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.

15th June 2013: Requiem For Equity Research Analysts?

In 2003, I did Masters essay post-mortems on the 1995-2000 dotcom bubble (PDF) and the 1998 collapse of the hedge fund Long-Term Capital Management (PDF). It was a turning point: then-Professor Richard Slaughter and I had discussed the more subcultural material I had written for Australia’s 21C Magazine and New York’s Disinformation website. The new material was like a requiem for the 1990s stockmarket, and for equity research analysts, in particular.

 

I kept reading about the dotcom era rise-and-fall of sell-side analysts like Jack Grubman, Henry Blodget, and Mary Meeker. I had my first taste of what being an equity research analyst might be like when I worked on the Smart Internet Technology CRC report Smart Internet 2o10 (PDF). We didn’t get any formal training in security analysis but I did some MBA classes in accounting, strategy, and opportunity evaluation. Our research team developed a qualitative screening methodology using expert consensus and thematic criteria. We did client briefings where we were sometimes asked for market views and stock picks. Then, Blodget wrote some Slate columns; came out with The Wall Street Self-Defense Manual (New York: Atlas Books, 2007); reconciled publicly with Eliot Spitzer; and launched Business Insider as a second act.

 

Still, no-one talked about equity research analysts in the same way as they did when Grubman, Blodget, and Meeker were dotcom stars. Securitization and ‘know your customer’ had replaced disintermediation as industry watchwords. Boris Groysberg’s Chasing Stars: The Myth of Talent and the Portability of Performance (New Haven, CT: Yale University Press, 2010) shifted attention from the foreground of dotcom era sell-side stars to the investment research organisation that the equity research analyst was in.

 

Equity research still featured prominently in CFA Institute training. But the dotcom scandals around Grubman and Blodget changed the public image of equity research. Turney Duff‘s excess-driven and somewhat derivative book The Buy Side (New York: Crown Business, 2013) appeared more attractive than examining analyst buy ratings or developing quantitative factor models. The public glamour of analyst-driven sales has diverted attention from the shift over the last decade to Bayesian probability and other structured analytic techniques that came from intelligence analysis. Buy-side analysis still remains secretive compared with sell-side analyst reports, which now get leaked to internet trading sites.

 

There are a bunch of core books around if you still decide to pursue a career as an equity research analyst:

 

  • The CFA-oriented Equity Asset Valuation (Hoboken, NJ: John Wiley & Sons, 2010) gives some of the core skills needed. Jeffrey C. Hooke’s Security Analysis and Business Valuation on Wall Street (Hoboken, NJ: John Wiley & Sons, 2010), and Martin J. Whitman and Fernando Diz’s Modern Security Analysis: Understanding Wall Street Fundamentals (Hoboken, NJ: John Wiley & Sons, 2013) give further details on security analysis and valuation methods that equity research analysts commonly use.
  • Jeremy Bolland’s Writing Securities Research (Hoboken, NJ: John Wiley & Sons, 2010) discusses the securities report as a writing genre, and the research methods involved.
  • James J. Valentine’s Best Practices for Equity Research Analysts (New York: McGraw-Hill, 2010) is the most encompassing and detailed of the career guides available. Gillian D. Elcock’s How To Get A Research Analyst Job (Herts, UK: 2010) covers the buy-side and asset management. Roy Cohen’s The Wall Street Professional’s Survival Guide (New York: FT Press, 2010) gives a coach’s perspective on how to move from buy-side to sell-side roles; how to format a curriculum vitae that is achievement and results-oriented; and how to prepare for interviews.

 

This suggests that in 2008-10, the equity research analyst role underwent a post-dotcom re-evaluation, during the 2007-09 global financial crisis. Or, equally likely, publishers decided enough time had elapsed from the dotcom era scandals to publish some new books for the next generation of financial professionals.

5th April 2012: Jack D. Schwager’s Market Wizards

http://www.youtube.com/watch?feature=endscreen&v=8SdHlfsA0P4&NR=1

 

Jack D. Schwager‘s book Market Wizards is mandatory reading for traders and out in a new, 2012 edition. Brenda Jubin’s review explains Market Wizard‘s impact, its interviewees, and its influence amongst traders. Schwager interviewed a diverse range of traders about their motivations, strategies and market insights. Schwager’s new book Hedge Fund Market Wizards will be published in May.

 

Market Wizards also reminds me of the fourth volume of interviews with futurists and strategic foresight practitioners that Richard Slaughter, Sohail Inayatullah, and Jose M. Ramos compiled for The Knowledge Base of Futures Studies.

A Challenging Conversation on Integral Futures

The Journal of Futures Studies (Tamkang University, Taiwan) has published a ‘trialogue’ on Integral Futures between colleagues Josh Floyd, Jose Ramos and myself.

The trialogue is an exploratory method that the late ethnobotanist Terence McKenna used at the Esalen Institute and Omega Institute to cocreate new knowledge informed by interdisciplinary expertise.  McKenna’s trialogues featured mathematician Ralph Abraham and biologist Rupert Sheldrake.  More recently, Erik Davis and Douglas Rushkoff have continued the tradition.  The theoretical physicist David Bohm developed a similar method for dialogue and group work.

Floyd, Ramos and I discussed this approach in February-April 2006 after taking three different
iterations of Advanced Professional Praxis a ‘capstone’ project unit in
Swinburne University’s Strategic Foresight program.  Richard Slaughter provided a focal point as he assembled papers for a special issue of the journal Futures (Elsevier) on Integral Futures Methodologies (November, 2007).  For over a decade, Slaughter had synthesised a Futures knowledge base of new frameworks, methodologies and visions.  Informed by Ken Wilber‘s Integral vision, Slaughter proposed Integral Futures as a “broader and deeper” horizon for Futures work.  Wilber and Slaughter galvanised a new cohort of practitioners to develop new Integral Futures methodologies.  Yet new creative horizons may create new problems.

How can Integral Futures practitioners be ethically informed about their new methods?  Our trialogue proposes Embodied Foresight as one possible way to achieve this: the cultivation of ethical sensitivity, situation awareness about the Teacher-Student relationship and pedagogical barriers, and self-reflection on the transformative potential of initiatory knowledge and wisdom traditions.  Or, “foresight-in-context” may anticipate and prevent hazards that might have unforeseen consequences.

The trialogue creates a space for each of us to bring theoretical frameworks and practitioner reflections into the discussion.  Floyd brings expertise in Zen Buddhism, cognitive science and phenomenology, and a familiarity with Wilber and Evan Thompson‘s research.  Ramos brings transcultural experiences in Futures, action research, and postcolonial insights on “model monopolies”.  I added some insights from mid-1990s exploration of the Gurdjieff Work and the Temple of Set, and experiences during Masters studies, publishing and research projects.

From our trialogue’s conclusion:

Embodied Foresight offers some emergent solutions for the individual practitioner to the challenges and difficulties of Integral Futures practice. These reflexive ‘problems’ are part of diffusion, initiation and knowledge transfer in many wisdom traditions. Our ‘trialogue’ has raised several ‘reflexive’ problems-from Teacher-Student relationships and pedagogical barriers to the archetypal dangers of Phobos and Thanatos-that each of us has personally experienced within the Futures Studies community and in other initiatory and wisdom traditions.