This is sort of a nice photo though I guess they won't be getting it framed. Photographer: Louis Lanzano/Bloomberg

Martoma Prosecutors Bask in Victory Over a Grain of Sand

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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Mathew Martoma's lawyers did an impressive job with what they had to work with, but it's no surprise that their client was found guilty of insider trading today. A doctor testifies he gave you secret terrible drug trial results, your hedge fund sells hundreds of millions of dollars of stock, and a week later the results come out and the stock tanks: You go to jail. That is a simple bad story. There are a lot of very gray-area insider trading cases, including some in the recent batch of SAC-linked prosecutions, but Martoma's doesn't really seem to be one of them.

Nor, I think, does his conviction carry any Big Implications. Will he roll and give prosecutors Steve Cohen's head on a sandy platter? I've always been skeptical of that theory: If Martoma had information that could be used to go after Cohen, and any inclination to use it, the time to do so was before getting convicted of a bunch of felonies. Whatever reason Martoma had for not cooperating against Cohen last week, he probably still has now. And cooperating now is not exactly a freebie do-over. You still gotta go to jail! Like, a lot.

Manhattan U.S. attorney Preet Bharara gloats:

"As the jury unanimously found, Mathew Martoma cultivated and purchased the confidence of doctors with secret knowledge of an experimental Alzheimer's drug, and used it to engage in illegal insider trading. Martoma bought the answer sheet before the exam - more than once - netting a quarter billion dollars in profits and losses avoided for SAC, as well as a $9 million bonus for him. In the short run, cheating may have been profitable for Martoma, but in the end, it made him a convicted felon, and likely will result in the forfeiture of his illegal windfall and the loss of his liberty. Mathew Martoma becomes the 79th person convicted of insider trading after trial or by guilty plea in this District in the last four years."

That's 79 convictions with no acquittals so rah rah rah. A perfect record! It's almost as though Bharara had the answer sheet before the exam.

So, whatever, Martoma. Let's talk about something else. Here is a nice post from venture capitalist Ben Horowitz about the time he almost went to jail. He was the chief executive officer of a company called Opsware, and he hired a new chief financial officer from another company, and she recommended to him a hot new idea that had been a big hit at her previous company. The idea was backdating employee stock options:

One area where she thought we were less than competitive was our stock option granting process. She reported that her previous company's practice of setting the stock option price at the low during the month it was granted yielded a far more favorable result for employees than ours. She also said that since it had been designed by the company's outside legal counsel and approved by their auditors, it was fully compliant with the law.

But Horowitz talked it over with his hippie lawyer and the hippie lawyer told him no. So Opsware never backdated options. Later the CFO went to jail for backdating options at her previous company. Bullet dodged, by Horowitz and Opsware anyway.

I bring this up mostly as a reminder of how dumb the stock-options-backdating prosecutions were. They were really dumb! That last block quote is more or less right: Backdating was a way to incentivize employees, it was extremely common, it got a lot of legal and auditor buy-in. But at some point prosecutors and the SEC decided it was cheating, so they sent some people to jail for it.

That point was 2006, and backdating prosecutions kept regulators entertained for a while until bigger problems came along. Here is Peter Lattman's 2010 retrospective on the backdating scandal; it begins like this:

Before Lehman Brothers imploded, before Bernard L. Madoff's arrest and before the global economy's near-collapse, there was the backdating of stock options.

Pretty much, right? When things were good, backdating prosecutions allowed prosecutors to stay in shape for when bigger things came along. But then 2008 happened, Lehman Brothers imploded, the global economy collapsed, and backdating fell way down the list of priorities.

Now one might argue that the seeds of Lehman's imploding and the economy collapsing were starting to sprout in 2006, and Madoff had been Madoffing for decades by that point, so maybe there were more important things to focus on than options backdating even in 2006. But, shhh. Backdating was a big scandal. We got it! Then we moved on to more important things.

Like winning 79 insider trading cases in the last four years in the Southern District of New York? I mean, I don't know, lots of people don't like insider trading. And most of the cases have the pleasing simple narrative of the Martoma case: He cheated, cheating bad. I'm not convinced that there's much social value in sending people to jail for years for getting certain kinds of trading advantage -- talking to the drug-trial doctors, say -- while allowing certain other kinds -- talking to different doctors, say, or flying helicopters over oil tanks and so forth. And it's hard to see how insider trading poses any serious threat to the financial system in the way that, say, Lehman did.

Prosecutors are 0 for 1 in Bear Stearns criminal cases, and 0 for 0 in Lehman ones. I can't think of a global-economy-collapse criminal prosecution. They did get Madoff, though in fairness he confessed. Does the intense multi-agency multi-year government focus on insider trading distract from other priorities? I don't know. Probably.

Financial-crime prosecutions seem to come in waves, or fads I guess. Different years have different fads, but the faddish crimes have some features in common. They're common enough that prosecutors can leverage their efforts into many convictions. And they come with a simple story to tell a jury: "This was cheating." Insider traders got the answer sheet before the test. Options backdaters got to change their answers after the test was graded.

Also they don't seem that important? Backdating and insider trading are cheating, sure, but they have diffuse (if any) victims and pose no real systemic risks. In 2006, focusing regulatory attention on that sort of thing was ... I guess wrong in hindsight, but understandable. In 2014 it's harder to understand.

(Matt Levine writes about Wall Street and the financial world for Bloomberg View.)

  1. Here is a claim that the 79-0 record "could also reflect a decision not to pursue more difficult insider cases." Maybe, though again my view is that some of the cases that Bharara's office has won are actually pretty dubious cases.

  2. Also it contains this sentence:

    That was a major challenge for prosecutors in these cases: The practice, which involved complex accounting, disclosure and tax issues, was not necessarily illegal.

    I feel like you read sentences like that a lot. "Prosecutors had just one problem: There wasn't any crime. But they worked through the night to solve the problem!" For instance.

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