May 19, 2024

Fair Game: How to Gauge SAC on the Richter Scale

At last count, SAC Capital had roughly $14 billion under management; a little more than half belongs to Mr. Cohen. He was not charged by the government, and the firm has denied the charges, saying it neither encouraged nor tolerated insider trading by its employees.

But SAC Capital is certainly under siege. The government contends that “systematic insider trading by SAC entity defendants” resulted in hundreds of millions of dollars of illegal profits and avoided losses at the expense of the investing public. SAC’s relentless pursuit of an information edge, the government contended, fostered a business culture “in which there was no meaningful commitment to ensure that such ‘edge’ came from legitimate research and not insider information.”

On Friday, an SAC spokesman said the firm would keep operating. But if investors continue to flee, it will have to meet those redemptions. Even before the indictment, many investors had requested that the firm return their money. In addition, the government said it would go after “any and all assets” of SAC Capital and its affiliates in collecting penalties.

It’s hard to know what stocks the fund holds and may have to sell, since its portfolio holdings are disclosed only quarterly and it is famous for short-term trading.

To be sure, SAC’s $14 billion under management is not enough to pose a risk to the financial system. And even though it is a large and well-known operation, SAC’s assets are a drop in the $2.4 trillion bucket of overall hedge fund assets, according to Hedge Fund Research.

But like most hedge funds, SAC uses leverage to try to amplify its gains. It can do this by borrowing money from the Wall Street firms that conduct its trades or other entities. As a result, its money under management significantly understates its total investment exposure.

As part of the Dodd-Frank legislation, large hedge funds were required to register with the Securities and Exchange Commission and to make new disclosures so regulators could watch for potential risks that these funds might pose to the financial system. Among the new disclosures the funds have to make are reports of assets under management and the use of leverage.

For SAC, this figure, known as total regulatory assets, stood at $50.9 billion, according to an S.E.C. filing made by the fund last Tuesday.

There is a big difference between $14 billion and almost $51 billion, of course — and it is leverage. A wonderful tool that generates heightened profits when assets are rising, leverage can crush you when it comes time to sell.

Adding to the difficulty in unwinding a large portfolio is this fact: When Wall Street firms get a whiff of trouble at a fund whose holdings they know well, they are known to capitalize by front-running — buying and selling in advance of the fund’s forced trades, increasing its losses as it liquidates.

That is precisely what happened when Long-Term Capital Management hit the skids in 1998. Some brokerage firms that held the fund’s securities profited from such front-running after being allowed to pore over its books as regulators fashioned a rescue. These trades exacerbated Long-Term Capital’s losses.

In other words, in a liquidation, Mr. Cohen may learn how loyal, or not, the firms on which he lavished such hefty commissions over the years will be. When it comes to unwinding a huge portfolio, these firms may make a notable 2004 art purchase by Mr. Cohen — of a tiger shark in formaldehyde, by Damien Hirst — look like a guppy.

Knowing a firm’s portfolio positions, especially if it is in distress, is a crucial edge, to use the government’s word, that Wall Street has over the rest of the world.

Mr. Cohen is obviously an intelligent man and a brilliant trader who may be able to keep his firm together while the criminal trial unfolds. Clients who believe in his trading skills may stick by him, preventing a liquidation. Certainly, the government’s charges of “hundreds of millions” in improper gains or avoided losses don’t come close to the gains SAC generated for investors over the years.

Some money managers believe that investors who ignore questionable activities at a hedge fund are part of the problem. “If investment gains were the result of insider trading, they should claw back some money from customers,” said Frederick E. Rowe, a money manager at Greenbrier Partners in Dallas. “If a client is paying a 3 percent management fee and 50 percent of the profits, as was the case at SAC, don’t you think he knows the guy’s got an edge he shouldn’t have?”

But a clawback of investor profits doesn’t seem to be coming. In prepared remarks announcing the SAC indictment on Thursday, Preet Bharara, the United States attorney for the Southern District of New York, said the government had chosen not to freeze the firm’s assets. “We are always mindful to minimize risks to third-party investors,” he said. “In other words, we have not restrained any money, and we will discuss with the company a reasonable method going forward to protect everyone’s legitimate interests.”

As the government moves forward to trial on the SAC case, some former Wall Streeters question why prosecutors are not also focusing on the big investment firms with which Mr. Cohen did business.

Ted Parmigiani is a former research analyst at Lehman Brothers who has tried to persuade regulators and prosecutors to investigate whether Wall Street releases market-moving research reports to favored hedge funds ahead of other customers.

He said the training that many future hedge fund traders receive at Wall Street firms sets the tone. “On the surface you’re going to find that Wall Street has great compliance,” Mr. Parmigiani said. “But a lot of these people learn early on that when you are making money for the firm, even if it is over the line, as long as you’re doing it and you’re smart about it, then there’s a place for you.”

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DealBook: A Towering Fine for Naught, as the S.E.C. Tracks Cohen

Steven Cohen's lawyers may not have seen the possibility of administrative charges by the S.E.C.Steve Marcus/ReutersSteven Cohen’s lawyers may not have seen the possibility of administrative charges by the S.E.C.

“We’re willing to pay $600 million because we have a business to run and don’t want this hanging over our heads with litigation that could last for years.”

That’s what Steven A. Cohen’s lawyer told a judge just four months ago to justify why Mr. Cohen had agreed to pay $616 million to the Securities and Exchange Commission to settle civil accusations that his firm was involved in insider trading without admitting or denying guilt.

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If that explanation sounded like a payoff — “buying off the U.S. government” is the way John Cassidy of The New Yorker put it at the time — that’s because, with hindsight, that’s what it was.

But it didn’t work.

The S.E.C., having been shamed by critics for making what seemed like a deferential deal, returned with a new civil action against Mr. Cohen individually on Friday, seeking to bar him from the industry.

The new charges and evidence raise all sorts of questions. But within the legal community, one question is now particularly baffling: Why did Mr. Cohen pay more than half a billion dollars to settle a case that now appears far from settled?

“It’s hard to believe he got bad advice. It’s not like he’s using some street-corner lawyer,” said Jacob S. Frenkel, a former S.E.C. enforcement lawyer who is now a partner at Shulman Rogers Gandal Pordy Ecker.

Within Mr. Cohen’s legal camp, which includes Paul, Weiss and Willkie Farr, the new civil action came as a surprise, according to people involved in the case. His legal team had thought that by settling with the S.E.C. in March for such a large sum it would be unlikely that the agency would come back for more, despite assertions by the S.E.C. that it reserved the right to pursue additional charges against Mr. Cohen.

At minimum, Mr. Cohen’s lawyers thought they had strong evidence that would help them talk the S.E.C. out of bringing a fraud charge against their client, these people said. In that regard, they succeeded. But they never imagined the S.E.C. would bring an administrative claim of “failure to supervise” against Mr. Cohen, which, to their way of thinking, would be an admission of defeat by the S.E.C. because it would be perceived as a demonstration of weakness, the equivalent of charging Al Capone with tax evasion.

“The S.E.C. created expectations in the settlement by strong inference,” Mr. Frenkel said. “There is an expectation of reasonable closure.”

