He's not Cohen, but he'll do.

Martoma Goes to Prison for SAC's Profits

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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Yesterday Mathew Martoma was sentenced to nine years in prison for insider trading, and you cannot say the day was full of surprises for anyone. Insider trading sentencing is pretty much a deterministic function of how much money you made insider trading. Martoma's inside information made his employer, SAC Capital, $276 million. So he was looking at something on the high end of historical insider trading sentences. And that's what he got.

This statement about Martoma's SAC boss, Steve Cohen, is also not exactly news, but it is still a little jarring to read it in a judicial opinion:

[I]t is much more likely than not that Cohen did, in fact, receive material, non-public information from Martoma on July 20, 2008, and that Cohen and SAC Capital's trades in Elan and Wyeth securities in the following days were based on this information.

That's from Judge Paul Gardephe's ruling yesterday morning that Martoma should be held responsible for the money that Cohen made on Martoma's inside information. That ruling is utterly utterly unsurprising. The law is pretty clear that people who pass on inside information are liable for trades made on it, even if they didn't know about the size of the trading; Martoma clearly knew how much Elan and Wyeth stock his fund was going to sell. So it's no surprise that he's on the hook for the full $276 million, even though he only saw $9.4 million of it in his bonus check.

And yet you can sympathize with Mathew Martoma's mother, who said that "the man who made all the money is on a yacht, my son is going to jail." There's something weird about making insider trading punishment a continuous function of money but a binary function of guilt. There are, after all, plenty of shades of guilt in insider trading. Consider:

  • Mathew Martoma. Look, I feel bad for the guy; nine years in prison is a barbaric punishment for a nonviolent crime. But if there's a guilty insider trader it's Martoma. Two doctors who gave him inside information testified at his trial. Martoma's defense was basically that he used illegally obtained inside information to tell SAC how to trade, but SAC was going to trade that way anyway. Ehhh. On the other hand: Is he vastly more culpable than the dozens of insider-trading golfer goons? Those guys will not be getting nine years, because they were not in a position to make $276 million with their insider trading. On the other hand, if they had been in that position, it seems unlikely that they'd have shown much restraint.
  • Those doctors. I mean? Martoma got his information from doctors who supervised Elan's drug trials and were sworn to secrecy, but who told Martoma the results anyway, in exchange for money and business contacts. That makes them about as guilty as Martoma, and about as responsible for SAC's $276 million of profits. But they got nonprosecution agreements. Martoma's crime was so terrible and damaging that he has to go to prison for nine years. The doctors committed the same crime, but weren't worth prosecuting at all.
  • Newman, Chiasson, Steinberg. Martoma was caught as part of a broader set of investigations into insider trading by current and former SAC employees and others linked to them. Portfolio managers Todd Newman, Anthony Chiasson and Michael Steinberg have all gotten lengthy prison sentences as part of that investigation. But the evidence against those guys is considerably less direct than the evidence against Martoma. They clearly got inside information -- their analysts testified that they (the analysts) had illegally obtained information and passed it on to Newman/Chiasson/Steinberg -- but it is much less clear that the portfolio managers knew that it was obtained illegally. That matters for the law, but in a binary way. Juries decided that they knew, based on circumstantial evidence that the information they got was too good and too fishy to have been obtained legally. So they will go to prison for years, based on the dollar value of their profits, unless (as many people expect) an appeals court comes out the other way on that binary question. There's nothing in between: Either they knew too much and so are very guilty, or they didn't and so are totally innocent.
  • Steve Cohen. Is basically in the same boat as Newman, Chiasson and Steinberg? Except that his bit of the boat isn't heading to prison. There's basically no debate that he got inside information (from Martoma). There's not much debate that he traded on it, or so you'd conclude from Judge Gardephe's opinion. But: Did he know that it was fishy? There was a famous July 20, 2008, 20-minute phone call between Martoma and Cohen, after which Cohen started selling, but nobody knows what was said on that call except Martoma and Cohen. And neither of them is talking. The circumstantial evidence is not un-fishy; nor is it much weaker than the circumstantial evidence against Newman, Chiasson and Steinberg. But, for now, it is weaker enough. So even though he made more money than they did, the slightly weaker evidence against him keeps him out of prison.
  • Everybody else. I mean, not literally everybody, but a lot of people. Yesterday Paul Murphy pointed out the disparity between Martoma's nine-year sentence and the fact that "CEOs strategically time corporate news releases to coincide with months in which their equity vests," so as to trade on those news releases. Here's a story from this morning, "GFI Group Soared 11% in Day Before Hostile Takeover Bid." Maybe a coincidence! "It does look shady," though, says a guy. Maybe inside information is constantly leaking in ways that only occasionally rise to prosecutorial attention, usually through the use of short-dated out-of-the-money call options. The trick is to make as much money as you can without getting noticed, because if you get noticed, the more money you made, the worse off you are.

