Circle of Friends (41 page)

In the summer of 2012, President Obama was locked in a tight race against his Republican challenger Mitt Romney, and the general feeling on trading desks across the banking sector was that a president who had made class warfare his campaign theme wasn't above making a high-profile arrest of a fat-cat Wall Street figure. It would be done, at least according to the trading desk chatter, as an “October Surprise,” that is, something big enough to prove to a skeptical public that the Obama Justice Department was tough on Wall Street crime and coming close enough to election day to have an impact on the result.

The names most bandied about included Lloyd Blankfein, the CEO of Goldman and a favorite whipping boy of congressional investigators looking at financial crisis excess, and Dick Fuld, the former Lehman Brothers chief. But Blankfein ran a too-big-to-fail bank and had already outmaneuvered a Justice Department referral made by Senator Carl Levin over statements he had made during a hearing into Goldman's behavior during the banking collapse. And for all the excesses of Lehman, the SEC labored to bring a case against Fuld, coming up with lots of smoke but little or no evidence of intent to break the law.

Another possibility: a high-profile arrest in an insider trading case that would garner fairly big headlines. The list of possibilities seemed endless given the success already achieved in convincing targets to cooperate and cough up other targets. Indeed, the FBI had even investigated a financial journalist for taking part in the scheme, a case that seemed to stall in fall 2012.

But investigators were aiming higher—much higher.

Back in 2008 and into 2009 as federal investigators were putting the finishing touches on their investigation of Raj Rajaratnam, Steve Cohen wasn't just on their radar screens, he was also on their tape recorders. That significant development remained confidential until early 2012. According to the Fox Business Network, Kang and his colleagues had been listening to calls Cohen had made from his home telephone in an effort to expand the probe of insider trading to include Cohen and SAC. Again, it was hardly news at this point that the feds had a passing interest in SAC and its founder; what
was
news was the feds' very direct interest in Cohen and its desire to do whatever it took to make a case.

Senior executives at SAC said they knew nothing about the matter and demanded that Fox clarify the report because it was still unclear whether the wiretap was placed on Cohen's phone or whether an outside cooperator, with a listening device on his telephone, had called Cohen.

It was a crucial difference, Jonathan Gasthalter, the Sard Verbinnen flack who worked most directly for SAC, argued. A wiretap on an outside cooperator didn't mean that the feds had gone to a judge and produced evidence of illegal behavior at SAC, a necessary step to get a court order for a listening device. If the feds merely taped a cooperator's calls, Cohen certainly wasn't the subject of the probe.

But before long, SAC received its clarification: Senior government officials with knowledge of the wiretaps said Cohen might be innocent, but he wasn't a complete bystander. The FBI had received a court order to wiretap his telephone. The tapes were said to have produced relatively little that could be used to build a case against either Cohen or the fund he ran, but that hardly ended the government's interest in Cohen.

SAC remained on edge, and friends said Cohen could feel the heat from the investigations growing around him.

Much was at stake, including billions of dollars of clients' money that might be redeemed if Cohen did become an official suspect. Fearing massive redemptions, Sard Verbinnen worked overtime to build the impression that it was business as usual in Stamford. Cohen, ever the master chess player, began to increase his political giving, embracing Mitt Romney over Obama for president in 2012.

Cohen's history of political giving (including the history of underlings at SAC) reflected a bias in favor of Democrats. But as usual Cohen was looking to gain an edge any way he could. With Romney in and Obama out, that would also mean walking papers for one of Cohen's chief antagonists, the Southern District chief, Preet Bharara, as well as the appointment of a new SEC chairman, possibly one less inclined to make insider trading the crime of the century.

Cohen had made his political trade—and did so in a fairly public manner. At one point in 2012, dressed uncharacteristically in a suit and tie, he was spotted dining with New Jersey governor Chris Christie at the popular Manhattan restaurant Quality Meats. Christie was one of Romney's top fund-raisers and a former prosecutor holding the functional equivalent of Bharara's post in New Jersey. It's unclear what was said during the conversation (neither would comment about it) but people in the restaurant say both men were engaged in intimate, quiet discussion over expensive steaks and at least one bottle of three-hundred-dollar Sassicaia wine.

