The government has told hedge fund titan Steven A. Cohen's SAC Capital Advisors that it is likely to face civil charges over alleged insider trading at the $14 billion firm, a source familiar with the matter said on Wednesday.
SAC told investors on a Wednesday conference call that the Securities and Exchange Commission had issued a so-called Wells notice to the firm, according to the source, who listened to the call.
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This puts new pressure on Cohen, who is one of the world's biggest and best-known hedge fund managers. For years, his firm has been dogged by allegations that it has relied on insider information to deliver an average annual return of 30 percent since Cohen founded it in 1992.
These kinds of returns have made Cohen, 56, a billionaire many times over and drawn large funds of funds and wealthy individual clients to his firm.
The news of the Wells notice also raises questions about SAC's future and how investors are likely to react.
SAC told investors of the notice one week after the arrest of Mathew Martoma, one of its former portfolio managers.
Authorities charged Martoma with using illegally obtained information from a doctor about poor clinical results at two healthcare companies - Elan Corp Plc and Wyeth, which is now owned by Pfizer Inc - to recommend that SAC eliminate a big position in their stocks. This recommendation kept the firm from incurring millions of dollars in losses, the government said.
Also last week, the SEC filed a civil securities fraud charge against CR Intrinsic, the affiliated fund where Martoma worked.
In seeking disgorgement of $276 million in profits and avoided losses against CR Intrinsic, the SEC did not specifically name SAC Capital in last week's civil complaint.
With the arrest of Martoma, the government has now charged five former SAC employees with insider trading while working for the Stamford, Connecticut-headquartered firm. In addition, several others who once worked for Cohen also have been charged with insider trading while working for other hedge funds.
Cohen, who the source said was on the Wednesday morning conference call, has not been accused of wrongdoing.
While 60 percent of SAC's $14 billion in assets belong to Cohen and his employees, the fund's strong and steady returns have made it popular with outside investors as well. Blackstone Group LP has been a long-term investor.
With so much of the money in SAC coming from wealthy investors, the firm may not suffer from the kind of redemptions that a fund dependent on pension fund money might.
The key will be what Blackstone Group's big fund of funds does, as it once had up to $500 million in SAC and is something of a bellwether in the hedge fund industry. Blackstone's investors include smaller and midsize endowments that might get itchy about SAC's Wells notice and pressure the fund of funds to pull its money from the firm.
A spokesman for Blackstone did not return a call seeking comment.
BEARING ALL LEGAL COSTS
On the conference call, SAC President Tom Conheeney again told investors that the firm would bear all costs of defending itself against any legal action, the source said.
Conheeney also said the SEC had questioned Cohen about this matter earlier this year and that he had been responsive to all of the government's questions.
SAC spokesman Jonathan Gasthalter said last week: "Mr. Cohen and SAC are confident that they have acted appropriately and will continue to cooperate with the government's inquiry."
The FBI has been investigating SAC on and off since 2007.
Despite SAC's outstanding returns, the firm's reputation as a rough-and-tumble trading shop has sometimes prompted advisors to tell clients to get out or steer clear of the hedge fund.
Todd Petzel, chief investment officer of Offit Capital Advisors, said he had never invested with SAC because of a lack of transparency, even though he knows of the firm's "incredibly demanding culture" through interactions with Cohen and former SAC employees.
"SAC will tell you that they have incredibly rigorous compliance process," Petzel said. "I'm sure if this ever comes to court they will demonstrate in court all the training that every one of their portfolio managers goes through."
On the other hand, he said Cohen probably protected himself by distancing himself from day-to-day activities.
The SEC usually issues Wells notices, which are often not made public, to give firms plenty of warning that legal action is coming.
In the last year, hedge fund manager Philip Falcone and his Harbinger Capital Partners said they had received such notices. It is not clear when SAC got its notice.
"Certainly the Wells process and the public disclosure that there is a Wells process with respect to a hedge fund is something that is very challenging for the management of the hedge fund," said Stephen Crimmins, a partner at law firm K&L Gates in Washington.
Cohen and his top-flight legal team will probably work around the clock to try to negotiate a resolution and avoid a civil lawsuit, Crimmins said.
"It's a period of intense activity," he said. "It's a period that usually doesn't last that long, so we should expect some more news from SAC."
(Reporting By Svea Herbst-Bayliss and Katya Wachtel with additional reporting by Emily Flitter and Sam Forgione; Editing by Matthew Goldstein and Lisa Von Ahn)