But Mr. Cohen’s lawyers — and perhaps everyone else — missed the larger picture: The S.E.C.’s “failure to supervise” case can still have the same effect as a more damning fraud charge because it has the potential to put his firm out of business.

When Mr. Cohen’s $616 million settlement was first presented to Judge Victor Marrero of Federal District Court in Manhattan, he resisted approving it, saying aloud what so many people were thinking at the time, “There is something counterintuitive and incongruous about settling for $600 million if it truly did nothing wrong.”

What Judge Marrero didn’t appreciate — and what the public may have missed as well — was the math behind why the whopping settlement arguably made sense if it would end the years-long investigation into Mr. Cohen.

The goal of the settlement, and its timing, were clearly aimed at assuaging nervous investors in Mr. Cohen’s fund so that they wouldn’t seek the return of their money. Mr. Cohen managed $15 billion, including about $9 billion of his money and other employees’. The remaining $6 billion comes from outside investors — and it is worth big fees to the firm. Mr. Cohen collects a 3 percent “management fee” and takes upward of 50 percent of profits. On $6 billion, if you follow the math, annual management fees collected can total as much as $180 million. If the firm can produce profits of as little as 10 percent, the firm can collect $300 million more. If the firm produces more than 30 percent returns, its historical average, the fees could jump to over $1 billion.

Consequently, a settlement payment of $616 million could pay for itself in a year or two.

That was then. Now, that $616 million settlement appears to be a down payment on a much longer soap opera that could still include a criminal case down the road.

When Mr. Cohen made his original settlement agreement, the S.E.C.’s leadership was in transition, a clear red flag from a tactical perspective. With the addition of Mary Jo White a month after the deal was reached, she pressed to continue the inquiry, and ultimately, the new action.

While the S.E.C. under Ms. White clearly didn’t rescind its previous agreement, the new civil action could have one adverse outcome: it could make the agency’s job more complicated in future investigations.

“This could impact the approach to cooperation,” Mr. Frenkel said. “You have to believe whatever ambiguities existed were intentional on the S.E.C.’s part. It calls into question whether the agency negotiated in good faith.”

Maybe so. But after years of Wall Street executives appearing to outnegotiate the S.E.C., it finally seems as if the agency won a round.

Andrew Ross Sorkin is the editor-at-large of DealBook. Twitter: @andrewrsorkin

A version of this article appeared in print on 07/23/2013, on page B1 of the NewYork edition with the headline: A Towering Fine For Naught, As the S.E.C. Tracks Cohen.

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DealBook: $616 Million Poorer, Hedge Fund Owner Still Buys Art

Less than two weeks after SAC Capital Advisors, the hedge fund owned by the billionaire trader Steven A. Cohen, agreed to pay the government $616 million to settle accusations of insider trading, Mr. Cohen has decided to buy a little something for himself.

A renowned art collector, Mr. Cohen has bought Picasso’s “Le Rêve” from the casino owner Stephen A. Wynn for $155 million, according to a person with direct knowledge of the sale who was not authorized to speak publicly. Although prices for top works of art have soared to new heights recently, Mr. Cohen’s acquisition is one of the most expensive private art sales transacted.

It is at least the second $100 million-plus acquisition of art by Mr. Cohen in the last two years. He is said to have paid about $120 million in 2012 for four bronze sculptures of a woman’s back, created by Henri Matisse over 23 years.

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Mr. Cohen, who is worth $9.5 billion according to the Bloomberg Billionaires Index, continues to loom large on the international art scene even as he fights to contain the fallout from the government’s investigation of insider trading at SAC.

Federal prosecutors have tied at least nine former or current SAC employees to insider trading while they were at the fund; four have pleaded guilty.

Last November, the authorities ratcheted up the pressure on Mr. Cohen by bringing a case against a former SAC portfolio manager that, for the first time, tied Mr. Cohen to trades the government contends were illegal. Investors have asked to withdraw $1.7 billion from his $15 billion fund.

The billionaire Steven A. Cohen reportedly has bought Picasso’s Le Rêve from the casino owner Stephen A. Wynn for $155 million.2013 Estate of Pablo Picasso/Artists Rights Society (ARS), New YorkThe billionaire Steven A. Cohen reportedly has bought Picasso’s “Le Rêve” from the casino owner Stephen A. Wynn for $155 million.

Hedge Fund Inquiry

Mr. Cohen, 56, has not been charged with any wrongdoing. He has told his investors and employees that he believes he has acted appropriately at all times.

Meanwhile, he continues to buy and sell stocks from his headquarters in Stamford, Conn. Over two decades, SAC has posted some of the best returns on Wall Street, averaging 30 percent annually. This year, the fund has gained about 4 percent through mid-March, outperforming the average hedge fund’s return but lagging the broader stock market index.

Friends of Mr. Cohen have said that an ability to compartmentalize has allowed him to concentrate on investing amid SAC’s escalating legal problems.

And despite the recent charge against his net worth — the $616 million settlement will effectively come from Mr. Cohen, who owns 100 percent of SAC — he has continued to add to his world-class art collection, which includes paintings by Jackson Pollock; masterworks by Monet and Manet; and Damien Hirst’s shark submerged in a tank of formaldehyde.

The newest addition, the 1932 “Le Rêve,” which depicts Picasso’s mistress Marie-Thérèse Walter asleep in an armchair, has been coveted by Mr. Cohen for years. He first tried to buy it from Mr. Wynn in 2006, agreeing to pay $135 million. But the deal was called off after Mr. Wynn, who has an eye disease, put his elbow through the painting. An art restorer repaired the canvas without, apparently, diminishing its value.

The Picasso purchase was reported earlier by The New York Post.

The painting had been a prized possession of Mr. Wynn, who displayed it in his Las Vegas art gallery and even named one of his hotels Le Rêve (The Dream). But recently he has been selling more art than he has been buying. Last November, Mr. Wynn auctioned another 1932 Picasso painting of Ms. Walter, “Nature Morte aux Tulipes,” at Sotheby’s. It sold for $41.5 million.

This is not the first time that Mr. Cohen has bought art directly from Mr. Wynn. In 2005, he bought several paintings, including a van Gogh and a Gauguin, both of which had hung in Mr. Wynn’s Bellagio Gallery of Fine Arts in Las Vegas. Mr. Cohen is said to have paid Mr. Wynn about $110 million for the works.

William Acquavella, the New York dealer who brokered the 2005 deal, declined to comment when asked on Tuesday if he also put together the recent sale of “Le Rêve.”

In addition to the Picasso and the Matisse bronzes, Mr. Cohen has made at least one other purchase in excess of $100 million. In 2006 he bought de Kooning’s “Woman III” from David Geffen, the entertainment mogul, for a reported $137.5 million.

Befitting a trader, Mr. Cohen has also been selling. Last November, he put an abstract painting by the German artist Gerhard Richter at a Christie’s auction, but it failed to sell.

More recently, he quietly offered other artworks through private channels, dealers said on Tuesday, in an apparent effort to raise cash for what they said they believe was his Picasso acquisition.

