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For SAC, Indictment May Imperil Its Survival

SAC Capital Advisors
Douglas Healey | Bloomberg | Getty Images
SAC Capital Advisors

Is SAC Capital Advisors going to be the next Arthur Andersen, a company destroyed by an indictment?

If so, there will be one primary distinction: Government officials came to regret forcing Andersen, the auditor of Enron and one of the Big Five accounting firms at the time, out of business. At SAC, the hedge fund manager run by Steven A. Cohen, that appears to be a primary goal of the government.

Corporations, as Mitt Romney famously said, are people, too, at least under the law. They can be — and are — indicted and convicted of felonies. They often face large fines, but, unlike people, they cannot be thrown into prison.

But as with people, the extent to which an indictment or even a conviction can be damaging depends very much on the details of the nature of the business and of the nature of a company's customers. In general, a company that has a primarily wholesale business, dealing with a relatively small group of customers, may be better placed to survive the bad publicity than would be one that dealt extensively with the public.

(Read more: The Secret to SAC's Returns May Be Weirdness)

By those criteria, SAC would appear to be relatively immune to reputational threats. Unlike, say, a large bank, it does not deal with many individual customers. There are institutional investors — notably some public pension funds — that might be barred by their own rules from dealing with a firm convicted of a felony. But at SAC, most such customers have probably closed out their accounts anyway during the years the firm has been under investigation.

And then there is the nature of the crime that prosecutors say took place at SAC — insider trading. That is a crime that, to some extent at least, can attract customers who hope to share in the profits. In fact, there have been many cases where individual investors were defrauded by promoters who falsely claimed to be sharing inside information.

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Mr. Cohen has become a billionaire many times over as a wildly successful hedge fund manager. The government believes that a significant amount of his firm's success came from insider trading, but it has so far been unable to build a case tying Mr. Cohen directly to acts he knew were illegal.

Instead, the firm itself is to be indicted, according to people briefed on the investigation. And the Securities and Exchange Commission, which has no criminal enforcement authority, has brought an administrative case that could lead to Mr. Cohen's being barred from managing outside investors' money. If so, that would force Mr. Cohen out of the firm that bears his initials and almost certainly lead to its closing, at least as a hedge fund open to other investors. Many hedge funds have closed to outside investors and continued as so-called family offices, managing their owners' money. About $9 billion of what is left of SAC's assets belongs to Mr. Cohen.

The prospect of a world without an active SAC does not seem to scare the government, and there is no reason to think it would. The disappearance of SAC would not lead to diminished competition in the hedge fund world; plenty of such firms would continue to seek to manage money.

But an indictment of a large bank could be a different story. Banks like Citigroup, Bank of America, JPMorgan Chase and Wells Fargo have millions of customers, and officials would hate to see one of them go away, even if the departure could be managed in a way that prevented the contagion that followed the collapse of Lehman Brothers in 2008.

Moreover, the Investment Company Act of 1940 bars felons from managing mutual funds. The S.E.C. could waive that penalty for a convicted bank, and it might do so if the crime were sufficiently removed from banking — say, illegally storing chemicals or something like that. But if the conviction was for defrauding investors, or money laundering or mortgage fraud, the chances of gaining such a waiver would probably be slim.

(Read more: Indictment expected for SAC Capital Advisors)

Eric H. Holder Jr., the attorney general, seemed to say during Senate testimony in March that some banks were "too big to jail," as critics immediately paraphrased.

"I am concerned that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if you do prosecute, if you do bring a criminal charge, it will have a negative impact on the national economy, perhaps even the world economy. And I think that is a function of the fact that some of these institutions have become too large," he said at the time.

He later tried to backtrack. "Let me be very, very, very clear," he said at a House hearing in May. "Banks are not too big to jail. If we find a bank or a financial institution that has done something wrong, if we can prove it beyond a reasonable doubt, those cases will be brought."

Nonetheless, it has long been Justice Department policy to bear in mind corporate issues not present in individual cases. In 1999, Mr. Holder, the deputy attorney general at the time, said in a memo to prosecutors that before indicting a company they should consider "collateral consequences, including the disproportionate harm to shareholders and employees not proven personally culpable."

Andersen, the accounting firm, went under because of its failed audits of Enron, and it probably would have done so even without the indictment, so severe was the hit to its reputation. In that case, prosecutor anger against the firm stemmed in part from the fact it had been spared indictment in a previous accounting scandal, involving Waste Management, after it promised to mend its ways. The Enron case made it clear those promises had not been kept.

(Read more: SAC Capital refutes allegations against Steve Cohen)

In recent years, some corporations do appear to have escaped indictment because of concerns about creating a new Andersen. In retrospect, many officials who concluded that four big accounting firms were too few wished that a way could have been found to keep a reformed Andersen alive.

At KPMG, one of the remaining Big Four accounting firms, former partners were convicted and imprisoned for their role in illegal tax shelters, but the firm itself escaped prosecution. It signed a "deferred prosecution agreement" in which it admitted culpability and paid a large fine but avoided a criminal record.

Such agreements, and related "nonprosecution agreements," have been signed with many large companies in recent years, among them Merck, JPMorgan, Google, UBS and Johnson & Johnson. None of those suffered obvious consequences in terms of the ability to conduct their business in the future.

And many companies have gone on to success after being convicted of felonies. One of the most famous antitrust cases ever, concerning a price-fixing conspiracy among large manufacturers of electrical equipment in the 1950s and early 1960s, led to a conviction for General Electric. And a subsidiary of Merck was forced to plead guilty to state criminal charges in connection with the marketing of the drug Vioxx, although the parent escaped with a nonprosecution agreement. In January, BP pleaded guilty to a series of felonies, including manslaughter, in connection with the 2010 Gulf of Mexico oil spill. On the day that was announced, its stock price went up.

By Floyd Norris of The New York Times.

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