Is Steven Cohen the Lance Armstrong of Wall Street?
The seven-time Tour de France winner has apologized to Oprah; can we expect the same from the leader of the world's most profitable hedge fund?
Doping has been rampant among professional cyclists: Of the Tour de France winners between 1996 and 2010, 80% of them have had their victories tainted by positive tests for performance-enhancing drugs. The foremost cyclist of them all, Lance Armstrong, after years of adamant denial, has just admitted to doping in an interview with Oprah Winfrey, and has been stripped of his record seven consecutive Tour de France wins.
In another world where edge is crucial -- Wall Street -- competitors have their own unethical, illegal ways of winning. Sitting at the top of the game, much like Armstrong did as a cyclist, is Steven Cohen, the manager of hedge fund SAC Capital Advisors. So, is Steven Cohen the Lance Armstrong of Wall Street?
Worth $8.8 billion, Steven Cohen is the 106th richest man in the world. An avid art collector, he owns masterpieces by Edvard Munch, Jackson Pollock, Andy Warhol, Jasper Johns, Francis Bacon, Pablo Picasso, and Willem de Kooning.
During the first 10 months of 2012, his hedge fund, SAC Capital, took in $789 million in fees and returns, making it the most profitable hedge fund in the world. Over his 20-year run at SAC, Cohen has averaged 30% returns, and because of it, charges up to 50% in fees, which is among the highest in the business.
Lance Armstrong similarly sat atop the world of cycling. A survivor of testicular cancer which had spread to his lungs and brain, Armstrong won seven Tour de France titles in a row between 1999 and 2005. During that time he had an incredible brand: He was offered endorsements from major companies like Nike (NYSE:NKE), he was given cameos in films such as Dodge Ball, and of course he ran his LiveStrong Company, famous for its once-ubiquitous yellow bracelets (which in turn started that whole colored rubber bracelet craze). It is estimated that he is worth $125 million. That’s a lot less than Cohen, but Cohen doesn’t have seven Tour de France titles and the reputation as one of the world’s greatest athletes. With the doping scandal now mostly behind us, Armstrong no longer has the wins nor the reputation.
In the world of hedge funds and Wall Street, edge comes from knowing information before anyone else. From an essay published in n+1, Gary Sernovitz, a former analyst, wrote this about Steven Cohen, whom he called the "Art Collector":
This is the definition of edge on Wall Street. Before the SEC passed Fair Disclosure rules in 2000 which outlawed the selective release of private information, it was a very common practice at hedge funds to use information from consultants and analysts to get the competitive edge in a very competitive field.
The Art Collector wasn’t that interested in what we thought about companies or industries, competitive advantages or long-term growth. No, the Art Collector’s trading strategy was based on the thesis that one could make money trading stocks by anticipating whether Wall Street’s equity research analysts, collectively, were going to increase or decrease their estimates of how much a company was going to make the next quarter
Though those rules are in place, if you want to stick around at SAC, you have to have edge, and to have edge, you have to know crucial information before the other guys do. Simply put, the atmosphere Cohen has created is too competitive for legitimate approaches alone. Intense research, knowing a company’s financials and history back and forth -- this just is not good enough anymore. Using your brain too much denies the randomness of the market, and that market tends to move when analysts upgrade or downgrade stocks.
In a Bloomberg Businessweek article, a former trader who is now a witness in the government’s investigation into insider trading at SAC (more on that below) was asked if he knew of any hedge fund that didn’t use illegal information. He answered no -- no hedge fund employee can survive without the edge. As Sheekah Kolhatkar puts it in the article, “In this way, trading on nonpublic material information is similar to doping in professional cycling: Once someone like Lance Armstrong starts doing it, everyone else has to as well.”
In cycling, doping has been rampant for much longer than people think (check out Wikipedia’s exhaustive list of doping cases in cycling). Among champion riders, it has been a common thread, particularly since 2000 when the test for erythropoietin (EPO) began. Note this is the same year the SEC’s Fair Disclosure rules were adopted.
