Over two years ago, on November 5, 2010, weeks before news broke out that the SEC had caught hedge funds in a massive insider trading scheme involving expert networks, and before the phrase expert network was even mentioned in places away from hedge funds, we wrote an article, titled "Is The SEC's Insider Trading Case Implicating FrontPoint A Sting Operation Aimed At S.A.C. Capital?" that predicted everything that has transpired with SAC since then: we said expert networks would be exposed as the root of virtually all "information arbitrage" alpha by Steve Cohen, more importantly, we exposed various biotech stock trading patterns, where the informational benefits from easily bribable doctors would result in immediate profits courtesy of advance knowledge of Phase 2, 3 and NDA results. Today, we discover not just how deep the SAC insider trading schemes went, but that the profit from such information abuse amounted to hundreds of millions in standalone cases. Adding these together and one can see why Steve Cohen - whose knowledge of these epic inside trading scheme is of course never implied by us: after all, that's what the DOJ, the SEC and the various DA offices are for - was generating 20% returns year after year and able to pocket 3% and 50%.
As a reminder, this is what we wrote, at a time when even suggesting in public that SAC was involved in insider trading was a taboo topic:
[Would] SAC be so kind as to provide the following information:
- Did SAC short CYBX in the days immediately preceding the adverse CYBX statement from August 12, 2004. And did it subsequently go long ahead of the favorable 8K from February 3, 2005. If so, what was the investment thesis/catalyst for such decision. Did SAC consult with an expert network or an outside consultant on any of the trades?
- Did SAC go long ITMN in the days immediately preceding the favorable ITMN statement from March 9, 2010. And did it subsequently sell all of its holdings in advance of the adverse news from May 4, 2010. If so, what was the investment thesis/catalyst for such decision. Did SAC consult with an expert network or an outside consultant on any of the trades?
- Did SAC sell its 700,000 shares in advance of the adverse MYGN news release from May 4, 2010. And did it subsequently sell all of its holdings in advance of the adverse news from May 5, 2010. If so, what was the investment thesis/catalyst for such a decision. Did SAC consult with an expert network or an outside consultant on any of the trades? Furthermore, what catalyzed the decision to reenter the stock.
Today, one by one all of our questions are being answered, in a way just as had been expected. From the FT:
A former portfolio manager at SAC Capital was arrested and charged with insider trading for allegedly dumping shares of two pharmaceutical companies after learning the results of a secret drug trial and made $276m in profits, in what authorities believe is the most lucrative illegal trading scheme.
Agents with the Federal Bureau of Investigation arrested Mathew Martoma early on Tuesday at his Boca Raton, Florida home. Prosecutors with the US attorney’s office in Manhattan, which announced the charges, said it “is believed to be the most lucrative insider trading scheme ever charged, resulting in benefits to the hedge fund of more than a quarter of a billion dollars.”
Mr Martoma worked for CR Instrinic, a unit of SAC Capital, the $14bn hedge fund run by Steven Cohen. SAC Capital had no immediate comment. Mr Martoma could not immediately be reached.
According to the complaint, Mr Martoma, a trader of pharmaceutical stocks, in October 2007 learnt confidential results of an Alzheimer drug trial conducted by Elan and Wyeth. Mr Martoma was introduced to a doctor, Sidney Gilman, involved in the drug trial the year before through GLG, an expert network firm, which matches money managers with industry experts.
On July 17 2008, Mr Martoma allegedly obtained the final disappointing results of the drug trial from Mr Gilman and three days later, according to the complaint allegedly “spoke to the owner” of the hedge fund where he worked and recommended selling Elan and Wyeth before the drug trial results were made public.
The next day, according to the complaint, Mr Martoma and the hedge fund owner instructed a trader to sell its entire 10.5m share position in Elan and 7m shares of Wyeth. The hedge fund also placed a bet that the two stocks would drop.
In other words, nothing that was not explicitly known by our readers for over two years. But to summarize, here is how one made millions in the mid-2000s:
- Get a job with a prominent hedge fund, but not as an analyst or sub-PM, but must run own pod of between $100 and $200 million of dedicated capital, where no individual stock trading decision has to go through committee. Best places for this have historically been SAC and Millennium.
- Get a Gerson-Lehrman or any other expert network subscription; become close friends with all disgruntled "experts" i.e., doctors supervising Phase [x] trials for prominent and one trick pony biotechs, paid $1000/hour for their services.
- Ahead of the public announcement (as far as possible to make it seem less shady, but even 24 hours ahead of time works) of drug efficacy, or lack thereof, take out said expert for a night on the town, just so there are no pesky recordable phone lines, whereby 500 freshly printed $100 bills exchange venue from one pocket to another, coupled with a substantial amount of alcohol consumption.If time is of the issue, skip all of the above and merely promise payment by phone in exchange for critical information.
- The next morning, using a VWAP algo so it doesn't appear too desperate, or in the worst case some In The Money calls, establish major position in the company whose drug trial will have favorable outcome. Invert for disappointing drug trials.
- Wait for news, act surprised, and sell small portion of position. Over next 3-4 weeks sell remainder.
- Collect one bonus, and if large enough (>$10 million), take a year off, then reenter work force and find employment with comparable silo-based hedge fund, where PMs have sufficient "independence" so that the head PM: Steve Cohen, Israel Englander, etc., can claim they had no idea what the standalone PMs were doing on their own.
- Repeat as necessary and pray 5 year statute on criminal limitations expires fast.
This is how it is supposed to work, and has worked for countless "PMs" in the period 2003-2009.
When it doesn't work quite as expected, get a 5 year jail sentence coupled with profit disgorgement, but not before parking $5-10 million in hush money from various "interested party" lawyers, just to keep one's mouth shut before various FBI, SEC, and DA representatives. Park money in Switzerland Singapore. Do 2.5 years on good behavior. Leave prison to $5-10 million in happy retirement money.
Oh, one more thing:
SAC still is accountable for 10% of daily NYSE volume, and now that it can no longer capitalize on "expert networks" alpha, is lately best known for running the entire market's stops both up and down (see AAPL yesterday), a feat made possible due to the total collapse in broad institutional volume. Have a wonderful manipulated day.
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Full Martoma filng below: