In the end, billionaire Steven Cohen, one of the most successful hedge-fund managers of his generation, could end up getting banned from the business he dominated for an error of omission, not commission.

In an administrative action that constitutes its first formal salvo against Cohen, the U.S. Securities and Exchange Commission alleged he failed to supervise two wayward portfolio managers and ignored “red flags.” The agency stops short of accusing the owner of SAC Capital Advisors LP of insider trading. While the proceeding may result in his being barred from managing other people’s money, it won’t carry the potential penalties available if the SEC had sued him. It also pales in comparison to a grand jury indictment for securities fraud, and the 20 year prison term a conviction could bring.

Instead, the SEC claim that Cohen should have known two of his subordinates were using material, non-public information to rack up hundreds of millions of dollars in trading profits will be easier to prove. The regulator will have a lesser burden of proof and won’t have to deal with all of the protections afforded a defendant in a lawsuit, let alone a prosecution.

“They are using an Al Capone-style tactic,” said John Coffee of Columbia Law School, referring to the prosecution of the Chicago gangster in 1931 on charges of tax evasion. “The SEC is aiming at his kneecaps, not his jugular,” he said. “This is a little like catching John Dillinger entering a bank with a submachine gun and charging him with double parking.”

‘Highly Suspicious’

The SEC, which seeks to ban Cohen from the financial industry for life in the non-court action, alleged he received “highly suspicious” information that should have caused any reasonable hedge-fund manager to investigate the basis for trades by subordinates Mathew Martoma and Michael Steinberg.

Cohen may find some guidance in how to respond to the agency from Rajat Gupta, the former Goldman Sachs Group Inc. director charged in the Galleon Group LLC insider trading probe.

Gupta sued the SEC after it filed an administrative action against him, saying he wanted the SEC to sue him so he could fairly defend himself. After both sides dropped their actions, agreeing any SEC matter would be in a federal court, Gupta was indicted by a federal grand jury. The SEC sued him, too.

An SEC administrative proceeding is held before an administrative law judge, not a U.S. district judge or federal jury. The administrative law judge, in Washington, will hear testimony and issue a determination, without a jury present, said Tom Gorman, a former lawyer with the SEC’s Enforcement Division who is now in private practice.

Administrative Judge

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