Black Edge: Inside Information, Dirty Money, and the Quest to Bring Down the Most Wanted Man on Wall Street

by Sheelah Kolhatkar

In a good market, when most stocks are going up, the gains on the longs eclipse the losses from the shorts; in a bad market, the shorts make money to help offset the losses on the longs. Being long some stocks and short others meant that you were “hedged.” This strategy could be applied to other financial instruments in addition to stocks, such as bonds and options and futures, in any market in the world.

The losses on a short position are potentially limitless if a security keeps rising, so it’s considered a high-risk activity. That, combined with the fact that many hedge funds employed leverage, or borrowed money, to trade with as they pursued different strategies in different markets around the globe, led regulators to decree that only the most sophisticated investors should be investing in them. Hedge funds would be allowed to try to make money almost any way they wanted, and charge whatever fees they liked, as long as they limited their investors to the wealthy, who, in theory at least, could afford to lose whatever money they put in.

For years hedge funds existed largely separate from Wall Street’s operatic boom-bust cycles, but by the mid-2000s they’d moved to the center of the industry. Some started producing enormous profits each year. Over time, the name hedge fund lost any connection to the careful strategy that had given such funds their name and came to stand, instead, for unregulated investment firms that essentially did whatever they wanted.

Though they became known for employing leverage and taking risk, the defining attribute of most hedge funds was the enormous amounts of money the people running them were taking in: The fees they charged were generous, typically a “management fee” of 2 percent of assets and a “performance fee” of 20 percent of the profits each year. Before earning anything for his or her investors, the manager of a $2 billion fund would be positioned to make $40 million in fees just to keep the place running.

In 2006, the same year that Lloyd Blankfein, the CEO of Goldman Sachs, was paid $54 million—causing outrage in some circles—the lowest-paid person on the list of the twenty-five highest-paid hedge fund managers made $240 million. The top three made more than a billion dollars each. Cohen was number five that year, at $900 million.

At a certain point, this quest for edge inevitably bumps up against, and then crosses, a line: advance knowledge of a company’s earnings, word that a chipmaker will get a takeover offer next week, an early look at drug trial results. This kind of information—proprietary, nonpublic, and certain to move markets—is known on Wall Street as “black edge,” and it’s the most valuable information of all. Trading on it is also usually illegal.

A “put” represents the right to sell shares of stock, which means that the owner of a put will benefit if the stock price drops, allowing him or her to sell the underlying shares at the agreed-upon higher price. “Calls” are the opposite, granting the holder the right to buy a particular stock at a specific price on or before the expiration date, so the owner of the call will benefit if the stock rises, as the option contract allows him or her to buy it for less than it would cost on the open market, yielding an instantaneous profit. Investors sometimes use options as a way to hedge a stock position they already have.

It was always a goal of the SEC to get a witness to admit that he was “taking the Fifth” on the record when he was refusing to answer their questions; it could be used later as an inference of guilt. If you were innocent, the thinking went, why wouldn’t you use the opportunity to tell the SEC all about it? White collar defense attorneys were well aware of this, of course, so it was their job to resist and try to avoid letting the client say that he was “taking the Fifth,” even when he was taking the Fifth, for precisely the same reason. It was standard legal maneuvering.

a lesson that many other suspects of financial crime would come to understand in the future had emerged: Taking the Fifth could take all the momentum out of a securities investigation.

Cohen grumbled constantly about the idea that other people were unfairly benefiting from his success. Almost every penny he gave to someone else, whether a commission to a broker or a bonus to a partner or a dollar in taxes, annoyed him.

In addition to his taxes, some of the business arrangements he’d negotiated years earlier started to seem overly generous. Cohen would fire people who suddenly started to make what he regarded as disproportionately large sums of money, or he’d refuse to pay them what they thought they were owed.

SAC was a hedge fund, he explained to the confused Goldman employees, some of whom had never heard of the company. They don’t just buy blocks of IBM to hold for months at a time while playing golf and collecting dividends, they trade. And they don’t just trade. They trade hundreds of stocks a day, hundreds of thousands of shares at a time. They were not interested in a company’s long-term health or whether the new products it had under development would enable it to hire more people in five years. SAC was interested in one thing: short-term movements in the stock price that it could exploit for profit.