While he displays much of his art in his 35,000-square-foot home in Greenwich, Conn., and SAC’s nearby headquarters, Mr. Cohen also lends his work and makes gifts to museums.

Last month, the Museum of Modern Art announced that Mr. Cohen and his wife, Alexandra, had made good on a number of promised gifts, including an untitled painting by the German artist Martin Kippenberger and a 1968 canvas by Ed Ruscha.

In an e-mailed statement at the time of the announcement, Mr. Cohen said, “We have a personal connection to these artists and are thrilled that museum visitors will view these pieces in their appropriate contexts as part of MoMA’s permanent collection.”

The spotlight on his art dealings may soon shift to his legal situation.

On Thursday, Mr. Cohen’s hedge fund will look to complete a major step toward resolving its regulatory woes.

Lawyers from SAC and the Securities and Exchange Commission are scheduled to present the terms of the settlement of two insider-trading lawsuits before Judge Victor Marrero in Federal District Court in Manhattan.

Legal specialists said one aspect of the agreement, allowing SAC to settle the case without admitting wrongdoing, could be called into question by the judge, as courts have recently criticized the commission for employing this settlement technique.

And Mr. Cohen and his employees remain in the government’s cross hairs.

In announcing the SAC settlements this month, the S.E.C.’s acting chief of enforcement noted that they did not prevent the future filing of charges against Mr. Cohen.

Prosecutors are close to deciding whether to file a criminal case against Michael Steinberg, a senior SAC portfolio manager, a person with direct knowledge of the matter said.

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DealBook: Prosecutors Weigh Insider Trading Case Against Raj Rajaratnam’s Brother

Prosecutors are readying insider trading charges against Rajarengan Rajaratnam, a younger brother of the imprisoned hedge fund manager Raj Rajaratnam, according to a person briefed on the case.

During Mr. Rajaratnam’s trial in 2011, Rajarengan Rajaratnam, who worked for his brother at the Galleon Group hedge fund, was heard speaking on several wiretaps of incriminating conversations that were played for the jury. Prosecutors identified him as an unindicted co-conspirator in the case.

Charges could be filed in the next month, this person said. There is an urgency to bringing an indictment against Rajarengan Rajaratnam, who goes by Rengan, because the five-year deadline for bringing securities fraud charges on certain trades is set to pass in the coming weeks.

He now lives in Brazil. If prosecutors charge him, they would have to use extradition laws to return him to the United States.

David C. Tobin, a lawyer for Rengan Rajaratnam, did not immediately return a request for comment. A spokeswoman for the United States attorney’s office declined to comment. News of a possible indictment against Rengan Rajaratnam was reported earlier by The Wall Street Journal

Though he was a much smaller player on Wall Street than his billionaire older brother, Rengan Rajaratnam is seen a seminal figure in the government’s broad inquiry into insider trading at hedge funds.

The origins of the investigation, which has led to more than 75 prosecutions of hedge fund employees and corporate executives, stretch back more than a decade. But a crucial breakthrough came in 2006 during an inquiry into Sedna Capital, a fund run by Rengan Rajaratnam. While reviewing e-mails and instant messages, securities regulators discovered damning communications between Rengan and his brother.

A graduate of the University of Pennsylvania and Stanford University’s business school, Rengan Rajaratnam did brief stints early in his career at Morgan Stanley and, for eight months, at the hedge fund SAC Capital Advisors. Prosecutors are investigating illegal trading at SAC, and have brought criminal charges against several former SAC traders. Steven A. Cohen, the founder of SAC, has not been charged with any wrongdoing.

Rengan Rajaratnam started Sedna in 2004. By mid-2006, Sedna was a small fund managing about $80 million. But its uncanny timing on several trades was brought to the government’s attention by an executive at the Swiss bank UBS, which provided services to Sedna.

In December 2006, lawyers at the Securities and Exchange Commission took Rengan Rajaratnam’s deposition. Sedna closed around that same time, and he joined his brother at Galleon.

Jurors at Raj Rajaratnam’s trial heard Rengan Rajaratnam on several calls, including one from August 2008, during which he told his brother about his efforts to press a friend, a consultant at McKinsey Company, for confidential information. Rengan Rajaratnam called the consultant “a little dirty” and boasted that he “finally spilled his beans” by sharing secrets about a corporate client.

Another former Galleon employee, Adam Smith, also testified that the day of Raj Rajaratnam’s arrest in October 2009, Rengan Rajaratnam took his brother’s notebooks from an office at Galleon.

Raj and Rengan Rajaratnam have another brother, Ragakanthan, who goes by R.K. and also worked at Galleon. R.K.’s name emerged during testimony at the trial of Rajat K. Gupta, a former Goldman Sachs director found guilty last year of passing the bank’s secrets to Raj Rajaratnam. Mr. Gupta is appealing his conviction.

R.K. Rajaratnam has not been charged with any crimes. Raj Rajaratnam is serving the second year of an 11-year sentence at a federal prison in Ayer, Mass.

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Steven Cohen of SAC Is Fascinating to Investigators, Too

From the outside, there’s nothing particularly special about this address, 72 Cummings Point Road. But inside — well, everyone on Wall Street has heard the stories.

Some of them are even true.

We are, after all, talking about the man known on the Street as “Stevie” — hedge fund magnate, multibillionaire, prodigious art collector and, of late, person of intense interest to federal authorities. Inside his offices, vast fortunes are won and lost. Careers are made and unmade. Type-A egos are inflated and crushed, sometimes in the space of hours. And there, Mr. Cohen, a trader with an almost preternatural knack for reading fear and greed in the marketplace, prowls relentlessly for an edge over everyone else.

Mr. Cohen, 56, today sits at the center of more concentric circles of money and power and worry and suspicion than perhaps anyone else in the hedge fund game. Neither he nor the private investment firm that bears his initials, SAC Capital Advisors, has been accused of wrongdoing. But over the past half-decade, as a vast federal investigation into insider trading has unfolded in stunning detail, the questions have returned again and again. In soft-carpeted executive suites, on fervid trading floors, in Park Avenue co-ops and on Connecticut back lanes, the same subject keeps coming up: Just what is going on inside 72 Cummings Point Road?

It is, perhaps, understandable. On Wall Street, Mr. Cohen is envied and feared in equal measure. Hedge fund managers like him have helped redefine what it means to be rich, even if most ordinary people don’t quite understand what they do or how they do it.

For years, the investigations had swirled around SAC, but that was about all. Then, on the afternoon of Nov. 28, the word went out across Wall Street: the Securities and Exchange Commission was warning that it might go after SAC, too. Elsewhere in the investigations, prosecutors have turned up damning evidence through F.B.I. wiretaps and reached into the boardrooms of some of the mightiest corporations. Seventy-one people have been convicted in a sweep that dwarfs the 1980s-era Wall Street scandals involving Ivan Boesky and Michael Milken.

But there is also this undeniable fact: The government inquiry has linked six former SAC employees to insider trading while at the fund; three have pleaded guilty. On Friday, a grand jury indicted Mathew Martoma, a former employee who was arrested last month on charges that he used inside tips about a clinical drug trial to help SAC earn profits and avoid losses totaling $276 million.  (A lawyer for Mr. Martoma says his client is innocent.) In the Martoma case, prosecutors for the first time have tied Mr. Cohen to questionable trades.