Cohen's political maneuvering didn't end there, as the alleged recluse from SAC held a fund-raiser for Romney at his Greenwich estate, attempting to appear as if he had not a care in the world. Reality, however, was far different.

S
omething big is coming,” David Chaves told his colleagues one afternoon in the late summer of 2012. He just received the latest briefing about an upcoming case that had captivated both the SEC and the FBI for the past year, and would emerge as the government's best chance yet to finally harpoon the elusive white whale of a trader from Stamford.

It was only fitting that the case began with the investigative work of Sanjay Wadhwa over at the SEC. By now Wadhwa had earned the distinction of being the only investigator who had been working on the insider trading crackdown since the beginning. The wiretaps might have been the sexy part of the Rajaratnam conviction, but if Wadhwa hadn't done all that legwork beforehand—beginning with his investigation into Rengan Rajaratnam, and then following the paper and email trails to Raj Rajaratnam, Roomy Khan, and others—B. J. Kang would never have known to show up at Roomy Khan's home in the first place. Without the probable cause evidence Wadhwa developed, there would be no wiretaps. Without Wadhwa, Galleon would still be making money illegally and Rajaratnam would be a free man. And his institutional knowledge was instrumental in cracking the next big phase of the investigation. Nearly from the beginning Wadhwa and his closest associate at the FBI, B. J. Kang, had smelled something bad at SAC Capital.

Some prosecutors in the Southern District have always had their doubts about making any case against Cohen—and whether, given the time and effort required, it was worth it. They compared Kang and Wadhwa to Ahab in Melville's
Moby-Dick
, with Cohen playing the part of the elusive white whale as the government obsessively hunts down a target of dubious worth, at least from a legal standpoint.

Wadhwa had heard the
Moby Dick
analogy and bristled at the suggestion because so much about SAC appeared to add up to trouble. What struck both Wadhwa and Kang about Cohen and the firm he ran was the simple fact that so many of the major targets and cooperators had some SAC connection. Like Goldman Sachs, you would expect a big, successful firm like SAC to have alumni everywhere in the financial world. But where the SAC diaspora differed from Goldman's was in the white-collar-crime department. Since 2007, Goldman has had its brushes with scandal, of course. But its alumni just weren't found on the lists of targets or suspected targets of securities fraud to the degree that the names of SAC's traders, both past and present, kept cropping up over that relatively short period of time.

Even Raj Rajaratnam's younger brother Rengan—the initial focus of Wadhwa's insider trading probe back in 2007—had worked at SAC. His firm, Sedna, was long closed down and he largely dropped off the radar, though not completely. Like Raj, he too would be indicted some six years later in the spring of 2013, just before the statute of limitations ran out—the same statute of limitations that Kang and Wadhwa would soon be racing to beat in their pursuit of the white whale from Stamford.

I
n the spring of 2009, Sanjay Wadhwa had just spent another grueling day at the office when he received a message from Cameron Funkhouser at FINRA about yet another batch of suspicious trades from SAC Capital. Wadhwa and B. J. Kang were at this point in the final stages of their Galleon investigation that in a few months would lead to Rajaratnam's arrest. The probe of SAC was considered a secondary matter in the grand scheme of things.

But Wadhwa has told people that Kang made an interesting, almost cryptic, statement to him at this time. Kang continued to probe SAC simultaneous to his work on Galleon. He planted a wiretap on Cohen's home telephone and unsuccessfully tried to plant a cooperator in SAC's ranks.

Through his research he came across something that led him to believe that investigators should look at a cluster of suspicious trades that occurred around the same time a year earlier.

Wadhwa had worked long enough with Kang to know to trust the agent's instincts, so he ordered FINRA to send him some of its red-flagged trading data from SAC. One set stood out. It came via the New York Stock Exchange surveillance system, and it involved massive amounts of trading at SAC—in both long and short positions—in shares of Elan and Wyeth in 2007 and 2008. After further investigation, he saw similar trading patterns the year before. The buying occurred right before key events, such as successful drug trials—the selling just before setbacks caused shares to drop.

