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Legal, financial fallout loom for SAC in insider trading case

By Svea Herbst-Bayliss, Katya Wachtel and Emily Flitter

BOSTON/NEW YORK (Reuters) - The fallout from the latest insider trading case against a former SAC Capital Group employee could reverberate throughout Steven A. Cohen's $14 billion hedge fund and impact the billionaire trader himself even though he has not been charged with any wrongdoing.

U.S. securities regulators, in charging former SAC Capital employee Mathew Martoma with insider trading, are also seeking to force the division where he worked to disgorge $276 million that was the result of the illicit trades.

But a person familiar with SAC Capital said wealthy investors in Cohen's fund won't be responsible for paying back that money if the SEC is successful.

Rather, it will be Cohen himself, or his management company, which will have to cover any court-ordered disgorgement of illicit profits. That means Cohen's own capital, which is believed to account for at least half of the $14 billion managed by SAC Capital, is at risk.

A person familiar with Cohen's fund said Cohen recently indemnified investors making sure that the management company that oversees the operation of his investment funds would be liable for any claims--and not individual investors.

The person, who did not want to be identified, said SAC Capital changed its legal structure some time ago to make sure that individual investors would not be liable for any legal claims that might arise.

Cohen has long been a target of prosecutors. In sworn testimony last year, he said rules governing insider trading were "very vague" and identifying a tip as material non-public information was sometimes "a judgment call.

U.S. authorities have been investigating the trading activities at SAC Capital since at least 2007, with Cohen looming large for U.S. authorities because the 56-year-old manager ranks as one of the hedge fund industry's most successful traders.

On Tuesday, federal prosecutors and the Securities and Exchange Commission filed complaints against Martoma, a former manager at CR Intrinsic, a division of SAC Capital, for trading two drug stocks based on inside information. Including Martoma, five former SAC Capital employees have been charged with engaging in insider trading while working for Cohen's widely followed and influential firm.

Martoma's arrest turns up the heat on Cohen because the government charged that Martoma worked closely with the SAC Capital founder on making the decision to unwind a previously bullish bet on Wyeth and Elan Corp, the two companies that were working together to make an Alzheimer's treatment drug.

The government hasn't alleged that Cohen knew Martoma had been relying on non-public information about problems with the drug trial. Nor has the government alleged that Cohen was aware of any the improper trading by other former employees charged in the long-running investigation.

TOO COZY CONNECTION?

A representative for SAC Capital reiterated what the firm said on Tuesday following Martoma's arrest: "Mr. Cohen and SAC are confident that they have acted appropriately and will continue to cooperate with the government's inquiry."

But legal experts said the close connection between Cohen and Martoma could leave the billionaire manager open to a future SEC action for a failure to properly supervise his employee.

These legal experts noted that since SAC is now a registered investment adviser, Cohen as its leader has a responsibility to supervise his funds' activities and install internal controls to prevent insider trading.

"What you're essentially arguing is that he was careless, he should have done better, said Donald Langevoort, a securities law professor at Georgetown University Law School.

Failure to supervise cases are common in the brokerage industry, which has long been regulated. But with big hedge funds like SAC Capital only recently being required to register with the SEC, the issue of bringing a failure to supervise case against a manager is untested.

Legal experts said it's not clear whether the "failure to supervise" provision could be applied to trades made in 2008, before SAC became a registered advisor. But they said it is something regulators might contemplate, if investigators can't find enough evidence to charge Cohen with insider trading.

TRYING TO BOOST CONFIDENCE

Of more immediate concern for Cohen is taking steps to calm the nerves of investors who may be unsettled by the latest charges and considering redeeming money.

But since SAC Capital takes in less money from public and corporate pensions, it is less vulnerable to negative headlines than other hedge funds.

People familiar with the firm said Cohen spoke to employees on Tuesday to reassure them and he and his management team have been speaking with some of SAC Capital's biggest investors.

About 60 percent of the firm's capital belongs to Cohen and his employees. And so far, there's no indication that Cohen's wealthy investors are looking to get out of a firm that has boasted an average annual return of 30 percent since its launch in 1992.

This year the fund is up 10 percent, more than double the hedge fund average.

Anthony Scaramucci of SkyBridge Capital, an investor, on Wednesday called the fund manager a "great guy" and a friend. He said, "Steve Cohen has not been indicted and in this country you are innocent until proven guilty." But he did not say whether he will keep his money in SAC.

Another investor, Blackstone Group, which at one point invested some $500 million in SAC Capital through an investment fund, declined to comment when asked about its commitment to Cohen's firm.

(Reporting By Svea Herbst-Bayliss, Katya Wachtel and Emily Flitter; edited by Matthew Goldstein, Jennifer Ablan and Leslie Gevirtz)

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