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Why the SEC can’t agree on what to do with Steven Cohen’s $600 million

Key Speakers At The Robin Hood Veterans SummitKey Speakers At The Robin Hood Veterans Summit
Steven A. CohenPhotograph by Scott Eells — Bloomberg via Getty Images

Around two years ago, Steven Cohen’s former hedge fund SAC pleaded guilty to some criminal and civil charges related to insider trading. Some of those charges were from the Securities and Exchange Commission. And to settle the SEC’s charges, Cohen’s firm agreed to pay a $616 million fine. That deal was finalized by a judge in March 2013.

Cohen’s hedge fund has since changed its name to Point72. The trader at the center of that case, Mathew Martoma, has been convicted, and was sentenced to nine years in jail. And Cohen has mostly gone on with his life. He’s been hurt by all the harsh words that have written and said about him (New York quoted Cohen’s wife Alexandra saying, “Even billionaires have feelings.”), but Cohen is a free man and it looks like he will remain that way. He recently spent $101 million for this Giacometti sculpture.

But that $616 million that the Securities and Commission collected a year-and-a-half ago? It’s still sitting there. Untouched. And the SEC can’t seem to agree where it should go.

When the SEC originally settled the case, the agency’s lawyers told the judge the money should just go back to the Treasury. But plaintiff lawyers argued that the money should go to pay back investors who lost money in the stocks SAC was insider trading in. The judge agreed. And that ignited bickering inside the SEC that basically froze the $600 million, and got us to where we are now.

On Tuesday, two Republican SEC commissioners wrote an op-ed for The Wall Street Journal blasting the SEC for planning to use the money to set up a “fair fund” to pay back investors injured by SAC’s insider trading based on a majority vote. Presumably, Daniel Gallagher and Michael Piwowar, the two Republican commissioners, did not vote with the majority. It is unusual for SEC commissions to publicly criticize the SEC, though it happens.

Gallagher and Piwowar say the fund will constitute a “massive wealth” transfer to plaintiffs lawyers and the fund’s administrators. Investors, who have already been harmed by insider trading, will be doubly damaged, Gallagher and Piwowar argue, by seeing the money they were supposed to get be siphoned off by lawyers. Of course, Gallagher and Piwowar don’t explain how their solution—which, it seems, is to give investors nothing—will do any less damage to those investors.

The SEC itself takes issue with Gallagher and Piwowar’s assertion. “A fundamental part of the SEC’s mission is investor protection, which includes compensating harmed investors,” a spokesperson said in a statement to Fortune. “So, in appropriate circumstances, like this one, we set up a fair fund to do just that—distribute funds directly to harmed investors, not to lawyers.”

Nonetheless, the two commissioners’ central point, which gets to the heart of the problem with insider trading cases, is a good one: it’s very hard to know who has been damaged.

It’s a problem the SEC has run into in the past with restitution funds. Late last year, the SEC set up a $200 million restitution fund for investors who were harmed by JPMorgan’s $6 billion London Whale trading loss. But the commission has yet to say what it plans to do with the fund. After numerous extension requests, the judge in the case required the SEC to tell the public what it planned to do by October 30. The SEC appears to have missed that deadline.

In the SAC case, Martoma, and presumably Cohen as well, allegedly received an inside tip that the clinical results for a promising Alzheimer’s treatment were going to be bad (although no one has proven this and the government gave up on trying). So they sold their stakes in Elan and Wyeth, and did some shorting of those stocks as well. That, according to the government, made or saved SAC and its clients $275 million.

Who was damaged by those trades? The standard answer is anyone who bought the shares that SAC sold because those investors incurred the loss that SAC would have had if Cohen hadn’t known to sell. But the investors who bought Elan and Wyeth’s stock from Cohen had no idea why Cohen’s fund was selling, or even that it was.

All they knew was that they wanted to buy shares of Elan and Wyeth. And presumably they would have paid a higher price if Cohen wasn’t at the same time dumping his large stakes in those companies. And they still would have lost money when the news surfaced that the Alzheimer’s drug was a disappointment. So Cohen’s “preselling” of the news actually saved those investors money. They benefited from insider trading as well.

The only people who could really make a case that they were damaged was anyone who would have sold those shares at a slightly higher price to those investors, who instead bought shares from Cohen. But trying to figure out who those people are, if they even exist at all, is really hard. The number of people who say they would have sold is much larger after a stock plunges than before.

But insider trading is not a victimless crime. Someone loses money. Cohen’s $275 million profit came from someone’s pocket. Investors in general lose from insider trading cases because it gives the market the appearance of being rigged and potentially keeps other investors away, which lowers stock prices for the rest of us, at least in theory. (There’s not great evidence that insider trading keeps people away.)

How do you refund the market as a whole? The SEC’s original plan for the money—give it back to the Treasury—is a pretty good solution. But U.S. taxpayers and stock market investors are not exactly the same group. Another answer is to put the money toward education programs about insider trading and teaching investors why it’s wrong. But the Justice Department’s campaign to put insider traders behind bars over the past few years has been a pretty effective way to teach hedge funders that they should not be insider trading. Class dismissed.

Probably, the best thing to do with the money is to give it to the SEC to spend on itself, so the agency can catch more insider traders. No one, particularly not two Republican commissioners, is going to go for that, even if it is a good idea.