Wadhwa had just gotten married; a child was on the way. What's more, he didn't have the manpower to take his investigators off the Galleon case so he decided to work a little longer and harder because he loved the thrill of the chase. And based on what he was seeing, he was now in the midst of chasing Steve Cohen.

Wadhwa reasoned, the SAC portfolio manager must be someone Steve Cohen trusted. The long positions in Elan and Wyeth were really long—often above $300 million through most of 2007 and into 2008. Then sometime in late July 2008, they suddenly exploded to more than $700 million.

And then just as suddenly—they vanished. Wadhwa had looked at lots of trading records during the inquiry, but nothing stood out quite like this one. From July 21 through 25, SAC began unloading shares en masse—a massive directional shift, described by the senior trader at SAC as “executed quietly and effectively over a four-day period through algos and dark pools.”

That wasn't all. SAC began shorting shares on July 28 and July 29—perfectly timed to news delivered at the International Conference on Alzheimer's Disease, a medical conference in Chicago that was being closely followed by the Wall Street trading community. At the conference, the expert on Alzheimer's, Sidney Gilman, reported that a drug called bapineuzumab that Elan and Wyeth had jointly developed to treat the disease had failed in clinical trials.

But that bad news was good news at SAC—yet another perfectly timed trade that produced profits and avoided losses of $276 million as shares of Elan and Wyeth tanked 42 percent and 12 percent respectively.

More than a year had passed before Wadhwa and his counterparts in the Justice Department could fully appreciate what they had stumbled upon. Of course, with the Galleon case and those that flowed from it, they had other matters to attend to. But by early 2012, the general feeling inside the government team was that these drug trades might be their best shot at making a case against SAC and possibly Cohen himself.

It wasn't easy identifying the man directly behind all this good fortune as Mathew Martoma, a former SAC portfolio manager, because of the sheer volume of buying and selling of stocks SAC does, and also because of the way SAC keeps its trading records.

But when they did, the case started to come together as Wadhwa and Kang began piecing together trades with telephone records and emails into what they believed was a coherent insider-trading narrative that involved Cohen directly.

What struck investigators as odd was that Martoma was hardly a seasoned hand at SAC. He had gone to law school, dropped out, and then graduated from Stanford University with an MBA. From his bio, he seemed nerdy and smart. He had an interest in medicine, particularly medical ethics. But they didn't think he was the type of guy Cohen would naturally trust. He was just thirty-four years old at the time and had been at the firm just a little more than a year. He had only been trading for about five years, far less time than the handful of SAC traders whom Cohen considered his closest advisers.

Wadhwa and Kang believed the emails provided the clue as to why a near novice had so much conviction. Martoma had an important, possibly unimpeachable, source at Elan; it was Gilman—the very same expert who announced the drug's poor test results at the medical conference. Gilman was a well-known physician from the University of Michigan who also moonlighted in several other capacities. For one thing, he was a consultant to Elan on bapineuzumab, so he would have firsthand knowledge of the research on the drug's prospects.

As a side job to his university gig, Gilman also did a lot of work for the pharmaceutical industry advising on drugs and various neurodegenerative diseases. He had earned millions of dollars in this capacity since at least the 1960s, when he also began advising traders and investors on drug company stocks. Since at least 2006, he was part of the Gerson Lehrman expert network, and it was around that time that he had begun advising Martoma at SAC at the price of $1,000 an hour, Wadhwa discovered.

Based on telephone records, the two spent a lot of time talking, particularly leading up to the Chicago conference on Alzheimer's where the findings of the Stage II clinical trial of the drug would be released by Gilman himself. It would be a critical date for shareholders of Elan and Wyeth; depending on the outcome, investors could lose or make millions.

Martoma had a forty-five-minute telephone call with Gilman on July 17—just days before the stock selling began. Later it would be revealed why they had such a lengthy conversation: Gilman had shown Martoma a confidential slide presentation revealing that the Alzheimer drug had flunked its Stage II trial.