Black Edge

by Sheelah Kolhatkar

  Into the midst of this tumultuous environment stumbled Mathew Martoma, the new healthcare portfolio manager at SAC’s CR Intrinsic unit. Martoma wanted to prove himself. On June 25, 2008, he instructed his trader, Timothy Jandovitz, to start accumulating shares of the pharmaceutical companies Elan and Wyeth. It was the worst June the stock market had experienced since the Great Depression, and most traders were anxious about holding shares of anything. Martoma was, however, determined.

  “I want to buy 750,000 to 1 million Elan over the course of the day,” Martoma told Jandovitz an hour before the market opened. That was just the beginning.

  CHAPTER 6

  CONFLICT OF INTEREST

  Alzheimer’s disease afflicts roughly five million people in the United States, a progressive assault on the brain that causes memory loss and changes in behavior. It’s agonizing for family members to watch their loved ones become more and more confused, unable to balance a checkbook, drive a car, or even brush their teeth as their minds deteriorate to the point that they don’t recognize their own children. The disease has proven to be a particularly stubborn adversary for scientists. Nothing has been shown to stop its effects, but scientists had hopes that the new drug bapineuzumab might be different. Elan, which was based in Ireland but traded on the New York Stock Exchange, and Wyeth, a midsized drug company founded in Philadelphia, had teamed up for the development of bapi, known also as AAB-001, in part to share the formidable costs of bringing a new pharmaceutical treatment to the market. If the companies were able to navigate the gauntlet of drug trials and regulatory permissions and come out with a safe and effective drug, they stood to make billions of dollars.

  Alleviating suffering was beside the point for the Wall Street investors, like Mathew Martoma, who were monitoring bapi’s long journey through the regulatory approval process. Each week, Cohen’s portfolio managers were supposed to send him written updates on the investment ideas they were following and offer recommendations for trades. The SAC compliance department had set up a special email address for these writeups, steveideas@sac.com, so that they could keep an eye on what was in there. Martoma used it to push bapi hard.

  The writeups followed a prescribed format, with the name of the stock at the top, followed by “Target Price”—where the portfolio manager thought the stock might go—and the timing that was suggested for the trade. The most important part of the memo was the “Conviction” rating, a number on a scale of 1 to 10 that conveyed how certain the portfolio manager was about what he was suggesting. Martoma sent a memo to Cohen on June 29, 2008, recommending Elan with a target price of $40 to $50. The stock was trading in the $26 range, so the increase he was predicting based on the research he had done so far was huge. Under “Catalysts,” which were the events he expected to move the stock price higher, Martoma wrote that there was an upcoming Phase II Alzheimer’s drug trial presentation at ICAD, an industry conference, at the end of July. For “Conviction” he wrote “9.” He sent a similar note for Wyeth, with a “9” attached to it as well.

  A conviction rating of 10 was reserved for “absolute certainty,” a level that would seem to be impossible to achieve through conventional research methods. How could a person be 100 percent certain about any event in the future, let alone the performance of a stock? The rating was how the traders communicated the value of their information to Cohen without exposing him to the details of how they knew something. Cohen relied on it to decide whether to buy for his own account. The rating system had been the idea of the compliance department, which was always trying to find ways to protect Cohen and keep him from explicitly receiving material nonpublic information—it was like a moat around the company’s most valuable asset.

  As SAC’s main healthcare trader, Tim Jandovitz was responsible for buying the shares of Elan and Wyeth that Martoma was recommending. Jandovitz was well suited to the job, with a brain that could execute complex calculations in seconds. He arrived most mornings by 7 A.M. and started the daily ritual of culling through dozens of research notes from Wall Street firms, making sure to forward the ones that were relevant to Martoma. He and Martoma usually huddled around 9:15 A.M., just before the market opened, to strategize on their trades for the day. By closely monitoring the market and striking at opportune moments, he helped Martoma build a bigger and bigger position in the two drug companies Elan and Wyeth, while Martoma also pushed Cohen to do the same. “I spoke to Steve about it,” Martoma would say after giving Jandovitz another buy order. He wanted to make it clear that their boss approved.