For every one of those shares that Goldman might buy or sell on SAC’s behalf, it collected six cents of commission. It didn’t take a PhD to understand the implications. Although Fidelity was much bigger, SAC generated far more revenue, based purely on volume.

In exchange for giving Goldman Sachs millions of dollars of its business, SAC wanted something in return, the salesman said, something that was commensurate with its importance to the company. It wanted preferential treatment, particularly when it came to moves Goldman’s analysts made that might affect a company’s stock price. “If you change a penny or two on your estimates, you call SAC first,” the salesman said. If an analyst was going to recommend that investors buy or sell shares in a company he or she covered, or revise the amount of money he or she estimated the company would make next quarter, SAC would like to know before anyone else. And when a Goldman...

A stock salesman at a rival brokerage firm who was responsible for the Cohen account described the dynamic this way: “If he was going to trade with you, he wanted the best price. He was willing to pay a lot of commissions. And he was willing to do so, so he could get the first call, any...

At Goldman Sachs, at least one analyst who heard the salesman’s speech that morning was shocked by the brazenness of the arrangement. Nobody was proposing anything that was against the law, exactly. But it made the analyst uncomfortable. It gave SAC a huge advantage in the market. With early information about a new “buy” or “sell” rating that was coming on a stock, SAC could anticipate what other investors were going to do in response to the news and buy or sell a split second before anyone else, accumulating tiny crumbs of profit that could add up to significant sums. Sleazy might have been too strong a word for it; it was more like distasteful. Yet at the same time, the analysts and salespeople understood that their priority was to serve the...

The Goldman salesman’s directive reflected an important shift on Wall Street, although its most entrenched players took a long time to recognize it. The new way to command power in the financial industry was to start a hedge fund. Doing so at the right time could turn someone who might have accumulated millions over the course of a twenty-year career at Goldman Sachs or Morgan Stanley into a billionaire almost overnight. In a matter of a few years, hedge funds went from a peculiar subculture on Wall Street to the center of the industry. They were far more demanding and difficult (and almost certainly more clever) than the Fidelitys and State Streets of the world, and the Goldmans and the Morgans had to go to a lot of trouble to keep them happy. But in the end, they were paid for ...

Catching Grodin trading on Lee’s information before sharing it made Cohen so crazy that he ordered his in-house programmers to design a system that would show him every trade order entered by anyone on SAC’s staff before it was executed, allowing Cohen to enter his own trades ahead of them if he wanted. The new software was referred to as the “eye in the sky.”

One of the things SAC looked for in new traders was personal connections the trader had with people working at public companies that might yield valuable intelligence. If a potential hire had a summer rental in the Hamptons with a corporate executive at an Internet company, for example, this was noted with approval in the file. Friends, fraternity brothers, fathers-in-law, and wives: They could all prove valuable when it came to getting information.

Art dealers and galleries in New York operated under their own restrictive code, and they wouldn’t deal with just anyone, no matter how much money he or she had. You couldn’t simply walk into a gallery and write a check for a Monet to hang on your penthouse wall. The gatekeepers of the art world understood that the exclusivity of their product depended on not allowing rich hedge fund managers from Greenwich to buy whatever they wanted. It was a form of discrimination, in a sense, but it was also simple market economics: In order to generate demand, you needed to control the supply. In response, Wall Street collectors needed to hire the right people to make the introductions that would move them to the front of the line.

Martoma was a first-generation American, a son of immigrants from India who had been raised to respect and fear his parents. Status, conferred through educational achievement at name-brand institutions, was a family obsession, along with the conviction that, as newcomers to America, they had to work harder than other Americans to find financial security. Theirs was a culture in which people were introduced with a lengthy summary of their achievements and credentials, including the number of school prizes they’d won going all the way back to second grade. In addition to making him rich, SAC would add another line to his sparkling résumé.

the Gerson Lehrman Group, which was an “expert network” or “matchmaking” firm. The matches it made were between Wall Street investors like Martoma and people who worked inside hundreds of different publicly traded companies, people responsible for ordering new truck parts or buyers for retail chains who could provide insight on their industries, their competitors, or even their own firms. The investors paid GLG a fee to connect them with these company employees, who in turn were paid handsomely—sometimes as much as $1,000 an hour or more—to talk to the investors. The company employees were supposed to share only information that was publicly available, to avoid breaking any laws. Or at least that was the idea.

