The man who made the regulators bow.

The more I read about legendary market investors or traders, one thing that keeps being highlighted is their willingness to earn more money. If you open any book on history and start reading about anyone who is or has been a participant in the markets, you will definitely come across this undying willingness to earn more money. Someone is obsessed with cars, some with homes; I personally am obsessed with compounding money. Trust me. The longer the compounding, the sweeter the taste.

Whenever I say investing, the possible names that pop up are those legendary investors that I have talked about a million times. But what about trading? Trading is one of the most lucrative segments of investments because it creates liquidity. Trading provides opportunities to buy a security at dirt cheap rates and sell the same at egregious valuations. Basically, it provides us the opportunity to take advantage of short-term discrepancies. It's almost impossible to talk about trading without talking about Mr. Steve Cohen.

Steve Cohen: The man who killed the markets. The man who got away from America's highest legislative authority and the man whose story was pictured in the famous TV show Billions. That's right. The protagonist of the show, Bobby Axelrod, was enacting Steve Cohen. After the Lehman Crisis, when Mr. Raj Rajan was taken into custody by the FBI, one name that kept coming up on the radar was Steve. Steve had made a billion with the help of insider trading. Insider trading is a form of trading where a trader acts on undisclosed information, taking positions before the news becomes public, in order to generate significant alphas. This is a crime all over the world.

A Wharton graduate, Steve had the urge to make money from the very beginning. When he joined Wharton, he became addicted to a fascinating game called poker. There are many similarities between trading and playing poker. To fulfill his ambitions, Steve joined a company called Gruntal at the age of 21. His dedication and genius could be seen by the fact that Gruntal was a loss-making firm and was famous for all sorts of illegal activities. His sole objective in joining this company was to get to know the art of skillfully manipulating markets. He chose this firm because it was loss-making and had no goodwill. The possibility of finding like-minded people was high in Gruntal. In less than a few years, Cohen made profits upwards of a few million dollars. His technique of sharpening the saw before cutting the trees was working wonders. When you make a lot of money in a very short period of time, people usually try to smell something unusual. Steve used to deal with heavy derivative contracts in order to take full advantage of leverage.

Even though he was using derivatives and leverage, his main entree was insider information. One incident that he took full advantage of was when General Electric was acquiring RCA. RCAs management provided him with the following information just before the news went public, making Steve richer by ~$16 million. Don't forget that this was the 90's, and a few million dollars in the 90's were approximately equal to a few hundred million in today's world.

14 years of hard work, insider information, networks, and his sources had uplifted Steve from a normal trader to an elephant in the room. The late Mr. Charlie Munger once said that the world is not driven by greed; it is driven by envy. I wish Steve would have met Charlie in the 90's. His millions weren't sufficient to satisfy his ambitions, and hence he started marching towards billions in full force. Remember, he was still working at Gruntal, and in order to fuel his ambitions, he felt the need to start his own fund, which he eventually did and called SAC Capital. He started with Rs 170 crore under management. Steve was growing faster than bamboo. He had successfully grown his AUM from Rs 170 Cr to Rs 800 Cr in just 3 years. That's a compounded return of 166%. By the end of 1999, Steve was managing more than Rs 8,000 crore. His record is unbeaten. The foundation on which he had grown SAC capital from a few million dollars to a billion was insider information.  

Post-2000, it was becoming harder for Steve to continue with his practices because everything was on record. The longevity of a business can be measured by the ability of the management to adapt to new and unfavorable changes. Considering this, Steve started hiring new traders who were either living under a mile from the headquarters of a listed company or had worked with the SEC in the past. He started offering 4X packages, just to stay ahead of the game. He was literally building an army of ex-presidents, ex-managers, ex-legal heads, and ex-SEC employees. By the end of 2002, he had an arsenal full of nuclear weapons, and their sole priority was profits, profits, and more profits. By the end of 2005, he was among the richest Americans, with a staggering net worth of $10 billion. He started buying average things owned by billionaires, like penthouses, yachts, private jets, etc. The SEC was doubtful because no other player with the same resources and capital had earned anywhere near a few millions, and here was Steve, who was one of the richest Americans.

