Bill Black:The Department of Justice’s Willful Blindness to the Willful Blindness of CEOs (Steve Cohen Edition)

Yves here. I’ve been loath to write about the prosecution of SAC Capital because I’ve viewed it as a misuse of scarce SEC and DoJ resources. We had a global financial crisis and they make their top priorities two hedgie insider traders, Raj Rajaratnam and Steve Cohen? Admittedly, with Raj the prosecutors got the bonus prize of former McKinsey managing director Rajat Gupta, but in terms of making the pool safe for investors, this was hardly the top priority (and don’t get me started on the Jumpstart Obama’s Bucket Shops act, or HFT). And with Cohen, they weren’t willing to put him in jail, so he can take his only slightly smaller pile of billions and start a new firm. Was the DoJ afraid to prosecute Cohen because they weren’t sure they could go toe to toe with the attorneys he would hire, or were they more confident of their ability to get a jury to buy into the idea that a dark-skinned furriner with an exotic name was a crook than a balding white man in a fancy suit?

By Bill Black, the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. Cross posed from New Economic Perspectives

The best thing that the Department of Justice (DOJ) could do immediately to restore faith in the criminal justice system is to prosecute Steven Cohen, the head of SAC. The indictment of SAC charges that many SAC officers committed crimes due to: “institutional practices that encouraged the widespread solicitation and use of illegal inside information.” That indictment supports that claim with detailed allegations. For example, paragraph 6 states that “employees were financially incentivized to recommend to [Cohen] ‘high conviction’ trading ideas” that would inherently come from insider information. Providing “high conviction” tips to Cohen was a job requirement and a code phrase that signaled to Cohen that he could invest his funds with confidence due to the insider information. Paragraph 7 observes that “the predictable and foreseeable result … was systematic insider trading.” Paragraph 11 explains that SAC investment managers had a duty to provide Cohen with “high conviction” deals and that Cohen made fulfilling this duty a top priority. Paragraph 13 explains that the managers’ bonuses largely depended on the “high conviction” tips they made to Cohen.

Many paragraphs of the complaint provide examples of Cohen trading on the basis of insider information, exhibiting willful blindness in the face of strong indications that his managers are providing him with illegal tips, and making enormous profits or avoiding huge losses. Paragraph 2 indicates the resultant magnitude of Cohen’s wealth (over $9 billion).

Logically, these allegations should have led to the prosecution of Steven Cohen for creating the incentive structures that made “systematic insider trading” at SAC “the predictable and foreseeable result.” CEOs who create perverse incentives that make crimes by their employees reasonably foreseeable or exhibit willful blindness act criminally. The indictment’s first paragraph stressed that the incentives Cohen shaped produced “pervasive” criminality “on a scale without known precedent in the hedge fund industry.”

SAC is the longest operating and most lucrative insider trader in history – turning Cohen into one of the richest men in the world through the traditional “sure thing” of fraud. It is stunning that DOJ refuses to prosecute the man its indictment says led, and was made wealthy by, history’s most lucrative insider fraud scheme. DOJ’s actions, including the indictment of SAC, suggest that Steve Cohen has committed the perfect crime and demonstrated that elite white-collar crime pays – massively. If that is true, then the Attorney General Eric Holder and President Obama should be urging Congress to act immediately to change the law and make criminal actions such as those it alleges Cohen took to produced “systematic insider trading.” Their failure to seek such an urgent change in the law demonstrates either that they realize that they could prosecute Cohen under existing law or that they feel no urgent need to fix a broken legal and financial system in which our elites become wealthy by designing the perverse incentive structures that make “systematic” fraud and catastrophic damage to our economy “the predictable and foreseeable result.”