Of course, GLG told the company employees it signed up as consultants not to share material nonpublic information with their Wall Street clients. But the employees often had only a fuzzy understanding of where that line was. The hedge fund investors, on the other hand, knew exactly what they were after and would do whatever they could to get it. SAC traders loved the service and had a $1.2 million annual subscription. It enabled them to have conversations with employees who worked at all levels of companies in healthcare, telecommunications, energy, and countless other industries, people they never could have found or persuaded to talk to them on their own. SAC was one of GLG’s best customers.

One physician in GLG’s network replied to him. “I am Chair of the Safety Monitoring Committee for this trial,” the doctor wrote in response to Martoma’s request. “Although I know more than is publicly available, I have a confidentiality agreement and will share only information that is openly available, of course.”

The doctor was a respected neurologist in his seventies, a leading expert in Alzheimer’s research who held an endowed chair at the University of Michigan medical school. His name was Sid Gilman.

Short sellers have an unsavory reputation in the market, as something akin to trolls who rejoice at the misfortune of others. Their livelihood depends on stocks going down, making them the natural enemies of most investors. Shorting is so risky, with potentially unlimited losses if a stock keeps going up, that only the most sophisticated investors, such as hedge funds, generally engage in it. Naturally, most corporate executives see the shorts as enemies of the happy stories they’re trying to tell about their companies, which tend to be full of puffery. For that reason, short sellers play a crucial role in the market, as the only actors who are motivated to look for problems at publicly traded companies—such as accounting fraud—which can be covered up for years. Short sellers were the first ones to point out problems with Enron. But the field is also filled with opportunities for abuse.

Cohen was so focused on making sure that he had access to every piece of available information that he hired research traders to filter through his messages and make sure that he saw the important ones. Any time he traveled to Las Vegas to visit his parents, or to Brown University, where Cohen was on the board of trustees, or on his yearly summer vacation with Alex, an advance team of consultants made the journey ahead of him. He rented an extra room wherever he was staying and used it as a staging area where his staff re-created his trading station in such detail that he could hardly tell he was away from his office.

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.

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.

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 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.

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 modifications 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 conduc...

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 unof...

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...

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 yo...

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.

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.

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.

“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, they 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 mor...

Though Martoma kept up a hard front, he felt increasingly vulnerable. He was starting to feel like Munno was trying to sabotage his career by going behind his back and sowing doubts about him with Cohen. He tried to double-check some of the information he was getting from Gilman with another doctor working on the trial, whom he found through a different expert network firm, Wall Street Access. Then in April, Martoma begged Gilman, his prized contact, to talk with Munno and Slate and encourage them to calm down a little.

As part of his role as an advisor to the more junior traders, Jason Karp developed a system for categorizing information that he taught to all of his analysts, a way to understand what was safe and what might be illegal. There was “white edge,” which was obvious, readily available information that anyone could find in a research report or a public document, information that wasn’t worth much, frankly, but wasn’t going to get anyone in trouble. Then there was “gray edge,” which was trickier. Any analyst doing his job well would come across this sort of information all the time.

Karp’s third category of information was “black edge,” information that was obviously illegal. If traders came into possession of this sort of information, the stock should be restricted immediately—at least in theory.

Permission for the government to listen in on private phone conversations is not something courts give lightly. The application is first reviewed by the Justice Department in Washington, D.C., before being submitted to the court with jurisdiction over the area where the crime is alleged to be taking place. For the request to be granted, the FBI must show evidence that a crime is in progress over the specific phone line they are interested in tapping and that other investigative methods—such as reviewing documents and finding cooperators—have been exhausted or are not likely to work. They must show that a wiretap, known as a “Title III,” is the only way for the government to put a stop to the criminal activity.

Gilman slowly recovered from his lymphoma treatment over the course of the summer. He was still weak, but his hair was starting to grow back. He waited for weeks to hear from Martoma, but there was no word. He was surprised by it. He couldn’t believe his friend wouldn’t at least check in on him, given his cancer and everything else—in the past, Martoma always showed such concern for Gilman and his health.