Introduction
"Black Edge" by Sheelah Kolhatkar is a gripping account of the rise and fall of Steve Cohen, one of Wall Street's most successful and controversial hedge fund managers. The book takes readers deep into the world of high-stakes trading, insider information, and the relentless pursuit of profit on Wall Street.
Kolhatkar, an investigative journalist, meticulously unravels the complex web of insider trading allegations surrounding Cohen and his hedge fund, SAC Capital Advisors. Through extensive research and interviews, she paints a vivid picture of the cutthroat culture of Wall Street and the lengths some traders will go to gain an edge over their competitors.
At the heart of the story is the concept of "black edge" - highly valuable, non-public information that can be used to make profitable trades. The book explores how Cohen and his firm allegedly sought out and exploited this type of information, pushing the boundaries of legality and ethics in their quest for astronomical returns.
The Rise of Steve Cohen
Early Years and Natural Talent
Steve Cohen's journey to becoming a Wall Street titan began in a middle-class family on Long Island, New York. From a young age, Cohen displayed a fascination with finance and a natural talent for trading. As a student at the prestigious Wharton School at the University of Pennsylvania, he honed his skills by reading the Wall Street Journal religiously and playing poker with fellow students - often coming out ahead.
Cohen's innate ability to read markets and make quick decisions served him well when he landed his first job at Gruntal & Co., a New York brokerage firm, in 1978. At just 21 years old, he quickly made a name for himself by generating impressive profits. In one particularly memorable afternoon, Cohen made $4,000 - a substantial sum for a rookie trader in the late 1970s.
Early Success and Controversy
As Cohen's career at Gruntal progressed, he continued to rack up impressive gains, earning between $5 million and $10 million annually. However, his meteoric rise was not without controversy. In 1985, Cohen faced his first brush with regulatory scrutiny when the Securities and Exchange Commission (SEC) investigated his trading activities.
The investigation centered around Cohen's profitable trades in RCA stock just before General Electric announced its takeover of the company. Cohen had received inside information about the impending deal through a friend and used it to make a staggering $20 million profit. Although the criminal case was eventually dropped, this incident foreshadowed the ethical questions that would dog Cohen throughout his career.
The Birth of SAC Capital
Striking Out on His Own
By 1992, after 14 years at Gruntal, Cohen had established himself as a respected figure on Wall Street. Ready to take his success to the next level, he decided to strike out on his own and founded SAC Capital Advisors. The hedge fund, named using Cohen's initials, started with a modest $23 million in assets and just nine employees.
Rapid Growth and Spectacular Returns
SAC Capital's growth was nothing short of phenomenal. Within three years, the fund had quadrupled in size to $100 million. The momentum continued, with assets doubling each year and surpassing the $1 billion mark by 1999. Cohen's personal wealth skyrocketed, and he quickly became one of the richest men on Wall Street.
The Secret to SAC's Success
Cohen's trading strategy at SAC focused on short-term movements in stock prices. His team would gather vast amounts of information about the market each day, make large stock purchases, and then sell them quickly when prices rose. This high-frequency trading approach, combined with Cohen's uncanny ability to read market trends, led to consistent, outsized returns that seemed almost too good to be true.
As SAC grew, Cohen recognized the need to evolve his strategy to maintain the fund's edge. He began hiring traders with deep knowledge and expertise in specific industries, seeking out those with personal connections that could potentially provide valuable intelligence. This shift towards seeking out "fundamental edge" would prove to be a pivotal moment in SAC's history.
The Culture of Insider Trading at SAC
Systematic Pursuit of Inside Information
As SAC Capital continued to grow, a culture developed within the firm that prioritized obtaining and trading on inside information. Cohen and his team actively sought out traders who had connections to industry executives or other potential sources of non-public information. The goal was clear: to gain any advantage possible in predicting stock movements before the rest of the market.
Expert Networks and Information Flow
One of the primary methods SAC used to gather valuable information was through "expert networks" such as Gerson Lehrman Group. These networks connected investors with company executives for paid consultations. While these meetings were ostensibly designed to provide general industry insights, they often resulted in executives dropping valuable hints about upcoming announcements or company performance.
