SAC Capital and Steven Cohen: Insider Trading is a Fog That Haunts Wall Street

Here we go again, another insider trading accusation on the heels of the Raj Rajaratnam conviction and sentencing. It involves SAC Capital Advisors and a former employee, Matthew Martoma. The entire episode is detailed in a New York Times article in Monday’s paper. The allegations of insider trading are very serious and could have ramifications to many more individuals before it is over.

Regulators should, at long last, clear up the rules that govern this illegal activity so that investors, compliance officers, and prosecutors can make good decisions about a possible illegal act and how it should be adjudicated. Regulations are only as beneficial as the draftsmanship of lawmakers. The confusion about what is inside information and what is not has befuddled both investors and juries for years.

The story tells of Steven A. Cohen, a self-made hedge fund billionaire and founder of SAC. Cohen’s “reputation as a market wizard” is well known throughout the financial community. He has surrounded himself with “hard-charging” traders, who thrive in a super competitive, “testosterone-fueled environment.” Cohen’s traders aggressively search out data that enables them to make savvy stock choices that usually turn out to be very profitable for SAC and for them personally. On occasion, traders dig too deep and sometimes find themselves with inside information about companies they want to invest in.

Inside information, simply, is the illegal practice of trading on the stock exchange to one’s own advantage through having access to confidential information. It is not illegal to know inside information, but it is illegal to trade securities based upon it or relate the information to others who may invest in the securities.

Our stock markets are predicated upon all investors having the same information, a level playing field if you will. So, if a person knows that a company will be introducing a revolutionary new product before it is announced to the investment community and invests in the company’s stock, he has an unfair advantage over other investors and has broken the law.

Here is some background information from the news story. SAC has about 1,000 employees and manages $14 billion of assets for other people. The company invests in a variety of assets, but common stock is its most common asset preference.

Martoma has a distinguished résumé that includes a degree from Duke in biomedicine, and he also worked in Washington at the National Human Genome Research Institute. Subsequently, Martoma received an MBA from Stanford.

When he joined SAC, he was assigned to work in its CR Intrinsic group, a research engine. Martoma made his reputation by betting on the outcomes of events like clinical trials for promising drugs using “a deep network of contacts in the pharmaceutical and biotech fields.”

In an effort to increase his knowledge base, Martoma worked with expert-networking firms, which employ consultants and match money managers with industry specialists. The amount of information that is shared with these affiliations often pushes the envelope of legal behavior, and may be considered inside information in certain situations by the authorities.

To make a long story short, Martoma has been accused of receiving information from a neurology professor at the University of Michigan; he was introduced to Dr. Sidney Gilman by an expert-network firm. Gilman is an expert in Alzheimer’s disease. Information was received from Gilman about an Alzheimer’s drug being developed by Elan and Wyeth, two pharmaceutical enterprises. Martoma allegedly made large bets totaling $700 million on these companies based upon confidential and positive data he received from Gilman.

Subsequently, Gilman said there were problems with drug tests. Before the test results were announced to the public, SAC sold its investments in Elan and Wyeth avoiding losses of about $194 million. Additionally, SAC sold the stocks short accumulating $83 million of gains. Martoma’s $9.4 million bonus was largely based upon the aforementioned transactions.

The regulatory agency responsible for monitoring suspicious stock trades noted large short sales of drug stocks prior to the Elan and Wyeth negative announcements. They, in turn, called for an investigation.

Typically, prosecutors try to convince lower level felons to “flip” on higher-ups. There are allegations that Cohen was involved in the aforementioned activities. So, prosecutors are supposedly trying to get Martoma to implicate his former boss. This would likely result in a more favorable sentence for Martoma. To this point, Cohen has not been accused publicly. Adding to the intrigue is the fact that Martoma was fired by Cohen for performance reasons.

The issues are whether the information received by Martoma constituted inside information, whether Cohen was briefed about the information, and whether Cohen knew it would be inappropriate to trade knowing the information. The technical aspects of a trial, if one actually occurs, will be overbearing and take weeks for prosecutors to make a case to a group of uninformed jurors.

Inside information has been a fuzzy area for some time. Many investors have been prosecuted for having used inappropriate information. The laws themselves exacerbate the difficulty of these efforts. It is about time that the rules were clarified for those accused and for the prosecution. Insider trading laws are one example of needed regulation that is not well defined, just as some claim relating to Dodd-Frank.

How much do you trust the information in this article?

Sal Bommarito

I spend most of my time writing a screenplay based on three of my published novels.

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