After decades of whispers that Stevie Cohen and SAC Capital were engaging in insider trading, the Securities and Exchange Commission has now sent a Wells notice advising the firm that the SEC is planning to bring a case against them.
As a result of the SEC's action, we will now see whether SAC, one of the most closely watched hedge fund operations on the Street, was making 20% to 30% annual returns through all markets as a result of superior business acumen or whether they were profiting illegally from inside information.
This case will answer two burning questions:
Is the SEC under a new chairman really going to go after the "biggest fish" onWall Street? Or, will it simply engage in a wrist slap fine in which SAC and Cohen would provide some "chump change" to the government?
[Related -8 Stocks to Beat Warren Buffett's Portfolio Return Easily]
Will this case show that Cohen and SAC are really smarter than the market and everyone else? Or did they have an unlawful edge in trading stocks based on inside information?
SAC possessing unlawful insider information is indeed possible and it's too early to say whether that was the case and whether it can be proved. As Reuters and many others noted last week when the Wells notice was first reported, the potential civil charges and SAC Capital appear related to the earlier arrest of Matthew Martoma, who worked at CR Intrinsic, a division of SAC Capital, until 2010.
The criminal case against former SAC portfolio manager Martoma involves allegations that SAC made $276 million in an insider trader scheme involving a confidential Alzheimer's drug trial involving Elan and Wyeth stock.
[Related -How the Chinese Slowdown Will Impact Your Investments]
According to the Feds, Martoma paid a neurology professor who chaired the safety monitoring committee of the Alzheimer's drug trial to provide him with inside information. Martoma met the professor through an expert networking firm, and the pair consulted 42 times between 2006 and 2008. After learning from the professor in 2008 that the drug trial had gone poorly, Martoma allegedly held a 20-minute telephone conversation with Cohen. Martoma and Cohen then instructed SAC's senior trader to sell all of the fund's Elan shares and most of its Wyeth shares.
It remains to be seen whether Cohen's investors will jump ship as more egregious allegations are revealed. As Reuters reporters Svea Herbst-Bayliss and Katya Wachtel noted: "The possibility the SEC could now file civil charges against SAC Capital might further unnerve investors in the hedge fund. Martoma is the fifth person associated with the hedge fund to be charged with insider trading."
The case will clearly send a message to the hedge fund community about whether the SEC is serious about fraud at hedge funds or whether it's just a publicity stunt.
Be assured that Cohen and SAC will receive a well-financed defense from the best lawyers on Wall Street. But is the SEC, under new leadership, up to the task?
Disclosure: Zamansky & Associates are securities attorneys representing investors in federal and state litigation and arbitration against financial institutions.