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Insider-Trading Probe Looms Over Hedge Fund Titan

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The long string of insider trading cases brought by US Attorney Preet Bharara since the summer of 2011 sheds a light on the challenges that hedge funds like SAC Capital face in the current market environment.

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It was only a matter of time. Hedge fund titan Steve Cohen's SAC Capital Advisors last week received what's known as a "Wells notice" from the Securities and Exchange Commission. That's a signal that the agency is opening a file on the company's activities that may well lead to some kind of civil action.

For years, since the SEC began its far-reaching investigation into insider trading within the hedge fund universe, its probe has led to civil and criminal charges against former SAC traders and investment managers. David Ganek and Anthony Chiasson left SAC to set up Level Global Investors, becoming among the first Cohen protégées to emerge as star hedge fund traders in their own right. Two years ago, however, the insider trading investigation reached Level Global, and the FBI raided the company's offices and ultimately brought insider trading charges against Chiasson, who was by then playing little role in the fund's daily activities.

Ganek and the firm were never charged, but only a few months later Ganek returned capital to investors and closed Level Global – a dramatic turnaround for a former high-flyer who had weathered the financial crisis and had been planning to raise new funds and expand his operations.

As for Chiasson, he's on trial in a Manhattan federal court for trading tech stocks like Dell (NASDAQ:DELL) on tips and information from analysts that prosecutors claim he should have known contained confidential corporate data. Prosecutors allege Chiasson and Todd Newman, a former portfolio manager with Diamondback Capital Management, made more than $60 million in illegal profits from such trades over a two-year period; lawyers for the two men say they didn't realize that the data was confidential.

Other former SAC folks have been hit with civil and criminal charges related to either their personal trading or their new ventures after leaving Cohen's firm. Richard Choo-Beng Lee, co-founder of Spherix Capital, another hedge fund, pled guilty to insider trading charges linked to the Galleon Group case that ended up sending Raj Rajaratnam to prison for 11 years.

Cohen himself has not been accused of any wrongdoing, but each new case has brought the SEC and FBI closer to SAC itself. Last week, regulators and federal prosecutors accused Mathew Martoma, who worked for a division of SAC Capital, of obtaining confidential data about a medical trial for a new Alzheimer's drug. According to the complaint, the regulators claim that Martoma not only traded on the information on behalf of the SAC unit (resulting in a net benefit of $276 million in either outright gains or losses that were averted) but advised Cohen of what was going on. Neither the civil nor criminal complaints filed against Martoma, CR Intrinsic (the SAC entity) or the physician referred to Cohen by name or brought allegations against him or SAC itself.

The long string of insider trading cases brought by US Attorney Preet Bharara since the summer of 2011 does shed a light on the challenges that hedge funds like SAC Capital face in the current market environment. Cohen is one of the biggest and wealthiest hedge fund managers out there today: He has built a multi-billion dollar fortune and can virtually dictate his own terms to his investors, including hanging on to nearly half of the profits made with their money (according to individuals familiar with details of some of the funds he has raised). Cohen himself has described what he does as "information arbitrage."
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No positions in stocks mentioned.
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