  Jandovitz wondered what it would take for a portfolio manager to label something a 10, indicating 100 percent conviction about a stock they were recommending. For that matter, he could hardly recall seeing a 9 before. It seemed strange to him, but it wasn’t his job to worry about it.

  —

  Martoma had been working for more than two years to learn everything he could about bapi. He had spoken to hundreds of doctors and medical researchers, and he was optimistic that bapi would work out. And he hoped to make a lot of money when it did.

  The immense confidence Martoma had in bapi came partly from the special source he had been developing. If you wanted Alzheimer’s drug expertise, Dr. Sidney Gilman was the best person available. He was affiliated with the University of Michigan Medical School and lived with his wife in Ann Arbor, Michigan. Gilman was considered a leading expert on Alzheimer’s disease and its treatments. Helping find a cure was his life’s mission.

  His many accomplishments concealed a troubled life. Gilman grew up poor in East Los Angeles, the son of struggling Russian immigrants. His father, who did odd jobs for a living, left the family when Sid was ten, leaving his mother to raise three boys on her own. Still, Gilman became an exemplary student, attending medical school at UCLA before going on to teach medicine at Harvard and Columbia University. He and his first wife, Linda, moved to Ann Arbor with their two sons in 1977 to run the University of Michigan’s neurology department. When their elder son, Jeff, revealed that he was gay, Gilman had trouble accepting it, and the two became estranged. Jeff had struggled with depression since childhood, and, after moving out of the house and dropping out of school, he committed suicide in 1983. It was a terrible echo of what had happened to Gilman’s mother, who had taken her own life at age sixty-seven.

  After they lost their son, Sid and Linda’s marriage deteriorated, eventually ending in divorce. In 1984, Gilman got remarried, to a psychoanalyst named Carol Barbour. He and Barbour didn’t have children of their own, and Gilman’s relationship with his surviving son, Todd, was not smooth. After Todd revealed to his father that he was gay, like his brother, he and his father stopped speaking. Thereafter, Gilman spent almost all of his time absorbed in his research, to the exclusion of any personal life. “The man worked himself to distraction,” one of his protégées at Michigan, Anne Young, the eventual chief of neurology at Massachusetts General Hospital, said. Seven days a week, Gilman could be found in his lab.

  Much of Gilman’s work outside of teaching and research was prestigious but unpaid. He served on national advisory panels and wrote hundreds of scholarly articles about dementia and diseases affecting the brain and central nervous system. He led research projects funded by $3 million in grants and wrote or edited nine books, all of which made him famous in his field.

  He barely knew what a hedge fund was, but when a manager from Gerson Lehrman Group approached Gilman in 2001 about becoming a consultant, he was intrigued. He could make the time, he figured, and the money was good. He soon found himself having hundreds of conversations a year with people he normally wouldn’t have had any contact with, cunning traders and analysts interested in different aspects of healthcare, from Parkinson’s disease to multiple system atrophy to Alzheimer’s. They were polite and well-informed, and the questions they asked were flattering to Gilman’s ego, always laced with compliments about the depth of his knowledge. They begged him to elaborate on obscure details of protein reactions or dose modificatio
ns that would have made most dinner party guests plead for mercy.

  Gerson Lehrman Group called itself a “knowledge broker,” a description that carried a certain irony. In reality, it was a vehicle for delivering superior information to sophisticated investors who were willing to pay for it. Gilman didn’t find his role as an actor in this small market injustice to be unpleasant, however. Quite the opposite. “It was a chance to talk with people with a totally different perspective than the students I dealt with day to day,” Gilman said of the work. “It paid well. It was a diversion. It was enjoyable.” He didn’t need the money—the university paid him $310,000 a year, a generous living in the frugal Midwest—but it didn’t hurt that he was seeing his bank account balance grow every month. For a thirty-minute phone call with a hedge fund trader, GLG paid him $1,000, around twice what top corporate lawyers billed. In-person meetings were charged at $2,000 each.

