The U.S. Department of Justice (“DOJ”) has unveiled a potentially potent new weapon for pursuing financial crimes. On July 25, 2013, U.S. Attorney Preet Bharara criminally indicted Steven A. Cohen’s eponymous hedge fund, S.A.C. Capital Advisors, LP (“SAC”), and its affiliates on four counts of securities fraud and one count of wire fraud related to alleged pervasive insider trading. Such a criminal corporate indictment is rare, but the accompanying civil complaint was in many respects unprecedented. On the same day that it issued the indictment, the U.S. Attorney’s office filed a civil asset forfeiture claim under 18 USC § 981(a)(1) seeking to forfeit “any and all assets” belonging to SAC and its various feeder funds.

The case marks the first time that the DOJ has used the money laundering forfeiture statute as a strategy in a high profile insider trading case. The government argues that by repeatedly and knowingly commingling the illicit gains from insider trading with other legitimate funds to facilitate and promote further insider trading, all of the firm’s assets are subject to forfeiture. The coercive impact of the government’s novel theory is already being felt by SAC. On August 9, 2013, SAC consented to a protective order requiring it to preserve 85% of its assets for potential forfeiture. 

While the government will face a potentially daunting task in proving that it is entitled to SAC’s commingled assets, the case, if successful, could set a new precedent for using the forfeiture statute in insider trading cases. Mr. Cohen can still potentially avoid the forfeiture if he can establish an “innocent owner defense” by showing that he did everything reasonable to prevent the insider trading by investing in compliance, an argument he foreshadowed against the SEC. Alternatively, Mr. Cohen may be able to challenge the forfeiture as an excessive fine under the Eighth Amendment. 

The ultimate outcome of the case could have a significant impact on the way that the government pursues financial crime cases involving alleged pervasive wrongdoing.1

Background

SAC’s consistently exceptional results have drawn the scrutiny of regulators for more than a decade, ultimately resulting in eight SAC employees being convicted or charged with engaging in insider trading. Until this summer, Mr. Cohen had managed to remain relatively unscathed. 

That began to change on November 20, 2012, when the SEC brought civil insider trading charges against SAC and a sixth SAC employee, Mathew Martoma, in the biggest insider trading case yet, involving an alleged $276 million in illicit gains. To the surprise of many, Mr. Cohen was not named as a defendant. An article at the time dubbed Peter Nussbaum, SAC’s general counsel, “Mr. Shark Repellant” for his efforts in building a corporate compliance program that had successfully insulated Mr. Cohen from the circling federal prosecutors and regulators.2 According to the article, “Nussbaum’s huge compliance department, observers said, was built, in large part, because of the perception that the government was determined to bust Cohen.” In April of this year, SAC settled the SEC claims for $616 million. Although Mr. Cohen once again had seemingly secured an outcome that avoided an admission of wrongdoing, the large settlement foreshadowed more trouble ahead. 

Just two months later, on July 19, 2013, the SEC instituted administrative proceedings against Cohen, individually. Those proceedings sought an injunction barring him from serving as an investment adviser based on his failure to properly supervise Martoma and other convicted former employees. On July 22, Mr. Cohen’s counsel submitted a white paper rebutting the SEC’s allegations and emphasizing Mr. Cohen’s “longstanding demonstrated commitment to the firm’s compliance efforts:”

SAC has spent tens of millions of dollars developing and implementing a robust and constantly improving compliance program. It has hired a staff of no fewer than 38 full-time compliance personnel.…SAC’s compliance team, with Cohen’s full support, deploys some of the most aggressive communications and trading surveillance in the hedge fund industry.3

Three days later, the U.S. Attorney responded by unleashing his two-pronged attack on SAC, this time using Cohen’s compliance shield as a sword against the company. In a press conference, Mr. Bharara laid out the case for the seldom-used corporate criminal indictment:

It is, more broadly, an account of a firm with zero tolerance for low returns but seemingly tremendous tolerance for questionable conduct. And so, S.A.C. became, over time, a veritable magnet for market cheaters. The S.A.C. Companies operated a compliance system that appeared to talk the talk, but almost never walked the walk. And that is why today the institution itself--rather than just individuals--stands charged with wire and securities fraud.4

