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The rise and fall of SAC Capital: a story of insider trading

Barbara Alfieri

Finance Division



The making of SAC Capital


SAC Capital Advisors was founded in 1992 by Steven A. Cohen, a trader who had already made a name for himself on Wall Street. Before starting his own fund, Cohen spent fourteen years at Gruntal & Co., a brokerage firm where he built a reputation for generating remarkable profits through short – term trading strategies, eventually managing his own portfolio and a small team of traders. When he decided to go out on his own, he launched SAC with around $20 million in starting capital, roughly half his own money and half from outside investors, giving him both the resources and the freedom to run the fund on his own terms. Strong returns quickly attracted institutional capital and SAC grew into one of the most prominent hedge funds in the industry, known for its high performance and its intense results – driven culture.

 

How hedge funds work


To understand what made SAC distinctive, it helps to first understand what hedge funds are and how they work. At their core, hedge funds are private investment vehicles that pool money from a relatively small number of wealthy individuals or institutional investors, such as pension funds, university endowments or large banks, and deploy it across financial markets with the goal of generating strong returns. However, what sets them apart from more traditional funds is their flexibility, as a matter of fact, they can invest in virtually any asset class, from stocks and bonds to currencies, commodities and derivatives. More importantly, they can employ strategies that conventional funds typically cannot, such as short selling, which involves betting that a stock's price will fall, or leverage, which means borrowing money to increase the size of their positions. This combination allows hedge funds to pursue returns in almost any market environment, including during downturns, which is precisely where the concept of hedging originally comes from, as a way to balance risk across different sides of the market. However, this flexibility comes with a different cost structure, in fact, unlike traditional funds, hedge funds charge significantly higher fees. Indeed, the industry standard is known as 2 and 20, a 2% annual fee on assets under management plus 20% of any profits. Though, SAC pushed this model even further, charging 3% and retaining 50% of gains, terms that investors accepted because Cohen's track record made them feel the premium was justified.

 

SAC’s winning formula


SAC was primarily an equity hedge fund, with stocks at the center of its strategy, but what truly set it apart was the speed and precision with which it operated. Rather than taking long – term positions and waiting for value to emerge over months or years, Cohen and his team moved in and out of trades at a much faster pace, constantly reacting to new information, such as earnings reports, shifts in industry trends and macroeconomic signals, with the goal of identifying stocks that the market had temporarily mispriced and acting on them before anyone else could. Therefore, to sustain that edge, Cohen built a large team of analysts and portfolio managers, each specializing in a specific sector such as healthcare, technology or energy. Indeed, their job was to develop a deeper and more timely understanding of their industries than the broader market had, feeding that insight to portfolio managers who were then given considerable autonomy to act on it. Cohen himself sat at the center of this operation, known for his ability to process vast amounts of information quickly and make sharp decisions under pressure. He reportedly tracked positions across the entire fund in real time, overseeing a culture where performance was the only currency that mattered, therefore, those who delivered were rewarded generously while those who didn't were moved on quickly.

 

Too good to be true


At its peak, the fund managed over $15 billion in assets and posted returns that few competitors could match, however, those returns, as impressive as they were, would eventually raise uncomfortable questions. To understand why SAC came under scrutiny, it is important to first understand what insider trading actually is and why it is considered one of the most serious violations in financial markets. In its simplest form, insider trading occurs when someone buys or sells a security based on non – public material, that is information that is not yet available to the general public and that, if it were, would likely affect the price of that security. This could be advance knowledge of a merger, of a company's earnings figures before they are released or, as in SAC's case, of the results of a clinical drug trial before any public announcement. The reason this is illegal is straightforward, indeed, financial markets are built on the assumption that all participants are working with the same publicly available information. However, when someone trades on information that others cannot access, they are not outsmarting the market through skill or analysis but they are simply cheating. As a matter of fact, what first drew investigators toward SAC was precisely the fund's extraordinary performance, as returns of 30% net of fees, year after year, for over two decades, are almost statistically implausible in efficient markets. Moreover, incredibly high returns combined with the exceptionally high fees Cohen charged, well beyond the industry standard of 2% on assets and 20% of profits, the fund had long attracted quiet suspicion on Wall Street. Therefore, when federal authorities began pulling on threads connected to broader investigations into hedge fund misconduct, those suspicions started to find concrete form.

 

The investigation begins


The thread that unraveled SAC began in 2009, when federal authorities arrested Raj Rajaratnam, the founder of the hedge fund Galleon Group, on charges of securities fraud and conspiracy. As investigators worked through that case, they uncovered a web of connections that extended well beyond Galleon itself and a former SAC employee who had been implicated in the probe began cooperating with the government, providing authorities with evidence of insider trading he had allegedly engaged in while at the fund. That cooperation opened the door to a much larger investigation and the picture that emerged over the following years was damning. Federal prosecutors and the SEC built a case that went far beyond a handful of rogue traders acting independently, arguing that the insider trading at SAC had occurred over the span of more than a decade, involved the securities of more than twenty publicly traded companies across multiple sectors and was the direct result of deliberate institutional failures, such as hiring practices that specifically sought out employees with access to networks of corporate insiders and compliance systems that were either too weak or too indifferent to catch what was happening. Finally, eight SAC employees ultimately either pleaded guilty to securities fraud or were found guilty at trial and the cases against them painted a consistent picture of a fund where the line between aggressive research and illegal information gathering had been systematically blurred.

 

The price of cheating


In November 2013, SAC Capital pleaded guilty to all counts of the indictment against it, securities fraud and wire fraud, becoming, for the first time in a generation, a Wall Street firm that had formally confessed to criminal conduct. The fund was required to pay a total financial penalty of $1.8 billion, split between a $900 million criminal fine and a $900 million civil forfeiture judgment, making it the largest settlement ever obtained in an insider trading case. As part of the agreement, SAC was required to shut down its investment advisory business and stop managing money for outside investors, effectively ending its existence as a hedge fund. The consequences extended beyond the firm itself, indeed, the case sent a clear signal across the entire industry that federal authorities were willing to pursue not just individual traders but the institutions that enabled their conduct, a significant shift in how Wall Street misconduct was prosecuted. For ordinary investors, the damage was less visible but no less real, in fact, the scandal deepened a broader loss of confidence in the fairness of financial markets, reinforcing the perception that the system was tilted in favor of those with access and connections. As for Cohen, he was never personally charged with a crime and continued managing his own fortune through a family office that in 2018 was relaunched as Point72 Asset Management, once again open to outside investors, an ending that many found difficult to reconcile with the scale of what had happened under his watch.

 


Bibliography


U.S. Department of

 

 



 


 
 
 

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