The SEC Talks Tough With the Cohen Case – Does it Have the Big Stick to Win?
The SEC is talking tough these days. A new policy will require admissions to settle in select cases; a settlement was rejected in the Falcone hedge fund case; charges were brought against the City of Miami. And, now the long rumored and much speculated about suit has been brought against SAC Capital founder Steven A. Cohen. In the Matter of Steven A. Cohen, Adm. Proc. File No. 3-15382 (July 19, 2013. Talking tough, however, is only effective if one also has a big stick to back it up. Whether the Commission has that big stick has yet to be seen.
The charges
The action against Mr. Cohen is built on two yet to be proven, pending criminal insider trading cases. One is against former SAC employee Mathew Martoma. The other is against current employee Michael Steinberg. The Order does not charge Mr. Cohen with insider trading. The sole charge is that he “failed to reasonably supervise.”
Part I: The Martoma case
The first part of the Order centers on trades in the securities of Elan Corporation, plc and Wyeth in 2008. The two pharmaceutical companies had a significant new drug under development that had been in trials since 2006.
During the trials, Dr. Sidney Gilman, University of Michigan, was a consultant to Elan. He also worked for, and was paid by, an expert network through which he met Mathew Martoma. SAC’s records reflect payment to the expert network firm which went to Dr. Gilman. SAC’s records also reflect e-mails between Mr. Martoma and the Doctor noting that he was a consultant to Elan and could not discuss the drug.
By 2007 Dr. Gilman was periodically providing Mr. Martoma with inside information about the trials, according to the Order. On June 17, 2008 Elan and Wyeth jointly released top-line results of the Phase II trial for the drug. The announcement also stated that the detailed results would be released on July 29, 2008. The market reacted positively to the release.
In 2007, and up to July 2008, SAC Capital and its affiliates established long positions in Elan and Wyeth valued at over half a billion dollars. The positions were controversial. Mr. Martoma backed the positions. Another portfolio manager at SAC agreed with Mr. Martoma on Wyeth but not Elan. Two other analysts repeatedly e-mailed Mr. Cohen advocating against both positions, suggesting trading strategies to hedge them.
During the controversy Mr. Martoma claimed to have unique insight about the drug trials, what one analyst called “black edge” – “illicit, nonpublic information” in the words of the Order. Other analysts expressed frustration with Mr. Martoma, arguing that it was not possible to have inside information because the trials had not concluded, a view transmitted to Mr. Cohen. Yet another analyst disputed Mr. Martoma’s view, informing Mr. Cohen in an e-mail that he spoke to a doctor who claimed that the results were statistically insignificant. Mr. Cohen forwarded that email to Mr. Martoma and told him to follow-up.
On July 15, 2008 Dr. Gilman traveled to San Francisco and participated in two days of meetings about the drug trials. Late on July 17, and on the next day, the Doctor spoke on the telephone with Mr. Martoma, providing detail about the drug trials, according to the Order.
Two days later, on July 20, 2008, Mr. Martoma spoke with Mr. Cohen. “According to Cohen, Martoma said that he was no longer ‘comfortable’ with the Elan investments . . .” the Order states. The next day, SAC began selling shares of Elan and Wyeth, a process that was completed by July 29 when detail regarding the trial results was announced. The firm ultimately took a short position in Elan.
Part II: The Steinberg case
The second centers on transactions in the shares of Dell, Inc. In 2008 and 2009 a Dell Investor Relations employee furnished advance information on quarterly results at the company to his friend Sandeep Goyal. He in turn passed the information to Jesse Tortora, an analyst at Diamondback Capital. Mr. Tortora shared the information with several others including -Jon Horvath.
Prior to Dell’s August 28, 2008 earnings announcement the Investor Relations employee told Mr. Goyal about the results. The information was given to Mr. Tortora. On August 18th, Mr. Horvath received an update on the information. He then e-mailed Mr. Steinberg and asked him to keep the information “down low.” That same day Mr. Steinberg began building a short position in Dell shares.
Mr. Cohen established a long position in Dell shares later, beginning on August 25. When Mr. Horvath learned about the position he and Michael Steinberg debated if they should inform Mr. Cohen of their view. As the two men debated Mr. Cohen continued purchasing Dell shares.
On August 26th Mr. Cohen was provided with conflicting views on Dell. Mr. Steinberg held one view while an analyst had another. Mr. Cohen directed the analyst and Mr. Horvath to compare notes. After a consultation Mr. Horvath spoke with Mr. Cohen. Shortly after that communication Mr. Horvath sent the analyst an e-mail on which Michael Steinberg was a recipient stating “I have a 2nd hand read from someone at the company . . . “ The analyst forwarded the e-mail to an employee whose job was to forward information to Mr. Cohen. After speaking to another SAC analyst Mr. Cohen reversed his position on Dell.
The Order claims that Mr. Cohen failed to take prompt steps to investigate these two situations. By not do so he “failed reasonably to supervise Martoma and Steinberg with a view to preventing their violations of Section 10(b) of the Exchange Act . . . “
Analysis
The Order does not allege insider trading by Steven Cohen, a charge which has been by all reports under consideration for some time. Apparently the Commission does not have facts sufficient to bring those charges.
This action appears to be an effort to bring something. And, it is something, with no legal analysis and few pertinent facts. It begins by relying on unproven allegations in two other cases. That links the outcome of this action, at least in part, to the determinations in those cases. While the Commission can argue that if the Martoma and/or Steinberg cases end in acquittals that the burden of proof differs in criminal and civil cases and that the duty to supervise is independent of the those results, there is little doubt that such verdicts would severely undercut this action.
Similarly, the Order is devoid of legal analysis. Unlike the typical Order which cites Sections of the securities laws and/or rules that are alleged to have been violated, here there is nothing. There is no citation to any statute. There is no citation to any rule that is claimed to have been violated. There is no citation to any case law. Indeed, there is no analysis of the legal violations. Only a vague claim that Mr. Cohen should have followed-up and that by failing to do so he failed to reasonably supervise is presented.
Likewise, the facts regarding Mr. Cohen and his obligations are at best sparse. The bulk of the Order is details taken from the Martoma and Steinberg cases. What little is stated about Mr. Cohen paints him at the center of repeated disputes among his lieutenants where ultimately he had to pick a side.
Rather the Order substitutes background facts from the two underlying insider trading cases with a mix of inference and innuendo. Background is interesting but it does not state a claim. Nor does innuendo. Phrases such as Mr. Martoma had “edge” – but others thought not; Mr. Martoma was “close” to the company; Mr. Horvath knew someone at Dell. Even when added to the background sections, the offer little. This is particularly true when what is missing is considered – the context of these discussions and statements and any discussion of the firm’s extensive insider trading policies and procedures. Yet the adequacy of those procedures would seem to have at least some relevance to a failure to supervise charge.
There is no doubt that the SEC is talking tough by bringing this action. Whether it is carry a big stick is yet to be seen. One point his clear however – this Order is not that big stick.