The criminal case advances three claims: (1) that SAC sought to hire portfolio managers and research analysts with proven access to public company contacts likely to possess inside information; (2) that SAC employees were financially incentivized to recommend to Mr. Cohen “high conviction” trading ideas, but were repeatedly not questioned when making trading recommendations that appeared to be based on inside information; and (3) that SAC failed to employ effective compliance procedures or practices to prevent employees from engaging in insider trading.5

In the weeks following the indictment, SAC and its affiliates have continued operations. If convicted, SAC will lose its 1940 Act IA license and will be restricted to managing Mr. Cohen’s money. The four counts of criminal securities fraud are capped at $25 million each, while the wire fraud charge is limited to twice the benefits from the wire fraud. At the time of writing, SAC is purportedly in talks with the government to settle the criminal charges for more than $1 billion.

The prospect of a financial “death penalty” is more likely to come from the second prong of Bharara’s offensive—the civil forfeiture suit. SAC has already committed to preserve 85% of SAC’s aggregate value as of July 1, 2013 as part of a forfeiture award.

Civil Forfeiture

Originally enacted as a powerful tool for pursuing drug cartels and other organized crime, the civil money laundering forfeiture statute authorizes the government to seek the forfeiture of “any property, real or personal, involved in” a violation of the money laundering statutes “or any property traceable to such property.”6 The money laundering statutes in turn prohibit knowingly conducting a financial transaction that involves the proceeds of “specified unlawful activity” with the intent either (1) to promote the carrying on of the specified unlawful activity; or (2) to conceal the unlawful activity.7 These are respectively referred to as the promotion theory and the concealment theory for money laundering. The list of specified unlawful activity includes almost all of the significant white collar statutes, including the ubiquitous mail and wire fraud provisions, which the government chose to rely on against SAC.

The SAC forfeiture case marks the first time that DOJ has used the money laundering forfeiture statute to pursue insider trading gains. The government is seeking forfeiture of “any and all assets” belonging to SAC and its feeder funds based on a promotion theory:

[A]t various times between 1999 and 2010, employees and agents of the SAC entity defendants used assets in the SAC investment funds to engage in insider trading that was substantial, pervasive, and on a scale without known precedent in the hedge fund industry….the illicit profits from insider trading were knowingly commingled with other capital in the SAC investment funds and used, inter alia, to promote further trades based on inside information.”8

To carry its burden of proving that the SAC assets are subject to forfeiture, the government must “establish that there was a substantial connection between the property and the offense.”9 In order to seize fungible property, like money, the government is required to prove that the money is traceable to a money laundering violation—the so-called tracing requirement.10

Commingling

In the past, the government has attempted to sidestep the potentially onerous tracing requirement under the theory that commingled innocent funds facilitate concealment. At least one Southern District of New York case has held that legitimate funds in a bank account commingled with “tainted funds” can be seized where “the deposits of legitimate monies facilitated the money laundering by providing a cover for the illegitimate funds.”11 In that case the defendant had transferred the proceeds from his illegal scheme to sell green cards to six separate bank accounts where he commingled the proceeds with legitimate personal funds. The court found that the fact that the defendant opened the accounts during the same period he began the scheme “strongly suggests that the Six Accounts were maintained solely for the purpose of disguising the source of the proceeds of his illegal activity.” Any legitimate money in the accounts “would serve to further disguise the source of the illegitimate funds and to make the proceeds of the green card scheme more difficult to trace,” thereby facilitating the money laundering scheme and subjecting the legitimate funds to forfeiture.12

However, the facilitation theory is not without limits. “Merely pooling tainted and untainted funds in an account does not, without more, render that account subject to forfeiture.”13 Another court in the Second Circuit held that in order to forfeit innocent funds the government must allege that they in fact facilitated the money laundering itself.14 In Contents in Account No. 059-644190-69, the government advanced the position that “the commingling of funds is itself evidence that the innocent funds were used to hide the tainted funds.” The court rejected that approach, describing the theory as a “nearly limitless contagion the government seeks to release into the banking system” and finding that accepting such an approach would render meaningless the § 981 tracing requirement. “If the tracing requirement in § 981 is to be given any effect—as, indeed, it must—then the government is required to demonstrate something more than the fact of commingling, even across a series of complicated transactions, to establish that legitimate money is forfeitable by virtue of its commingling with tainted funds.”15

As demonstrated by the cases cited above, the vast majority of cases applying the facilitation theory to commingled innocent funds have found that the innocent funds facilitated the concealment of the tainted funds. It is unclear how this commingling theory would apply to the government’s promotion theory. Stefan Casella, former Deputy Chief of the DOJ’s Asset Forfeiture and Money Laundering Section, has written that “it is not obvious how clean money that just happens to be present in an account can be said to be involved in an offense that has no conceal or disguise element, but instead involves only the deposit, withdrawal, or expenditure of dirty money.”16 If the government is held to a strict tracing requirement, the burden of tracing tainted funds through hundreds if not thousands of subsequent trades will be onerous to say the least.

