In what they called "the most lucrative" insider-trading scheme ever, prosecutors alleged that Mathew Martoma helped Cohen's firm avoid losses and reap profits totaling $276 million in the summer of 2008 by using insider tips he got from a doctor about Elan Corp and Wyeth LLC.

Martoma is the fifth person associated with SAC Capital, one of the most widely followed and influential hedge funds, to be charged with insider trading in either a criminal or civil proceeding. He had worked for a unit of SAC Capital called CR Intrinsic Investors in Stamford, Connecticut, until 2010.

The criminal complaint against Martoma does not name Cohen but refers to him as the "owner" of the hedge fund and makes clear that Cohen and Martoma talked often about the fund's trading in shares of Elan and Wyeth. The court papers do not say Cohen knew how Martoma obtained his information.

Martoma's lawyer, Charles Stillman, said his client was an "exceptional portfolio manager" and he is confident Martoma will be exonerated.

A spokesman for SAC Capital said "Mr. Cohen and SAC are confident that they have acted appropriately and will continue to cooperate with the government's inquiry".

The charges against Martoma stem from the U.S. government's long-running investigation of improper trading in the $2 trillion hedge fund industry, which the Federal Bureau of Investigation has called Operation Perfect Hedge.

The investigation has led to more than 50 convictions so far, most notably former Galleon founder Raj Rajaratnam and former Goldman Sachs Group director Rajat Gupta.

Slowly, U.S. authorities have been filing charges and winning convictions against lower-level traders and analysts who once worked for Cohen, one of the hedge fund industry's most successful and best-known traders.

Authorities are stepping up pressure on Cohen and his hedge fund. This summer, the U.S. Securities and Exchange Commission took a deposition from Cohen as part of an insider trading investigation. It is not clear what the SEC asked Cohen about.

Recently, a top deputy of Cohen's, Michael Steinberg, was named as an unindicted co-conspirator in court documents in a separate insider trading matter.

The $14 billion SAC Capital, which charges some of the highest fees in the industry, is up about 10 percent this year - double the performance of the average U.S. hedge fund.

MAJOR REVERSAL

According to court papers filed on Tuesday, Martoma spoke in July 2008 to the "hedge fund owner" - Cohen - and recommended selling shares of Elan and Wyeth before a negative announcement on clinical trial results for an Alzheimer's drug jointly developed by the two companies.

CR Intrinsic, which in 2008 mostly traded with Cohen's own money, had initially taken long positions in Elan and Wyeth stocks before reversing itself over the course of one week, selling some stock and building up massive short positions that accounted for one-fifth of all trading in Elan, federal prosecutors said.

The criminal complaint filed by federal prosecutors and a related civil lawsuit filed by the SEC contend Martoma got insider information from a doctor who is not named in the criminal complaint because he is now cooperating with prosecutors after agreeing to pay a $186,781 disgorgement.

The SEC complaint identifies the doctor as Sidney Gilman, who once worked as a consultant for a so-called expert network. Hedge funds use such networks to gain insight into various industries.

Gilman, an 80-year old neurology professor at the University of Michigan, is serving as a confidential cooperating witness in the criminal case.

"Dr. Gilman is cooperating with the SEC and we expect to settle that case in short order," said Gilman's lawyer, Mark Mukasey, a partner at Bracewell & Giuliani.

The name of the expert network firm does not appear in the court documents. A disclosure attached to a paper by Gilman in the medical journal Neurology lists him as a consultant for the Gerson Lehrman Group.

A spokesman for GLG declined to comment.

The court papers describe phone calls in which Gilman shared detailed information about the Alzheimer's drug's clinical trial. Gilman was chair of a committee to monitor patients' safety during the trial.

According to the criminal complaint, Gilman scheduled meetings and phone calls with Martoma that allowed him to pass on new information about the trial quickly after receiving it. He was initially positive about the drug; as a result Martoma vigorously bought shares of Elan and Wyeth.

The complaint says the hedge fund owner defended Martoma against other people inside SAC Capital who criticized the large position.

After Gilman learned the drug trial results were mostly negative, a trader for CR Intrinsic unwound its positions and made a move into options that paid off when the stocks fell. Elan shares, for example, fell about 70 percent following the news of the trial results.

Of the $276 million in profits, $81 million came from short sales and other options on the two stocks and $194 million came from losses avoided by selling the stocks before the trial results were revealed to the public, according to the complaint.

"By cultivating and corrupting a doctor who had access to secret drug data, portfolio manager Mathew Martoma and his hedge fund benefited from what might be the most lucrative inside tip of all time," Manhattan U.S. Attorney Preet Bharara told reporters on Tuesday, in discussing the charges.

FIFTH FORMER SAC TRADER

The charges against Martoma are the latest in a string of insider trading allegations to be leveled against former top traders and analysts who worked at SAC Capital.

A person familiar with SAC Capital said Martoma, an alumnus of the Stanford Graduate School of Business in California, sat near Cohen at SAC Capital's large trading floor in Stamford.

Cohen has long been a target of prosecutors. In sworn testimony last year, he said rules governing insider trading were "very vague" and identifying a tip as material non-public information was sometimes "a judgment call."

But experts said prosecutors lack proof that Cohen knew the trades on Elan and Wyeth were based on inside information. They said more evidence would be needed to make a case, even if Martoma agreed to testify against Cohen as part of a deal.

Experts noted that prosecutors won a conviction of Rajaratnam using wire taps to show the fund manager receiving insider tips. While other convictions have been won without wire taps, they said a single witness testifying after a plea bargain with prosecutors would not stand up under cross examination.

Two former traders, Noah Freeman and Donald Longueuil, pleaded guilty to insider trading charges last year. Jon Horvath, a former analyst at a division of SAC, pleaded guilty to insider trading charges in September.

Another former SAC Capital employee, Jonathan Hollander, settled civil charges of insider trading last year with the SEC.

Martoma was arrested on Tuesday morning in Boca Raton, Florida, according to an FBI spokesman. He was freed on a $5 million bond.

(Reporting by Emily Flitter and Basil Katz; Additional reporting by Katya Wachtel; Editing by Matthew Goldstein, Jennifer Ablan, Andrew Hay, Leslie Gevirtz and David Gregorio)

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