SAC traders were encouraged to leverage these networks and their personal connections to gain an edge. The pressure to deliver consistent profits was intense, and the line between legitimate research and insider trading became increasingly blurred.
Accusations of Market Manipulation
By the mid-2000s, SAC's outsized returns had attracted attention not just from investors, but also from regulators and competitors. In 2006, the firm faced accusations of manipulating stock prices from two Canadian companies: Biovail, a drug manufacturer, and Fairfax, an insurance company.
These companies alleged that SAC had spread false and negative reports about their performance and business practices, causing their stock prices to drop. SAC traders then profited by betting against these companies' success. While these accusations were difficult to prove, they added to the growing suspicion surrounding SAC's trading practices.
The Bapi Scandal: A Turning Point
The Promise of an Alzheimer's Breakthrough
In 2008, SAC became embroiled in what would become one of the most significant insider trading scandals in Wall Street history. The case centered around the development of a potential breakthrough drug for Alzheimer's disease, known as Bapineuzumab or "Bapi."
Two pharmaceutical companies, Elan and Wyeth, were working on Bapi, and the potential for massive profits from a successful Alzheimer's treatment caught the attention of Wall Street investors, including SAC Capital.
Mathew Martoma and Dr. Sidney Gilman
Mathew Martoma, an SAC trader, took a particular interest in the Bapi trials. He cultivated a relationship with Dr. Sidney Gilman, the chair of Elan's safety monitoring committee and a key figure in the drug's development. Despite having signed a confidentiality agreement, Dr. Gilman was persuaded by Martoma to discuss confidential details about the Bapi trials.
The $276 Million Trade
Based on the positive information initially provided by Dr. Gilman, Cohen and Martoma accumulated over $700 million worth of Elan and Wyeth stocks. However, as the final test results approached, Martoma learned from Dr. Gilman that Bapi was not as promising as initially thought.
On July 20, 2008, just days before the official announcement of the trial results, Martoma called Cohen with this crucial information. They quickly agreed to sell off their positions and even short the stocks. When the disappointing Bapi results were officially released on July 28, Elan and Wyeth's share prices plummeted. Thanks to their advance knowledge, SAC had avoided massive losses and instead made a profit of $276 million.
This trade would later become a central focus of the investigations into SAC's trading practices and would ultimately play a significant role in the downfall of the firm.
The Walls Close In: Regulatory Investigations
FBI and SEC Take Notice
By the late 2000s, US regulatory authorities had begun to take a closer look at insider trading practices on Wall Street, with a particular focus on hedge funds. In 2009, the FBI launched a secret investigation into SAC's business practices, searching for evidence of suspicious trades.
The FBI's strategy was to start with junior analysts and work their way up the chain, hoping to gather enough evidence to eventually implicate Cohen himself. They found their first lead in Jonathan Hollander, a former junior analyst at SAC who had traded stock in Albertsons based on inside information about an impending takeover.
The SEC Joins the Hunt
Simultaneously, the Securities and Exchange Commission (SEC) began its own investigation into SAC's trading activities. They were particularly interested in the firm's suspiciously successful trades in Elan and Wyeth stocks just before the Bapi trial results were announced.
The Investigation Goes Public
On November 19, 2010, the Wall Street Journal published an article detailing the FBI's and SEC's investigations into SAC Capital. This public revelation sent shockwaves through Wall Street and put SAC traders on high alert. Many scrambled to destroy potential evidence, complicating the ongoing investigations.
Martoma and Gilman in the Spotlight
In May 2011, the authorities had their first major breakthrough when they identified Mathew Martoma as the SAC trader who had been in contact with Dr. Sidney Gilman regarding the Bapi trials. The investigators discovered that Martoma had contacted Cohen shortly before SAC sold off its Elan and Wyeth shares, providing a potential link between the insider information and Cohen himself.
As they dug deeper into Martoma's background, the investigators uncovered more red flags. They learned that Mathew Martoma was not his real name - he was born Ajai Thomas and had changed his name after being forced to leave Harvard Law School for forging his transcript grades.
The Noose Tightens: Arrests and Settlements
Martoma's Arrest
In late 2012, after months of investigation and questioning, the FBI finally had enough evidence to arrest Mathew Martoma. He was charged with insider trading related to the Bapi scandal and faced up to ten years in prison.