And, of course, there are the stories. The mind-boggling investment returns. The office tantrums. The pressure-cooker environment inside SAC. The time that Mr. Cohen’s wife, Alexandra, gave him an A.T.M. for Christmas, because he kept borrowing cash from her. The time she gave him an Aston Martin sports car for his birthday, and he promptly sold it.

All of those are true.

But there are other stories, too, like the one about how Mr. Cohen engaged in insider trading back in the 1980s, before hedge funds like SAC burst onto the scene. That claim was made by Mr. Cohen’s former wife, in a 2009 lawsuit in which she sought $300 million. A judge dismissed her claims as little more than rumor and speculation.

And then there is the one about how Mr. Cohen and a cabal of other hedge fund managers waged a campaign of dirty tricks in the early 2000s to sink the share prices of several companies. Judges tossed out those cases, too. (SAC maintained that the various lawsuits were groundless, and one of the companies ended up issuing an apology.)

Mr. Cohen declined to be interviewed for this article. But a spokesman for SAC reiterated what the firm has been saying all along: SAC and Mr. Cohen acted appropriately.

Friends stand by Mr. Cohen. Several point to his charitable works.

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DealBook: Trail to a Hedge Fund, From a Cluster of Cases

Donald Longueuil, who worked at SAC Capital Advisors, received inside information about the chip maker Marvell Technology from Noah Freeman and earned more than $1 million in profit. He pleaded guilty to conspiracy and securities fraud and is serving a two-and-a-half year sentence.Brendan McDermid/ReutersDonald Longueuil, who worked at SAC Capital Advisors, received inside information about the chip maker Marvell Technology from Noah Freeman and earned more than $1 million in profit. He pleaded guilty to conspiracy and securities fraud and is serving a two-and-a-half year sentence.

In April 2009, an F.B.I. agent visited the Silicon Valley home of Richard Choo-Beng Lee, a hedge fund manager with deep contacts inside technology companies. The government, the agent said, had overwhelming proof that Mr. Lee had engaged in insider trading. Within weeks, Mr. Lee confessed and began cooperating.

A year and a half later, in the parking lot of a New England prep school, the same agent approached Noah Freeman, a Harvard-educated money manager turned teacher. After the agent played a secretly recorded conversation of Mr. Freeman swapping illegal tips, Mr. Freeman admitted to crimes and started assisting the authorities.

Last winter, another agent confronted Mathew Martoma, a pharmaceutical-industry analyst, at his 8,000-square-foot Florida mansion. As they stood on the front lawn, with Mr. Martoma’s wife and children inside, the agent told him that they had evidence that he had broken the law.

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Overcome with stress, Mr. Martoma passed out.

Three criminal defendants — Mr. Lee, Mr. Freeman and Mr. Martoma — have a common denominator: Each had worked for SAC Capital Advisors, the hedge fund run by Steven A. Cohen, one of the most powerful figures in finance. By posting impressive annual returns averaging 30 percent across two decades, Mr. Cohen, a 56-year-old Long Island native, has amassed a fortune estimated at nearly $9 billion.

Mr. Cohen has not been accused of any wrongdoing and he may never be charged, but he has become a central focus of the government’s sprawling investigation into criminal conduct at hedge funds. A picture of the inquiry has emerged from interviews with people involved with the case.

The trail leading to SAC has emerged out of a cluster of cases, many of them connected to the prosecution of the fallen titan Raj Rajaratnam. Investigators heard SAC traders on incriminating wiretaps; in other instances, cooperators and informants accused the fund of misconduct. As the authorities painstakingly pieced together dozens of cases across multiple, overlapping conspiracies, again and again one name kept popping up: Mr. Cohen’s SAC.

Complete Coverage: Insider Trading at a Top Hedge Fund

Investigators have penetrated SAC and other funds by aggressively deploying techniques — wiretaps, cooperators and informants — once reserved for infiltrating the Mafia and narcotics rings. Government lawyers have reviewed millions of pages of documents and taken hundreds of depositions. Securities watchdogs, meanwhile, have developed more sophisticated methods to detect insider trading, which is defined as trading based on material, nonpublic information.

The long-running inquiry has linked six former SAC employees to insider trading while at the fund; three, including Jon Horvath, who has implicated one of Mr. Cohen’s top lieutenants, have pleaded guilty. At least six other former employees have been tied to insider trading after leaving SAC. Several more have received subpoenas, people briefed on the case say.

Since 2002, the financial industry’s self-regulatory groups have referred about 80 instances of suspicious SAC trading activity to federal authorities for further investigation. In 2007, as the citations piled up, the self-regulatory groups took a more aggressive tone, noting that the hedge fund had been “repeatedly” flagged for suspicious trading. (An SAC spokesman has said that the fund trades in thousands of stocks each day, so given its level of activity it is not surprising that the fund would show up in referrals.)

“Government lawyers go where the facts take them,” said H. David Kotz, a former inspector general at the Securities and Exchange Commission now with Berkeley Research, a consulting firm. “With so many disparate strands of the investigation leading to SAC, it makes perfect sense that they would be closely looking at the guy in charge.”

And they are looking very closely. A few years ago, the F.B.I. secretly recorded the telephone line at Mr. Cohen’s Greenwich, Conn., estate, said two people briefed on the investigation. It is unclear what precipitated the wiretapping and whether any evidence was collected. Federal securities regulators have had previous brushes with SAC in 2003 and Mr. Cohen in 1986, but neither inquiry resulted in any action. Last summer, S.E.C. lawyers deposed him.

Speaking to his roughly 1,000 employees last week, Mr. Cohen expressed confidence that he acted appropriately. In defending the fund, SAC cites its strong culture of compliance and says it is “outraged” and “deeply disturbed” by the conduct of former employees.

But with Mr. Martoma’s arrest Nov. 20 — the first case that directly ties Mr. Cohen to questionable trades — the investigation has entered a more serious phase. The S.E.C. warned the fund that it was preparing a civil fraud lawsuit against SAC related to Mr. Martoma’s case. A lawyer for Mr. Martoma, Charles A. Stillman, said that he expected his client to be exonerated.

And just as it did in the investigation of Mr. Rajaratnam and in the landmark 1980s prosecutions of the financial giants of that era, Michael R. Milken and Ivan F. Boesky, the government is pursuing lower-level employees and then seeking their cooperation in the hopes of building a case against the boss.

C. B. Lee

Had he made different career choices, Richard Choo-Beng Lee might have been an engineer at Apple or Intel. Instead, armed with a computer science degree and a knack for numbers, Mr. Lee became a star technology analyst on Wall Street.

Known as C. B., Mr. Lee worked in the 1990s at the brokerage firm Needham Company alongside Mr. Rajaratnam. In 1999, Mr. Lee landed at SAC, where he earned millions working for a team of tech-stock traders. After five years, he left, and in 2008 started his own California-based hedge fund, Spherix Capital.