  Gilman was soon earning hundreds of thousands of dollars a year consulting, simply by talking about the work he loved. His lifestyle didn’t change dramatically—as one former student put it: “He was not a flashy guy who reveled in expensive toys.” But he started to allow himself certain luxuries, such as first-class flights and a car service.

  The hedge fund work consumed more and more of his time, and it was all conducted out of view of his colleagues in the scientific community. Increasingly, Gilman was leading a secret life.

  He made it a point never to invest in pharmaceutical stocks, as he worried about potential conflicts of interest. But he soon found himself prioritizing his consulting work over other things he used to do, such as serving on advisory panels and authoring articles that paid little or nothing. He wasn’t the only one. Many of his friends and colleagues were doing it, too. In fact, the medical profession was being infiltrated by Wall Street, as more and more physicians were drawn into the web of high finance as paid sources for money managers. In 2005, Journal of the American Medical Association published a study finding that almost 10 percent of the doctors in the United States had paid ties to Wall Street investors, an increase of 750 percent since 1996. The unofficial number was probably much higher. The rapid coopting of the medical profession, according to the article, was “likely unprecedented in the history of professional-professional relationships.”

  The process of developing a new drug was long and expensive; pharmaceutical companies increasingly avoided it in favor of marketing or repurposing drugs that were already in circulation. When they did choose to embark on such a costly journey, it culminated with the human testing phase, the final stretch before a new drug could receive FDA approval and be sold to consumers. Testing began with Phase I, which was the first time a drug was tried out on a small sample of humans. If the drug proved safe and effective on that smaller first group of volunteers, it moved on to Phase II, where it was tested on a larger group of two hundred or so patients. If the drug was shown at that point to be safe and effective, it entered Phase III. There, two independent studies would be done to confirm what had been observed before: that it was safe and that it worked. In 2004, Gilman was recruited by Elan to serve as the chair of the bapi safety monitoring committee, a group of independent clinicians responsible for tracking the progress of the study, to ensure that none of the patients suffered any serious adverse effects.

  Everyone involved in the bapi trial was asked to sign a confidentiality agreement covering every aspect of the program. “You and your staff should refrain from commenting to third parties on the clinical trial or AAB-001 until the final analysis and trial results have been released to the public,” read one directive from the company sent to participants. “Analysts, hedge fund employees, investors, newspaper reporters and even other pharmaceutical representatives may contact you seeking trial-related information or your opinion about the expected results of the clinical trial.” Another warned: “Trading in Elan or Wyeth securities while in possession of material non-public information may subject you personally to civil or criminal liability under the state and federal trading laws.”

  At first, Gilman did his best to follow the rules. He knew that his reputation depended on it.

  —

  Almost immediately after the trial began, the bapi safety monitoring committee started receiving reports of a worrisome side effect. It was called vasogenic edema, a type of swelling in the back of the brain that was detected through regular brain scans. Gilman was concerned. He had observed brain swelling in the trial of a previous Alzheimer’s drug called AN-1792. In that instance, the drug companies had to halt the trial in 2002 as a result of severe cases of encephalitis among patients, which indicated that the drug was toxic. This time seemed like it might be different. Researchers believed that Alzheimer’s was caused by a buildup in the brain of “sticky protein,” or plaque, called “beta amyloid,” that interfered with communication between nerve cells. Bapi was designed to attack that plaque. Gilman hoped that the swelling in the patients’ brains was a sign that bapi was actually working, by burrowing itself into the patient’s blood vessels and wiping out the plaque.

