Hedge fund investors divided on SAC probe

A pair of hands resting on prison bars
Pension plans worry about reputational risk associated with investing in a rogue manager

In March, Steven Cohen set a record in the art world when he paid $155 million for ‘Le Rêve’, Pablo Picasso’s portrait of his muse and mistress Marie-Thérèse Walter.

‘Le Rêve’ fetched the highest price ever for a Picasso even though it was badly damaged in 2006 when its former owner, the casino magnate Steve Wynn, accidentally put his elbow through the canvas. By all accounts the painting was expertly repaired and the mishap did not diminish its value.

Cohen hopes investors will feel the same way about SAC Capital Advisors after it agreed to pay a record $616 million to settle allegations of insider trading at two of its affiliated entities.

The settlement was agreed for two separate incidents.  CR Intrinsic Investors, an affiliate of SAC, agreed to pay nearly $602 million, the largest-ever settlement for insider dealing. Sigma Capital Management, another affiliate of SAC Capital, agreed to pay nearly $14 million to settle charges. In a statement SAC welcomed the settlement as “a substantial step toward resolving all outstanding regulatory matters” and said it allowed the company “to move forward with confidence”.

However, SAC faces multiple hurdles. On March 28 a federal judge refused to approve the CR Intrinsic settlement and raised questions about SAC’s refusal to admit wrongdoing in relation to trades in two pharmaceutical stocks that regulators allege resulted in around $275 million of illegal profits and avoided losses.

At a hearing in Manhattan, judge Victor Marrero reserved judgment on the settlement, saying, “There is something counterintuitive and incongruous about settling for $600 million if [SAC] truly did nothing wrong.”

The following day brought further bad news. Federal agents arrested Michael Steinberg, a senior portfolio manager who has worked for SAC since 1997. He is accused of trading on illegal information passed on to him by former SAC analyst John Horvath, who pleaded guilty to insider trading last September.

Federal agencies have now charged or implicated nine current and former SAC employees in their long-running investigation into insider trading at hedge funds.

Cohen was not named as a defendant in the settlement and has not been charged with any crime.

Investors, who redeemed $1.7 billion from SAC’s funds in February, are jittery. “Given the number of people that have been implicated by the authorities, this looks like a systemic problem [at SAC],” says an executive at a hedge fund investment company that does not have money in SAC’s funds.

He expects to see further outflows in mid-May, which is the next deadline for redemption requests.

SAC seems well placed to weather the storm. According to regulatory filings, roughly 60% of the money in SAC’s two largest funds belongs to Cohen and his employees, providing it with a stable base of assets.

Another 20% of SAC’s roughly $14 billion asset base comes from funds of hedge funds (FoHFs), including those managed by divisions of Blackstone Group, HSBC and Morgan Stanley.

This lot seems divided on what to do.

Blackstone is one of SAC’s largest external investors with around $550 million invested in its funds at the end of last year. It has chosen to keep most of its money invested with SAC’s funds after pressing the hedge fund to loosen its redemption terms and provide assurances that legal and settlement costs would not be passed on to investors.

Meanwhile, HSBC’s private bank advised its clients not to put any more money in SAC’s funds earlier this year. However, it is not clear if its FoHF group has redeemed its SAC investments. HSBC is reported to have placed around $500 million with SAC through its private banking and FoHF businesses.

Several other FoHFs have already withdrawn their money from SAC’s funds. Lyxor Asset Management and Titan Advisors put in redemption requests at the end of last year, while Citi’s private bank has also pulled $187 million of its clients’ money from SAC’s funds.

The remaining 20% of SAC’s assets comes largely from wealthy individuals and family offices, according to sources with knowledge of the company’s investor base.

Many of these investors view the settlement favourably and were reassured to see Cohen keep his promise to cover the full cost of the settlement and legal expenses, rather than passing them on to investors.

Some say SAC may have been within its rights to charge the roughly $281 million in disgorged illegal gains and losses avoided to its funds, but such a move would have enraged investors.

“We’re pretty impressed with the way [Cohen] has treated his clients in all this,” says one hedge fund investor who does not have money in SAC’s funds.

However, that may not be enough to win over the large public pension plans and other institutional investors who have largely avoided SAC in recent years.

A number of investment consultants that advise US pension plans on hedge fund allocations say they will not recommend SAC to clients.

A senior figure at one large consultancy says his company made an active choice to steer clear of SAC and has no plans to change its position because of the settlement.

Other consultants to pension funds express similar views.

One investment consultant acknowledged that while investors have not suffered any losses in recent insider trading cases, the reputational risk associated with being invested in a rogue manager is a major concern for public pension plans, which tend to be highly conservative by nature.

For some at least, reputations are more valuable than Picassos.

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