That same year, a government informant taped incriminating calls with Mr. Rajaratnam, who by then had become a billionaire running the Galleon Group. On the basis of those calls, prosecutors received a judge’s approval to wiretap Mr. Rajaratnam’s cellphone. They also received permission to eavesdrop on Danielle Chiesi, a close associate of Mr. Rajaratnam. Ms. Chiesi was heard on calls with Mr. Lee passing inside information.

B. J. Kang, an F.B.I. agent, showed up at Mr. Lee’s modest San Jose, Calif., home in 2009. After pleading guilty, he closed Spherix Capital and became a cooperator, recording conversations that helped ensnare several defendants.

Securing Mr. Lee’s cooperation proved to be a major breakthrough because he helped them better understand SAC’s trading practices and culture. As part of Mr. Lee’s plea agreement, he agreed to share information about illegal conduct that he saw while working for Mr. Cohen.

He also provided investigators with detailed insights into expert-network firms, a growing business that connected traders with sources at publicly traded companies. Mr. Lee said SAC and other funds aggressively used these matchmaking firms, some of which were cesspools of inside information.

A few months after Mr. Lee “flipped,” the F.B.I. directed him to try to get rehired by SAC, said a person briefed on the case. Mr. Cohen entertained his request but ultimately rebuffed him, leery that Mr. Lee had abruptly closed his fund, this person said.

Jeffrey Bornstein, a lawyer for Mr. Lee, 56, said that his client continues to cooperate with the government.

Noah Freeman

When Noah Freeman graduated from Harvard in 1999, the stock market was roaring. After a stint in management consulting, Mr. Freeman tried his hand at hedge funds. He started at Brookside Capital, a unit of Bain Capital.

Mr. Freeman joined SAC in 2008, lured by a two-year, $2 million-a-year guarantee. The fund gave him several hundred millions of dollars to manage.

Mr. Freeman routinely shared his best ideas with Mr. Cohen. Unlike hedge funds with one manager making investment decisions, SAC has about 140 teams — each controlling several hundred millions of dollars. The teams give their “high conviction ideas” to Mr. Cohen, who directly manages only about 10 percent of the fund. SAC compensates employees based on a percentage of the winnings they generate for the fund, as well as on profits they make for Mr. Cohen’s portfolio.

An accomplished speed skater and triathlete, Mr. Freeman thrived in the high-stress world of hedge funds. But the pressure to perform was immense. To help gain an edge, Mr. Freeman became a big user of expert networks, especially Primary Global Research. His principal contact at Primary Global was Winifred Jiau.

Mr. Lee and other informants had told government investigators that Primary Global was especially dirty, and investigators began listening to its phone calls. On one call in May 2008, Ms. Jiau was heard giving Mr. Freeman inside tips about Marvell Technology. Mr. Freeman shared the information with another SAC colleague, Donald Longueuil, who used it to earn more than $1 million in profits.

SAC fired Mr. Freeman in 2010 for poor performance, according to a fund spokesman. Disillusioned with Wall Street, Mr. Freeman went into education. He took a job teaching honors economics at the Winsor School, a prestigious all-girls school in Boston. One day, in November 2010, Mr. Kang, the F.B.I. agent, was waiting for Mr. Freeman in the parking lot of Winsor.

As a government cooperator, Mr. Freeman wore a wire and secretly recorded conversations with Mr. Longueuil, who had been the best man at his wedding. Mr. Longueuil is serving a two-and-a-half year sentence.

In a Dec. 16, 2010 interview, Mr. Freeman told investigators that he thought that trafficking in corporate secrets was part of his job description at SAC, according to an F.B.I. agent’s notes of the interview, which were in a court filing and first reported by Bloomberg News.

“Freeman and others at SAC Capital understood that providing Cohen with your best trading ideas involved providing Cohen with inside information,” the agent wrote.

Prosecutors announced charges against Mr. Freeman and Mr. Longueuil in February 2011. Primary Global has closed. Ms. Jiau, who was found guilty at trial, is in prison. At her trial, Mr. Freeman testified that he gave investigators the names of at least a dozen people who he believed were involved in criminal conduct.

Mr. Freeman, 36, who has yet to be sentenced, is currently a stay-at-home father, and his cooperation could spare him prison time. His lawyer, Benjamin E. Rosenberg, declined to comment.

Jon Horvath admitted to insider trading while at SAC Capital and cooperated with investigators.Mary Altaffer/Associated PressJon Horvath admitted to insider trading while at SAC Capital and cooperated with investigators.

Jon Horvath

In November 2010, the F.B.I. raided two hedge funds that heavily used expert-network firms: Level Global Investors and Diamondback Capital Management. Both had strong ties to Mr. Cohen; each was started by SAC alumni.

Fourteen months after the raid, prosecutors charged seven traders — including two each from Level Global and Diamondback — in what it called a “criminal club” that made nearly $70 million trading on secret information gleaned from sources inside technology companies.

Among those arrested was Jon Horvath, an SAC tech-stock analyst who once worked at Lehman Brothers. Low key and analytic, Mr. Horvath lacked the swagger of many of his peers. For months, he maintained his innocence.

But in September, a month before trial, Mr. Horvath admitted to insider trading while at SAC and agreed to cooperate. In court, Mr. Horvath said that he — along with his SAC manager — traded on confidential financial results. “In each instance I provided the information to the portfolio manager I worked for and we executed trades in the stocks based on that information,” he said.

The portfolio manager is Michael S. Steinberg, according to two people briefed on the inquiry. Prosecutors have not charged him, but have named him an unindicted co-conspirator.

Barry Berke, a lawyer for Mr. Steinberg, 40, and Steven Peikin, a lawyer for Mr. Horvath, 42, declined to comment.

Though recently placed on leave, Mr. Steinberg is one of SAC’s longest-tenured employees. He joined in 1997, when it was just Mr. Cohen and several dozen traders; for years, he sat near Mr. Cohen on the trading floor and the two grew close. When Mr. Steinberg was married in 1999 at the Plaza Hotel, Mr. Cohen attended the black-tie affair.

Federal agents have asked Mathew Martoma to help build a case against Steven A. Cohen of SAC.Seth Wenig/Associated PressFederal agents have asked Mathew Martoma to help build a case against Steven A. Cohen of SAC.

Mathew Martoma

In 2008, a team of S.E.C. enforcement lawyers in New York, led by Sanjay Wadhwa, noticed a pattern in the “suspicious trading reports.” CR Intrinsic Investors, a unit of SAC Capital, had made an uncanny string of immensely profitable, well-timed trades in technology and health care stocks. Their suspicions raised, the team requested more trading reports from the regulatory arm of the New York Stock Exchange. Huge bets by CR Intrinsic on the pharmaceutical companies Elan and Wyeth, placed just before they announced disappointing results from a drug trial, jumped off the page.

The S.E.C. issued a subpoena requesting that SAC produce documents — e-mails, instant messages, phone and trading records — connected to the unusual trades. As they combed through e-mails, S.E.C. lawyers discovered reams of correspondence between Mathew Martoma, a drug stock specialist at CR Intrinsic, and Dr. Sidney Gilman, a neurologist.

