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From Bernie Madoff to Steven Cohen, Enabling Suspiciously High Returns

It looks more and more as if Steve Cohen's returns at the hedge fund SAC have been generated not only through his trading brilliance but also through a culture of cutting corners. So why do major institutional investors still have any money with him?

To have one employee tied to insider trading may be regarded as a misfortune. But, with apologies to Oscar Wilde, to have six looks like carelessness.

Poor Steven A. Cohen, the powerful hedge fund manager who heads SAC Capital Advisers. People he employs just keep getting swept up in the sprawling insider trading investigation that has spanned years now. In addition to the six who have gotten in trouble for activities when employed at SAC, at least six others have been ensnared by insider trading investigations after leaving the firm. The latest arrest, of the pharmaceutical industry analyst Mathew Martoma, is the first that ties Mr. Cohen to trades the government says were illegal.

An investment manager has defended Mr. Cohen as the “Michael Jordan” of the investing world. But what if he is the Lance Armstrong?

While Mr. Cohen has not been accused of any wrongdoing, you have to wonder whether his returns have been generated not only through his trading brilliance but also through a culture of cutting corners and pushing employees to the point where they break the law. In the United States, you are innocent until proven guilty, and nowhere can that be seen more than for a man who can generate amazing investment returns.

Astonishingly, investors don’t seem to mind terribly. They added as much as $1.6 billion in new capital to SAC’s flagship fund from 2010 to the end of 2011, when the insider trading investigation was in full bloom, according to Absolute Return, an industry trade publication.

“Insider trading isn’t acceptable in our culture of compliance, and we don’t give a wink or nod to the contrary,” said a SAC spokesman, who declined to make Mr. Cohen available for comment.

At least some big institutions have begun to contemplate thinking about perhaps withdrawing money from Mr. Cohen. Congratulations. What took them so long? Citigroup’s private bank has told its clients not to put in new money, according to Bloomberg. What about getting their clients out? Why hasn’t bank given that advice before this?

A Citigroup spokeswoman explained that the private bank “typically puts funds on watch when there is significant news around a company; that is not a recommendation to move or keep money in the fund.” She declined to comment on Citigroup’s relationship with SAC.

Blackstone is thinking hard about it, according to reports. Think think think. That firm declined to comment.

Several high profile funds-of-funds still have money with him. Société Generale, the big French bank, decided to redeem its money only after the latest allegations. Given all that we know, how in the world do major institutional investors still have any money with Mr. Cohen?

The biggest, most sophisticated investors certainly put enormous amount of pressure on hedge funds. But almost none of it is about ethics and clean culture. It’s about performance. A fund that runs a few ticks lower than its peers for several months running can get put out of business.

But investors seem to demonstrate little interest in whether the person is ethical and trustworthy. Shouldn’t their threshold be a wee bit higher? After all, these institutions are mainly investing other people’s money. Investing money isn’t quite a sacred trust, but it’s a trust nonetheless.

Many institutional investors have so perfected the art of looking the other way that they make bystanders on a New York City subway platform look like models of social responsibility.

The operating standard is to allow fund managers — or affiliated businesses or employees — to go as far as they can until the moment they are caught doing something wrong. Through their actions, Citigroup, Blackstone and the others are sending a message that they will forgive rotten ethics for great returns.

This is a long-standing Wall Street custom. Citigroup and JPMorgan played handmaiden to help Enron commit fraud, according to the Securities and Exchange Commission. The two banks didn’t admit or deny guilt in settling with the regulator.

There is a point where willful blindness turns to complicity. Investors profit from any added juice that SAC might gain, whatever its source. And if Mr. Cohen were to face charges, they would pay no price.

Major banks and investors around the world shoveled money to Bernard L. Madoff despite doubts about his purity. Some thought that Mr. Madoff was using his brokerage firm to front-run. In other words, they thought he was cheating on their behalf, not ripping them off. And that was an enticement.

The arrests and bad trades are finally hitting close to SAC, but there is nothing new about the questions surrounding Mr. Cohen’s business. He was always one of the most aggressive traders on Wall Street. Speculation that he may have tapped into legally dubious information wasn’t just whispered in private but splashed across the pages of The Wall Street Journal in a 2006 profile that raised questions about whether his firm traded improperly.

In the firm’s defense, a person familiar with the firm points out that two of the employees charged with insider trading started their scheme before joining the fund and have admitted taking extraordinary steps to circumvent SAC’s procedures while another was trading in his personal account.

“We expect our people to play by the rules and act with integrity,” the SAC spokesman said.

The firm boasts more than 30 legal and compliance officials in addition to a dedicated technology team devoted to compliance, says the person familiar with the firm.

But given how forgiving institutional enablers are, one wonders why Mr. Cohen even bothers.

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