NEW YORK (Reuters) - Federal prosecutors on Friday lost one opportunity to build a case against hedge fund manager Steven A. Cohen when a grand jury indicted one of Cohen's former employees on charges related to an insider trading scheme, severely reducing the possibility he would cooperate as a witness against Cohen.
The grand jury in New York returned an indictment against Mathew Martoma, a former portfolio manager at CR Intrinsic Investors, one of SAC Capital Management's funds, in what prosecutors have called the "most lucrative" insider trading scheme ever.
Martoma, 38, of Boca Raton, Florida, was indicted on three counts of conspiracy to commit securities fraud and securities fraud related to trades made in Elan Corp Plc and Wyeth - now part of Pfizer Inc - based on tips prosecutors say he received from a doctor.
The trades allegedly helped CR Intrinsic avoid losses and reap profits totaling $276 million in the summer of 2008. The indictment followed an earlier criminal complaint federal prosecutors filed November 20.
Martoma is the seventh former employee of Cohen's to be charged or implicated in insider trading schemes, and the criminal complaint against him is the first to refer to Cohen.
Cohen appears as "Hedge Fund Owner" in the criminal complaint and "hedge fund manager A" in the corresponding civil complaint against Martoma, filed by the U.S. Securities and Exchange Commission, according to a source familiar with the case.
"Though disappointing, today's events come as no surprise," said Martoma's lawyer, Charles Stillman, founding member of Stillman Friedman in New York.
"The simple fact is that Mathew Martoma did not trade on inside information, is innocent of all these charges, and we look forward to his ultimate vindication."
The same day as the indictment, investors in Elan's American depositary receipts sued SAC Capital, Cohen and Martoma, among others, for federal securities law violations related to the alleged the insider trading.
The lawsuit, filed in the U.S. District Court in New York, appears to be the first private action against SAC stemming from the insider trading criminal case. The lawsuit seeks class action status and unspecified damages.
After the Federal Bureau of Investigation arrested Martoma in late November, federal prosecutors filed a criminal complaint against him but did not formally charge him, a move widely seen as leaving the door open for Martoma to "flip." Had he flipped, he would have had to agree to a plea deal in exchange for becoming a cooperating witness for the government.
"The reports have been that the government has made significant efforts to enlist Mr. Martoma as a cooperating witness and he has refused," said Tom Gorman, a partner at Dorsey & Whitney in Washington.
"The fact that they've incited him probably means that they've given up on that, but he could still change his mind."
Gorman added defendants often grow more willing to make a deal as the time of their trial nears.
"The process looks a lot different when you're sitting there looking at jury selection," he said. "By that time, everybody starts to get true religion. It's the pressure of the process."
A spokesman for SAC Capital declined to comment for this story. Spokeswomen for the FBI and for Preet Bharara, U.S. Attorney for the Southern District of New York, both declined to comment.
The charges against Martoma stem from the U.S. government's long-running investigation of improper trading in the $2 trillion hedge fund industry.
The investigation has led to more than 50 convictions so far, most notably that of Galleon founder Raj Rajaratnam and former Goldman Sachs Group director Rajat Gupta.
Slowly, U.S. authorities have been filing charges and winning convictions against lower-level traders and analysts who once worked for Cohen, one of the hedge fund industry's most successful and best-known traders.
Authorities are stepping up pressure on Cohen and his hedge fund. This summer, the U.S. Securities and Exchange Commission took a deposition from Cohen as part of an insider trading investigation. It is not clear what the SEC asked Cohen.
Recently, a top Cohen deputy, Michael Steinberg, was named as an unindicted co-conspirator in court documents in a separate insider trading matter.
The $14 billion SAC Capital, which charges some of the highest fees in the industry, is up about 10 percent this year - double the performance of the average U.S. hedge fund.
The criminal complaint filed by federal prosecutors and the SEC's civil suit contend Martoma got insider information from a doctor who is not named in the criminal complaint because he is now cooperating with prosecutors after agreeing to pay a $186,781 disgorgement.
The SEC complaint identifies the doctor as Sidney Gilman, who once worked as a consultant for a so-called expert network. Hedge funds use such networks to gain insight into various industries.
Gilman, an 80-year old neurology professor at the University of Michigan, is serving as a confidential cooperating witness in the criminal case.
"Dr. Gilman's accomplishments in medical education and research speak for themselves," said Gilman's lawyer, Mark Mukasey, a partner at Bracewell & Giuliani. "He has been a leader in the fight to find a cure for people suffering from debilitating neurological diseases. Going forward, he will abide by the terms of his agreements with the US Attorney's Office and the SEC."
The name of the expert network firm does not appear in the court documents. A disclosure attached to a paper by Gilman in the medical journal "Neurology" lists him as a consultant for the Gerson Lehrman Group.
A GLG spokesman declined to comment.
The court papers describe phone calls in which Gilman shared detailed information about the Alzheimer's drug's clinical trial. Gilman was chair of a committee to monitor patients' safety during the clinical trial.
According to the criminal complaint, Gilman scheduled meetings and phone calls with Martoma that allowed him to pass on new information about the clinical trial soon after receiving it. He was initially positive about the drug; as a result, Martoma vigorously bought shares of Elan and Wyeth.
The complaint says the hedge fund owner defended Martoma against other people inside SAC Capital who criticized the large positions.
After Gilman learned the drug trial results were mostly negative, a trader for CR Intrinsic unwound its positions and made a move into options that paid off when the stocks fell. Elan shares, for example, fell about 70 percent following the news of the trial results.
Of the $276 million in profits, more than $81 million came from short sales and other options on the two stocks and $194 million came from losses avoided by selling the stocks before the trial results were revealed to the public, according to the complaint.
Reporting By Emily Flitter and Nate Raymond in New York; Editing by Nick Zieminski