Date: 2025-05-01 Page is: DBtxt003.php txt00017336
Banking and Finance
Hedge Fund Behavior
Inside the Rise and Fall of Wall Street’s Most Powerful Hedge Fund
Peter Burgess
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Date: 2025-05-01 Page is: DBtxt003.php txt00017336 | |||||||||
Banking and Finance | |||||||||
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Burgess COMMENTARY Peter Burgess | |||||||||
| Inside the Rise and Fall of Wall Street’s Most Powerful Hedge Fund Published on February 18, 2017 Sheelah Kolhatkar Sheelah Kolhatkar Staff Writer at The New Yorker, Author of Black Edge It would be an investigation unlike any other in the history of Wall Street, a decade-long, multiagency government crackdown on insider trading focused almost entirely on hedge funds. It began with Raj Rajaratnam and the Galleon Group and quickly expanded to ensnare corporate executives, lawyers, scientists, traders, and analysts across dozens of companies. Its ultimate target was Steven Cohen, the billionaire founder of SAC Capital Advisors, possibly the most powerful hedge fund firm the industry had ever seen. In 1992, the year Cohen started SAC, the average person had only the faintest idea of what a hedge fund was. Most funds like his began as tiny, informal operations founded by eccentric traders whose financial ambition couldn’t be satisfied by even the mightiest investment banks on Wall Street. They had little patience for corporate culture and no interest in negotiating over their bonuses each year. Many of them wore jeans and flip-flops to work. Their aversion to the big banks and brokerage firms was a source of pride. Hedge funds were conceived as a small, almost boutique service, as vehicles for wealthy people to diversify their investments and produce steady, moderate returns that were insulated from swings in the stock market. The idea behind them was simple: A fund manager would identify the best companies and buy their shares while selling short the stock of ones that weren’t likely to do well. Shorting is a bet against a stock on the expectation that it will go down, and the practice opened up new opportunities to sophisticated investors. The process involves borrowing a stock (for a fee), selling it in the market, and then, if all goes well, buying the shares back at a lower price and using them to repay the loan. In a good market, when most stocks are going up, the gains on the longs eclipse the losses from the shorts; in a bad market, the shorts make money to help offset the losses on the longs. Being long some stocks and short others meant that you were “hedged.” This strategy could be applied to other financial instruments in addition to stocks, such as bonds and options and futures, in any market in the world. The losses on a short position are potentially limitless if a security keeps rising, so it’s considered a high-risk activity. That, combined with the fact that many hedge funds employed leverage, or borrowed money, to trade with as they pursued different strategies in different markets around the globe, led regulators to decree that only the most sophisticated investors should be investing in them. Hedge funds would be allowed to try to make money almost any way they wanted, and charge whatever fees they liked, as long as they limited their investors to the wealthy, who, in theory at least, could afford to lose whatever money they put in. For years hedge funds existed largely separate from Wall Street’s operatic boom-bust cycles, but by the mid-2000s they’d moved to the center of the industry. Some started producing enormous profits each year. Over time, the name hedge fund lost any connection to the careful strategy that had given such funds their name and came to stand, instead, for unregulated investment firms that essentially did whatever they wanted. Though they became known for employing leverage and taking risk, the defining attribute of most hedge funds was the enormous amounts of money the people running them were taking in: The fees they charged were generous, typically a “management fee” of 2 percent of assets and a “performance fee” of 20 percent of the profits each year. Before earning anything for his or her investors, the manager of a $2 billion fund would be positioned to make $40 million in fees just to keep the place running. By 2007, hedge fund founders like Paul Tudor Jones and Ken Griffin were managing multibillion-dollar pools of money, building twenty-thousand-square-foot palaces to live in, and traveling on $50 million private jets. To work at a hedge fund was a liberating experience for a certain kind of trader, a chance to test one’s skills against the market and, in the process, become spectacularly rich. Hedge fund jobs became the most coveted in finance. The immense fortunes they promised made a more traditional Wall Street career—climbing the hierarchy at an established investment bank such as Bear Stearns or Morgan Stanley—look far less interesting. In 