The Justice Department's prosecution of Mathew Martoma, a former portfolio manager at Steven A. Cohen's SAC Capital Advisors, over insider trading involved a new tactic â€" a nonprosecution agreement â€" to gain the cooperation of a crucial witness.
Though the tool is commonly used in criminal investigations, this appears to be the first time it has been used to secure evidence from an individual in a prominent white-collar crime case.
This is an intriguing development because white-collar defense lawyers may seek similar agreements for their clients rather than entering into plea bargains that result in a criminal conviction and punishment. An important issue for the Justice Department will be developing standards for when a nonprosecution agreement is better than using plea bargains in order to secure the cooperation of witnesses.
Prosecutors accuse Mr. Martoma of receiving information from Dr. Sidney Gilman, who entered into the nonprosecution agreemen t. The information concerned problems in a clinical trial for a drug to treat Alzheimer's disease that was being developed jointly by the pharmaceutical firms Elan and Wyeth.
SAC Capital sold out its positions in the two companies ahead of the announcement of the test results and made bearish bets against them. The moves allowed the hedge fund to avoid losses of $194.2 million and generate profits of $82.8 million.
Dr. Gilman served on a committee monitoring the safety of the drug being tested. An expert networking firm had put the two men together. Dr. Gilman received approximately $108,000 in consulting fees. But he did not trade on the information and he did not receive any portion of SAC Capital's enormous benefits from the well-timed trades.
The case against Mr. Martoma hinges largely on Dr. Gilman's credibility as a witness. Although there are suspicious e-mails and meetings between the two men, there are no recordings or other evidence to show exact ly what they discussed.
According to the criminal complaint, Dr. Gilman filled in those blanks by telling investigators that he passed along the information about the clinical trial just days before SAC Capital sold out its positions in Elan and Wyeth. Without the cooperation of Dr. Gilman, prosecutors would have highly suspicious trades and a potential source of inside information but little else to prove a violation of federal securities laws.
Prosecutors have filed charges against other people in expert networking cases, including Winifred Jiau, who worked for a California firm and passed on information about Nvidia and Marvell Technology to hedge fund traders. Other tippers who have not directly profited from trades have also been charged. A prominent recent case involved the successful prosecution of a former Goldman Sachs board member, Rajat K. Gupta, who was convicted of tipping the former hedge fund manager Raj Rajaratnam with inside information.
The current trial against Anthony Chiasson and Todd Newman over insider trading hinges largely on the testimony of traders at their hedge fund firms. Unlike Dr. Gilman, they entered into plea agreements with the Justice Department that will result in criminal convictions and sentences at some point in the future.
In other cases involving individuals, prosecutors have used deferred prosecution agreements, which are similar to nonprosecution agreements because neither type results in a criminal conviction. But those agreements were not used as a means of securing the cooperation of an important witness who would testify in a criminal case.
In August, the cyclist Floyd Landis entered into a deferred prosecution agreement for defrauding donors who had contributed to a fund to defend him from accusations that he had used performance-enhancing drugs while riding as a professional cyclist. Although his cooperation was helpful in building the United States Anti-Doping ag ency's case against Lance Armstrong, Mr. Landis did not testify in any criminal prosecutions.
A recent prosecution of five executives from the insurance companies General Re and American International Group was resolved by a deferred prosecution agreement. But that only came after their convictions were reversed by a court of appeals, and the government used the agreements to avoid another lengthy trial in which the prospects for success were in doubt.
If prosecutors want testimony from a witness, one means to compel cooperation is through a grant of statutory immunity. Such a move, however, prevents the government from prosecuting the person based on any information provided. The Justice Department is often reluctant to give immunity when it is not clear what the person's involvement was in the misconduct for fear of giving protection to the worst offender.
Prosecutors had fairly substantial leverage over Dr. Gilman to persuade him to cooperate in the face of potential insider trading charges. Under the federal sentencing guidelines, a tipper is responsible for the tippee's gains and losses avoided, so the potential sentence would have been 15 to 19 years, based on the $276 million that SAC Capital generated from the information.
So why did the Justice Department opt for a nonprosecution agreement with Dr. Gilman rather than a plea bargain?
The agreement appears to be a middle ground between a plea bargain and immunity. It contains terms normally seen in a plea agreement, like a promise of continuing cooperation in exchange for not pursuing additional charges. He also agreed to repay the benefits he received from Mr. Martoma, and settle civil charges filed by the Securities and Exchange Commission. Like a grant of immunity, Dr. Gilman will not be prosecuted for what he says, but he does admit in the agreement that he violated the law.
Dr. Gilman is a well-regarded neurologist at the University of Michigan Me dical School, where he is the William J. Herdman Professor of Neurology. In addition, he is 80 years old, so prosecutors may have concluded that there was little upside to a guilty plea when there was only a small likelihood that a person of his stature and professional background would receive a prison sentence.
Perhaps more important, Dr. Gilman held the key to possibly building a case against Mr. Cohen through Mr. Martoma. As DealBook's Peter Lattman reported, prosecutors applied pressure to get Mr. Martoma to cooperate against his former boss, no doubt threatening him with the same potential sentence of 15 to 19 years in prison. Dr. Gilman is a much smaller fish than the traders at SAC Capital, so he had leverage of his own in negotiating with the Justice Department.
White-collar defense lawyers will be eager to figure out what led the Justice Department to give Dr. Gilman a nonprosecution agreement, and whether their clients might obtain similar outcomes. T his type of agreement is far preferable to a guilty plea in exchange for a lenient sentence because the collateral consequences are minimized.
If nonprosecution agreements are a new direction for federal prosecutors in white-collar crime cases, then lawyers will have an even stronger incentive to get a client to cooperate early on in order to get this kinder and gentler disposition.
