U.S. Markets close in 3 hrs 26 mins

SAC Is Going Down but Does it Help Main Street?

SAC Is Going Down but Does it Help Main Street?

Yesterday U.S. Attorney General of the Southern District of New York, Preet Bharara, achieved what many think is his greatest ambition when he charged SAC Capital Advisors and by association their founder, Steven A. Cohen, with criminal responsibility for insider trading.

For the record, SAC pled innocent on Friday. The point is largely moot. SAC is finished running outside money whether they know it or not. Clients can't afford to be involved with a firm being charged with illegal conduct. Outside money will leave SAC. It's inevitable, but does it matter?

Bharara says SAC "fostered a culture that focused on not discussing inside information openly rather than not seeking or trading on such information in the first place." The way SAC went about these activities involved, in effect, setting up more than 100 smaller funds in which the company had a stake.

Related: SAC Capital Indicted for Criminal Securities Fraud

Those smaller funds would then kick their best idea to SAC. In the words of the complaint:

"... at all relevant times the SAC Owner required each SAC PM [portfolio manager] to share “high conviction” investment ideas- i.e., the investment recommendations in which the SAC PM had the greatest confidence - with the SAC Owner. In fact, providing such ideas to the SAC Owner was an express part of a SAC PM’s duties and was emphasized to SAC PM's in the hiring process and once working at SAC"

For the portfolio managers in question the stakes were incredibly high. If their funds made money, and their high conviction ideas worked, the portfolio managers would make tens of millions of dollars. From the available evidence if either of those conditions weren't met the fund managers would be fired.

Given the culture and hiring practices of Wall Street, what SAC did was hire the very best traders they could find and turn them loose on the world. In a triumphant press conference Bharara described SAC as "a veritable magnet of market cheaters." On that charge he is right. Unfortunately SAC and funds like it, of which there are legions, are also a magnet for the brightest, best, and most aggressive traders and investors on Wall Street.

The problem is that it's hard to tell the difference between crooks and aggressive traders. There is no question certain portfolio managers at SAC engaged in nakedly criminal behavior. That's not the charge here. The question is whether or not SAC intentionally fostered and created a culture of systemic illegal behavior. The answer is going to come down to how insider trading is defined in instances that don't involve trading off of explicitly non-public information before the public has access.

The government says SAC sought analysts who had "an edge." CEO of Baker Avenue Asset Management, Simon Baker wonders what that means. On that front the SEC isn't giving him much help. "It's so opaque," says Baker of where having an edge stops and cheating begins. "Clearly as a good analyst you want to get an edge, that's what you're paying an analyst to do is get better information."

Related: The SEC Blinks! Steven Cohen’s Wrists Get Slapped, Not Cuffed

Is it inside information to trade off rumors? SAC is accused of trading off the advice of a portfolio manager who had a "second hand source" at Dell (DELL). What is a second hand source? A guy who knows a person at the company complaining about work? An executive paid specifically to leak quarterly results in advance?

The answer seems to depend on whatever the government decides.

Why it matters

So who should care if two arrogant ambitious men fight over arcane security laws? Anyone who trades in the market.

Insider trading should be defined and prosecuted not just to stick it to rich fund managers, but to provide more safety to individual investors. To level the playing field. The entire exercise of going after SAC, for instance, is pointless if it doesn't result in ridding the market of criminals.

Dragging down Cohen is emotionally satisfying but that should not be confused with making the markets more fair. Analysts are going to be aggressive in their work because they get paid a ton of money to do so. That's how Wall Street works. If the tools used to keep these traders in check are vague and prosecution is selective all the case against SAC will accomplish is making it terrifying to be an analyst. It will drive evil doers deeper into a hole, in effect making the market less fair to those on the outside.

Unless the case against SAC results in better laws individual investors are better off thinking of it as a battle between an attorney general with enormous ambitions and a rich guy no one likes. That's more disheartening than the charges never being filed at all.

More From Breakout:

Amazon Earnings Disappoint, Shares Move Higher

Google Chromecast: $35 Cable Industry Killer?

Investing in Real Estate Without Buying Property