Elan Corporation, plc (ADR) (ELN): The Biggest Insider Trade in History

By now you’ve probably at least heard of SAC Capital, the massive hedge fund founded and run by the eponymous Steven A. Cohen. It was indicted on Thursday for a decade-long insider trading scandal that the Justice Department has described as “substantial, pervasive and on a scale without known precedent in the hedge fund industry.”

The facts of the case — alleged by the government in multiple court filings, guilty pleas, and indictments — are breathtaking. In short, it’s alleged that the fund intentionally hired analysts and portfolio managers with reputations for insider trading, incentivized them to further cultivate inside information for the benefit of their respective portfolios, and obliged them to share the information with Cohen, who then used it to trade in a separate portfolio that he alone controlled. By doing so, SAC Capital is thought to have earned “hundreds of millions of dollars” in illegal profits and avoided losses.

As investors, there’s a lesson we can learn from this. And, no, the lesson isn’t that insider trading is bad. I mean, it is, but hopefully most of us already know that. Instead, as I read through the court filings describing SAC’s insider contacts and the quality of information its traders had access to ahead of earnings announcements and other material events, it made me realize just how asymmetric the knowledge in the market truly is. In other words, any individual investor who thinks he can beat the market by speculating on things like earnings surprises is living in la-la-land.

Of the dozens of trades alleged in the various documents, the one that best demonstrates this is SAC’s bet on the pharmaceutical giant Elan Corporation, plc (ADR) (NYSE:ELN) in anticipation of the latter’s Phase II trial results for a drug to treat Alzheimer’s disease. I’ve mapped out the trade in the chart below.

During the first half of 2008, and based upon the advice of the doctor in charge of announcing the results, an SAC portfolio manager by the name of Matthew Martoma began constructing a massive stake in Elan Corporation, plc (ADR) (NYSE:ELN), eventually topping out at 10.5 million shares. The move began to look particularly prescient when shares rose more than 10% following the June 17th release of the trial’s top-line results.