Circle of Friends (10 page)

Proving the crime of insider trading, the government was beginning to realize, would take something else. In fact, FBI agents and prosecutors were now coming to the conclusion that cracking Wall Street's vast inside trading rings was not unlike cracking the mob since they both operated on the pursuit of profit and an ingrained code of silence.

In both cases, there are very few incentives to cooperate with the government.

What eventually made so many mob cases, besides good detective work, were informants who had
incentive
to flip because of incontrovertible evidence that their own misdeeds would put them in jail for far longer than seven years (or for the five months that Martha Stewart served at a federal women's prison known as “Camp Cupcake”).

That evidence was usually found on a wiretap.

I
t would be several years after Martha Stewart was convicted that wiretaps would gain prominence as an effective tool in combating white-collar crime, particularly insider trading. Federal judges at the time were loath to grant such an invasion of privacy for any other potential crime outside of organized crime and terrorism. They established a pretty high barrier to boot: Investigators would have to prove that they couldn't get incriminating evidence any other way.

Meanwhile, Funkhouser continued to scan his computer database for potential miscreants. By the early years of the millennium, an increasing proportion of stock trading was done by sophisticated computerized programs, though old-fashioned stock picking was still very much in vogue by the ever-swelling ranks of hedge funds looking for a performance edge to justify the high fees they charged to investors.

As regulators examined the data, they began to see certain patterns they didn't see in the past, namely performance that didn't just beat the market over the long haul based on long-term bets on companies' performance—which was the mark of great but honest value investors like Warren Buffett. Instead, they were starting to see traders who
consistently
beat the market and had an uncanny ability to buy or sell stocks at precisely the right times.

Another difference from Buffett: This new group of market geniuses comprised people who were far from familiar names on Main Street, even though they were well-known at the big banks for being great customers because they traded so much and demanded banking services. They were hedge fund traders and they also had a knack for buying or selling stocks right before corporate events—mergers, surprise earnings announcements, you name it—at a profit. They had to know something the public didn't know, and given their size and scope they weren't just making a few bucks à la Martha Stewart (Stewart avoided a loss of around $50,000), but millions of dollars on each trade.

If they were trading illegally, that would mean insider trading had now spread like a cancer through the markets. It was no longer confined to a few dumb-ass players like Sam Waksal, Martha Stewart, or Kathryn Gannon, but had now reached large, established players mainly in the hedge fund business.

High on this list of traders whose records seemed too good to be legal was a guy named Raj Rajaratnam, a Sri Lankan–born trader who ran a hedge firm called the Galleon Group. And another trader drew the fed's attention: a man from Stamford, Connecticut, who ran a firm called SAC Capital and was known simply as “Stevie.”

W
alking through the SAC parking lot in Stamford is a lot like walking through a Ferrari, Lamborghini, or Bentley dealership.

Inside the firm's headquarters, some traders toil for thirteen-hour shifts each day. The most successful earn millions; those who aren't successful are almost immediately shown the door. But those who make it can be set for life after just one good year, earning millions for a single profitable idea.

So aggressive are the traders at SAC that they monitor every change in a stock's performance, however infinitesimal to most investors. “I deal with big funds and they call you when shares move a buck or two away from their trade,” said one analyst who regularly deals with big fund accounts, including the traders at SAC. “But at SAC if a stock goes three cents in the opposite direction of his trade the trader is immediately on the telephone freaking out.”

The reason for the freak-out is the man whose name was on the door, Steve “Stevie” Cohen. Funkhouser barely knew who Stevie Cohen was when trades from his firm, SAC Capital, a massively successful hedge fund, began to appear on his surveillance screens. Cohen rarely appeared in the media, and he kept a low social profile. And yet, right around the time that Martha Stewart was going to jail over lying about her suspicious trades, this little-known trader from Stamford was starting to make investigators jumpy.

