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SAC Case Threatens a Wall St. Cash Cow

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Wall Street now has to contemplate life without SAC Capital Advisors, the hedge fund that manages billions of dollars.

In a rare and aggressive action, federal authorities on Thursday indicted the fund on criminal charges. And in doing so, the government may have threatened the life of a big golden goose for Wall Street.

SAC Capital, led by Steven A. Cohen, has been a prodigious, unruly force in the market for years.

Its whirlwind trading style has helped move stock prices. And the fund consistently pays millions of dollars in commissions and fees to prominent investment banks that handle its trading.

(Read more: Federal prosecutors seek 'any and all' SAC assets)

Banks received $9.3 billion from clients in stock trading commissions in the 12 months through the first quarter of this year, according to a study by Greenwich Associates. Brokers said that SAC Capital was one of the largest commission generators for Wall Street.

Not only does Wall Street support the fund's stock and derivatives trades, but the firm is also a reliable client for those further down the food chain, like technology equipment providers. Now, the fund's banks face an uncomfortable choice. Should they keep acting as a broker to SAC Capital? There will be strong temptation to maintain full ties with the fund. The payments from SAC Capital are welcome during these leaner times on Wall Street. And banks may be reluctant to drop a client that has not yet been proved guilty.

But since the financial crisis, banks have to care more about their public reputations and the desires of their regulators. Senior bank executives and their lawyers may therefore decide that the risks of staying loyal to SAC Capital outweigh the financial benefit of having it as a client. "They really don't need this additional reputational load," said Ingo Walter, a professor of finance, corporate governance and ethics at New York University.

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Banks write contracts with hedge funds that allow them to drop the funds under certain situations. An indictment might be such a catalyst in the contracts banks have with SAC Capital. But the brokers would have wide discretion over whether to end the relationship.

"It would be highly unusual to have something that is automatically triggered," Leigh R. Fraser, a partner at Ropes & Gray, said.

Unlike a bank, SAC Capital isn't wholly reliant on the confidence of others to stay alive. An indicted bank would almost certainly face collapse. The investment bank Drexel Burnham Lambert filed for bankruptcy protection in 1990 after it faced the possibility of an indictment.

"If you have a bank that is charged with criminality, customers will withdraw," Charles Geisst, a professor in the economics and finance department of Manhattan College, said. "But if a customer is charged, I don't think there are too many banks that will turn them down, at least initially."

(Read more: Grassley: BringCohen before Congress)

Arthur Andersen wasn't a bank, yet it collapsed in 2002 after it was indicted. The accounting firm imploded because its clients fled. But SAC isn't wholly reliant on client money.

The United States attorney's office is seeking a forfeiture of some of the firm's assets, but SAC would likely have considerable resources left even after such an action. In recent months, SAC Capital investors have in effect taken out as much as $5 billion of their money, and the remaining $1 billion to $1.5 billion could well leave after the indictment on Thursday.

But the fund would still have an estimated $9 billion that belongs to Mr. Cohen and other employees. SAC Capital could close down, pay a fine and still move much of that left over money to a new company. Mr. Cohen himself does not face criminal charges, but the Securities and Exchange Commission has accused him of failure to supervise. If found liable, he could be barred from investing money for others but could be allowed to manage his own sizable sum of money.

But any new investment vehicle set up by Mr. Cohen would still need Wall Street. And the banks would have to decide whether they wanted to do business with him.

"His money will be just as green after this indictment as it was before," said Jonathan R. Macey, a law professor at Yale.

So far, SAC Capital's problems have not weighed on the wider market. If a large financial firm becomes unstable, regulators often worry that it will dump its assets, setting off a fire sale. Smelling blood, other investment funds may also bet against those shares to make a profit.

But some of SAC Capital's previously disclosed investments were holding up well on Thursday. For instance, recent filings showed that SAC Capital owned a big stake in GNC Holdings, the retailer of vitamins and health products. Its stock was up over 10 percent on Thursday after reporting earnings.

One wild card is whether SAC Capital has been using margin, or borrowed money from its brokers, to make its biggest bets. If a Wall Street bank demanded those loans be paid back immediately, the fund could face trouble.

(Read more: Bharara on SAC: Illegal trading spanned a decade)

SAC Capital's assets look relatively small when placed in the context of the wider market. Hedge funds — which manage money on behalf of college endowments and pension funds as well as the wealthy — as a whole have $2.4 trillion of assets under management, according to Hedge Fund Research. Mutual funds have $28 trillion of assets, according to the Investment Company Institute.

But SAC Capital's frantic trading made it a much bigger source of earnings for Wall Street than investment companies that were many times its size.

SAC Capital's indictment could serve as a reminder to Wall Street and investors not to grow too dependent on funds that pursue aggressive strategies. Assets at hedge funds have grown even though they have generally underperformed in the market. SAC Capital's high profile problems could do even more to take the gloss off the sector.

"Hedge funds were touted as being smarter than everyone else," Mr. Geisst said. "I think this marks something of an end to that era of hedge funds."

By Peter Eavis of The New York Times

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