The arrests are the latest escalation in the federal government's wide-ranging probe into insider trading at hedge funds. The offices of Level Global and Diamondback were both raided in 2010.
SAC Capital is a $13 billion hedge fund founded by Steven Cohen. It’s long been thought that busting SAC Capital may be the goal of investigators, despite the fact that until today only former SAC employees had been charged. Back in 2010, however, SAC informed investors in its funds the government had issued an "extraordinarily broad" subpoena. The sheer number of people once affiliated with SAC who have been charged with or convicted of insider suggests that authorities have a special interest in the fund.
Not everyone buys that reasoning. One hedge fund founder I spoke with — a guy who has never worked at SAC Capital — said SAC is such a large fund, with so many talented traders, that any random sampling of hedge fund traders would likely produce connections to SAC.
“SAC winds up at the center of these things because they are so central to hedge funds altogether. A lot of funds were launched by SAC veterans and the rest of us just try to hire their best traders,” he said.
The main reason for thinking that SAC Capital is in the crosshairs of government authorities is the firm has performed so extraordinarily well for so many years. In fact, some people say that Cohen and his cadres may be the most successful traders ever.
In testimony to Congress last year, Securities and Exchange enforcement head Robert Khuzami said the SEC was looking closely at hedge funds with “aberrational performance.” The basic idea is that because markets tend to be efficient, consistently beating them should be impossible. So hedge funds that consistently beat market averages may be benefiting from tips.
Khuzami even had a bit of a metric for measuring when the SEC’s insider trading spider-sense would start quivering, noting that “anybody who is beating market indexes by 3 percent and doing it on a steady basis” would be worth taking a closer look at.
If outperformance is taken as an indicator of being dirty, authorities would have to be curious about Cohen and SAC.
“No one, the thinking goes, can be that good — and that lucky — for so long. Ergo, he must be cheating. Specifically, engaging in insider trading. And that's why they've been after him for all this time,”Duff McDonald wrote in a 2010 piece for Fortune about the probe.
At some point, however, the very breadth and length of the government’s probe will begin to seem exculpatory for Cohen and SAC.
If the FBI and the SEC devoted all these years, manpower, wiretaps and informants hoping to pin something on SAC, they’ve failed badly. And that failure may make even the harshest critics of SAC finally admit that maybe, just maybe, Cohen and his people really are just the best traders ever.
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