Innocent Owner Defense

While it remains to be seen whether the government will be able to trace substantial profits to early insider trading gains, Mr. Cohen’s best shot at protecting his fortune will be asserting the statutory “innocent owner defense.”17 To establish the affirmative defense, Mr. Cohen has the burden of proving that either he did not know of the insider trading involving his funds or upon learning of the conduct giving rise to forfeiture, he “did all that reasonably could be expected under the circumstances to terminate such use of the property.”18

After having eight employees convicted or charged with insider trading, Cohen’s innocent owner defense will likely turn on whether SAC’s compliance program meets the second standard. The test has been described as “an objective test with a limited subjective component: ‘[T]he question is what measures were reasonable under the particular circumstances confronted by the property owner in question. Those circumstances may include the property owner's reasonable fears and concerns, its degree of familiarity with crime prevention, and its economic resources.’”19

The statute provides two examples of ways that an owner can establish reasonable conduct: (1) by giving timely notice to an appropriate law enforcement agency of information that led the owner to know the conduct giving rise to a forfeiture would occur or has occurred; and (2) by revoking permission for those engaged in such conduct to use the property or by taking reasonable actions in consultation with a law enforcement agency to discourage or prevent the illegal use of the property.20 Mr. Cohen is unlikely to invoke either defense. 

Mr. Cohen’s legal team has sought to use SAC’s “robust, industry-leading compliance program” as a shield in defending Cohen in the SEC administrative action seeking to bar him from serving as an investment adviser. He is likely to invoke these same arguments as part of his innocent owner defense to forfeiture. In sharp contrast, the forfeiture complaint alleges the SAC entity defendants “further enabled and promoted the insider trading scheme by employing limited compliance measures designed to detect or prevent insider trading.”21

Whether Cohen will prevail in establishing an innocent owner defense will depend on how the jury resolves the contrasting characterizations of SAC’s compliance program. The following are some representative examples.

Hiring practices

The government alleges that SAC placed “an emphasis on hiring personnel with company contacts in their respective sectors,” citing a 2008 write-up which described a candidate as “the guy who knows the quarters cold, has a share house in the Hamptons with the CFO of [a Fortune 100 industrial sector company], tight with management.”22The government also alleges Cohen hired Richard Lee as a trader despite receiving a warning that Lee had a reputation for insider trading and objections from SAC’s legal department. Mr. Lee recently pled guilty to insider trading charges.

Meanwhile, Mr. Cohen cites hiring due diligence as one of the bedrocks of SAC’s compliance program: “The firm has an independent due diligence function that reviews the candidate and conducts reference checks. In several instances, thanks to its due diligence process, SAC has refused to hire an investment professional candidate because of compliance-related concerns with the candidate’s information gathering strategy.”23

Training

The government alleges that Mr. Cohen “fostered a culture that focused on not discussing Inside Information too openly, rather than not seeking or trading on such information in the first place.”24The indictment cited a July 29, 2009 instant message sent by a newly hired SAC employee to Mr. Cohen in which the employee relayed to Mr. Cohen that he planned to short-sell Nokia based on some “recent research.” “The New [Portfolio Manager] apologized for being ‘cryptic’ but noted that the head of SAC compliance ‘was giving me Rules 101 yesterday- so I won’t be saying much [.] [T]oo scary.”25 According to the indictment, Cohen did not react or respond to the message.

Mr. Cohen’s lawyers describe a starkly different environment, citing SAC’s “mandatory compliance training sessions covering, among other things, the firm’s insider trading policies and the firm’s legal obligations to avoid insider trading.”26

Management’s failure to investigate red flags

The government has emphasized that “SAC’s compliance department contemporaneously identified only a single instance of suspected insider trading by its employees in its history.”27 The indictment acknowledged that it was Cohen that “initially inquired about the trading” but that despite this “the consequences were limited.”28 SAC imposed monetary fines on the two offenders, but allowed them to keep their jobs, and failed to report the insider trading to any regulatory or law enforcement personnel.