  Over the following months, Gilman and Martoma spoke about bapi often on the phone, sometimes for hours at a time. They met for coffee at medical conferences, where Martoma usually traveled with Rosemary and the kids. Rosemary continued to be deeply involved in every aspect of his work. “Mathew didn’t just do that job by himself,” she later said. “It was heads-down, tails-up, twenty-four-seven kind of work.” They discussed his research and investment ideas at length and debated how much money he should invest in each one. She took full responsibility for their home and children so that he could do his job without distraction. The subject of bapi became an ongoing joke in the household. She and Martoma peppered their conversations with a new exclamation: “Bapsolutely!”

  Although Gilman spoke to dozens of other hedge fund traders, Martoma was his top consulting client. During their conversations, Martoma confided in him, sharing details about his relationship with his wife and the challenges of having children so close together. Although Gilman initially resisted Martoma’s push to be friends, because it seemed inappropriate, he felt genuinely, perhaps inexplicably, concerned for Martoma’s well-being. Gilman wanted him to succeed and felt invested in that success. The truth was, Martoma reminded him of his first son, Jeff. In turn, Martoma treated Gilman as something of a father figure. Their relationship became so close that Gilman barely noticed when Martoma started nudging him into areas of discussion that were explicitly forbidden. Gradually, Martoma began asking more direct questions. He seemed especially focused on the side effects Gilman was observing among the patients taking bapi, which could indicate whether there was a problem with the drug. “What side effects might one expect to see?” Martoma kept asking. Through his exhaustive research, he understood that vasogenic edema, or brain swelling, was a possibility, and he pressed Gilman about it. A side effect like that had the potential to derail the drug’s approval.

  One day, under intense questioning from Martoma, Gilman grew uncomfortable. He tried answering in theoretical terms, keeping his responses vague and far removed from what was actually occurring. “For example,” Gilman told him, “in diseases in which there are large doses of antibody, like lupus, rheumatoid arthritis, you get pain, you get headache, you get pain in the back, pain in the joints….”

  “Well, that’s very interesting,” Martoma said. He was silent for a moment, trying to nudge the conversation back toward the bapi trial. “What did you actually see?”

  Gilman knew that Martoma was asking for details that he was forbidden to share. “I can’t tell you that,” he said.

  Martoma kept pushing, asking to know what had been observed with bapi.

  “With multiple antibodies, one might expect to see some nonspecific effects, primarily on joints, so that low back pain or headache or joint pain or other kinds of rheumatological consequences may occur,” Gilman said.

  “Did they occur?” Martoma asked.

  “Yes, the
y did,” Dr. Gilman finally said. He felt sick to his stomach. The safety monitoring committee was fielding multiple reports of vasogenic edema in patients. Although it was a secret, Martoma seemed, somehow, to be aware of it and was looking for confirmation, and Gilman had just given it to him. The trial clinicians were still debating whether the side effect was a sign of potential toxicity, of bapi’s effectiveness, or both. Gilman knew that he had crossed a line by disclosing it to Martoma. But he felt powerless to say no.

  He started sharing secret details of the bapi study with Martoma on a regular basis. He told him about how the brain swelling could be a sign that the drug was working, how different doses appeared to be affecting the patients, how carriers of a specific gene tied to Alzheimer’s were responding. Martoma took it all in and pressed for more. He was especially interested in the number of patients showing side effects, the more specific the better. Gilman tried not to think about what Martoma was doing with the information he gave him.

  —

  Loud arguments were not uncommon on the trading floor at SAC. Cohen liked to position analysts and portfolio managers with different opinions against one another and watch them try to defend their points of view. Even in such an environment, the Elan and Wyeth trades were controversial. Though Martoma was relatively junior, he had somehow convinced Cohen to build up enormous positions in both securities. Most other traders at the firm were confused about why. People started to ask questions.

  Another group of healthcare traders, led by Jason Karp, had been studying the bapi trial, too, and they had come to a different conclusion: They thought the drug was going to fail. Part of Karp’s job was teaching the other analysts at the firm how to build models for estimating the value of different stocks. He was popular with his colleagues and, even though he was only in his early thirties, he thought of himself as a mentor. He loved to dispense advice. But he also knew how to navigate office politics.