Outsider Trading: How Martha Stewart Beat Fidelity

Martha Stewart’s wasn’t the only interesting call ImClone CEO Sam Waksal received on Dec. 27. On Dec. 26, Waksal had learned the FDA wouldn’t approve his cancer drug Erbitux. He (and perhaps others) allegedly warned enough holders of ImClone stock that their exodus caused the price to fall, alarming other investors. The House committee investigating ImClone has procured  Waksal’s Dec. 27 phone log.What’s remarkable about the document is who did call, and who didn’t.

These days, Wall Street is thought to be a (relatively) level playing field for ordinary investors. Little guys are guarded by investor protection laws passed since the crash of 1929. More important, ordinary investors now have pros on their side, brokers and mutual-fund managers whose control of billions of dollars is supposed to give them insider access. This didn’t help in the ImClone case.

ImClone’s biggest investor, aside from Bristol-Myers, was Fidelity, the Boston fund behemoth that represents 17 million investors. Fidelity held a whopping 15 percent of ImClone shares, worth as much as $750 million at their peak. According to mutual-fund researcher Morningstar, Fidelity kept most of its ImClone in eight funds, with the biggest stockpile—nearly 6 percent of ImClone—comprising 1.3 percent of Fidelity Growth Company, one of America’s 20 biggest mutual funds. We may be pondering for years who got an ImClone tip, but Fidelity sure didn’t. Fidelity has a reputation of throwing its weight around, but no one at the mutual-fund company called Waksal on Dec. 27,according to the phone log. Nor does any other mutual-fund manager appear in the log.

Fidelity got killed by ImClone’s collapse. As of Fidelity’s May 31 SEC filing, it still held 9 percent of ImClone. Alpha Equity Research CEO David O’Leary, a leading Fidelity watcher, figures that Fidelity has lost about $600 million by not getting out at the peak. (The stock traded at $75.45 in November, but closed Wednesday at $6.52. However, the filings don’t make clear when or what Fidelity may have sold.)  O’Leary says Fidelity was likely trusting the wisdom of Bristol-Myers, which didn’t get cold feet till spring. If the ImClone hit were distributed equally around Fidelity (which, obviously, it wasn’t), that $600 million would translate to a $34 loss for every Fidelity investor. So if you’re wondering who was hurt by the possible insider trading at ImClone, look no further than your own 401(k) plan.

Your fund manager wasn’t chatting up Waksal, but hedge-fund managers were. At least three hedge funds appear on the Waksal call list: Ziff Brothers Investments, Merlin BioMed, and SAC Capital. While the typical mutual-fund investing household makes just $62,100 a year, hedge funds generally require at least $1 million to invest. Two of the hedge funds that called on Dec. 27, SAC and Merlin, were actively trading in ImClone, according to Dec. 31 filings with the SEC.

Waksal’s secretary took a message from Stuart Weisbrod, the chief investment officer of Merlin BioMed: “re: shares?” Weisbrod, who used to be a famed pharmaceutical analyst, did not return a request for comment. SEC filings show that on Dec. 31, Merlin BioMed held ImClone “put option” contracts (which are bearish) valued at $4.6 million, along with $1.8 million in ImClone stock.

The call from SAC Capital was turned over to someone at ImClone named Andrea. A spokesman for SAC said that the call was forwarded to investor relations but not returned. “There was no call. There was no conversation,” the spokesman said. SAC are the initials of the fund’s founder, legendary trader Steven A. Cohen, the most powerful person on Wall Street you’ve never heard of. SAC is well-known for leaning on trading desks for the latest information on companies.

SEC records show that SAC also held both ImClone stock and options betting against it on Dec. 31, the first trading day after the FDA announcement. The current amended filing shows that SAC had a long position of $17.9 million and $1 million in options betting against ImClone. It’s impossible to discern from this snapshot what SAC’s strategy, profit, or loss was.

In short, Waksal’s phone log represents queries from the rich—most famously, of course, Martha Stewart, but also Carl Icahn—and from people who manage the money of the rich. (While some of the calls seem personal, others must now be making the people who made them cringe. “Is it time yet?” asked a 1 p.m. message from Robert Takeuchi, president of Softbank Finance, a Japanese venture firm. Softbank had invested $10 million in Waksal’s Scientia investment fund.)

And at least two of those calling directly to the CEO were major Wall Street investors who would soon play the stock. This is exactly the kind of behavior and special advantage that the SEC’s recent Regulation Fair Disclosure, or Reg FD, was trying to prevent. The purpose of last year’s rule was to ensure that “all investors, large and small, should have equal access to material information about a public company at the same time.”

Frank Heflin, an assistant management professor at Purdue University who studies Reg FD, said the legality of the calls would hinge on what was said. Still, calling the CEO seems odd. “I’m kind of struggling to think of an example of something [they could have talked about] related to the company that was not in violation of Reg FD,” Heflin said. “Why spend the time and the trouble to ask if you don’t think you’re going to get something out of it?”

Clearly those who called Waksal had confidence or, at a bare minimum, hope he would reveal something about the company. This is a sign of how unfair Wall Street still is: Ordinary investors, perversely, should be asking why their mutual funds didn’t make the same sleazy calls.