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Wall Street: Not Too Big to Jail or Nail

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Billionaire Steven Cohen keeps in his office, at SAC Capital Advisors in Connecticut, a work of art consisting of a giant tiger shark suspended in formaldehyde. A couple of years ago, the shark had to be replaced by another at great expense because it had rotted. At the same time, Cohen displays a refrigerated bust of an artist made from the sculptor's frozen blood which has to be regularly replaced too.

Clearly, Cohen's favorite art pieces are as aggressive, and time-sensitive, as is his trading empire. But his flamboyant and transient world was rocked, perhaps for the last time, this week on July 25 when Cohen's company -- not him personally -- was indicted by federal authorities on five counts of criminal fraud.

The feds maintain that SAC was a culture of corruption and will ask for a return of any ill-gotten gains they prove were made by SAC over the years. This is on top of the $616 million paid in March to securities regulators to settle a civil lawsuit related to improper.

This week's enterprise criminal fraud charges are even more serious and layered on top of another set of administrative charges against Cohen by the Securities and Exchange Commission, in a civil case, that he did not properly supervise two traders who face criminal charges for insider trading this fall.

Clearly, the feds are gunning for SAC's shark tank, the king of the hedge funds and for Cohen, its proprietor. But these multiple investigations represent a blow to hedge funds, who charged rich investors obscene commissions for years. These funds collectively have underperformed the S&P500 for the past five years after 20 years of beating the index by a factor of 15.

But now it's obvious why: Some were involved in shifty practices and the rest benefited mostly from the lending and stock market bubbles created by Wall Street that collapsed in 2008.

At the press conference, U.S. Attorney for the Southern District of New York, Preet Bharara, did not mince words. He described SAC's operating ethics as so loose that they "became a magnet for market cheaters". He noted that despite investigations by outside authorities and its enormous trading volumes -- up to 5% of the U.S. total according to some estimates -- SAC officials never reported suspicious trading to anyone.
Bharara also boasted to the New York media that "nobody was too big to jail".

SAC has denied all wrongdoing and said operations would continue as usual while legal proceedings advanced. But redemptions, as rumors of looming charges spread this year, will be significant. Up to $6 billion has left already, but SAC reportedly still has $15 billion under management, $8 billion of which belongs to Mr. Cohen. He owns 100% of the firm.

The case, if proven, will establish a precedent that a proprietor cannot leverage his wealth off a culture of corruption without consequence. The government will argue that Mr. Cohen was responsible for the actions of those who worked for him while he will argue that he could not possibly have been.

Bloomberg's Jonathan Weil compares this issue of enterprise fraud to charges leveled against Enron's accounting firm Arthur Anderson. The case sank the firm completely.

But these latest charges this week are not a "slam dunk", wrote Weil. "History tells us it [SAC] probably can't [survive a major indictment]; no major U.S. financial-services firm has before. Separately, the Securities and Exchange Commission's enforcement division last week filed an administrative proceeding accusing Cohen of failing to properly supervise two employees now facing criminal insider-trading charges. If Cohen loses, he could be banned from managing other investors' money."

Cohen has not been criminally charged but, if found guilty, he may be banned from managing money for others. But he could still manage his own billions.

Already, authorities clearly want to shut down the firm for "systematic insider trading" that made hundreds of millions in "illegal" profits dating back to 1999. They claim there was a breakdown of internal controls and ethics or "institutional indifference" to wrongdoing.

For instance, investigators cited an email sent to Cohen that indicated wrongdoing. In a memo to employees this week, Cohen's lawyers responded that Cohen didn't read that email because it was one of about 1,000 he received daily.

The Federal Attorney, Securities and Exchange Commission and the FBI have been investigating SAC (and other hedge funds) for seven years and have, thus far, come up with 80 indictments and 73 convictions. The most high profile was the conviction for insider trading of Galleon Group's Raj Rajaratnam along with one of his sources, Raj Gupta, former CEO of McKinsey & Co. and director of Goldman Sachs, Procter & Gamble and American Airlines.

This week's big splash press conference against SAC and Cohen is a blow against a hedge fund industry that has played fast and loose and delivered stunning results that are clearly these days under suspicion. Not surprisingly, SAC investors like Blackstone Group and Citigroup have pulled out of the fund.

The new enterprise charge also raises concerns about SAC among firms that execute its trades, and finance some of its deals, such as Goldman Sachs. Up to 10% of all trading in any given year was done for SAC and in such activities reputation is important.

So will the shark tank survive? That's the $15-billion question on Wall Street these days.

*This article previously appeared in the Financial Post