On Tuesday, the Securities and Exchange Commission released news of an alleged insider-trading scheme that reaped profits and avoided losses of more than $276 million. The SEC brought the charges against (1) CR Intrinsic Investors LLC, (2) its former portfolio manager, Mathew Martoma, and (3) a medical consultant for an expert network firm, Dr. Sidney Gilman. The insider trading scheme involving a clinical trial for an Alzheimer’s drug being jointly developed by two pharmaceutical companies. The illicit gains generated in this scheme make it the largest insider trading case ever charged by the SEC.
Dr. Gilman has agreed to settle with SEC and cooperate. The Department of Justice has brought criminal charges against Mr. Martoma and tossed a non-prosecution agreement to Dr. Gilman.
According to the complaint, Dr. Gilman chaired a committee that oversaw a clinical trial for an Alzheimer’s drug that Elan Corporation and Wyeth were developing. Dr. Gilman, a professor of neurology at the University of Michigan Medical School served as the chairman of the Safety Monitoring Committee overseeing the clinical trial of the Alzheimer’s drug. Elan and Wyeth selected him to present the final clinical trial results at a July 29, 2008 medical conference. This would coincide with the after-market hours public announcement of the trial results by the two companies.
CR Intrinsic is a unit of Steven A. Cohen’s SAC Capital Advisors LP, the firm at the center of the expert network cases being brought by the SEC. Mr. Martoma met Dr. Gilman through an expert network firm. During consultations, the SEC alleges that Dr. Gilman provided Martoma with material nonpublic information about the ongoing clinical trial, including the actual, detailed results in advance of the July 29 Announcement.
According to the complaint, Mr. Martoma used the information to reposition almost a billion dollars in Elan and Wyeth stock, reaping profits and avoiding losses of over $276 million. At one point Elan and Wyether wer over 10% of the fund’s portfolio. At the end of 2008 Mr. Martoma pocketed a bonus of $9.3 million. CR Intrinsic paid Dr. Gilman $100,000 for his information.
The complaint does not identify the expert network firm, but the Wall Street Journal points to Gerson Lehman.
The facts look very bad for the parties. I assume that is why Dr. Gilman settled. Why is Mr. Martoma fighting the charges? He is subject to criminal charges and I assume the prosecutors wanted more prison time than Mr. Maroma was willing to serve.
The big question is whether the trades were illegal insider trading. The prosecutors will need to prove that Dr. Gilman had material non-public information and had a duty to keep that information confidential. They will need to prove that Mr. Martoma knew or should have known that the information should not be traded upon. That will be the test of this case and other expert network cases. These are likely to be the key issues to prove in this case:
61. Martoma knew, recklessly disregarded, or should have known, that Gilman owed a fiduciary duty, or obligation arising from a similar relationship of trust and confidence, to keep the information confidential.
63. Martoma and CR Intrinsic each knew, recklessly disregarded, or should have known, that the material nonpublic information concerning the Phase II Trial that each received from their respective tippers was disclosed or misappropriated in breach of a fiduciary duty, or similar relationship of trust and confidence.
There is no doubt that fund managers were using expert networks to gain an information edge on the markets. As Gordon Gecko said: “The most valuable commodity I know of is information.” The issue is finding the line between legitimate information gathering and illegally using material non-public information.
According to the SEC press release: “Since October 2009, the SEC has filed more than 170 insider trading actions charging more than 410 individuals and entities. The defendants in these actions are alleged to have made more than $875 million in illicit gains comprised of profits and the avoidance of losses.”