EPO is one of the drugs that Lance Armstrong was accused of using. It is a hormone naturally produced in the kidneys that stimulates the production of red blood cells. Putting additional EPO into the bloodstream creates more red blood cells. This allows for more oxygen to enter the bloodstream, giving the doper a better ability to recover and higher endurance. In addition to EPO, Armstrong was accused of using blood transfusions, corticosteroids, and testosterone. In a sport where most of the top competitors were using such drugs, how could he, with such ambition and natural talent, deny himself the edge to allow him to realize his potential? Employees at SAC must feel the same way.
Investigations and Trouble
Cohen’s SAC is at the heart of a six-year, multi-agency (including the SEC and the Department of Justice) investigation into illegal trading activity on Wall Street. The investigation has so far led to 73 convictions or guilty pleas. And it’s not just the little guys that are getting busted: Last year, Raj Rajaratnam, the co-founder of the Galleon Group, was convicted for insider trading.
For years Cohen remained outside of any kind of clear connection to insider trading, but that changed last year. On November 20, Matthew Martoma, a 34-year-old portfolio manager for SAC, was charged with securities fraud for trading health care companies Elan (NYSE:ELN) and Wyeth (BSE:WYETH) with advance, illegal news of a new Alzheimer’s drug. Earlier, when Martoma had invested in the companies without any hedge, he drew skepticism from nearly everyone from the firm, except for Cohen, that is.
On January 23, Martoma pleaded not guilty. He is the eighth SAC employee linked to allegations of insider trading, but the first so closely linked to Cohen himself.
On that same day that Martoma was charged, SAC received a Wells Notice, indicating that civil charges may be coming.
In cycling, the EPO test that began in 2000 started identifying and disqualifying more competitors. Somehow, Armstrong was able to get through his historic winning streak at the Tour de France without testing positive. But in 2006, one of Armstrong’s primary competitors, Floyd Landis, the winner of the race that year, tested positive in a drug test and was stripped of his title.
After years of positive tests and scandals in the cycling world, Landis pointed his finger at Armstrong, with a series of claims that his former teammate had been doping as well. Armstrong adamantly denied the claims as he had done since 2004 when journalists Pierre Ballester and David Walsh published their expose L.A. Confidential.
By 2010, a federal inquiry had begun, and in 2011, the US Anti-Doping Agency began its investigation into Armstrong’s alleged doping. On October 10, 2012, the USADA published its findings, stating that, yes indeed, Armstrong had used performance-enhancing drugs. The Union Cycliste Internationale, the governing body of cyling, decided not to appeal. Moreover, he had led a complicated and wide doping ring in the professional cycling circuit. Allegedly, he was encouraging the pursuit of the edge by proliferating performance enhancing drugs. Like Cohen, his competitiveness had made the edge a necessity.
We have the evidence for Armstrong’s use of performance-enhancing drugs (as much as many of us have had to fight the urge not to believe it), but we don’t have conclusive evidence that Cohen is enhancing his performance at SAC. What we do know is that Cohen’s hedge fund is very competitive, and that his employees need to produce returns and results if they want to stay on. In order to produce consistent returns, it's likely that those employees, like Martoma, are using illegally obtained information that gives them a competitive edge. Martoma is denying illegal activity, but so did Armstrong. Will continued pressure change his tune? Will Cohen eventually be charged? Will he have to apologize to Oprah?
Lance Armstrong has lost his image, his reputation, his record-breaking performance. His cheating was unfair, yes, but he wasn’t playing around with billions of dollars, moving the stock markets, and affecting the world’s economy. Cohen, at his biggest of hedge funds, is.
We are all upset about Armstrong. If it turns out that Cohen is at the heart of illegal insider trading activity at SAC, we should be much more upset with him. At least Armstrong’s performance inspired us, however artificially fueled it may have been. Unfortunately the sport of cycling is tainted, but so is Wall Street, and so is our economy. Illegally enhancing one's performance at a hedge fund, stealing virtually untold amounts of money -- that is the real crime.