Case Against SAC Is Aided by Hiring of Fired Trader

Richard S. Lee’s first day of running a trading desk was his last.

In March 2008, hours after starting a new job at Citadel, Mr. Lee signed into the hedge fund’s accounting system and misstated the value of his holdings, according to people briefed on the matter. That effort ultimately would have inflated Mr. Lee’s returns by about $4.5 million. Citadel, based in Chicago, detected the misconduct and fired him the next morning.

Such a shady move would have blacklisted most traders from Wall Street, but Mr. Lee found a new home: SAC Capital Advisors, the hedge fund run by the billionaire stock picker Steven A. Cohen that federal prosecutors have called a “magnet of market cheaters.” Although a Citadel employee and SAC’s legal department warned about Mr. Lee’s past, Mr. Cohen hired him anyway.

An examination of Mr. Lee’s hedge fund career underscores his importance to the government’s criminal insider-trading case against SAC. Federal authorities in Manhattan announced SAC’s indictment last week, an unusual, forceful action against a large company.

Mr. Lee, who has pleaded guilty and is cooperating with investigators, proved crucial to the government’s case â€" not so much because of his illicit trading, but because of how he landed a job at SAC despite his earlier misstep. Mr. Lee’s interview process added to questions about SAC’s hiring practices and controls. His cooperation, as well as evidence suggesting that SAC recruited employees with sources inside publicly traded companies, provided ammunition for the government’s claim that SAC and its units permitted a “systemic” decade-long insider-trading scheme.

People briefed on the investigation say that Mr. Lee also possesses a rich vein of information about other illicit activity at SAC, including potential insider trading in the shares of Gymboree, the children’s clothing store. The trade, linked to Bain Capital’s 2010 takeover of Gymboree, was not cited in the indictment, which said that Mr. Lee obtained secrets about “various” companies, including “but not limited to” Yahoo and 3Com, a maker of computer hardware and software.

“Richard Lee has accepted responsibility for his prior conduct,” said Mr. Lee’s lawyer, Richard D. Owens of Latham & Watkins. Mr. Owens declined to comment on his client’s time at Citadel, but a person close to Mr. Lee said that he did not intend to misstate the value of the trades.

It is unclear whether Mr. Lee has provided prosecutors with evidence against Mr. Cohen, who is not accused of any criminal wrongdoing. Yet the government is still homing in on other former SAC employees, people briefed on the investigation said, and is still trying to build a criminal case against Mr. Cohen. In a separate civil case filed last month, the Securities and Exchange Commission accused Mr. Cohen of failing to supervise his employees.

Under this cloud of suspicion, SAC is carrying on business as usual, and Wall Street banks continue to trade with the firm.

On Wednesday, a top bank executive spoke publicly in support of the hedge fund for the first time since the indictment. Gary D. Cohn, the president of Goldman Sachs, said that his firm continued to do business with SAC, which is based in Stamford, Conn., and manages about $14 billion.

“They’re an important client to us, they have been an important client to us,” Mr. Cohn said in an interview on CNBC. “We continue to trade with them, and they’re a great counterparty.”

Goldman’s open embrace of SAC comes at a tricky time. That bank, along with others, came under scrutiny for its conduct leading up to the financial crisis. On Thursday, after a civil trial, a jury found that Fabrice Tourre, a former Goldman trader, defrauded the bank’s investors in the sale of a complex mortgage-bond deal.

Over the years, SAC has generated billions of dollars in commissions for brokerage firms and is a Top 5 client on stock-trading desks at most large banks. Banks have also earned big revenues supporting SAC by clearing its trades and financing its operations.

It remains to be seen whether SAC will become a less important client on Wall Street over the longer term. The fund’s assets under management are dropping as investors have asked to withdraw money amid the intensifying investigation. Over the last six months, many investors have cut ties with SAC, with roughly $5 billion of $6 billion in outside money being withdrawn from the fund.

The firm could also see an exodus of employees. Already, according to one executive of another hedge fund, some SAC employees are stealthily conducting interviews in hotel rooms and private homes to avoid being seen on rivals’ trading floors.

After the indictment last week, senior bank executives debated whether the government’s charges required them to terminate their relationship with SAC, or whether it was too hazardous trading with a firm operating under indictment.

“Everyone had the conversation, and it happened at the highest levels,” said a senior Wall Street executive who spoke on the condition that he not be named because he was not authorized to discuss the matter publicly.

The decision to keep SAC as a client was based on a number of factors, according to conversations with four executives at three banks, who all deal directly with the fund.

A major reason the banks continue to trade with SAC is that the fund is viewed as a safe trading partner. SAC is considered very well capitalized, and the government did not freeze any of its assets nor has it tried to affect the fund’s operations.

Another critical factor is the presumption of innocence. Bank executives reason that it would be unfair to terminate a relationship based on accusations. The fund said that it “has never encouraged, promoted or tolerated insider trading and takes its compliance and management obligations seriously.”

The banks also note that SAC has bolstered its legal and compliance staff. Today, there are about 40 compliance personnel, an increase from 10 in 2008, when much of the activity at the center of the indictment took place. SAC spends millions of dollars a year on surveillance of trading activity and communications like e-mail and phone conversations.

“You’re dealing with a more buttoned-up infrastructure there in 2013 than you were a few years ago,” a Wall Street executive said.

There is also, in some executives’ views, little that is new contained in the indictment. Prosecutors still have not charged Mr. Cohen, who owns 100 percent of the firm. They also note that of the eight former SAC employees accused in the filing of insider trading, seven were previously known, with six having already pleaded guilty.

Mr. Lee was the former employee whose role in the investigation was not publicly known until last week.

A 34-year-old trader who graduated from Brown University, Mr. Lee pursued Wall Street riches after a stint at the Clinton Foundation and at the consulting firm McKinsey & Company, according to public records. His hedge fund career began in 2003 as an analyst for the prestigious firm Farallon Capital Management. Seeking a new role three years later, he interviewed at SAC, but accepted a job at Citadel.

Working from his native Chicago, Mr. Lee was part of Citadel’s special situations group, placing bets tied to events like product recalls or companies being sued. With a trim build and a soft-spoken manner, Mr. Lee did little to attract attention.

But after two years, when his boss moved on, Citadel thrust Mr. Lee into a new role atop the desk. The promotion took effect on March 31, 2008.

That evening, as Mr. Lee valued existing positions, he edited some of the figures to underestimate his predecessor’s returns. That way, the people briefed on the matter said, Mr. Lee could collect even greater gains if the position continued to rise, a move that would have increased his pay by $100,000 or more. Within hours, the people said, a colleague flagged Mr. Lee’s activity.

Kenneth C. Griffin, Citadel’s chief executive, approved the decision to fire him.

In April 2009, Mr. Lee joined SAC. He did so, prosecutors said, over objections of SAC’s lawyers. Mr. Cohen “received a warning” from a Citadel employee that Mr. Lee belonged to Citadel’s “insider trading group,” said the government filing.

Citadel, which has not been accused of wrongdoing, said in a statement that “it does not have, and never has had, an ‘insider trading group.’ ”

It is unclear how Mr. Lee, despite his problems at Citadel, persuaded SAC to hire him, though he had a previous interview experience to draw upon.

In a 2006 interview with SAC, the indictment said, Mr. Lee told the fund that he routinely relied on so-called expert networks that connect traders with corporate insiders. A senior SAC executive, however, told Mr. Lee that the fund’s top traders typically tapped their own personal network of public company employees for information.