Insider Crackdown Uses SAC Manager to Pivot to Fraud

Steven A. Cohen’s SAC Capital Advisors LP is at the center of the biggest insider case ever brought in a nationwide crackdown on illicit hedge fund trading -- one focusing on the exploitation of secret information on volatile health care stocks often obtained through expert consultants.

In doing so, the new case has brought the five year probe beyond the realm of technology stocks and into the burgeoning underworld of health care industry securities fraud. The charges against former SAC portfolio manager Mathew Martoma also bring U.S. prosecutors closer than ever to Cohen, the hedge fund’s billionaire owner and founder, in the biggest probe of insider trading in a generation.

Martoma, 38, was accused by prosecutors in Manhattan with playing a lead role in what they called the most lucrative insider-trading scheme in history given the $276 million profit he allegedly helped the hedge fund achieve.

Prosecutors said Martoma participated in trading on insider tips about clinical trials of bapineuzumab, a drug to treat Alzheimer’s disease. He advised Cohen to sell shares of Wyeth LLC (PFE) and Elan Corp. (ELN) before bad news about the drug’s prospects was announced, according to a criminal complaint.

Cohen’s firm made huge profits or avoided losses after receiving the advice, prosecutors said in the complaint.

Illegal Tips

Martoma is charged with conspiracy and securities fraud, a crime that carries a maximum 20-year prison term. Prosecutors don’t say in the complaint whether Cohen knew Martoma’s advice was based on illegal insider tips. Neither Cohen nor SAC Capital was charged or sued over the matter.

The U.S. may be seeking to persuade Martoma to assist in a probe of others at SAC, said Andrew Frisch, a defense attorney in New York and former federal prosecutor.

“That they’re proceeding by a complaint, as opposed to an indictment, often means the government wants to convince the defendant of the wisdom of cooperation,” Frisch, who isn’t involved in the case, said in an interview. “Cooperation is always a possibility for a defendant, but it’s a question of whether he has information.”

More than 80 people have been sued by regulators or charged by prosecutors since 2008 for passing or getting inside tips about pharmaceutical, biotechnology or other health-care stocks.

Health-care businesses offer illegal traders more opportunities to profit than the finance and technology sectors that have traditionally been prime victims of insiders who leaked confidential data about earnings or deals.

Health companies can live or die on the results of drug trials, which stretch for years before regulators make decisions that can trigger hundreds of millions of dollars in profits or losses. And the industry has undergone significant consolidation, leading to several multibillion-dollar mergers.

Lineup of Accused

The lineup of accused health-industry insider traders includes: chief executive officers, hedge fund traders, bankers, lawyers, doctors, accountants, a retired Delta Air Lines Inc. pilot, a film producer and a member of Major League Baseball’s Hall of Fame have been charged or sued by regulators. It has touched the Food and Drug Administration and large health-care companies such as Bristol-Myers Squibb Co. and Abbott Laboratories.

Martoma is the latest current or former SAC employee implicated in alleged insider trading by U.S. prosecutors, including former portfolio managers Noah Freeman and Donald Longueuil and analyst Jon Horvath.

Billionaire Cohen

Billionaire Cohen, 56, started SAC Capital in 1992. His hedge fund manages $14 billion. He has been deposed by SEC investigators about trades made close to news such as mergers and earnings that generated profit for his fund, a person familiar with the matter said in June. The person asked not to be identified because the investigation wasn’t public.

“Mr. Cohen and SAC are confident that they have acted appropriately and will continue to cooperate with the government’s inquiry,” Jonathan Gasthalter, a company spokesman, said yesterday in an e-mailed statement.

Martoma worked as a portfolio manager for CR Intrinsic Investors in Stamford, Connecticut, a unit of SAC Capital, the U.S. Securities and Exchange Commission said in a lawsuit it filed against him in New York yesterday. In addition to Martoma, the SEC named as defendants CR Intrinsic and Sid Gilman, a University of Michigan neurologist who was the chairman of a safety-monitoring committee that oversaw a clinical trial of bapineuzumab, or bapi. Gilman wasn’t charged criminally.

$700 Million Position

Martoma, according to prosecutors, urged Cohen to buy Wyeth and Elan (ELN) shares based on good news about the trial, then advised him to liquidate SAC’s $700 million position after getting a secret tip that the trial had gone badly.

“It appears that the government is sending the message that they believe the owner of the hedge fund is acting alongside Mr. Martoma,” Brad Simon, a former federal prosecutor now in private practice in New York, said yesterday in a phone interview. “This would indicate to me that the government’s investigation is moving up the chain at a very rapid pace.”

Martoma was arrested at his home in Boca Raton, Florida, at 6:30 a.m. yesterday, said Peter Donald, a spokesman for the Federal Bureau of Investigation in New York. He appeared before U.S. Magistrate David Brannon in West Palm Beach and was released on $5 million bond secured by two family members, said Mary Delsener, a spokeswoman for Manhattan U.S. Attorney Preet Bharara. Martoma is scheduled to be in federal court in Manhattan on Nov. 26, Bharara said at a press conference yesterday.

‘Exceptional’ Manager

“Mathew Martoma was an exceptional portfolio manager who succeeded through hard work and the dogged pursuit of information in the public domain,” his lawyer, Charles Stillman, said in an e-mailed statement yesterday. “What happened today is only the beginning of a process that we are confident will lead to Mr. Martoma’s full exoneration.”