Meanwhile, Cohen’s lawyers assert that “Cohen has himself exemplified the firm’s expectation that compliance is the responsibility of all of its employees. As the firm’s emails reflect, Cohen has frequently forwarded to compliance staff communications he receives that caused him concern.”29

Excessive Fines Analysis

If Cohen is unable to establish an innocent owner defense, a remaining option is to challenge the forfeiture under the Eighth Amendment’s prohibition against excessive fines. The touchstone of the constitutional inquiry under the Excessive Fines Clause is the principle of proportionality: The amount of the forfeiture must bear some relationship to the gravity of the offense that it is designed to punish. A punitive fee violates the Excessive Fines Clause if it grossly disproportional to the gravity of a defendant’s offense.

Conclusion

Both parties face significant obstacles in staking out their respective claims in the civil forfeiture case. The outcome of this battle could have ramifications for future insider trading and similar prosecutions. Until the outer bounds of civil forfeiture are established, the prudent course for any corporation or organization is to ensure that its compliance and oversight programs meet the standard for an innocent owner.

1Just prior to publication—on November 4, 2013—the U.S. Attorney’s office announced that the parties reached a settlement to resolve both the criminal and civil forfeiture cases for $900 million each. The government agreed to credit the $616 fine SAC paid to resolve a related insider trading case against the forfeiture amount, resulting in a total penalty of $1.2 billion. The relatively low forfeiture amount could suggest faltering confidence in the government’s novel commingling theory. However, the government stressed that the settlement does not provide any individual with immunity from prosecution. The government may seek to pursue additional forfeitures if new evidence emerges directly linking Cohen to insider trading.

2Click here.

3July 22, 2013 White Paper Regarding the SEC’s Administrative Proceeding Against Steven A. Cohen for Failure to Supervise, 2, 33-34 (hereafter “White Paper”).
4Preet Bharara July 25, U.S. Attorney for the Southern District New York, SAC Capital Prepared Remarks (July 25, 2013), available here.
5Sealed Indictment at ¶ 6, United States v. S.A.C. Capital Advisors, L.P., No. 13 Crim. 541 (SDNY July 25, 2013).

618 U.S.C. § 981(a)(1)(A).
718 U.S.C. 1956(a)(1)(A)(i)-(ii).
8Application for a Post-Complaint Consensual Protective Order Pursuant to 18 U.S.C. § 983(j)(1) at 4, United States v. S.A.C. Capital Advisors, L.P., No. 13 Civ. 5182 (S.D.N.Y. August 9, 2013).
918 U.S.C.A. § 983 (c)(2); Von Hofe v. United States, 492 F.3d 175, 179-80 (2d Cir. 2007).
10United States v. Contents in Account No. 059-644190-69, 253 F. Supp. 2d 789, 794 (D. Vt. 2003).
11United States v. Contents of Account Numbers 208-06070 & 208-06068-1-2, 847 F. Supp. 329, 334 (S.D.N.Y. 1994).
12Id. at 335.
13United States v. Tencer, 107 F.3d 1120, 1134 (5th Cir. 1997).
14Contents in Account No. 059-644190-69, 253 F. Supp. 2d at 799.
15Id. at 800.
16Stefan Casella, The Forfeiture of Property Involved in Money Laundering Offenses, 7 Buff. Crim. L. Rev. 583, 652 (2004).
1718 USC § 983(d).

1818 USCA § 983(d)(2(A)(i)-(ii).
19United States v. 16328 S. 43rd E. Ave., Bixby, Tulsa Cnty., Okla., 275 F.3d 1281, 1285-86 (10th Cir. 2002) (quoting United States v. Lot Numbered One (1) of Lavaland Annex, 256 F.3d 949, 955 (10th Cir. 2001)).
2018 U.S.C.A. § 983(d)(2)(B)(i)(I)-(II).
21Verified Complaint at ¶ 37.
22Sealed Indictment at ¶ 17.

23White Paper at 37.
24Verified Complaint at ¶ 23.
25Id.
26White Paper at 38.
27Sealed Indictment at ¶ 28.
28Id.
29White Paper at 34.