Cohen was the best at it. One of his favorite sectors was health care. He hired a biotechnology specialist from a small hedge fund in Boston named Mathew Martoma, who had an MBA from Stanford. Martoma’s base salary of $200,000 was nothing compared to the millions he’d make in bonuses every year if his trades went well.
Allegations of Insider Trading
Martoma paid close attention to two medical companies: Elan Corporation and Wyeth. They were testing a new drug to treat Alzheimer’s, called bapineuzumab or “bapi” for short. It was a medication that some speculated would be the biggest-selling drug of all time. Martoma was really confident in the drug because of the information he was getting about it from a source. SAC Capital used the services of a matchmaking firm to connect Martoma with a medical expert. And not just any medical expert. Martoma connected with Dr. Sidney Gilman, the Chair of the Safety Monitoring Committee involved in the clinical trials for Bapi. None of this came cheap; experts were compensated $1,000 for a 30-minute phone call. Dr. Gilman signed up not for the money but because he could talk about the work that he loved. He made it clear to Martoma that he couldn’t disclose confidential information: “Although I know more than is publicly available, I have a confidentiality agreement and will share only information that is openly available, of course.” However, as conversations flow and bonds form, Gilman begins sharing. He and Martoma spoke often on the phone, sometimes for hours. Gilman saw Martoma as the son he lost to suicide. Martoma capitalized on his friendship with Gilman to nudge him into confidential areas. Martoma wanted to know if the drug had any side effects that could derail its approval. Gilman admitted there were side effects of brain swelling but said it could actually be a sign the drug was working. (Brain swelling detected in regular brain scans) Researchers believed Alzheimer’s was caused by a buildup in the brain of a “sticky protein” or plaque called beta-amyloid. Bapi was designed to attack the plaque. And the brain swelling might have been a reaction to the drug actively working to clear out the plaque.
Martoma’s Involvement
Martoma was so certain that the new drug would cure Alzheimer’s that he sent Cohen a memo with a “Conviction” rating of 9 on a scale from 1 being not certain and 10 being very certain that the drug showed promise. The rating system was how Cohen’s traders communicated the value of whatever information they were getting without exposing Cohen to any details of how they knew something. In other words, the rating system protected Cohen from the behavior of his employees. Martoma convinced Cohen to build up enormous positions in Elan and Wyeth securities. Totaling $700 million in value by the spring of 2008. Interestingly, another group of healthcare traders at SAC felt the bapi trial was going to fail and didn’t understand why Cohen had taken such huge positions in both companies. Elan, in particular, was the smaller of the two companies and the riskier bet. And what amplified the gamble was that all this was happening amidst the catastrophic financial crisis of 2008, a period marked by widespread economic collapse. When the skeptical SAC analysts went to Cohen with concerns about the bapi drug, he waved them off, accusing them of “pissing on the parade”. In July 2008, Dr. Gilman was set to present the full results of the drug trial at the annual International Conference on Alzheimer’s Disease in Chicago. Martoma wanted to know about the results beforehand. He called up Gilman and said he was going to be passing by Ann Arbor, Michigan where Gilman lived, as his late uncle had passed away a couple of months before and was buried nearby. He asked if he could meet Gilman. Gilman agreed and they met at his University of Michigan office…where he showed Martoma the PowerPoint presentation he planned to give at the Alzheimer’s conference. The presentation was marked: “Confidential, Do Not Distribute.” Martoma could tell from the slides that the results of the drug trial were going to be disappointing. Bapi had only been effective for a small group of patients — those without the gene predisposing them to Alzheimer’s. And treatment didn’t get better with more doses. Although Dr. Gilman felt the drug might have potential, Wall Street didn’t see it the same way. As Martoma explained to Gilman, “The market doesn’t like a drug that only helps half the population.” Martoma knew shares of Elan and Wyeth would crash once news got out. The following day, on July 20, 2008, he typed an email to Cohen with this subject line: Is there a good time to catch up with you this morning? It’s important. Then they spoke on the phone for 20 minutes. Over the course of the next nine days, SAC Capital liquidated its entire equity position in Elan and almost all of its position in Wyeth — totaling 17.7 million shares worth approximately $700 million. SAC didn’t want to draw attention to the selloff and kept trading in low visibility accounts and “dark pools” — private stock exchanges where trades were executed anonymously. And on top of that — SAC also shorted nearly 8 million shares of Elan and Wyeth.
