Equity swap complicates SAC Capital's insider trading narrative

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Given the government's strong win-loss record in insider trading trials, Mathew Martoma might have seemed foolhardy in choosing to fight the charges against him.

But it may be that he took close look at the evidence against him and decided that the odds were in his favor. That may be wishful thinking, but the Martoma camp is letting it be known that there are some wrinkles in the government's narrative that makes the alleged insider trading seem less cut and dried. While SAC Capital at the behest of Martoma, then a drug company analyst, undoubtedly sold large positions in Elan and Wyeth and subsequently established short positions, the hedge fund was also hedged to a degree on the short positions by an equity swap trade, such that the exposure of the fund in sum was neither positive nor negative.

"SAC was short 4.5 million shares of Elan but, taking the swap into account, effectively long about 8.7 million shares of Wyeth," notes DealBook.

When the stock tanked, the short positions paid off, but the swaps lost money. So the net gain was relatively small.

"While such details would seem to contradict how authorities have described the trading, prosecutors could argue that SAC had little choice but to leave the swaps in place, and that was part of the strategy to trade on inside information. That is because selling a swap would be difficult to do without attracting attention in the marketplace. If SAC had sold its swaps, it would have had to notify the Wall Street bank that it entered into the swap transaction with and, in turn, the bank's trader would have most likely sold the shares on the open market," according to Dealbook.

The government was aware of the swaps trade but it was not the result of insider information. One issue is at what time the swap position was established, and if it were in essence a long bet that the company couldn't wind down in time. Perhaps the short position was designed to offset the losses the fund knew it would take on the swaps.

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