Should Steve Cohen shut down SAC?

A new arrest at an SAC fund brings the government closer to Steve Cohen’s door. Now might be a good time to become a family office in order to avoid future scrutiny.

FORTUNE — The past few days haven’t been kind to Steve Cohen, founder of the mega-hedge fund SAC Capital.

SAC Capital’s Steve Cohen has not been charged with anything. But try telling that to the fund’s investors.

On Thursday, a judge decided not to approve his firm’s settlement of insider trading charges with the Securities and Exchange Commission.

A day later, Michael Steinberg, a top portfolio manager at an SAC fund, was arrested and charged with securities fraud. The criminal indictment reignited speculation that the government is trying to nail Cohen for insider trading, and it forced the firm to yet again remind the world that Cohen is innocent until proven otherwise.

“Steve Cohen has not been charged with any wrongdoing and has done nothing wrong,” a spokesman for SAC said.

Be that as it may, investors seem concerned about the ongoing government investigations at SAC and the fact that arrests of current and former employees have averaged about one a quarter for the past few years. In February, a source close to SAC told CNNMoney and others that it lost about $1.7 billion to redemptions. A month earlier, SAC was expecting redemptions of just $1 billion.

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Investors left despite the fact that Cohen is still making money. His firm gained about 13% in 2012, and this year it’s up more than 4% as of mid-March, according to a person close to the firm. And another round of redemptions is expected in May.

The client defections mean that about 70% of SAC’s assets under management come from within the firm, and the bulk of that amount is Cohen’s own capital. Given these numbers, one wonders why the billionaire hedge fund manager doesn’t just return money to investors and run SAC as a so-called family office.

Such a move could lessen the public scrutiny on Cohen, says Ron Geffner, a partner at law firm Sadis & Goldberg who specializes in structuring, organizing. and counseling hedge funds and other investment advisors. “A manager who returns money and is no longer accepting new investments theoretically has no obligation to communicate any factual information regarding ongoing investigations,” he says.

With the government continuing to probe SAC and related hedge funds, Cohen has reportedly discussed these matters on group calls and in private conversations with his investors. That has fanned worries that the insider trading investigations could be a distraction for portfolio managers at SAC.

And it’s possible that ongoing investigations could deeply damage Cohen’s firm and reputation, even if he is never found guilty. Pequot Capital, which like SAC had reached $15 billion in assets under management, shuttered in 2009 amid years of insider trading probes. “Public disclosures about the continuing investigation have cast a cloud over the firm and have become a source of personal distraction,” Pequot founder Arthur Samburg wrote in a letter to investors. “I have concluded that Pequot can no longer stay in business.” Samburg, who settled with the government, was never found guilty of insider trading.

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Many high profile managers have recently closed funds to outside investors, including George Soros, Stanley Druckenmiller, and Carl Icahn. While none of them were under investigation, each felt that the world had changed dramatically — new regulations, saturated markets, a radically different hedge fund landscape — and that those changes made it too difficult to operate as they once had.

Of course, turning SAC into a family office doesn’t mean that prosecutors can’t still try to take assets from employees or investors. “The government can try to claw back profits if they deem that they were gained through violative activity,” says Geffner.

And Cohen’s dilemma is far different from that of a Soros and Druckenmiller. By closing their firms, they no longer had to deal with the things that made running a hedge fund difficult. With or without outside money, regulators will still be eyeing Cohen and his firm.

So while turning SAC into a family office could help in some respects, one attorney said that it would be sending the wrong message. If Cohen is innocent, he should continue to accept money from outside investors. “Why should the terms of his firm be dictated by others?” says Stuart Slotnick, a securities lawyer who specializes in white collar crime. “Notwithstanding all the rumor and innuendo, he’s still running a successful business.”

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