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November 22, 2012 8:02 pm
When a Federal Bureau of Investigation agent arrived at Mathew Martoma’s multimillion-dollar seaside home in Florida on Tuesday morning, it marked a new turn in the US investigation into insider trading at SAC Capital, the hedge fund.
As the sun rose in Boca Raton, Mr Martoma, a former portfolio manager at SAC subsidiary CR Intrinsic, was handcuffed and charged with securities fraud for allegedly trading shares in pharmaceutical companies Elan and Wyeth in 2008 after learning the secret results of a clinical trial for a new Alzheimer’s drug.
According to a civil complaint filed by the Securities and Exchange Commission, SAC made a total of $276m – $82.8m in profits and $194m in avoided losses – in what authorities allege is the most lucrative insider trading in US history.
While the scene was quiet outside Mr Martoma’s home in the Royal Palm Yacht and Country Club, the broader implications of the probe are echoing through the halls of hedge funds thousands of miles away on Wall Street.
Authorities allege that Mr Martoma passed the tip to Steven Cohen, SAC’s founder (the firm takes its name from his initials) and one of Wall Street’s most prominent hedge fund managers, who then traded on the information before it was made public.
Neither SAC nor Mr Cohen has been accused of any wrongdoing.
That trade, made four years ago allegedly on the recommendation of Mr Martoma, who was fired in 2010 for poor performance, has come back to haunt one of the most powerful hedge funds on Wall Street.
Since 1992 SAC, with Mr Cohen at its heart, has ploughed a furrow as one of the equity markets’ most influential and enigmatic operators. The firm’s stunning returns – 30 per cent for clients annually, on average, for two decades – have been matched only by its fees. No hedge fund in the world charges its clients more: SAC takes more than half of everything it makes.
The practice has made Mr Cohen – a quiet but intense man who is known for his brusque, ruthless trading style – one of the richest men in America with a personal fortune estimated at more than $8bn.
Throughout its history, SAC has remained inscrutable. The firm is run far from Wall Street in leafy Connecticut. A mythology has built around it, thanks in part to the rigour and precision with which it operates.
The 20,000 foot trading floor is chilled to 69F. Employees are provided with monogrammed fleeces if they get cold. Silence reigns. Phones do not ring, they flash. And at the centre, with cameras beaming his image to myriad trading desks, sits Mr Cohen, trading constantly and watching the flow of money hawkishly on a huge curved bank of monitors.
Half a decade ago, US investigators tore up their playbook on insider trading and started using techniques previously used for tackling organised crime and drug trafficking, writes Brooke Masters.
They started data mining – combing through databases to look for relationships between lucky traders and possible sources of inside information. They used confidential informants and wiretaps to record potentially criminal conversations.
They also started looking beyond the usual bankers, accountants and lawyers who had been the focus of most insider trading prosecutions, to look at executive network firms and hedge funds.
Although this method proved expensive and labour-intensive, the work bore fruit, leading to the conviction last year of Raj Rajaratnam, the founder of Galleon Group hedge fund, and about a dozen others.
In June, Rajat Gupta was convicted of passing confidential information he learnt while on the board of Goldman Sachs to Rajaratnam, who made $1m of profit by trading ahead of good news and avoided an estimated $4m in losses.
Authorities also stepped up their cross-border work, with the US Securities and Exchange Commission and the UK Financial Services Authority combining forces to catch and punish an insider dealing ring that used UK spread bets to trade ahead of US technology mergers.
More cases are likely. A Federal Bureau of Investigation supervisor said last month that the number of new FBI investigations into insider trading was up 43 per cent nationwide for the fiscal year that ended September 30.
The investigation into Mr Martoma and CR Intrinsic is the latest in a longstanding probe by the US attorney’s office in Manhattan, the FBI and the SEC into insider trading on Wall Street. That has resulted in insider trading charges against 73 consultants, traders and analysts, including five who previously worked for SAC. SAC was subpoenaed in 2010 and has said it is co-operating with the probe.
CR Intrinsic, an internal fund unit that was set up by Mr Cohen to take longer-term bets with his and clients’ money, was sued by the SEC on Tuesday and is contesting the allegation.
It is the first action directed at a part of Mr Cohen’s $14bn operation, even though numerous cases have been brought against former SAC employees or third party hedge funds part-sponsored by SAC.
The SEC warned the hedge fund in 2003 in a Wells Notice that it intended to file civil charges against it in connection with an investigation into a former SAC trader. He was suspected of trading on research reports written by his wife, a high-profile Wall Street analyst, before they were published. No charges were ever filed against SAC or the trader.
The Financial Industry Regulatory Authority, Wall Street’s self-regulating body, referred 20 instances of suspicious trading by SAC to the SEC between 2002 and 2010, according to people familiar with the matter. There were never any charges.
In the mid-2000s the authorities began to work more closely together and to take a different approach, focusing on associations and connections between people who may handle secret information and securing co-operators on Wall Street.
The new approach led in 2011 to criminal insider trading charges against Donald Longueuil, a portfolio manager with CR Intrinsic, and Noah Freeman, a portfolio manager at SAC. Both pleaded guilty. Co-operating witnesses led to the arrest earlier this year of Jon Horvath, a former analyst with SAC’s Sigma Capital. Mr Horvath was arrested for trading Dell stock after being tipped off about the computer maker’s confidential earnings results by a “circle of friends”.
Mr Horvath pleaded guilty in September and struck a deal with the government. He said he shared the inside information with his boss, Michael Steinberg, a portfolio manager at SAC who has worked alongside Mr Cohen for 15 years.
Prosecutors have in court called Mr Steinberg an “unindicted co-conspirator”. But they have not charged him with any wrongdoing or alleged that he spoke with Mr Cohen about any trades. SAC has placed Mr Steinberg on paid leave.
Lawyers say that judging from the indictment of Mr Martoma, it is clear the authorities will have looked at Mr Cohen’s actions. It is unclear if Mr Martoma will co-operate or what he told Mr Cohen about the source of the information. His lawyer declined to comment.
A spokesman for Mr Cohen said: “Mr Cohen and SAC are confident that they have acted appropriately and will continue to co-operate with the government’s inquiry.”
Mr Steinberg could not be reached for comment.
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