N.Y. feds claim most lucrative insider-trading case

Adam Shell, USA TODAY | USATODAY

NEW YORK — The government's five-year war to root out illegal insider trading on Wall Street displayed fresh firepower Tuesday when prosecutors charged a former money manager at a unit affiliated with hedge fund titan Steven Cohen's SAC Capital Advisors in what they're calling the "most lucrative insider-trading scheme" ever.

This case is stunning because of the sheer size of the allegedly ill-gotten gains, which federal prosecutors say are around a quarter of a billion dollars.

Also, the "evidence trail" appears to be edging to the billionaire founder of SAC, says Thomas Gorman, partner at law firm Dorsey Whitney and former senior counsel at the Securities and Exchange Commission's division of enforcement. "This is a very high-profile case due to the size of the ill-gotten gains and where the case might go," Gorman said. "Stay tuned for the next chapter."

To be perfectly clear, Cohen and SAC Capital were not charged or even mentioned in the 21-page complaint USA v. Mathew Martoma. The 38-year-old former portfolio manager at SAC affiliate CR Intrinsic Investors, Mathew Martoma, was arrested Tuesday. He was the only one charged with allegedly helping the hedge fund make $276 million in illegal profits and avoided losses on shares of drugmakers Elan Pharmaceuticals and Wyeth in July 2008, after getting illegal inside tips related to clinical trial results of an Alzheimer's drug the two companies were developing — and trading on the information before it was made public, which is illegal.

SAC did not return a call from USA TODAY or provide a statement. An SAC spokesman e-mailed TheWall Street Journal that "Mr. Cohen and SAC are confident that they have acted appropriately and will continue to cooperate with the government's inquiry."

The government has stepped up its scrutiny of SAC Capital in recent years. Four former employees of the hedge fund firm or its affiliates have already pleaded guilty to criminal charges during the government's most recent push to weed out illegal insider trading. Last year, Congress probed the firm's trades in the options market.

Prosecutors allege that Martoma got "sneak peeks at drug data" before other investors via phone calls, e-mails and PowerPoint presentations from an 80-year-old neurology professor at the University of Michigan Medical School who was overseeing the drug's clinical trial, as well as providing consulting services to the hedge fund via a so-called expert networking firm, where he "moonlighted" for $1,000 an hour.

In announcing the criminal charges, Preet Bharara, the U.S. Attorney for the Southern District of New York, said Martoma and his hedge fund benefited from "what might be the most lucrative inside tip of all time." Also Tuesday, the SEC filed a parallel civil complaint, charging Martoma, CR Intrinsic and the neurologist, Dr. Sidney Gilman, who is cooperating with prosecutors.

The complaint references Martoma speaking to the "hedge fund owner where he was employed" about his "recommendation" to sell shares of Elan and Wyeth after receiving the illegal inside information on July 17, 2008, that the Phase II trial of the drug did not go as well as Wall Street was expecting. The complaint alleges that on July 21, 2008, both Martoma and the "hedge fund owner" instructed a trader at the firm to sell its entire positions of Elan and Wyeth before the public dissemination of the trial results, scheduled for release on July 29, 2008.

The hedge fund ended up selling 10.5 million shares of Elan and 7 million shares of Wyeth. The hedge firm also placed a big trade that would allow it to profit if the stock fell in value once the bad news on the drug trial findings went public. And that's what happened. Shares of Elan plunged 42% and Wyeth fell 12% in the first trading day after the drug's poor trial results were made public.

The evidence trail pointing toward Cohen includes the mention of Martoma speaking to the "hedge fund owner" about the illegal stock trades.

It also includes the fact that CR Intrinsic Investors is an affiliate of SAC and was named as a defendant in the SEC case. Intrinsic also shares the same address with SAC, adds Jack Sylvia, co-chair of the securities litigation practice at Mintz Levin.

While, Sylvia notes, "there is nothing in the complaint that states that the person Martoma is alleged to have provided the information to was aware the information was non-public or aware of the source of the information, ... the fact that Steven Cohen owns SAC (leads to the) inference that Cohen is the hedge fund owner referenced" in the complaint.

Adds Jacob Frenkel, head of the securities enforcement practice at Shulman Rogers, "The wording of the charges suggests strongly that there still are other targets inside the hedge funds and expert networks whom the government has not charged yet."

FBI special agent-in-charge April Brooks said Tuesday's moves are the latest offensive in the FBI's "five-year campaign to root out insider trading at hedge funds and expert networking firms."

Since the crackdown on insider trading began, there have been more than 70 arrests, says Brooks. The biggest hedge fund titan to be ensnared in the multiyear probe was Raj Rajaratnam, head of hedge fund group Galleon, who was found guilty in October 2011 and was sentenced to 11 years in prison.