On July 25, 2013, the U.S. Attorney for the Southern District of New York announced a host of insider trading charges against SAC Capital Advisors and its related companies. According to the forty-one page indictment, the hedge fund and its billionaire owner, Steven Cohen, “fostered a culture that focused on not discussing inside information too openly, rather than not seeking or trading on such information in the first place.” SAC Capital allegedly hired traders with broad public networks and financially incentivized these individuals to trade on any information that would give SAC an “edge” over other investors—without questioning whether the “edge” constituted inside information. Such was compounded by SAC Capital’s failure to employ effective compliance procedures to detect and prevent insider trading. Finally, the guilty pleas of at least six former SAC employees for multiple insider trading violations substantiate the allegations and serve as the prosecution’s coup de grâce.
The far-reaching consequences of the indictment have yet to play out; however, there is some indication of what’s to come. First, although Mr. Cohen is expected to avoid individual charges, the indictment could be the death knell for SAC Capital. Even if not convicted, some believe that the hedge fund will go the way of Arthur Anderson in the wake of Enron scandal. While many in the prosecution’s camp ultimately regretted the collapse of the accounting giant, they appear to be comfortable with this possibility in the present case.
Second, the indictment serves as yet another example of the government’s willingness to hold financial institutions accountable for illicit activities. This, more than anything else, emphasizes the importance of a rigorous compliance program. As the indictment notes throughout, it is simply not enough to have a compliance plan—the plan must also be effectively enforced. In many instances, SAC Capital failed to investigate potential violations and when it did, the investigations were cursory. Indeed, its compliance procedures only detected one instance of insider trading in its entire history—something clearly contradicted by the guilty pleas alone.
In short, questionable activity, whether in the form of an insider trading “edge” or something else, must be reported and investigated thoroughly to avoid the imposition of a potentially fatal enforcement action.