Cohen was basically invisible to the public but on Wall Street he was considered a rising rock star. “He's everyone's first call,” then Bear Stearns chief executive Jimmy Cayne would say when Cohen's name came up. Word spread that he was charging his customers almost double the fees of most hedge funds. Whereas the vast majority of hedge funds charge investors 2 percent of their assets under management, and another 20 percent of their returns, SAC charges 3 percent of assets and 50 percent of its returns, and even after subtracting expenses, Cohen had been handing his clients an average of 30 percent in profits since he opened shop.

It was pretty obvious that Cohen's customers were more than happy to pay all those fees and expenses because Cohen and his traders reciprocated with returns far exceeding anything else on Wall Street.

Steve Cohen is known on Wall Street as “a trader's trader” because he might be—at least on paper—the best that ever lived. He began reading the
Wall Street Journal
when he was eleven, trading stocks in high school, hanging out at a local brokerage office in his hometown of Great Neck, New York, and further perfecting his market skills while in college.

He had already made a name—and a small fortune—for himself at the age of thirty at the Wall Street firm Gruntal & Co., albeit quietly. At Gruntal, he was a star trader without a name, known for “reading the tape,” a Wall Street term for traders who look at stocks and their trading patterns, factor in the market chatter, and make money by guessing the stock's next move up or down.

Gruntal was the perfect place for Cohen; it was a no-frills firm for a no-frills guy known for wearing polo shirts instead of tailored suits. More than that, people who know Cohen say it was a replica of what he wanted to start on his own: a firm dedicated to making money trading, and little else.

He stayed at Gruntal for nearly a decade, and launched SAC Capital (his initials) in 1992.

His style of trading was hyperaggressive; the reason for his traders freaking out was that they were on standing orders to make money on small increments of stocks, so-called teenies, which when multiplied with volume could produce big results. He demanded market knowledge that wasn't available on the Internet; he traded so much, he wanted the Wall Street desks that got his commissions to reciprocate in kind, through more and better market intelligence.

As evolving legend would have it, he did it through a trading style that resembled that of a day-trader, rapidly buying and selling stocks. Or as Cohen put it in a speech: “We trade a lot, over twenty million shares a day. A broker's dream come true. We trade fast. . . it's not growth investing. It's not value investing. It's short-term catalyst investing.”

At SAC Cohen soon doubled and tripled the $25 million initial investment he had to work with (half of it his own cash) in just a couple of years. By the end of the decade, he was a billionaire and his fund one of the most successful in the hedge fund business. At the same time, Funkhouser's computers and those now running at the SEC and the Justice Department were picking up disturbing patterns that the profitable trades were often made before corporate events.

How Cohen managed to achieve such consistent, over-the-top success became a matter of fierce debate on Wall Street, in the media, and increasingly among regulators. His friends, mainly at the big banks—those “brokers” he referred to on Wall Street who get paid fees for executing the massive volume of trades from SAC—simply consider him a genius. Larry Fink, the head of the big money management firm BlackRock, described him as an “information junkie,” someone who knows more about stocks than just about anyone else alive.

With that power comes privilege; even people who admire Cohen and his firm say he and his team will use SAC's leverage as a major supplier of trading order flow to get first dibs on research, or market intelligence that's only handed out by Wall Street to its best customers.

All of which is perfectly legal.

What isn't legal—if you believe criticism from competitors and even some former employees—were allegations that SAC used confidential tips as part of their trading strategies. These detractors describe SAC as something close to a sweat shop. Cohen sits in the middle of SAC's massive trading floor listening to investing ideas from traders and portfolio managers and occasionally barking out orders. Traders and portfolio managers need to hit certain yearly performance benchmarks or else face termination. “If you're up fifteen percent one month and down two percent the next you can get fired,” one former trader said. At SAC it's called hitting your “down-and-outs.” Cohen even hired a psychiatrist as a coach for his traders so they can better handle the stress of his daily grind and reach their peak performance.

Those who hit their marks are rewarded handsomely, and when they leave SAC on their own accord to set up their own hedge fund, they can expect to receive an investment from Cohen himself.