Two days before Thanksgiving, federal agents arrested Mr. Martoma. Prosecutors said that Dr. Gilman had leaked him secret data about clinical trials that he was overseeing for an Alzheimer’s drug being jointly developed by Elan and Wyeth.

The case was a turning point in the investigation of SAC because, for the first time, the government linked Mr. Cohen to trades that it contends were illegal. Mr. Martoma and Mr. Cohen collaborated on the Elan and Wyeth transactions, prosecutors said, earning SAC profits and avoiding losses totaling $276 million. After Mr. Martoma learned from Dr. Gilman — whom he met through an expert network — that there were problems with the trials, he reached out to his boss, the government said.

“Is there a good time to catch up with you this morning? It’s important,” Mr. Martoma e-mailed Mr. Cohen in July 2008, just days before Elan and Wyeth announced their findings.

An hour later, Mr. Martoma and Mr. Cohen had a 20-minute telephone conversation. SAC promptly sold a $700 million position in Elan and Wyeth and then made a big negative bet. After the drug companies released the negative data, their shares plummeted.

An S.E.C. lawyer interviewed Mr. Cohen about the Elan and Wyeth trades this summer, according to a person briefed on the case. In sworn testimony, he said that SAC sold the stocks because Mr. Martoma told him that he had lost conviction in the position, this person said. Otherwise, Mr. Cohen had little recall of their conversation.

Federal agents paid a house call to Mr. Martoma a year ago, pressuring him to “flip” and help build a case against Mr. Cohen. While speaking with the agents in his front yard, Mr. Martoma fainted. After picking himself up, he declined to cooperate. When the S.E.C. deposed him earlier this year, Mr. Martoma refused to answer questions, invoking his Fifth Amendment right against self-incrimination.

The government has said it will not prosecute Dr. Gilman, who has agreed to testify against Mr. Martoma.

SAC continues to operate during the intensifying investigation. The negative attention and controversy aggravates and angers Mr. Cohen, said a friend, but his ability to compartmentalize allows him to maintain a focus on investing.

An SAC spokesman said Wednesday that Mr. Cohen is cooperating with the government’s inquiry.

During market hours, Mr. Cohen can be found at the center of his football field-size trading floor in Stamford, Conn., sitting among his traders, sifting through information, and buying and selling stocks. SAC, which manages $14 billion, is up about 12 percent this year through the end of last month.

“None of this stuff is material to his returns and it’s all just a lot of noise,” said Ed Butowsky, managing partner of Chapwood Investments, a longtime SAC client. “Steve Cohen is the Michael Jordan of the hedge fund business. When people are successful everyone likes to take shots at them.”

Ben Protess contributed reporting.

A version of this article appeared in print on 12/06/2012, on page A1 of the NewYork edition with the headline: Trail to a Hedge Fund, From a Cluster of Cases.

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DealBook Column: Martoma Insider Trading Case Puts Spotlight on ‘Expert Networks’

Toward the end of 2007, Silver Lake Partners, a well-respected investment firm, made what then seemed like a curious investment: it paid about $200 million to buy slightly less than a quarter of a fast-growing company called the Gerson Lehrman Group.

The investment was unusual because Gerson Lehrman, a so-called expert network firm that links hedge fund investors with experts in various fields, had been under scrutiny by regulators and the press for creating a business model that some said was tailor-made to foster insider trading on Wall Street.

A hedge fund manager could call up Gerson Lehrman, ask to speak with an expert — often a current or former employee of a company that the hedge fund was considering investing in — and, for prices as high as $1,000 an hour, the “expert” would, with luck, divulge what he knew. A front-page article in The Wall Street Journal in 2006 provided a series of anecdotes of questionable information being sought by Gerson Lehrman’s clients.

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Gerson Lehrman insisted that its business was honest, and it instituted a variety of compliance programs to prevent investors from seeking inside information from its experts. Soon after, all the regulatory investigations into the firm seemed to dry up.

Then came the investment from Silver Lake, a firm with a track record for investments in information technology and a group of founders with illustrious backgrounds in Washington, on Wall Street and in Silicon Valley. (Glenn Hutchins, one of the founders, worked as a special adviser to President Bill Clinton, for example.) So Silver Lake’s investment came across as a seal of approval. The firm, which had been a client of Gerson Lehrman, said it had done significant diligence on the firm and was more than satisfied.

And yet here we are: last week, federal prosecutors announced what they said was the largest insider trading case in its history, charging Mathew Martoma, an employee at the hedge fund SAC Capital Advisors, with using inside information about drug trials from one of these experts, Dr. Sidney Gilman, a neurology professor at the University of Michigan Medical School who had been hired by Elan and Wyeth to oversee the drug trials. The transfer of information was made possible by Gerson Lehrman, which had played matchmaker. If this expert network did not exist, it is not clear that Mr. Martoma and Dr. Gilman would ever have found each other. More on that in a moment.

The criminal case against Mr. Martoma suggests that he used Gerson Lehrman’s services repeatedly, paying a total of $108,000 to Dr. Gilman, who was paid about $1,000 an hour for his expert counsel — or his dispensing of inside information, as the government sees it. Dr. Gilman, 80, entered into a nonprosecution agreement in exchange for providing information on his discussions with Mr. Martoma to the government.

In fairness to Gerson Lehrman, the various complaints against Mr. Martoma make clear that the firm put Mr. Martoma and Dr. Gilman through a number of compliance programs and repeatedly provided them with notices — boilerplate e-mails — that Mr. Martoma was not to seek inside information and Dr. Gilman was not to provide it.

One e-mail explicitly instructed that the expert “will not reveal any information that the [expert] has a duty to keep confidential, including material nonpublic information.” The e-mail also said experts “participating in clinical trials may not discuss the patient experience or trial results not yet in the public domain.”

Based upon the complaints against him, Mr. Martoma appears to have tried to dupe Gerson Lehrman about the true intent of his requests to talk to Dr. Gilman by mischaracterizing the subjects he hoped to discuss.

And yet, the information appears to have been passed with tremendous efficiency. Each phone call between the two men was organized and documented by Gerson Lehrman, in part so that Dr. Gilman could be properly compensated for his expert advice. Gerson Lehrman, however, does not chaperon the calls.

Of about a million “consultations” the company has conducted between its clients and “experts,” this is the first time a criminal complaint has been filed against a client or expert of Gerson Lehrman. The Gerson Lehrman Group has not been charged or implicated in any way.

Still, the expert network business model is inherently perilous. Many expert network firms have gotten caught up in one insider trading case or another. Primary Global was featured in the Raj Rajaratnam case; it has since closed its doors. While Gerson Lehrman remains the leader in the business and might have the best compliance program in the industry, one of its experts was interviewed by the F.B.I. in 2010 after a client was raided. No charges were brought.

The original purpose of these firms was to provide primary information to investors looking for research after the old Wall Street research business model seemed to collapse under the weight of an industry settlement over conflicts of interest, led by Eliot Spitzer when he was the attorney general of New York. Gerson Lehrman became so popular that Goldman Sachs considered buying it, and other banks sought to copy its model.

Silver Lake declined to comment. Gerson Lehrman’s chief, Alexander Saint-Amand, said: “Professionals need to consult with other professionals to learn and make better decisions, especially as the business environment becomes more not less complex. That’s true for all of our clients — investors, corporations, law firms, nonprofits.”

So what to think of expert networks now?

On one side, there is a good argument that these firms help investors and others find one another — consider it a high-priced Facebook for consultants. Gerson Lehrman has expanded its business beyond simply working with investors; it now helps corporations looking for experts, or advertising agencies looking for help ahead of a big pitch.

There is clearly a market for matchmaking, and without a Gerson Lehrman, it is very possible that some interactions would take place over beers or expensive dinners — without the compliance efforts and audit trails that the firm provides. With the advent of LinkedIn and other social networks, there are increasingly new ways to find experts.

But investors don’t pay hundreds of thousands of dollars a year for information that isn’t material — at least, material to them. In the best of worlds, the expert network business model is about pushing clients as close to the “line” as possible without crossing it. That’s a tough thing to do consistently — and a precarious way to run an enterprise.

A version of this article appeared in print on 11/27/2012, on page B1 of the NewYork edition with the headline: Knowledge Is Money, But the Peril Is Obvious.

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DealBook: Trial to Open in $68 Million Insider Trading Case

Anthony Chiasson, who co-founded the Level Global Investors, faces charges of insider trading.Mike Segar/ReutersAnthony Chiasson, who co-founded the Level Global Investors, faces charges of insider trading.

In the sharp-elbowed world of Wall Street, Anthony Chiasson and Todd Newman stood out as two of the good guys.

Both were hard-working, below-the-radar types who eschewed the flashy lifestyle embraced by many millionaire hedge fund traders. Mr. Chiasson’s mother told reporters that her son’s idea of a fun weekend was to return to his hometown, Portland, Me., to attend church. Mr. Newman, also originally from New England, worked out of Boston, where he is raising a family in Needham, Mass., a low-key suburb.

Yet federal prosecutors say Mr. Chiasson and Mr. Newman were criminals, operating “a tight-knit circle of greed” along with six others who trafficked in secret information about technology companies.

On Tuesday, Mr. Chiasson, 39, a co-founder of the now-defunct Level Global Investors, and Mr. Newman, 47, a former portfolio manager at Diamondback Capital Management, are set to stand trial in Federal District Court in Manhattan. Prosecutors say they were part of a conspiracy that made about $68 million illegally trading the computer company Dell and the chip maker Nvidia.

The other six traders have pleaded guilty. Some are expected to testify against Mr. Chiasson and Mr. Newman.

Mr. Chiasson’s and Mr. Newman’s trial is expected to shed light on the trading strategies and techniques of SAC Capital Advisors, based in Stamford, Conn., a hedge fund giant run by the investor Steven A. Cohen.

SAC Capital, which has one of the best investment track records on Wall Street, has become a breeding ground for hedge fund managers. Both Level Global and Diamondback were started by traders who trained under Mr. Cohen. And one of the six traders who have admitted to the conspiracy was employed at SAC Capital.

The case is one of the larger prosecutions brought by the government in its broad investigation into insider trading, which has yielded 69 convictions and resulted in prison sentences for dozens of hedge fund traders. Last month, Rajat K. Gupta, a former director of Goldman Sachs, was sentenced to two years in prison after a jury found him guilty of leaking boardroom secrets about the bank to the former hedge fund billionaire Raj Rajaratnam, who is serving an 11-year term.

Most of the defendants in the insider trading cases have pleaded guilty, but of the eight who have taken their cases to trial, all have been found guilty.

The case is the outgrowth of the Federal Bureau of Investigation’s raid two years ago this month of Level Global and Diamondback. Last January, Preet Bharara, the United States attorney in Manhattan, brought the criminal case against Mr. Chiasson, Mr. Newman and six others.

Among those accused of being co-conspirators with the defendants are Spyridon Adondakis, a former trader at Level Global who worked under Mr. Chiasson, and Jesse Tortora, a onetime Diamondback employee. Both men have pleaded guilty to insider trading charges. They have cooperated with prosecutors and are expected to testify against their former colleagues.

Todd Newman was a portfolio manager at Diamondback Capital Management.Charles Krupa/Associated PressTodd Newman was a portfolio manager at Diamondback Capital Management.

Lawyers for Mr. Chiasson and Mr. Newman are expected to attack the cooperators, accusing them of trying to curry favor with the government by accusing their bosses of being involved in their illegal trading scheme.

The former SAC Capital trader who admitted being part of the scheme is Jon Horvath. Mr. Horvath admitted passing confidential information to his portfolio manager, who was named an unindicted co-conspirator in the case. The portfolio manager is Michael Steinberg, according to a person with direct knowledge of the case who requested anonymity because he was not authorized to discuss it publicly.

Barry Berke, a lawyer for Mr. Steinberg, declined to comment.

The reported conspiracy’s origins are traced to Sandeep Goyal, a former Dell employee who left the technology industry to take a job on Wall Street. While working as a tech-stock analyst at the money manager Neuberger Berman, Mr. Goyal tapped a contact inside Dell to obtain advance word about the computer maker’s financial results. He then gave that information to his network of contacts on hedge fund trading floors, and it ultimately reached Mr. Chiasson and Mr. Newman, prosecutors say.

Mr. Goyal has pleaded guilty to insider trading charges; the unnamed Dell executive has not been charged in the case. Earlier in their careers, Mr. Goyal, Mr. Tortora and Mr. Adondakis all worked together at the Prudential Equity Group, and they socialized together in Manhattan and the Hamptons.

The F.B.I. raid had a devastating effect on Level Global, which was forced to close shortly after the federal agents seized trading records and hardware from the firm. Diamondback has remained in business. This year, it paid about $9 million to settle a lawsuit brought against it by the Securities and Exchange Commission related to the Dell trades. It also struck a nonprosecution agreement with the Justice Department.

Level Global made by far the most profit in the conspiracy, pocketing about $57 million by betting against Dell stock ahead of a negative earnings announcement, prosecutors say.

Mr. Chiasson and David Ganek started Level Global in 2003 shortly after leaving SAC Capital. At Level Global’s peak, they managed about $4 billion in assets and had marquee clients like New York’s state pension fund. They used the name Level, Mr. Chiasson once said, because it was “a palindrome which connotes balance and adaptability — two key investing traits.”

Mr. Chiasson’s reserved style contrasted with that of Mr. Ganek, a more voluble type. While Mr. Chiasson steered clear of New York society, Mr. Ganek and his wife, the novelist Danielle Ganek, became fixtures at Manhattan charity events and art auctions. Mr. Ganek has not been charged in the case.

Mr. Newman, who is accused of making about $3.8 million in illegal profit, worked at the Tudor Investment Corporation, one of the world’s most prominent hedge funds, before joining Diamondback. He was part of a tight network of hedge fund traders based in Boston who specialized in technology stocks.

Lawyers for Mr. Chiasson and Mr. Newman tried to make their cases two separate trials, arguing that they were not part of a single purported conspiracy. Judge Richard J. Sullivan denied that request.

Reid H. Weingarten, a partner at Steptoe Johnson who defended Bernard J. Ebbers, the former WorldCom chief executive, and Gregory Morvillo of the Morvillo law firm, represent Mr. Chiasson. Representing Mr. Newman are Stephen Fishbein and John A. Nathanson, both of Shearman Sterling.

Trying the case for the government are Antonia M. Apps and Richard C. Tarlowe, one of the prosecutors who secured a conviction of Mr. Gupta, the former Goldman director.

A 12-person jury has been impaneled after two days of jury selection. Lawyers dismissed a number of potential jurors with connections to the case, including a doorman at Mr. Chiasson’s luxury Upper East Side apartment building and a former business-development executive at SAC Capital.

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DealBook: Appeals Court Revives Insider Trading Case Against Obus

Accused of insider trading in 2002, Nelson Obus refused to settle: That is the same as guilty to me.Chang W. Lee/The New York TimesAccused of insider trading in 2002, Nelson Obus refused to settle: “That is the same as guilty to me.”

A Federal Appeals Court has revived a decade-old insider-trading case brought against a New York hedge fund manager by the Securities and Exchange Commission.

Nelson Obus, the president of Wynnefield Capital, was charged by the S.E.C. with illegal trading in the stock of SunSource after receiving confidential information about the company. Also charged in the case were Peter Black, an analyst at Wynnefield, and Thomas B. Strickland, a former employee at General Electric who was the alleged source of the secret tip that SunSource was about to be acquired by another company.

Judge George B. Daniels, a federal trial court judge in Manhattan, had thrown out the case in late 2010. But on Thursday, a three-judge panel for the United States Court of Appeals for the Second Circuit reversed his decision.

“The S.E.C. established genuine issues of material fact with respect to its claims of insider trading,” wrote Judge John M. Walker Jr., a Federal Appeals Court judge.

Joel M. Cohen, a lawyer for Mr. Obus, said he and his client were disappointed by the ruling. “We will now prepare for trial and welcome the full airing of the facts, which will confirm the merits of our case,” he said.

Mark S. Cohen, a lawyer for Mr. Black, did not immediately respond to a request for comment.

“We are of course disappointed by this outcome, but we knew it was a possibility based on the complexity of the law in this area,” said Roland G. Riopelle, a lawyer for Mr. Strickland.

The case against Mr. Obus centered on Allied Capital’s 2001 acquisition of SunSource, a manufacturer of bolts, washers and lock nuts. Wynnefield Capital, Mr. Obus’s hedge fund, owned nearly 6 percent of the company. The S.E.C. said that Wynnefield made $1.3 in illegal profits trading on an inside tip about the deal.

Wynnefield’s source on the deal, regulators said, was Mr. Strickland, an associate at GE Capital, which was looking to finance Allied’s acquisition of SunSource. Mr. Strickland spoke with Mr. Black, his friend and an employee of Wynnefield, but they insisted that they did not discuss the potential merger.

The S.E.C. said that Mr. Obus bought SunSource stock while in possession of secret information about the Allied deal. Mr. Obus said he had no knowledge of any possible transaction. When Allied announced its purchase, SunSource’s stock nearly doubled.

Among the sticky legal issues in the case is whether Mr. Strickland violated a duty to his employer, General Electric, a necessary element of an insider trading lawsuit. Mr. Obus’s lawyers argue that Mr. Strickland did not violate his duty to G.E., and that G.E. had not entered into any confidentiality agreement with SunSource.

Judge Daniels, the trial court judge, dismissed the case, ruling that “neither Strickland nor his employer, GE Capital, was a corporate insider of SunSource.” He added that the S.E.C. had not “demonstrated the requisite degree of deceptive conduct on the part of any defendant.”

The Federal Court of Appeals disagreed, ruling that “the S.E.C. has established genuine questions of fact about whether Obus knew that Strickland had breached a duty to GE Capital and whether Obus traded in SunSource stock while in knowing possession of the material non-public information that SunSource was about to be acquired.”

On Thursday, Mr. Cohen, a lawyer for Mr. Obus, said that for more than 10 years his client has refused to settle this lawsuit as a matter of principle.

“The facts remain the same: the lawsuit is baseless; Obus and Wynnefield behaved properly; and this case never should have been brought,” he said.

Mr. Obus, whose fund managed about $280 million in assets, has called the case “a nightmare” and said he has racked up more than $6 million in legal bills.

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DealBook: Amid Insider Trading Inquiry, Tiger Asia Calls It Quits

Tiger Asia, a spinoff of Tiger Management, the hedge fund founded by Julian Robertson, told investors in a letter that the fund would be returning their money in the coming weeks as a result of a “prolonged legal situation.”

That situation is a three-year insider trading investigation by the Hong Kong authorities into allegations of trading improprieties at the hedge fund, which was founded by Bill Hwang. The Securities and Exchange Commission has also been investigating the fund.

“As you are aware, the firm has been the subject of government investigations of alleged trading based upon confidential information and engaging in certain manipulative trades in late 2008/early 2009 in Asian markets,” Mr. Hwang wrote in his letter to investors. “We continue to work to resolve these matters in the U.S. and overseas and look forward to putting them behind us.”

Mr. Hwang is the latest investor to throw in the towel as a hedge fund manager because of a government investigation. His fund has dwindled to about $1.2 billion from about $3 billion in 2010. Though he has not been formally charged with any wrongdoing in the United States, Mr. Hwang has decided to no longer manage outside capital.

He is not the first hedge fund manager to make that decision. David Ganek decided to shutter Level Global Investors, which was raided by the Federal Bureau of Investigation in late 2010. Mr. Ganek said at the time that with the government scrutiny, he did not feel he could comfortably make investment decisions for the long term. Later, Mr. Ganek’s co-founder, Anthony Chiasson, was charged with insider trading.

Mr. Hwang held on to his operation for several years, despite the allegations made by the Securities and Futures Commission of Hong Kong. Regulators there have accused Mr. Hwang of obtaining inside information during 2008 and 2009 about placements of shares in the China Construction Bank Corporation and Bank of China, tips that regulators say earned him $5 million.

The regulator sought to bar Tiger Asia from trading on Hong Kong exchanges altogether, the first time it had ever tried to exclude an entity from trading on its exchanges. That litigation is still pending.

The investigation spread to the S.E.C., which subpoenaed the fund in 2010. While Mr. Hwang has denied the allegations, those claims did little to quell investors or end the investigation.

Mr. Hwang founded Tiger Asia, which is based in New York, in 2001 after working for Mr. Robertson at Tiger Management. He focused his trading on Asia, and like his mentor typically bought and sold stocks.

“I am saddened by the news but certainly understand Bill’s decision,” said Mr. Robertson in a statement. “I have worked side-by-side with Bill for 20 years. I have enormous respect for him as an individual and an investor. He has always been a great partner, a great person and a great friend. I continue to hold him in the highest regard.”

Since its inception, the firm has returned about 16 percent a year for its investors, handily beating the indexes during the same period. In the letter, Mr. Hwang said Tiger Asia would continue as a family office with most employees remaining at the firm.

“It is my hope that someday I will again have the privilege to manage your capital,” he wrote in the letter.

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