Yesterday, the judge in the SAC case accepted the firm's plea deal with the Justice Department, in which the firm and its subsidiaries pled guilty to wire fraud and securities fraud and agreed to pay a $900 million penalty and $300 million in disgorged profits. The Southern District hailed the deal as the crowning victory in their multi-year campaign against insider trading, which notably has resulted in more than 70 convictions and exactly zero acquittals. Congratulations.
But what many of us want to know is: why, immediately after the most severe financial crisis in more than seventy years, which resulted in the loss of almost nine million jobs, did the Justice Department choose to train its heavy artillery on insider traders? Sure, insider trading is bad. It's very rich people cheating to make themselves extravagantly rich. It should be illegal, and people should go to jail for it. But it's far from the biggest thing wrong with our financial markets and institutions.
There are some serious academics who even think that insider trading should be legal. The argument goes roughly like this. Say a company discovers a new drug that can cure cancer. Once that information becomes public, the company's stock price will soar. But we all know that some people find out sooner than others. By the time you read it in the Wall Street Journal, lots of other people know it already. High-speed trading firms buy access to electronic news and data feeds in part so that they can trade on that information milliseconds before anyone else. In any case, you aren't going to be the person who buys more stock in the brief window before the stock reaches its new equilibrium price. It's going to be some hedge fund manager in Greenwich. Now, why is that better for society than if the person who benefits from the information is a company insider? Furthermore, if we allow insiders to trade, then stock prices will respond to new information more rapidly, which means stock prices will more accurately reflect fundamental values, which is a good thing.
The world is more complicated that, and as I said above, I do think insider trading should be illegal. But I don't think it's nearly as bad—either in a moral sense, or in its impact on society—as, say, pushing toxic loans onto poor people, or misleading investors about the contents of CDOs, or fraudulently foreclosing on people when you don't even own the note for their mortgage loan.
But, you say, the behavior that produced the financial crisis wasn't actually illegal, so the government couldn't send anyone to jail for it. Well, to some extent this is just a question of motivation. Most lawyers will tell you that the Justice Department has an awe-inspiring array of resources, if it chooses to use them. The dizzying array of crisis-related settlements provides strong evidence of serious wrongdoing—wrongdoing that could have been the basis for criminal indictments, had the DOJ been so inclined.
More specifically, look at what they did in the SAC case. They went after lower-level portfolio managers, found evidence of insider trading, and then convinced most of them to plead guilty and cooperate with the investigation. They then used those guilty pleas as the basis for the criminal case against SAC, on the grounds that the firm enabled and benefited from the fraudulent behavior by its employees. This is from the criminal indictment, paragraphs 6–7:
"The SAC ENTITY DEFENDANTS enabled and promoted the Insider Trading scheme through several means . . . Second, the SAC ENTITY DEFENDANTS' employees were financially incentivized to recommend to the SAC Owner 'high conviction' trading ideas in which the SAC [Portfolio Manager] had an 'edge' over other investors, but repeatedly were not questioned when making trading recommendations that appeared to be based on Inside Information. Third, on numerous occasions the SAC ENTITY DEFENDANTS failed to employ effective compliance procedures or practices to prevent SAC [Portfolio Managers] and SAC [Research Analysts] from engaging in insider trading.
". . . Further, the relentless pursuit of an information 'edge' fostered a business culture within SAC in which there was no meaningful commitment to ensure that such 'edge' came from legitimate research and not Inside Information. The predictable and foreseeable result . . . was systematic insider trading by the SAC ENTITY DEFENDANTS."
In other words, SAC broke the law by implicitly encouraging its employees to commit insider trading and not doing anything to prevent them from committing insider trading. This is essentially what the big banks did, only for "insider trading," substitute: buying loans they knew to be fraudulently underwritten; packaging loans that they knew did not comply with the description of the loans in the placement memorandum; lying to buy-side clients about the contents of the securities they were selling them; or selling Fannie and Freddie loans that they knew did not meet the criteria they claimed.
It's true that Steven Cohen himself is not going to jail. But going after the firm is one way to get around the plausible deniability problem: Lloyd Blankfein (for example) can always say that he didn't do anything illegal and didn't know any of his employees were doing anything illegal. But the SAC case shows that if a firm's executives create an incentive system and a culture that predictably results in criminal behavior, then the firm itself is a criminal. And surely Lloyd Blankfein doesn't want Goldman Sachs to have to plead guilty to a crime on his watch.
Preet Bharara, the U.S. Attorney for the Southern District, said of SAC, "Today’s sentence affirms that when institutions flout the law in such a colossal way, they will pay a heavy price." If only that were true for the biggest institutions that flouted the law with the most colossal consequences for all of us.