Steve Cohen and the Hamptons pool defense

SAC Capital's response to charges that the hedge fund founder Steve Cohen failed to supervise employees comes in an unusual form—a 46-page white paper authored by two outside law firms.

The paper was circulated Monday to employees and promptly leaked to the media. It's relatively clear that the paper was written for public consumption. This is a document intended to cast doubt about the Securities and Exchange Commission's case in the minds of reporters and—importantly—investors in Cohen's funds.

Not surprisingly, the SAC paper takes a very strong line here.

"Steve Cohen did nothing wrong, and any fair review of the evidence will show that the SEC's charges are unfounded," the paper declares on its first page.

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Cohen will have an uphill battle if he's trying to win over public opinion. Nine former employees of SAC Capital have been tied to insider trading. Four have pleaded guilty to criminal charges. It's not exactly far-fetched to conclude that something about SAC permitted or perhaps encouraged illicit trading.

The SEC complaint against Cohen, however, doesn't allege that he engaged in any criminal wrongdoing. It doesn't allege that he engaged in any improper trades at all. Rather, it says he ignored "red flags" that should have alerted him to illicit trading and triggered measures to prevent it.

The SEC's case centers around two sets of trades made by SAC in 2008. Let's start with Dell. The SEC's filing last Friday pointed to an e-mail about Dell that an SAC trader forwarded to Cohen, who was working at his summer home in the Hamptons. The e-mail came from Jon Horvath, an SAC research analyst who pleaded guilty to criminal charges last year, and contained a "2nd hand read from someone at" Dell. That turned out to mean detailed information about Dell's financial performance for the quarter.

(Read more: Bull's-eye! SEC pins charges on SAC Capital's Cohen)

SAC lawyers put forth three responses. First, they say Cohen didn't read the email. Like most of us, Cohen gets far too many emails to read them all. According to the paper, he gets roughly 1,000 emails each day. This is highly plausible for someone in Cohen's position. Let's call this the "Email is Broken" defense.

The second response is the "Hamptons Pool" defense. When the email was sent to Cohen, at 1:29 in the afternoon, Cohen was in the middle of a 19 minute telephone call with SAC's head of business development. A minute and a half after the conclusion of that phone call, at 1:37:46, Cohen got a call from a research trader, discussing something or other (no one is certain what). At 1:39:11, an order to sell shares of Dell in Cohen's personal account at SAC was placed.

Now Cohen is perhaps the best stock trader in history. His lawyers write as if it is simply impossible to think that Cohen would have been able to read the email while on the telephone call with his biz dev guy, or while on the phone with the trader. So according to them, this leaves Cohen only seconds to read the Horvath email, contact his trader and order the sale of Dell stock. That stretches credibility a bit. It's highly likely that Cohen is the kind of guy who is capable of multitasking at a very high level. This guy has seven screens at the desk of his Hamptons vacation home, according to his lawyers. Surely he can take a call while scanning emails.

(Read more: SAC Capital's biggest positions)

Even his lawyers seem to understand this—which is why they mount the Hamptons Pool defense. They say that Cohen probably wasn't even at his desk at the time. If he was taking calls from traders—rather than instant messaging them—he was likely somewhere else. They don't quite say he was lying by the pool but that's the implication. This is entirely reasonable—if you had to suffer through a 19-minute call with a biz dev guy, you'd probably want to do it from a poolside lounge chair, too. (Assuming, of course, that you were the kind of person who has a biz dev guy and a poolside upon which to lounge.)

The last line of defense here seems pretty strong: The information in the "second hand read" email was wrong. Dell's gross margins were far worse than the range the email predicted. In other words: this doesn't really seem like top secret corporate information at all.

As it turns out, the "second hand read" information came from an investor relations officer at Dell. That person just thought he was doing his job, no doubt trying to manage expectations in light of coming under-performance, rather than leaking nonpublic data. No charges have been filed against him.

Note, however, that Cohen's traders could do something that ordinary retail investors probably cannot—get an email from Dell hinting at what's going to happen in a coming earnings report. This is not, however, unique to SAC Capital. No doubt traders and analysts at any big financial company can do the same thing. But it is a sign that regulations intended to "level the playing field" aren't really working out.

The other part of the SEC case involves SAC's trades in the stocks of the pharmaceutical companies Elan and Wyeth. At the time, the two companies were jointly developing an Alzheimer drug. One of the traders involved in these trades, Matthew Martoma, has been accused in a criminal trial of trading on inside information obtained from a doctor overseeing the drug's clinical trial. Martoma has pleaded not guilty to the charges.

Unlike a number of other drug stock analysts at SAC, Martoma had been a bull on Elan in the summer of 2008. Cohen, following Martoma's advise over the objections of the other analysts, had built up a large position in the companies. The day after a 20-minute phone call with Martoma in July 2008, SAC began aggressively selling the shares in the two companies through various dark pools and other schemes designed to prevent others from noticing that SAC was selling its position.

The SEC says Cohen should have suspected Martoma was getting his information from insiders. When Martoma told Cohen that he was no longer "comfortable" with the position, Cohen should have seen that as a red flag and taken action to prevent illegal trading, according to the SEC.

The SAC white paper draws attention to the fact that this was taking place in the summer of 2008—just before everything went into full meltdown mode. The broader market was in sharp decline, while shares of Elan had gone up by 40 percent, making it the second-best performer in the S&P. With perceptions of global risks mounting, having big positions in anything didn't make much sense. Even if Martoma's turnaround on Elan might have raised a "red flag" in different circumstances, getting nervous about a big position in the summer of 2008 just seemed like prudence, according to SAC's lawyers.

(Read more: Social media reaction to the Cohen charges)

What's clear from the white paper is that the SEC faces a feisty opponent in Cohen—and one armed with very clear and plausible arguments against the claims made against him. For the most part, he's not relying on legal technicalities. He's going directly at the factual claims of the government and explaining them with a compelling counter-narrative.

Here and there, however, glimpses into the darkness emerge, even in a paper written by SAC's lawyers. At one point when discussing information received from a doctor, who may or may not have had nonpublic information about the Elan/Wyeth drug trials, the white paper says that even if the doctor did have confidential information he wouldn't have been under a legal duty to keep it confidential (which, in turn, means trading on it wouldn't have been illegal). That's the kind stuff that sends chills through the spines of investors or regulators—the idea of hedge funds with access to confidential information that they are somehow allowed to trade on.

—By CNBC's John Carney. Follow him on Twitter @carney.