Insider Trading Scheme
Through all this, SAC earned profits and avoided losses of $275 million. While this was going on, SAC Capital actually hired a former SEC chairman to give a talk about insider trading, which is beyond ironic! When news came out that the drug was a failure, shares of Elan and Wyeth plummeted. In three days, Elan dropped from $33.75 to below $10. Other traders at SAC thought it would spell disaster for the company only to learn that SAC had sold its positions in Elan and Wyeth.
When Dr. Gilman presented the findings at the Alzheimer’s conference, he was recovering from cancer. Given everything that had happened, he couldn’t believe that Martoma hadn’t checked in on him. He sent him an email: “Hi, Mat. I haven’t heard from you in a while and hope that all is well with you…I just wonder how you’re faring.” Meanwhile, Martoma received a $9 million bonus for his excellent work on the drug trades. But if SAC didn’t think anyone would notice the trades — they were wrong. A trader at RBC Capital Markets noticed the unusual activity and made a complaint to a regulatory body. By this time, regulators were already starting to unravel the intricate web of insider trading within the hedge fund industry. In 2009, they arrested Raj Rajaratnam, the founder of the hedge fund Galleon Group, on securities fraud charges. And this was just the tip of the iceberg. They targeted a network that they hoped would eventually strike the bull’s eye: Steven Cohen. When the Wall Street Journal published an article in November 2010 titled: “U.S. in Vast Insider Trading Probe”, it blew the quiet investigation out of the water. After former SAC portfolio manager Donald Longueuil read the article, he panicked and destroyed his USB and hard drives containing incriminating evidence and threw them into random garbage trucks in the middle of the night. He confessed this to his best friend, fellow SAC manager Noah Freeman. What Longueuil didn’t realize was that Freeman had become an FBI informant to save himself. He was wearing a wire and recorded their conversation. Longueuil ended up pleading guilty to insider trading charges. However, his conviction didn’t bolster the FBI’s case against Cohen as there was not much to implicate him. The FBI kept digging. Another suspicious case involved a SAC analyst hearing that Dell’s earnings were going to be a disappointment. SAC research analyst Jon Hovarth was tipped off by an analyst friend, who got it from an analyst at another hedge fund who obtained the information from an insider at Dell. Horvath relayed the tip to his boss at SAC, portfolio manager Michael Steinberg. Horvath wrote: “I have a 2nd hand read from someone at the company…” Steinberg responded with discretion: “Please be discreet.” Steinberg then shorted his shares of Dell, pocketing a profit of $1 million. And two days before Dell reported earnings, Cohen sold his entire long position of 500,000 shares.
