Reading Steve A. Cohen’s White Paper in the SAC Insider Trading Case

I’ve followed hedge funds – pooled fund structures that engage in active management often uncorrelated with financial markets – for about a decade.

 

Almost 12 years ago I wrote a Masters paper on Long-Term Capital Management (PDF) in Swinburne University’s Strategic Foresight program. I read Sebastian Mallaby’s history More Money Than God (PDF) and MIT’s Andrew Lo. Hedge funds appeared to be exemplars of Richard Slaughter‘s Institutes of Foresight thesis. More recently, I have thought of hedge funds as possible examples of meso-level, organisational strategic subcultures.

 

Today, I re-watched the PBS Frontline documentary ‘To Catch A Trader‘ (2014) and read the white paper (PDF) from SAC founder Steve A. Cohen’s lawyers in the now-notorious Elan and Wyeth insider trading case. Cohen’s portfolio manager Matthew Martoma was convicted of insider trading and sentenced to jail. Cohen’s SAC was fined millions and is now basically a family office.

 

I’ve had the white paper for over a year but only today got a chance to have a close read of it with an eye on how Cohen’s lawyers describe his trading strategies. I learned to do this when studying strategic foresight methodologies.

 

Some of my summary notes from the white paper:

  • Back of envelope estimate of Steve Cohen’s trading portfolio size in July 2013: $US1,253,000,000.
  • Cohen trades over 80 individual securities a day.
  • Algorithms, direct market access, and dark pools are routinely used for trade execution.
  • The PBS Frontline documentary describes Edge as an informational advantage about market activity.
  • The white paper describes the following as Events: (1) corporate access (competitor announcements; adverse developments); (2) market moving (catalysts, technical analysis); (3) analyst convergence (broker-deal reports; ratings such as downgrades); and (4) market rumours (false market).
  • SAC portfolio managers develop a Company Investment Thesis. This may involve: (1) trimming positions whilst going into earnings announcements; (2) using option hedges to offset long/short positions using a market neutral strategy; (3) anticipating slippage: incremental shifts in share prices due to the timing of executed trades; and (4) responding to risk reviews of large positions.
  • Market price-psychology patterns that Cohen has identified: (1) increases in individual share prices versus S&P 500 declines (deteriorating market) over specific time periods; (2) tests of if positive market reaction is sustainable (possible mean reversion); (3) company news that is ambiguous or less-than-spectacular information that will trigger a decline; and (4) rapid stock appreciation that creates high expectations and the probability of a price decline.

 

The Steve A. Cohen white paper illustrates how to potentially reverse engineer a hedge fund’s trading strategy – as a strategic foresight example – and to not be a Muppet-like naive retail trader.