SAC's Record-Breaking Fine
As the legal pressure mounted, Cohen and SAC Capital sought to contain the damage. In the spring of 2013, SAC agreed to pay a record fine of over $600 million to settle the insider trading cases. Cohen hoped that by writing a large check, he could make the legal issues disappear and protect himself from further scrutiny.
The Dell Email and Additional Charges
However, the SEC was not finished with SAC or Cohen. They uncovered an email linking Cohen to another instance of insider trading involving Dell computer stock. This new evidence led to an additional settlement, with SAC agreeing to pay another record fine of $1.2 billion in July 2013.
Cohen's Legal Strategy
Throughout the investigations and legal proceedings, Cohen's lawyers employed a clever strategy to protect their client. When confronted with evidence like the Dell email, they argued that Cohen received thousands of emails daily and only read a small fraction of them. This made it difficult for prosecutors to prove that Cohen had knowingly acted on inside information.
Martoma's Sentencing and Cohen's Escape
In the fall of 2014, Mathew Martoma was sentenced to nine years in prison for his role in the insider trading scheme. Despite being offered multiple opportunities to cooperate and potentially reduce his sentence by testifying against Cohen, Martoma remained silent.
Remarkably, Steve Cohen himself was never convicted of any criminal charges. While his firm paid billions in fines and several of his traders went to prison, Cohen managed to avoid personal legal consequences.
The Aftermath: Cohen's Continued Success
Rebranding and Moving Forward
In April 2014, Cohen rebranded the tarnished SAC Capital Advisors as Point72 Asset Management. Despite the legal troubles and negative publicity, Cohen's reputation as a brilliant trader remained intact among many on Wall Street.
Continued Wealth Accumulation
Perhaps the most striking aspect of the SAC Capital saga is that Steve Cohen not only avoided jail time but continued to amass enormous wealth. In 2014 alone, the year after his firm paid billions in fines, Cohen personally earned $2.5 billion.
Lessons and Implications
The Culture of Wall Street
The story of Steve Cohen and SAC Capital provides a revealing look into the culture of Wall Street, where the pursuit of profit often overshadows ethical considerations. The pressure to deliver consistent, market-beating returns can drive even successful firms to push legal and moral boundaries.
Regulatory Challenges
The case also highlights the challenges faced by regulatory agencies in policing complex financial crimes. Despite years of investigation and mountains of circumstantial evidence, prosecutors struggled to definitively prove insider trading charges against top executives like Cohen.
The Power of Wealth and Connections
Cohen's ability to avoid personal criminal charges, despite the downfall of his firm and the conviction of several employees, demonstrates the power of wealth and connections in the financial world. His story raises questions about accountability and justice in white-collar crime cases.
The Persistence of Insider Trading
Despite increased regulatory scrutiny and high-profile cases like SAC Capital, insider trading remains a persistent issue on Wall Street. The potential for enormous profits continues to tempt traders and executives to seek out and exploit non-public information.
Final Thoughts
"Black Edge" offers a fascinating and troubling look at the inner workings of one of Wall Street's most successful hedge funds. Sheelah Kolhatkar's meticulous reporting and engaging narrative style bring to life the complex world of high-finance and the characters who inhabit it.
The story of Steve Cohen and SAC Capital serves as a cautionary tale about the dangers of unchecked greed and the corrosive effects of a win-at-all-costs mentality. It also raises important questions about financial regulation, the nature of insider trading in the modern era, and the challenges of proving such cases in court.
Ultimately, "Black Edge" leaves readers with a deeper understanding of the mechanisms behind Wall Street's biggest scandals and the ongoing struggle to create a fair and transparent financial system. While Steve Cohen may have escaped legal consequences, his story serves as a stark reminder of the ethical challenges facing the financial industry and the work that remains to be done to ensure accountability and integrity in our markets.
As Wall Street continues to evolve and new financial instruments and technologies emerge, the lessons from the SAC Capital saga remain relevant. The pursuit of "edge" - whether black, grey, or white - will likely continue to drive behavior in the financial world. It falls to regulators, lawmakers, and ethical market participants to ensure that the quest for profit does not come at the expense of fairness and integrity in our financial markets.