The SEC claimed Martoma, who specialized in health-care stocks, used Gilman’s illegal tips to trade for CR Intrinsic as well as for “hedge fund portfolios managed by an affiliated investment adviser” and controlled by an unidentified “Portfolio Manager A.” That manager was Cohen, according to a person familiar with the matter.

“In this instance, what we see is an unholy alliance between an insider willing to divulge valuable, nonpublic information and a money manager who knew that information is as good as gold,” April Brooks, an FBI agent in charge of the New York office’s criminal division, said at the news conference yesterday.

‘Favorable Announcement’

“Martoma and the owner of the hedge fund that employed him traded heavily and aggressively on the expert’s information based on inside information in advance of the favorable announcement,” Brooks said

Gilman, 80, is a professor of neurology at the University of Michigan Medical School. He has entered into a non- prosecution agreement with prosecutors in which he agreed to testify before a federal grand jury and to forfeit $186,761, money which he was paid by Elan for his consulting work.

“He is cooperating with the SEC and the U.S. Attorney’s Office,” Marc Mukasey, Gilman’s lawyer, said. “We expect to settle with the SEC in short order.”

The doctor met Martoma as a consultant for an expert- networking firm based in Manhattan and had sessions with Martoma from mid-2006 to July 2008, according to the government.

Gerson Lehrman

Gilman worked for Gerson Lehrman Group’s Scientific Advisory Board starting in 2002, according to a 2011 curriculum vitae posted online by the University of Michigan.

Loren Riegelhaupt, a spokesman for the New York-based expert-networking firm, declined to comment on the case. Bloomberg LP, the owner of Bloomberg News, has an agreement to offer its clients access to Gerson Lehrman consultants.

Over the course of about 42 consultations, Martoma persuaded the doctor to talk about his work on the drug trial, Bharara said.

The doctor passed along the generally positive safety data about the trial, according to the criminal complaint, which doesn’t identify the neurologist by name. The SEC’s complaint names Gilman as Martoma’s source.

Relying on the safety data, Martoma allegedly bought shares of Elan and Wyeth for his portfolio. Cohen also bought Elan and Wyeth, based on Martoma’s recommendation, prosecutors said. By the end of June 2008, SAC held about $700 million in the two companies’ stocks.

‘Massive Position’

“The hedge fund built up over time a massive position in Elan and Wyeth stock. The hedge fund built up this position, even though it was vocally opposed by several others at the hedge fund who were worried about the risk of that investment,” Bharara said. “Martoma was the only person at the hedge fund who was recommending establishing such a large position in Elan and Wyeth based on that drug.”

In mid-July 2008, Gilman received secret data showing that bapineuzumab failed to halt progression of Alzheimer’s in patients in the clinical test, the U.S. said. The doctor e- mailed Martoma a 24-page PowerPoint presentation detailing the results, which he was scheduled to present at a medical conference on July 29, according to the U.S.

“That is when Martoma, according to the complaint, had to do a spectacular about-face, because he understood that with these negative results looming, the hedge fund’s massive $700 million stake had become a terrible bet,” Bharara said. “Overnight, Martoma went from bull to bear as he tried to dig his hedge fund out of a massive hole.”

Selling, Shorting

Prosecutors said that on July 20 Martoma e-mailed Cohen to ask, “Is there a good time to catch up with you this morning? It’s important.” The two later talked for about 20 minutes, according to the complaint.

After that conversation, SAC allegedly sold all its Elan shares and shorted the stock in a little more than a week. SAC also liquidated most of its Wyeth stock and took short positions, the U.S. said.

During that time, SAC’s Elan trades accounted for more than one-fifth of its trading volume, Bharara said.

On July 27, an unidentified “Senior Trader” at Martoma’s company e-mailed Cohen about the week’s trading activity, according to prosecutors.

The e-mail said that the fund “executed a sale of over 10.5 million ELN” for four internal hedge fund accounts. The sales were carried out “quietly and effectively” over four days through dark pools and other means, and booked into accounts that had “very limited access,” according to the e- mail cited in the criminal complaint.

Shares Fall

After the results became public, Wyeth and Elan shares plummeted. Wyeth, which is now owned by Pfizer Inc., fell the most in almost six years on the news. Elan dropped the most in three years.

Prosecutors said Martoma was paid a bonus of $9.38 million in January 2009, based largely on the hedge fund’s profit from the Wyeth and Elan trades.

Martoma lost money in the next two years and was fired after another unidentified employee said in a May 2010 e-mail that he was a “one-trick pony with Elan,” according to the government.

In addition to the former SAC employees who have been charged criminally, Michael Steinberg, a portfolio manager at SAC’s Sigma Capital Management unit, has been described by federal prosecutors as an “unindicted co-conspirator” of Horvath, a former analyst he supervised who pleaded guilty to receiving and passing inside information. Longueuil, who worked for CR Intrinsic in New York from July 2008 to July 2010, was accused of giving information to Freeman, his friend.

In April 2011, former SAC analyst Jonathan Hollander agreed to settle SEC allegations that he traded on inside information about a pending takeover of the Albertson’s LLC grocery chain.

The criminal case is U.S. v. Martoma, 12-MAG-2985; and the civil case is SEC v. CR Intrinsic Investors LLC, 12-8466, U.S. District Court, Southern District of New York (Manhattan).

To contact the reporters on this story: Bob Van Voris in New York at rvanvoris@bloomberg.net; Patricia Hurtado in New York at pathurtado@bloomberg.net

To contact the editor responsible for this story: Michael Hytha at mhytha@bloomberg.net

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