It's this pressure to produce, according to people who have worked for Cohen and those who know about his activities, that at the very least creates the environment for traders to push the envelope. As SAC grew through much of the 1990s into the next decade, those whispers began making their way back to investigators, including a growing number of SEC officials, FBI agents, and more than a few prosecutors who began taking a deeper dive into SAC's trading activity and the secrets to Steve Cohen's success.

CHAPTER 3

DO WHATEVER IT TAKES

P
athmark was once the largest grocery chain in the New York City area. It was so successful it remained open twenty-four hours a day, seven days a week, featuring football-field-sized stores that stocked just about everything in the world.

But by the 1990s the chain was falling apart;
Forbes
magazine called its stores “unkempt, dirty, and outmoded” while continuing “to stock scores of the dreary no-frills offerings customers have shunned for years.” Pathmark filed for bankruptcy reorganization in 2000. It secured bank financing and began to rebuild some of its most dreadful outlets. The company would soon emerge somewhat healthier and regain its listing on the New York Stock Exchange.

But Pathmark would never return to its glory days. Not even close. Underscoring its downmarket status, a grungy Pathmark in Long Island, New York, was featured in the Michael Moore documentary
Sicko
, about the healthcare crisis and the poor souls at dead-end jobs with no health insurance coverage.

As bad as things were, Pathmark still had a brand that was recognizable in Middle America. And that brand caught the attention of a white knight, billionaire grocery store magnate Ron Burkle, who in 2005 took a 40 percent controlling interest in the food chain through his investment company Yucaipa Companies.

From the moment Burkle announced his investment, the speculation on Wall Street was that he would do his best to unload the stake when the timing was right. But first he needed to repair a company that suffered from years of neglect, by cleaning up the 140 stores now under his control and replacing the old management with a new one.

It doesn't appear that Wall Street paid much attention to Pathmark's transformation. Shares hovered around $11, and Pathmark continued to lose money. But rival chains did, making offers to buy Pathmark to expand their reach. Burkle, wasting little time, agreed to the first serious offer he received, unloading Pathmark to A&P in a deal that was announced in early 2007. According to media reports, Burkle pocketed around $150 million on the Pathmark sale. He celebrated it in style with a “swanky dinner with Bill Clinton, Jay-Z and Bono,” raved the
New York Post
.

But Burkle wasn't the only one making a fast buck on Pathmark; in fact, someone on Wall Street may have made an even faster one.

H
ow the fuck did Steve Cohen know about the deal?” raged a Pathmark board member to one of the company's corporate attorneys. “Someone has got to tell the SEC!”

The news of SAC's investment in Pathmark slid across the wires on December 21, 2006—a couple of months before the chain's publicly announced sale to A&P. SAC had bought 2.6 million shares, a 5 percent stake, in a money-losing company. Sure, there had been plenty of talk and at least one trade-publication report speculating about a possible Pathmark sale, given Burkle's propensity to wheel and deal. In early December 2006, during Pathmark's third-quarter earnings conference call with Wall Street analysts, Pathmark CEO John Standley was asked by a Wall Street analyst “whether or not you guys may be looking to possibly merge with one of your competitors. . . for instance, A&P. . . . Are you guys looking to possibly do that?”

“We're not making any comments about rumors about anything,” Standley shot back. “We're not going to do that.”

But based on the filing, Cohen's hedge fund appeared to be betting big that Pathmark was on the verge of completing something significant. SAC's timing was possibly too good, one former Pathmark board member recalled in an interview years later.

That's because SAC's December 2006 filing disclosed that it was accumulating shares just as both sides were finally drawing up official merger documents, the board member said. The deal was on schedule to be announced in late February 2007, nearly two months to the day
after
Cohen's fund placed its bet. When the deal was announced as planned in February 2007, shares of Pathmark soared, of course, handing a nice profit to those who saw the deal coming.