SAC Capital Advisors: How Steve Cohen Could Silence His Accusers

By Duncan Parker  JUL 30, 2013 4:00 PM

If Steve Cohen really is one of the greatest arbitrageurs of all time, it's his next trade that could seal his legendary status and permanently silence his detractors.

 


I’ve never met Steve Cohen. Heck, I’ve never even been to Connecticut. But just a few hours ago I awoke from deep REM sleep with a sharp, clear thought: Steve Cohen is not going to take this lying down. Why? I have no earthly idea. Did a witch-doctor make Mr. Cohen a voodoo doll to assist in reaching out to financial media? Seems plausible, but that would imply that even said witch-doctor was in on the joke; I’m no John Hilsenrath.

Like many, I’m often amazed by the intellectual oddities present in dreams. There are endless reports of people dreaming in languages they cannot speak, conquering subjects they’ve never studied, and bearing witness to events they would have no way of knowing would occur at the time. Bizarre for sure, but perhaps nowhere near as bizarre as the dream in which I awoke this morning which outlined what could be Steve Cohen’s “checkmate.” Bear with me while I explain:

Over the last several weeks most financial types have likely found themselves fairly well-read on the insider trading saga grappling SAC Capital Advisors. Consensus reporting estimates SAC’s assets under management (AUM) at $14 billion, at least $10 billion of which is said to comprise the wealth of Cohen and employees of the firm -- $10 billion that rock-star US Attorney for the Southern District of New York, Preet Bharara, asserts was acquired through fraud and should be confiscated.

SAC is thought to operate at a leverage ratio of 4:1, a relatively conservative ratio considering that Wall Street firms often operate at anywhere from 15:1 to 40:1, but enough to likely raise the firm’s estimated market exposure to greater than $46 billion. That would make SAC one of the largest market participants worldwide and a top payer of commissions to the Wall Street counterparties who execute trades on their behalf. In comparison, the Lehman Brother’s bankruptcy in 2008 is said to have wiped out nearly $48 billion of shareholder value.  Although not an apples-to-apples comparison, the possibility of an evaporation of liquidity to this degree, even temporarily, has many questioning the potential systemic implications of a sudden SAC exit from financial markets. Some have suggested SAC’s counterparties could or should reduce the availability of leverage to SAC, although much of this speculation died quickly given that non-professional investors with $100,000 or more to invest can readily obtain a “portfolio margin” of 6:1 from most major US brokerage firms today. That would mean SAC could increase its leverage 50% above current levels without raising any eyebrows. Score one for Cohen.

SAC sent an internal email to employees last Friday stating that in its negotiations with regulators, it managed to come to an agreement that would ensure “business as usual” throughout the ongoing investigation. Meanwhile the indictment’s gravity has no doubt permeated the psyche of Cohen, SAC’s attorneys, employees of the firm, and the Street in general, which raises the question as to whether the government was too quick to agree to certain terms while the investigation continued. In trading and in life, the party who has the benefit of time on his or her side retains the edge.  It had widely been assumed an agreement would be reached at the time charges were announced, and therefore we can derive that regulators were aware that a major fallout was possible -- a shock that could whiplash five years of unprecedented economic accommodation, send still-bruised world economies spiraling, and bring financial markets in the US and abroad back to their proverbial knees. Runner on first.

It’s hard to imagine that any hedge fund under severe regulatory scrutiny, such as SAC, would even trade directly in the equity issues of public companies given the new landscape of exchange traded funds (ETFs). It’s long been stated that as much as 75% of any company's equity return was more attributable to its sector than its own merit. ETFs offer traders and investors more than plain-vanilla equity exposure alone. Double- and triple-leveraged ETFs are commonplace and offer exposure to nearly every tradable instrument known to mankind. SAC still at bat, runners on first and second, no outs.

And then there’s the current state of the markets. As we sit just below major overhead resistance with markets stretched near the outer limits of their historical metrics, indicating “warning” levels, it probably doesn’t come as a surprise that many traders and asset managers are reticent to commit new, long-term capital to the markets today. Why do traders like pullbacks? Because panic happens fast; it’s exciting and the financial reward for those positioned correctly can be unfathomably great even in the shortest of time frames -- many times the average return of a meandering bull market in respect to time duration of investment.  

As buying strength wanes, the inevitability of a strong, broad market decline comes to the forefront; a perfect-storm situation could arrive just in time for Cohen to make the largest bets (and returns) of his life while everyone is watching -- all in ETFs and ETF derivatives free from accusations of “insider trading.” In fact, should volatility arrive on schedule, Cohen could escape any such judgment entirely through trading the VIX (INDEXCBOE:VIX) alone. Irony. Can you imagine that headline?  “Cohen Trades Fear During SAC Criminal Trial.”  Bases loaded, bucko.

If there’s any truth at all to his skill (and I believe there is, or at least, there was), Cohen’s ability to generate returns far in excess of 100% shouldn’t be discounted. Ordinarily, such returns require a risk-reward profile greater than Cohen may have felt necessary to undertake given his already substantial wealth. We all know to a fault that the SAC indictment has nothing to do with failure to supervise and everything to do with strong suspicion of cheating. If Cohen really wants to silence his accusers, there’s every opportunity for him to do so in a big way on the biggest stage of his life.

Bases loaded, Stevie. Whatcha gonna do?
No positions in stocks mentioned.