The obvious question is: Why didn't Martoma testify against Cohen? That is clearly what prosecutors wanted: to move Cohen from his non-prison-bound boat to the Newman/Chiasson/Steinberg boat, which requires some nefarious explanation for that 20-minute phone call. If Martoma had testified that he spent that call explaining his research process -- mostly bribing doctors -- and urging Cohen to sell based on inside information, then surely that would be enough to give prosecutors the scalp they so desperately wanted?

But he refused. Why? I don't know, no one knows, it remains a mystery. One simple explanation is that it's not what happened. Maybe Martoma persuaded Cohen to sell without telling him anything illegal. "Just trust me on this, Steve, I've got a bad feeling," or something like that. I suppose Martoma's father supported that theory yesterday when he said that "his son had refused to cooperate with the federal authorities against Mr. Cohen because he did not want to violate the Commandment against 'bearing false witness.' " That seems to rule out the possibility of true witness.

Another possible explanation is that Martoma wouldn't be that good a witness -- what with his Harvard difficulties and obvious guilt -- and so wouldn't get that much leniency from the government. If he was going to get prison time anyway, he might as well stick together with Cohen, because Cohen's story -- that he didn't trade on what Martoma told him -- was helpful for Martoma anyway. If this was the calculation, it doesn't seem to have worked out great, but we don't know the counterfactual.

Could he still cooperate now? "While Martoma has refused to cooperate with the government, prosecutors may still seek leniency for defendants who provide information, even after they are sentenced." But I wouldn't bet on it. If he was a bad witness before, the conviction and sentence and "false witness" comments don't make him more useful to prosecutors. And of course prosecutors want leverage to get defendants to cooperate before trial and conviction and sentencing. Giving Martoma a do-over would make it harder for them to get cooperation in future cases.

The insider trading investigations burble on, but Martoma was probably prosecutors' best hope of getting Steve Cohen, and that hope seems to have died. It continues to bother people, though, because it was such a close question. It does seem a little irrational how little the difference is between Cohen's yachting and Martoma's nine years in prison.

  1. Technically Cohen didn't make that money; SAC did, and at the time SAC was a hedge fund managing outside money as well as Cohen's (though: a lot of Cohen's). But of course between being the fund's biggest investor and getting performance fees on other investors' money, Cohen did end up with a lot of it. Now of course SAC is called Point72 Asset Management and is a family office.

  2. Which, I mean. You can see why "nonono my boss made $276 million; I only made $9.4 million" would not be a super-sympathetic argument.

    In general the argument that Cohen's trading shouldn't be attributed to Martoma, while not a terrible argument abstractly (Cohen himself has said that he relied on other inputs to sell the stock, not just Martoma's advice), is a terrible argument after Martoma has been convicted. The problem is that Martoma never traded Elan or Wyeth stock in his personal account; all he ever did was tell his employers at SAC Capital to trade that stock. So if a jury convicted him of insider trading, it's because it found beyond a reasonable doubt that SAC Capital traded on his illegally obtained inside information. (And SAC Capital pled guilty to doing that.) So really Judge Gardephe is understating it to say that "it is much more likely than not" that Cohen traded on material non-public information that he got from Martoma. It's actually true beyond a reasonable doubt as a matter of law. At least for purposes of Martoma's sentencing.

  3. She's not being metaphorical: "This summer, Mr. Cohen and his family rented a yacht off the Greek islands for a vacation."

  4. A "victimless" crime? Discuss amongst yourselves. I will say only that there are no identifiable victims, that the FBI acts like it's a victimless crime, and that "confidence in capital markets" is overrated as a rationale for punishing insider trading. But I don't especially think that it's victimless.

  5. I am being a little loose here. Technically there is not much debate that he traded on inside information from Martoma, but that doesn't mean that he necessarily got it. Martoma could have said "Steve just sell," based on Martoma's inside information, and Cohen could have traded without further inquiry. This does not seem like the most plausible interpretation but it is not impossible.

  6. By the way you could still imagine taking that case to the jury, on a circumstantial view that Cohen should have known that Martoma's bad feeling was obtained illegitimately. I would not convict based on that, but it's not that far off from the Newman/Chiasson/Steinberg prosecutions.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matthew S Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Toby Harshaw at tharshaw@bloomberg.net