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An Unwelcome Spotlight Falls on SAC Capital

In the last two months, SAC Capital Advisors has turned into a $13 billion piñata.

Since federal prosecutors began making arrests in a major insider trading investigation in October, SAC, which is based in Stamford, Conn., and owned by Steven A. Cohen, has been linked to the case.

Mr. Cohen, 53, is among the world’s richest hedge fund managers, with a personal fortune estimated at $6 billion. In the 1990s, he gained fame as a rapid-fire trader with an uncanny sense of short-term market moves.

Today, he spends much of his time running SAC but still trades actively. A collector of modern art, he prizes privacy for himself and his fund. He is rarely seen in public, and SAC employees must sign confidentiality agreements when they join the firm.

Now, the insider trading investigation has thrown an unwelcome spotlight on Mr. Cohen and the remarkable returns of his hedge fund firm.

No current employee or manager has been charged with wrongdoing in the investigation, which is continuing. But a former SAC analyst, Richard Choo-Beng Lee, has pleaded guilty on charges related to insider trading that occurred years after he left the firm and has agreed to provide any information he might have about insider trading that occurred when he was at SAC.

More or less by itself, that fact has stirred a flurry of articles trying to connect SAC to the investigation.

Mr. Cohen’s record is not entirely clean. In 1995, the New York Stock Exchange censured him for inflating the price of a penny stock to increase the value of a portfolio he managed. The manipulation took place in 1991, when Mr. Cohen worked at Gruntal & Company, a small investment bank.

As a penalty, Mr. Cohen agreed to a four-week ban from “employment or association in any capacity” with any broker-dealers on the exchange.

He left Gruntal three years earlier, so the penalty was effectively a slap on the wrist. He neither admitted nor denied wrongdoing as part of the settlement.

Despite the 1995 censure, former SAC employees say that Mr. Cohen does not tolerate wrongdoing and that the firm, which manages about $13 billion, is being unfairly smeared. Its compliance department has about 15 employees who watch for suspicious trading patterns and other potential violations. The firm neither encourages nor condones insider trading, these former employees said.

“There was a culture of compliance,” one former manager said. “People who couldn’t explain how they were doing things were let go.”

These former employees said many outsiders do not understand the way SAC operates. Some mutual and hedge funds have investment committees that review major investments. In others, a single manager runs the fund and makes every bet.

SAC works differently. The firm has about 100 portfolio managers who work independently, each making investments that are relatively small compared with SAC’s overall portfolio and each paid based only on his own results. Even Mr. Cohen manages less than 10 percent of the fund’s capital.

Under those circumstances, SAC has no reason to condone insider trading by individual managers, because doing so would risk the firm’s entire business for only minor upside. SAC’s pay structure, however, could drive individuals to take risks that are not in the firm’s overall interest.

Neither Mr. Cohen nor any current employees would discuss his fund’s trading practices or compliance policies. The former employees all insisted on speaking anonymously, citing clauses in their contracts with SAC that prohibit them from talking about Mr. Cohen or the firm.

Nonetheless, the former employees painted a consistent picture of SAC, which was founded in 1992 with nine employees and $25 million under management. The firm now has 800 employees, including about 300 portfolio managers, traders and analysts.

The firm’s stellar returns have driven its growth. Since 1992, SAC has produced average annual returns of about 30 percent, after fees, nearly four times the average return of the Standard & Poor’s 500-stock index, according to a person close to the fund.

Managers: eat what you kill.

The returns, and Mr. Cohen’s secretiveness, have fed the firm’s mystique and led competitors to question whether it bends the rules. But the former employees say the firm’s success rests on a relatively simple formula. Because its returns have been so high, SAC can charge investors hefty fees. It charges an annual fee of 3 percent of assets under management, and keeps 50 percent of the profits. Typical hedge funds charge 2 percent of assets and keep 20 percent of profits annually.

Those huge fees allow it to poach talented people from other funds. The firm gives new hires a pool of money and the implicit promise that if they do well, they will eventually be able to start their own funds, former employees say.

“They provide a great platform for people who have been in the business for a while and want to become a portfolio manager,” said a former employee who now has his own fund. “And they are very generous.”

Once they join SAC, managers find a relentlessly competitive environment. No matter the firm’s overall profitability, managers are paid based on their own results. Essentially, portfolio managers are paid a percentage of the profits they generate — a percentage determined in the contracts they sign when they are hired. That pay structure allows SAC to avoid the year-end fights over bonuses that rack other firms.

At the same time, the firm’s managers have little reason to cooperate with one another. “It is an absolutely intense environment — eat what you kill — and the compensation environment does not encourage you to share,” a former SAC executive said.

The internal competition can verge on the absurd. At breakout sessions at investment conferences, where corporate executives meet with fund managers to talk about their businesses, the executives must sometimes meet with SAC managers one by one, because managers do not want others at the firm to hear their questions.

Over time, managers who perform well are given more money to run. Eventually, many leave to start their own funds, which often receive investments from SAC. The firm has little patience with poor performers, who are usually encouraged to leave if they do not begin making money within a year of being hired.

So SAC effectively operates as a group of small hedge funds, rather than a single huge fund that makes very large bets to generate its returns. Because SAC knows that a single charge of insider trading could devastate the firm, it vigorously enforces securities rules, former employees said.

Analysts and fund managers are told to ask SAC’s lawyers for approval before trading in cases when they receive corporate tips that might fall into the category of inside information. If the lawyers decide that the tips indeed qualify as inside information, they place the company’s stock on a “restricted list,” blocking any manager at SAC from buying or selling its shares.

“There was a process, you were expected to run those facts and circumstances up the ladder,” one former portfolio manager said.

While SAC has never been charged with wrongdoing, authorities appear to be looking at SAC in the current investigation into insider trading, which began at least two years ago and became public in October. Since then, prosecutors have charged more than 20 fund managers, analysts, lawyers, and corporate executives from Wall Street to Silicon Valley in several related cases. The list is expected to grow.

Mr. Lee, who worked as an analyst at SAC from 1999 until 2004, is the closest connection to SAC. Mr. Lee pleaded guilty in October to two counts of trading on inside information when he managed his own hedge fund in California. He did not plead to any infractions at SAC.

Even so, prosecutors directed Mr. Lee to disclose any insider trading he committed at SAC, or “a conspiracy to commit the same,” as part of his plea agreement. Earlier this year, while cooperating with prosecutors, Mr. Lee tried to rejoin SAC, but to no avail.

Jeffrey L. Bornstein, Mr. Lee’s lawyer and a partner at K&L Gates, said last month that Mr. Lee was cooperating with the authorities but declined to say whether they had asked him to build a case against SAC.

In 2008, as markets tumbled, SAC had its worst year ever, with its main fund down 19 percent. This year, the firm has recovered, gaining 26 percent through Nov. 30, net of fees — though that figure is less impressive than it seems, since the S.& P. 500-stock index is up about 24 percent.

Like some other major hedge funds, SAC spent much of the last decade diversifying from its core business of trading stocks into other markets, including commodities, bonds and emerging markets. Mr. Cohen hoped eventually to create a global money-management firm.

But since early 2008, SAC has retrenched. While large by hedge fund standards, it is tiny compared with publicly traded investment banks like Goldman Sachs, and competing directly with them would have required SAC to borrow many billions of dollars to build its balance sheet.

Even before last fall’s market upheaval, Mr. Cohen concluded that his firm would be best served by avoiding that leverage and sticking to its core business of stock trading, former employees said.

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