Stanley Sporkin — former SEC Enforcement Director, CIA general counsel, and federal judge – likes to say that an SEC staff attorney ought to be just as happy closing an investigation as one is bringing a public enforcement action. As a younger staff attorney at the SEC, I understood the principle, but I thought that was some amount of hooey. It seemed like an easy thing to say coming from somebody who’d already made a stunning career and didn’t especially need to run up the score. I was much happier actually suing somebody than shutting an investigation down, thank you. I get it, though. If the facts aren’t there, better to cut your losses and move on to some securities fraud that can be documented with admissible evidence. You can be sure it’s out there somewhere.
I’ve been thinking a bit about Judge Sporkin’s happiness principle since last Friday when the SEC brought an administrative action against Steve Cohen for failing to supervise two portfolio managers who reported to him at his giant hedge fund, SAC Capital. Several things occur to me.
This is a Substantial, and Probably Appropriate Case
Cohen has been in the crosshairs of the SEC and the U.S. Attorney’s Office for some time now, and to some, this administrative case against Cohen seemed like an anticlimax. At Yahoo! Finance’s Breakout, the headline practically screamed: “The SEC Blinks! Steven Cohen’s Wrists Get Slapped, Not Cuffed”. Business Insider editor Henry Blodget, whose work I really like, tweeted, “After all that, Steve Cohen gets accused of ‘failing to oversee’? Clear who won that one.” Politico’s Ben White dismissively added, “Not even close.”
I suspect Cohen is not feeling so victorious, though. And I really don’t think it’s a loss for the SEC. A corollary to the Sporkin principle might be: an SEC staff attorney ought to be just as happy bringing a supportable case as one is bringing a shaky case for fraud under Rule 10b-5. Here, Cohen sits atop a fund empire in which nine current or former employees have been linked to insider trading while working at the firm, including four who have pleaded guilty to crimes. In those circumstances, as Matt Levine at Dealbreaker says, “the SEC really ought to charge you with ‘fail[ing] reasonably to supervise’ your employees, no?” It may simply be that this action was the one best supported by the evidence available, and the SEC decided to bring it. In which case, victory! For this to be a “win” for Cohen, I think one has to assume that (1) there is evidence of Cohen’s illicit trading somewhere in the universe, and (2) the SEC was not capable of digging that evidence up. Good for Cohen, I guess, if that’s the situation.
Also, if the SEC is successful in this matter, Cohen is likely to be at least suspended from the securities industry. Here we have Yahoo! talking about a “wrist slap,” but if this were SMU football in the 1980s, we’d be discussing the “death penalty.” And, the SEC has a case based in negligence, not fraud. It will be much easier to get over that hurdle than it would if it were trying an insider trading case under Rule 10b-5.
The SEC Played Fair with Cohen
Separately, Andrew Ross Sorkin ran an interesting piece on Monday raising the possibility that the SEC had allowed SAC Capital to settle to $616 million in sanctions for insider trading last March, while letting the firm think the agency was done with it. The article quotes a former SEC lawyer now in private practice as saying, “The SEC created expectations in the settlement by strong inference. There is an expectation of reasonable closure.” The lawyer goes on to say, “This could impact the approach to cooperation. You have to believe whatever ambiguities existed were intentional on the SEC’s part. It calls into question whether the agency negotiated in good faith.” I have to say, those who believed the government was through with Cohen after that settlement may have been a bit naïve.
First, Matt Levine forecast this issue in March when he presciently noted that SAC Capital’s $600 million had resolved all of ten days of trading in two securities. Everything else? Still on the table. Second, one of the portfolio managers at issue in the current matter, Matthew Martoma, is headed toward trial in his own criminal case in the Southern District of New York. Prosecutors there have, one assumes and reads, done their level best to flip Martoma and secure his testimony against Cohen. If Martoma had flipped, a criminal case would have followed against Cohen, and this failure-to-supervise matter may have been unnecessary. He didn’t, and the SEC thinks it is necessary. Again, Sorkin’s piece is interesting, but suggesting that the SEC negotiated in bad faith seems a little silly to me.
The SEC May Want to Stick to the Gameplan
For all of the talk about how “easy” the SEC’s path is, the administrative order seems to be pretty focused on alleging that Steve Cohen didn’t just fail to supervise his employees, but sort of insider traded himself. I suspect the Commission doesn’t want to continue down that path if it wants to win this case. Proving 90% of an insider trading case will be less effective than proving 100% of this failure to supervise case.
It’s important to note that Section 203(e)(6) of the Advisers Act provides investment advisers and their supervisory personnel with an affirmative defense to a failure to supervise charge. Cohen will be off the hook if he has (1) established procedures and a system for applying those procedures that reasonably would be expected to prevent and detect securities law violations, and (2) reasonably discharged his obligations under those procedures and system without reasonable cause to believe that the procedures were not being complied with. Pretty mundane stuff, right? But this case will be won or lost here, and not on sort-of smoking guns linking Steve Cohen to actual illicit trades.