More On Legal & Compliancefrom The Advisor's Professional Library
- Risk-Based Oversight of Investment Advisors Even if the SEC had a larger budget and more resources, it is doubtful that the Commission would have the resources to regularly examine all RIAs. Therefore, the SEC is likely to continue relying on risk-based oversight to fulfill its mission of protecting investors.
- Conducting Due Diligence of Sub-Advisors and Third-Party Advisors Engaging in due-diligence of sub-advisors isnt just a recommended best practice it is part of the fiduciary obligation to a client. An RIA should be extremely reluctant to enter a relationship with a sub-advisor who claims the firms strategy is proprietary.
The Securities and Exchange Commission and the Department of Justice on Tuesday charged hedge fund advisory firm CR Intrinsic Investors LLC, which is a unit of SAC Capital Advisors, and its former portfolio manager along with a medical consultant for their roles in a $276 million insider trading scheme. The SEC says in its civil complaint that the illicit gains in the alleged scheme make it the largest insider trading case ever charged by the agency. The DOJ filed a separate, criminal complaint on Tuesday.
The alleged scheme involved a clinical trial for an Alzheimer’s drug being jointly developed by two pharmaceutical companies.
The SEC alleges that Mathew Martoma, a former trader for the Stamford, Conn.-based hedge fund, illegally obtained confidential details about the clinical trial from Dr. Sidney Gilman, who served as chairman of the safety monitoring committee overseeing the trial. Gilman was selected by Elan Corp. and Wyeth to present the final drug trial results to the public.
According to the SEC, in phone calls that were arranged by a New York-based expert network firm for which he moonlighted as a medical consultant, “Dr. Gilman tipped Martoma with safety data and eventually details about negative results in the trial about two weeks before they were made public in July 2008. Martoma then caused several hedge funds to sell more than $960 million in Elan and Wyeth securities in just over a week.”
Gilman, who lives in Ann Arbor, Mich., where he works as a medical school professor, has agreed to settle the SEC’s charges and cooperate in this action and related SEC investigations. Gilman has agreed to pay more than $234,000 in disgorgement and prejudgment interest. In a parallel action, the U.S. Attorney’s Office for the Southern District of New York on Tuesday announced criminal charges against Martoma and a non-prosecution agreement with Gilman. Martoma lives in Boca Raton, Fla.
Gilman has also agreed to a permanent injunction against further violations of the federal securities laws. The proposed settlement is subject to approval by the court, which also will determine at a later date whether any additional financial penalty is appropriate.
“Today’s record-setting insider trading case reinforces the cold, hard lesson of so many other recent cases that when you trade on inside information, you’re not just betting your money but also your career, your reputation, your financial security, and your liberty,” said Robert Khuzami, director of the SEC’s Division of Enforcement, in a statement. “Now, yet another corrupt hedge fund manager has learned the high cost of ignoring that lesson.”
Sanjay Wadhwa, associate director of the SEC’s New York Regional Office and Deputy Chief of the Enforcement Division’s Market Abuse Unit, added in the same statement, “Today’s action against CR Intrinsic underscores our commitment to hold hedge fund advisory firms accountable when their employees break the law for the firms’ benefit. The clear message is that firms should adopt appropriate procedural safeguards and a culture of zero tolerance toward employee misconduct that could subject the firm to such serious consequences.”
The SEC’s complaint filed in federal court in Manhattan explains how the scheme worked. Martoma first met Gilman through paid consultations arranged by the expert network firm. Gilman provided Martoma with material nonpublic information concerning the Phase II trial of the potential Alzheimer’s drug called bapineuzumab (bapi). They coordinated their expert network consultations around scheduled safety monitoring committee meetings, and during their phone calls they discussed PowerPoint presentations made during the meetings and Gilman provided Martoma with his perspective on the results. Gilman developed a personal relationship with Martoma, eventually coming to view Martoma as a friend and pupil.
The SEC alleges that Martoma caused hedge funds managed by CR Intrinsic as well as hedge funds managed by an affiliated investment advisor to trade on the negative inside information he received from Gilman. “Although Elan and Wyeth’s shares rose on June 17, 2008, on the public release of top-line results of the Phase II trial, market participants were disappointed by the detailed final results issued on July 29, 2008. Double-digit declines in Elan and Wyeth shares ensued,” the complaint says.
“After Martoma was tipped, the hedge funds not only liquidated their combined long position in Elan and Wyeth of more than $700 million, but went on to hold substantial short positions in both securities. This massive repositioning allowed CR Intrinsic and the affiliated advisory firm to reap approximately $82 million in profits and $194 million in avoided losses for a total of more than $276 million in illicit gains,” the complaint says.
According to the SEC’s complaint, Martoma received a $9.3 million bonus at the end of 2008--a significant portion of which was attributable to the illegal profits that the hedge funds managed by CR Intrinsic and the other investment advisory firm had generated in this scheme. Gilman, who was generally paid $1,000 per hour as a consultant for the expert network firm, received more than $100,000 for his consultations with Martoma and others at the hedge fund advisory firms. Gilman also received approximately $79,000 from Elan for his consultations concerning bapi in 2007 and 2008.