Wednesday, October 30, 2013

Financial Cases: Hedge Funds versus Banks

Financial Cases: Hedge Funds versus Banks

SAC Capital Advisors is expected to plead guilty to securities fraud and pay a criminal penalty of $1.2 billion.[1]  The firm had previously settled civil charges with the SEC for around $600.  SAC will no longer invest money on behalf of outside clients.  In exchange for the plea, the government will dismiss all its civil forfeiture claims, which sought to seize assets from SAC.  As a result, Stephen A. Cohen and his employees would still have $8 or $9 billion of their own money to invest.

As I discussed yesterday, the Department of Justice recently won a civil fraud case against Bank of America.  The DoJ pursued a civil case because the standard of proof was lower than in a criminal proceeding.
Reassigning Colleagues (2007)
So why is SAC pleading guilty, while Bank of America and most of the other banks are being pursued under civil fraud statutes?  Unquestionably, part of the reason has to be the evidence.  Insider trading which is at the heart of the SAC case, underpinned the Galleon conviction, and has driven other money management prosecutions tends to produce a clear trail of phone calls, emails, and witnesses.  Moreover, in many of these cases, the government has been able to turn an analyst or portfolio manager into a cooperating witness or informant.

The bank cases, which typically involve the sale of mortgage-backed securities, leave a much murkier trail of evidence.  Since banks are extremely complex organizations, especially in comparison to money managers, accountability, intent, and other necessary elements are harder to establish.  It’s also useful to remember that the packaging of mortgages was undertaken under the watchful eye of attorneys.  By contrast, insider trading isn’t conducted with the lawyers in the room.

When the government pursues a hedge fund, it doesn’t much matter if it is suing the management company or the individual managers, since they own the company and usually have most of their net worth invested in the hedge fund.  By contrast, when the government pursues a bank, they are threatening investors.  Typically, management only owns a relatively small stake in the bank, so they have far less at risk than hedge fund managers when the government extracts huge penalties from a bank.

Evidence aside, banks have another thing going for them when it comes to criminal prosecutions.  Prosecutors are well aware that a guilty verdict against a bank could threaten the bank’s charter and result in massive layoffs.  When a hedge fund gets hit, the economic and employment implications are minor.

Even if SAC and the hedge funds are easier to pursue than the banks, you can’t feel too sorry for Stephen A. Cohen.  He gets to keep his billions of dollars and I’m sure he’ll still be welcome in the refined world of New York area charities and the estates in Greenwich.


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