After earnings came out, Cohen complimented Steinberg: “Nice job on dell.” Steinberg responded: “Thanks. This ole dog can still hunt.” Horvath’s email not only reached Steinberg but also another manager, who passed it on to another portfolio manager, who then shared it with…Steven Cohen. The Feds thought this was the proof they needed to connect Cohen to insider trading. However, Cohen’s defense believed otherwise. Cohen’s lawyer, Marty Klotz, argued that Cohen received thousands of emails in his inbox daily, making it unlikely he even saw this particular one. Even if he had, there’s no clear evidence it amounted to insider trading since Cohen didn’t know where the tip came from. On December 18, 2013, a jury found Steinberg guilty of insider trading. He was so overwhelmed he fainted before the verdict was delivered. He was sentenced to three and a half years in prison. Steinberg had refused to cooperate with authorities and as a result, they didn’t have enough to nail Cohen. This was frustrating for FBI agents who understood that Cohen knew all and controlled all. As former SAC analyst C.B. Lee described to the FBI, the operational structure at SAC resembled a bicycle wheel: the spokes represented the portfolio managers with their teams of analysts and traders, and at the hub, was Steven Cohen. Since Steinberg had refused to cooperate, the Feds only hope was the pharmaceutical case involving Martoma. Phone records had shown Martoma was the SAC employee in touch with Dr. Gilman. The FBI was certain Martoma would flip on Cohen to avoid a lengthy prison sentence of up to ten years. Yet, surprisingly, Martoma refused to turn against Cohen. Even after SAC fired him for being a “one-trick pony”, unable to replicate his past success with Elan and Wyeth. He pleaded the Fifth, refusing to incriminate himself or his boss. It’s worth noting that Martoma’s lawyer was on SAC’s payroll. Authorities then questioned Cohen. While he admitted to investing in Elan based on Martoma’s advice, he never specified what that advice was.
Investigation and Legal Actions:
Cohen never mentioned Dr. Gilman. The prosecution painted Dr. Gilman as the victim — a lonely older man who had been charmed by a young trader. As a result, he saw his career crumble as he resigned from the University of Michigan in disgrace. When asked what set Martoma apart from the other investors he dealt with, Gilman replied: “He was personable. And he, unfortunately, reminded me of my first son. In his inquisitiveness. His brightness. And, sadly, my first son was very bright also. And committed suicide.” After a bit of hesitation, he mentioned that when FBI agent Kang first approached him, “The agent also mentioned that I am only a grain of sand, as is Mr. Martoma
They are really after a man named Steven A. Cohen.” And yet, Martoma refused to testify against his former boss in exchange for a lighter sentence. One can only speculate why, but there are three lines of thought: He didn’t want to snitch, which is honorable yet it was seemingly at odds with his questionable actions earlier in life. It came out in court that he had been expelled from Harvard Law School for altering his transcripts when applying for federal clerkships. The second possibility was fear of retribution from Cohen, though there was no evidence Cohen had any ties to mobsters. The third possible reason for staying mum had to do with money. The case had ruined Martoma financially — he had to give his house in Boca Raton, Florida, and millions of dollars of his own money. Did he hope that Cohen would repay his loyalty? Mathew Martoma’s father Bobby had another explanation, saying said his son believed in the Ninth Commandment: “Thou shalt not bear false witness against thy neighbor.” The jury has come back with a verdict and it is guilty. It is a verdict against 39-year-old Mathew Martoma. For the verdict to come back this quickly in two full days is unusually quick. Mathew Martoma was found guilty of securities fraud. He was sentenced to nine years in prison. On the day Martoma was supposed to start his sentence, Cohen spent $101 million at Sotheby’s to buy an Alberto Giacometti sculpture called the Chariot. Steven Cohen was never charged with insider trading. The SEC dropped that charge against him and instead charged him with “failure to supervise” Steinberg and Martoma. The SEC worried about how it would look to lose to the head of one of the world’s most powerful hedge funds in light of a lack of concrete evidence. Cohen also never faced any criminal charges, though his firm, SAC Capital, pled guilty to insider trading charges and paid $1.8 billion in fines. As part of the settlement, SAC agreed to stop managing outside money and convert into a family office, which meant Cohen could only manage his own personal wealth of $10 billion — so he was far from being out of the game.
SAC Capital rebranded to Point72 Asset Management. While his underlings went to prison, life went on for Steven Cohen. He bought the New York Mets in 2020 for $2.4 billion. He continued to buy art. And kept on trading. The family office was allowed to reopen its doors to outside investors in 2018. Last year, it generated $2.4 billion in profit. When I was a child, I remember my mom worked overtime nearly every night to make ends meet. Despite my parents’ limited means, they still saved up for my weekly piano lessons, a testament to their love for me. But I often wished they had someone to help them better manage their finances in a new country.