2006, the same year that Lloyd Blankfein, the CEO of Goldman Sachs, was paid $54 million—causing outrage in some circles—the lowest-paid person on the list of the twenty-five highest-paid hedge fund managers made $240 million. The top three made more than a billion dollars each. Cohen was number five that year, at $900 million. By 2015, hedge funds controlled almost $3 trillion in assets around the world and were a driving force behind the extreme wealth disequilibrium of the early twenty-first century. The hedge fund moguls didn’t lay railroads, build factories, or invent lifesaving medicines or technologies. They made their billions through speculation, by placing bets in the market that turned out to be right more often than wrong. And for this, they have gained not only extreme personal wealth but also formidable influence throughout society, in politics, education, the arts, professional sports—anywhere they choose to direct their attention and resources. They manage a significant amount of the money in pension and endowment funds and have so much influence in the market that CEOs of public companies have no choice but to pay attention to them, focusing on short-term stock performance to keep their hedge fund shareholders happy. Most of these hedge fund traders don’t think of themselves as “owners” of companies or even as long-term investors. They are interested in buying in, making a profit, and selling out. If there was one person who personified the rise of hedge funds, and the way they transformed Wall Street, it was Steven Cohen. He was an enigmatic figure, even to those in his own industry, but his average returns of 30 percent a year for twenty years were legendary. What was especially intriguing about him was that his performance wasn’t based on any well-understood strategy, unlike other prominent investors such as George Soros or Paul Tudor Jones; he wasn’t famous for betting on global economic trends or predicting the decline of the housing market. Cohen simply seemed to have an intuitive sense for how markets moved, and he entered the industry at precisely the moment when society reoriented itself to reward that skill above almost all others. He traded in and out of stocks in rapid-fire fashion, dozens of them in a single day. Young traders longed to work for him and rich investors begged to put their money in his hands. By 2012, SAC had become one of the world’s most profitable investment funds, managing $15 billion. On Wall Street, “Stevie,” as Cohen was known, was like a god. WATCH: Meet Steven Cohen: Wall Street’s 'White Whale' Word quickly spread about this new way to become wildly rich, and thousands of new hedge funds opened up, all staffed with aggressive traders looking for investments to exploit. As the competition became more intense and the potential money to be made ballooned, hedge fund traders started going to extreme lengths to gain an advantage in the market, hiring scientists, mathematicians, economists, and shrinks. They laid cable close to stock exchanges so that their trades could be executed nanoseconds faster and employed engineers and coders to make their computers as powerful as those at the Pentagon. They paid soccer moms to walk the aisles at Walmart and report back on what was selling. They studied satellite images of parking lots and took CEOs out to extravagant dinners, digging for information. They did all this because they knew how difficult it is to beat the market, day after day, week after week, year after year. Hedge funds are always trying to find what traders call “edge”—information that gives them an advantage over other investors. At a certain point, this quest for edge inevitably bumps up against, and then crosses, a line: advance knowledge of a company’s earnings, word that a chipmaker will get a takeover offer next week, an early look at drug trial results. This kind of information—proprietary, nonpublic, and certain to move markets—is known on Wall Street as “black edge,” and it’s the most valuable information of all. Trading on it is also usually illegal. When one trader was asked if he knew of any fund that didn’t traffic in inside information, he said: “No, they would never survive.” In this way, black edge is like doping in elite-level cycling or steroids in professional baseball. Once the top cyclists and home-run hitters started doing it, you either went along with them or you lost. And just as in cycling and baseball, the reckoning on Wall Street eventually came. In 2006, the Securities and Exchange Commission, the Federal Bureau of Investigation, and the U.S. Attorney’s Office declared they were going to go after black edge, and before long their search led them to Cohen. Whatever it was that everyone was doing, they realized, he was clearly the best at it. Read more of the story of the billionaire trader Steven A. Cohen, the rise and fall SAC Capital, and the largest insider trading investigation in history in BLACK EDGE: INSIDE INFORMATION, DIRTY MONEY, AND THE QUEST TO BRING DOWN THE MOST WANTED MAN ON WALL STREET by Sheelah Kolhatkar, available now from Random House. Report this Published by Sheelah Kolhatkar Sheelah Kolhatkar Staff Writer at The New Yorker, Author of Black Edge Published • 3y 2 articles Inside the Rise and Fall of Wall Street’s Most Powerful Hedge Fund Sheelah’s profile photo Sheelah Kolhatkar Published on LinkedIn It would be an investigation unlike any other in the history of Wall Street, a decade-long, multiagency government crackdown on insider trading focused almost entirely on hedge funds. It began with Raj Rajaratnam and the Galleon Group and quickly expanded to ensnare corporate executives, lawyers, scientists, traders, and analysts across dozens of companies. Its ultimate target was Steven Cohen, the billionaire founder of SAC Capital Advisors, possibly the most powerful hedge fund firm the industry had ever seen. In 1992, the year Cohen started SAC, the average person had only the faintest idea of what a hedge fund was. Most funds like his began as tiny, informal operations founded by eccentric traders whose financial ambition couldn’t be satisfied by even the mightiest investment banks on Wall Street. They had little patience for corporate culture and no interest in negotiating over their bonuses each year. Many of them wore jeans and flip-flops to work. Their aversion to the big banks and brokerage firms was a source of pride. Hedge funds were conceived as a small, almost boutique service, as vehicles for wealthy people to diversify their investments and produce steady, moderate returns that were insulated from swings in the stock market. The idea behind them was simple: A fund manager would identify the best companies and buy their shares while selling short the stock of ones that weren’t likely to do well. Shorting is a bet against a stock on the expectation that it will go down, and the practice opened up new opportunities to sophisticated investors. The process involves borrowing a stock (for a fee), selling it in the market, and then, if all goes well, buying the shares back at a lower price and using them to repay the loan. In a good market, when most stocks are going up, the gains on the longs eclipse the losses from the shorts; in a bad market, the shorts make money to help offset the losses on the longs. Being long some stocks and short others meant that you were “hedged.” This strategy could be applied to other financial instruments in addition to stocks, such as bonds and options and futures, in any market in the world. The losses on a short position are potentially limitless if a security keeps rising, so it’s considered a high-risk activity. That, combined with the fact that many hedge funds employed leverage, or borrowed money, to trade with as they pursued different strategies in different markets around the globe, led regulators to decree that only the most sophisticated investors should be investing in them. Hedge funds would be allowed to try to make money almost any way they wanted, and charge whatever fees they liked, as long as they limited their investors to the wealthy, who, in theory at least, could afford to lose whatever money they put in. For years hedge funds existed largely separate from Wall Street’s operatic boom-bust cycles, but by the mid-2000s they’d moved to the center of the industry. Some started producing enormous profits each year. Over time, the name hedge fund lost any connection to the careful strategy that had given such funds their name and came to stand, instead, for unregulated investment firms that essentially did whatever they wanted. Though they became known for employing leverage and taking risk, the defining attribute of most hedge funds was the enormous amounts of money the people running them were taking in: The fees they charged were generous, typically a “management fee” of 2 percent of assets and a “performance fee” of 20 percent of the profits each year. Before earning anything for his or her investors, the manager of a $2 billion fund would be positioned to make $40 million in fees just to keep the place running. By 2007, hedge fund founders like Paul Tudor Jones and Ken Griffin were managing multibillion-dollar pools of money, building twenty-thousand-square-foot palaces to live in, and traveling on $50 million private jets. To work at a hedge fund was a liberating experience for a certain kind of trader, a chance to test one’s skills against the market and, in the process, become spectacularly rich. Hedge fund jobs became the most coveted in finance. The immense fortunes they promised made a more traditional Wall Street career—climbing the hierarchy at an established investment bank such as Bear Stearns or Morgan Stanley—look far less interesting. In 2006, the same year that Lloyd Blankfein, the CEO of Goldman Sachs, was paid $54 million—causing outrage in some circles—the lowest-paid person on the list of the twenty-five