Finally, in 2006, SAC Capital got its first notice from the SEC for manipulating two stocks: Bio Whales, a Canadian pharma company, and Fairfax, an American insurance company. These companies submitted reports to the SEC stating that false reports had been circulated in the markets about the company and insider information had leaked. SAC circulated so much negativity that these companies had to book tremendous business losses. SAC used to call the promoters of these companies in order to manipulate their moves. They were literally abusing the management in order to get the desired results. Even though these allegations cooled off, the SEC wasn't satisfied with their investigation and continued with it.

They started following their start traders in order to catch a big fish, and the SEC didn't have to wait long. Matthew Martoma, one of the elite traders of SAC, found out that a scientist in America had found the cure for Alzheimer. Almost 50% of Americans face either a minor or major Alzheimer, and hence this company, which Mathew was researching, had prospects of making billions. Dr. Sindy Phill, the doctor whose brain was behind this drug, started befriending Mathew. He signed a confidentiality agreement in order to keep the information from leaking. Dr. Phill undertook a lot of tests and was simultaneously informing Mathew about them, which was further supplied to SAC Capital in order to take advantage. Altogether, SAC Capital made Rs 600 crore in profits by longing this stock.

Wait a minute; the story doesn't end here. Matthew thought that this drug could only cure 50% of the population. What about the remaining 50%? Hence, on July 20th, Steve Cohen started dumping his positions, and simultaneously, SAC Capital took short positions on the stock. Mota Moti and SAC Capital made around Rs 1800 crore on one single bet. SEC was waiting for this, and hence they started targeting small traders of SAC, hopefully leading to Steve Cohen. By the end of 2009, even the FBI had joined the investigation. The SEC captured a guy by the name of Jonathan Hollander. Jonhathan had a friend who worked for a retail company called Albertson and was sophistically sharing insider information about the company with Jonathan. 

Steve knew from the very beginning that every single trader in his firm was manipulating markets and working on insider information. As a prerequisite, Steve asked his traders to write down the reasons why they bought or sold the shares immediately after the trade was taken.  He knew that the SEC was coming for him, and he wanted to safeguard his castle. So, when the SEC actually came, he had it all ready. Every investigation that was in process wasn't public until November 19, 2010, when the Wall Street Journal made it public that the SEC and FBI were hunting for SAC Capital. Matthew was on the hit list. Back when he traded on insiders, Steve and Matthew had signed a confidentiality contract that restricted Steve from disclosing any sort of information. Even though the news was made public about SAC insider activities, the SEC and FBI were unsuccessful in finding any single piece of evidence against Cohen. Matthew was arrested because he confessed his wrongdoings. Matthew was very adamant about revealing one name that the SEC and FBI were looking for. The FBI offered to decrease his jail period if he said those two words, Steve Cohen.

Matthew was finally taken into custody in 2010. All this scrutiny was creating a negative image about SAC Capital, and hence, in order to control the damage, Steve approached the SEC with a proposal to pay Rs 3000 crore as a penalty in order to settle the case. The SEC was frustrated as they had been behind Steve for a few years, and the penalty payment was like a knockout punch for them, demeaning their ability as regulators. The SEC wanted to send a message to all fund managers that doing unethical business wouldn't be tolerated, but they knew that they had failed miserably.

To date, the regulators have been trying to collect evidence against SAC and Steve Cohen but haven't had much success. After the negative publicity at SAC Capital, Steve closed down his fund and started Point 72 Asset Management Company in order to keep printing money. 

The world of hedge funds, investment banking, private equity, etc. is as black as coal. It is very hard for new entrants to create their own brand in the business because these vultures are there to eat your flesh. Insider trading has been the foundation of all the investment gurus that we all admire. It's sad, but it's true. A friend of mine once said that you can either become a good politician and a bad person, or a bad person and a good politician. Balancing both is a sure-shot way to heaven. The same thing applies to the world of business as well. People like Steve Cohen have so much power and money that they can literally challenge the highest legislative authority and their ways of scrutinizing things in order to get favorable results. It's like the story of an alcoholic and his two sons. One becomes an alcoholic, and one becomes a teetotaler because his father was an alcoholic. Perhaps. 

POV: Billions on Netflix is a must.