Hedge Funds

SAC: A textbook case of corporate prosecution

James B. Stewart
Steven A. Cohen
Scott Eells | Bloomberg | Getty Images

SAC Capital's agreement to plead guilty to insider trading and $1.2 billion fine may represent a sweeping victory for Preet Bharara, the United States attorney, and his team of prosecutors, and vindication for their multi-year investigation of one of the country's most successful hedge funds. But the decision to indict a company, and to spare, at least for now, its founder and billionaire manager, Steven A. Cohen, has already ignited criticism.

"A company can't commit a crime," said Edwin T. Burton, a professor of economics at the University of Virginia, who wrote a widely circulated blog post this summer that criticized the government's indictment. "They should only go after the people doing things wrong. There are innocent bystanders, a lot of them, who get hurt. Why is the villain the one who sweeps out the floor every night?"

(Read more: Up big, this fund poaches talent from SAC, others)

The Justice Department itself recognizes in its "Principles of Federal Prosecution of Business Organizations" that "corporate prosecutions can potentially harm blameless investors, employees, and others." The collapse of Arthur Andersen after it was indicted in 2002, reducing the number of large international accounting firms to just four, is widely cited as an example of the collateral damage that corporate prosecutions can have.

SAC Capital takes responsibility

But SAC Capital is no Arthur Andersen.

"Based on all that we know and the evidence that's come to light, I'd say justice was done," said Lawrence M. Friedman, a professor at the New England School of Law and author of "In Defense of Corporate Criminal Liability" in the Harvard Journal of Law and Public Policy. "It's hard to imagine a better case for advancing the goals of criminal liability."

Mr. Bharara said in an interview on Monday that he didn't want to comment on the SAC plea deal, which still must be approved by a federal judge. But, he said: "There are lots of different ways to punish wrongdoing and effect deterrence. Sometimes you charge individuals, sometimes you seek a large penalty, sometimes you send people to jail and sometimes you try to make the world understand that an entire institution deserves to be held blameworthy. Just because you do one doesn't mean you don't do the others."

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Given the broader goals of the criminal code, SAC Capital may emerge as a textbook case for prosecuting companies — and a harbinger of far more aggressive prosecution of corporate crime.

While Professor Burton is correct that only human beings can commit crimes, the notion that corporations are the same as individuals in the eyes of the law dates at least to an early 19th century Supreme Court case, which held that corporations, like people, can enter into contracts. That view was reaffirmed in the recent Citizens United case, which held that corporations are entitled to the free speech guarantees of the First Amendment.

The federal government has long prosecuted corporations whose managers engaged collectively in criminal behavior. "Corporations should not be treated leniently because of their artificial nature nor should they be subject to harsher treatment," the Justice Department principles state. "Vigorous enforcement of the criminal laws against corporate wrongdoers, where appropriate, results in great benefits for law enforcement and the public."

These benefits, according to Professor Friedman, include protecting the public, deterring similar unlawful conduct and what he called "expressive value," which is the public statement that certain behavior should be subject to criminal sanction.

They should only go after the people doing things wrong. There are innocent bystanders, a lot of them, who get hurt. Why is the villain the one who sweeps out the floor every night?
Edwin T. Burton
Economics professor, University of Virginia

"There are many critics who will say, 'You can't incarcerate a corporation, so what's the point?' My view is, what they did, it was just as wrong, and by treating it as a criminal rather than civil matter, it makes an important statement about the seriousness of the wrongness."

There's surely no dispute that SAC Capital was the site of some of the most brazen and widespread insider trading in Wall Street history. In its plea agreement, the firm admitted committing five felonies. Six of the firms' traders have pleaded guilty to securities fraud charges, and two more are awaiting trial in what the prosecutors have called a systemic insider trading scheme that spanned more than 10 years.

And while Mr. Cohen hasn't been charged with any crime, he can't claim to be simply an innocent bystander. The Securities and Exchange Commission has filed civil charges against Mr. Cohen claiming failure to supervise, and said he didn't follow up on numerous "red flags" indicating potential insider trading at the firm. (Mr. Cohen has denied the charges and vowed to fight the suit, which wasn't affected by the guilty pleas on Monday.)

US vs SAC: Pain for stocks?

It's true that many of SAC's employees may lose their jobs as the firm winds down; it has already shrunk considerably. And many investors have already moved their money elsewhere, and may have trouble replicating SAC's astounding track record. But presumably, traders at one of the country's most successful hedge funds will have no trouble landing new, multi-million dollar positions at rival firms in the fiercely competitive hedge fund world. And investors can hardly complain that they can no longer earn market-beating returns aided by illegal insider trading.

(Read more: SAC Capital to become a 'family office')

As for deterrence, "This is a very visible case with a very large dollar sign attached to it," Professor Friedman said. "You could argue that the audience for this is very sensitive to dollar signs. They're other hedge funds and money managers. It's a big enough number to get attention, because if it's too low, it's just perceived as another cost of doing business."

And given Mr. Cohen's ownership of the firm, the $1.2 billion fine, as well as a previous $600 million settlement with the SEC, will come out of his pocket, rather than public shareholders'. With a fortune estimated at $9 billion, Mr. Cohen will still be a billionaire many times over, but the fine is nonetheless more than a dent in his personal fortune.

FBI: SAC cultivated a culture of corporate corruption

This aspect even mollified a critic like Professor Burton. "At least the target is the same as the alleged villain," he said, referring to Mr. Cohen. "This is almost never the case when you sue and indict a public company."

(Read more: SAC to shutter London office in downsizing move)

SAC Capital didn't even pay lip service to the idea that it would unconditionally cooperate with the government's investigation, let alone make a "timely and voluntary disclosure of wrongdoing," which is another factor in the Justice Department's guidelines that SAC flouted. "It's extraordinary that they said publicly they would not cooperate," Professor Friedman said. "They evidently thought they would get away with it with impunity."

Mr. Cohen's lavish spending during the course of the investigation — he bought "Le Rêve" by Pablo Picasso for $155 million and paid $60 million on a Hamptons estate earlier this year — was widely perceived as thumbing his nose at prosecutors.

Even after his company's guilty plea, Mr. Cohen is hardly out of the woods, and he won't find any comfort in the Justice Department's principles. They state, "Prosecution of a corporation is not a substitute for the prosecution of criminally culpable individuals within or without the corporation." And, "Only rarely should provable individual culpability not be pursued, particularly if it relates to high-level corporate officers, even in the face of an offer of a corporate guilty plea or some other disposition of the charges against the corporation."

(Read more: SAC trader fired over bogus bonus scheme: Report)

—By James B. Stewart, The New York Times.