highest-paid hedge fund managers made $240 million. The top three made more than a billion dollars each. Cohen was number five that year, at $900 million. By 2015, hedge funds controlled almost $3 trillion in assets around the world and were a driving force behind the extreme wealth disequilibrium of the early twenty-first century. The hedge fund moguls didn’t lay railroads, build factories, or invent lifesaving medicines or technologies. They made their billions through speculation, by placing bets in the market that turned out to be right more often than wrong. And for this, they have gained not only extreme personal wealth but also formidable influence throughout society, in politics, education, the arts, professional sports—anywhere they choose to direct their attention and resources. They manage a significant amount of the money in pension and endowment funds and have so much influence in the market that CEOs of public companies have no choice but to pay attention to them, focusing on short-term stock performance to keep their hedge fund shareholders happy. Most of these hedge fund traders don’t think of themselves as “owners” of companies or even as long-term investors. They are interested in buying in, making a profit, and selling out. If there was one person who personified the rise of hedge funds, and the way they transformed Wall Street, it was Steven Cohen. He was an enigmatic figure, even to those in his own industry, but his average returns of 30 percent a year for twenty years were legendary. What was especially intriguing about him was that his performance wasn’t based on any well-understood strategy, unlike other prominent investors such as George Soros or Paul Tudor Jones; he wasn’t famous for betting on global economic trends or predicting the decline of the housing market. Cohen simply seemed to have an intuitive sense for how markets moved, and he entered the industry at precisely the moment when society reoriented itself to reward that skill above almost all others. He traded in and out of stocks in rapid-fire fashion, dozens of them in a single day. Young traders longed to work for him and rich investors begged to put their money in his hands. By 2012, SAC had become one of the world’s most profitable investment funds, managing $15 billion. On Wall Street, “Stevie,” as Cohen was known, was like a god. WATCH: Meet Steven Cohen: Wall Street’s “White Whale' Word quickly spread about this new way to become wildly rich, and thousands of new hedge funds opened up, all staffed with aggressive traders looking for investments to exploit. As the competition became more intense and the potential money to be made ballooned, hedge fund traders started going to extreme lengths to gain an advantage in the market, hiring scientists, mathematicians, economists, and shrinks. They laid cable close to stock exchanges so that their trades could be executed nanoseconds faster and employed engineers and coders to make their computers as powerful as those at the Pentagon. They paid soccer moms to walk the aisles at Walmart and report back on what was selling. They studied satellite images of parking lots and took CEOs out to extravagant dinners, digging for information. They did all this because they knew how difficult it is to beat the market, day after day, week after week, year after year. Hedge funds are always trying to find what traders call “edge”—information that gives them an advantage over other investors. At a certain point, this quest for edge inevitably bumps up against, and then crosses, a line: advance knowledge of a company’s earnings, word that a chipmaker will get a takeover offer next week, an early look at drug trial results. This kind of information—proprietary, nonpublic, and certain to move markets—is known on Wall Street as “black edge,” and it’s the most valuable information of all. Trading on it is also usually illegal. When one trader was asked if he knew of any fund that didn’t traffic in inside information, he said: “No, they would never survive.” In this way, black edge is like doping in elite-level cycling or steroids in professional baseball. Once the top cyclists and home-run hitters started doing it, you either went along with them or you lost. And just as in cycling and baseball, the reckoning on Wall Street eventually came. In 2006, the Securities and Exchange Commission, the Federal Bureau of Investigation, and the U.S. Attorney’s Office declared they were going to go after black edge, and before long their search led them to Cohen. Whatever it was that everyone was doing, they realized, he was clearly the best at it. Read more of the story of the billionaire trader Steven A. Cohen, the rise and fall SAC Capital, and the largest insider trading investigation in history in BLACK EDGE: INSIDE INFORMATION, DIRTY MONEY, AND THE QUEST TO BRING DOWN THE MOST WANTED MAN ON WALL STREET by Sheelah Kolhatkar, available now from Random House. 1,385 Likes 36 Comments | |||||||||