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Common Sense

SAC Case Tests a Classic Dilemma

Mathew Martoma, charged with insider trading, could face decades in prison if convicted.Credit...Spencer Platt/Getty Images

Imagine the pressure on Mathew Martoma, the 38-year-old former portfolio manager at SAC Capital Advisors charged with insider trading who may — or may not — be in a position to implicate Steven A. Cohen, the hedge fund’s billionaire founder and owner.

So far, Mr. Martoma has defiantly asserted his innocence and refused to cooperate with prosecutors. He could change his mind, but the clock is ticking. The government faces a mid-July deadline when it must decide whether to seek criminal charges against Mr. Cohen relating to the trades at the center of Mr. Martoma’s case.

For all concerned, the stakes are huge. The government has already convicted 73 people in the last three years in an insider trading crackdown that in its sweep and impact has been without precedent on Wall Street. But none of them has had the iconic status of an Ivan Boesky, the 1980s arbitrageur who wore a wire to record secretly the junk bond titan Michael Milken. With a net worth estimated by Forbes at $9.3 billion, Mr. Cohen could be the marquee name that would lend the investigation a new level of public awareness and potential deterrence.

Mr. Martoma could face decades in prison if convicted. His potential prison term is especially severe because the federal sentencing guidelines are based on the amount of the illegal profit, which in Mr. Martoma’s case are said to be huge. Prosecutors have called the case the most lucrative insider trading scheme ever.

Mr. Martoma is married to a medical doctor and they have three children. A long prison term could be devastating for his family. With his wife and children inside his house in Florida, Mr. Martoma fainted on his front lawn in late 2011 when F.B.I. agents arrived to warn him that he might face charges.

But Mr. Martoma may also be in a uniquely advantageous position to make a deal with prosecutors. He’s the only former SAC trader who, the government has said, had direct dealings with Mr. Cohen concerning suspicious trades. The government said the two had a 20-minute telephone conversation the night before SAC started trading shares of two pharmaceutical companies based on confidential information Mr. Martoma gained from a doctor involved in clinical trials of an important Alzheimer’s drug. So far as is known, Mr. Martoma hasn’t told prosecutors the substance of that conversation.

This is about as close as possible to what in game theory is known as the “prisoner’s dilemma,” Randal Picker, University of Chicago law professor and a co-author of “Game Theory and the Law,” pointed out. The game was developed by RAND Corporation scientists and formalized in 1950 by a Princeton mathematician, Albert W. Tucker, who gave the game its name.

In the now-classic version, the police have arrested two suspects and are interrogating them in separate rooms. Each can either confess and implicate the other, or remain silent. If only one confesses, he goes free and the other gets a harsh sentence. If both confess, each gets a reduced sentence, but still goes to jail. If neither confesses, the government lacks the evidence needed to convict and both go free.

Game theorists have demonstrated that the rational choice, or dominant strategy, is always to confess and implicate the other, even though the optimal outcome for both occurs if neither cooperates. That’s because, as Professor Picker explained, if one prisoner has confessed, the best the other can hope for is also to confess and get the moderate sentence rather than the harsher sentence reserved for those who don’t cooperate. If one prisoner doesn’t confess, the other can go free by implicating him. Although they collectively are better off if neither cooperates, their individual self-interest dictates cooperation.

That may be one reason that, when it comes to white-collar crime, “the overwhelming majority of people tend to cooperate, in my experience,” said John F. Savarese, a partner at Wachtell, Lipton, Rosen & Katz and chairman of the New York City Bar Association’s White Collar Criminal Law Committee.

That has certainly been the case in the current insider trading scandal. Of the 73 defendants who pleaded guilty or were convicted since 2009, 37 cooperated and only 10 have taken their cases to trial. (All were found guilty.)

So what explains the behavior of Mr. Martoma? “The problem with games like the prisoners’ dilemma is that they may not represent the real world where sophisticated parties are making the decisions,” Professor Picker said. “This isn’t an episode of ‘Law and Order.’ ”

Mr. Martoma has already lost one round. Dr. Sidney Gilman, a once-distinguished neurologist at the University of Michigan Medical School who, the government says, was Mr. Martoma’s source and co-conspirator in the scheme, agreed to cooperate with the government and implicated Mr. Martoma. That became a basis for the charges against him. In a close parallel to the outcome in the prisoner’s dilemma game, Dr. Gilman won’t be charged with any crime.

Government prosecutors, along with the judges who sentence those convicted, have created powerful inducements to cooperate. Wesley Wang, a former SAC analyst, admitted his role in an insider trading ring but cooperated and even worked undercover to record secretly his co-conspirators. Judge Jed S. Rakoff of United States District Court, Southern District of New York, sentenced Mr. Wang to two years of probation and praised his cooperation. The judge noted that prosecutors “could not achieve the marvelous successes they’ve had in sophisticated crimes, like insider trading, without asking judges to give a very substantial benefit to cooperators.”

Compare Mr. Wang’s outcome with that of Anthony Chiasson, a former hedge fund manager and SAC trader. Mr. Chiasson refused to cooperate, went to trial and was convicted. Judge Richard J. Sullivan sentenced Mr. Chiasson to six and a half years in prison and fined him $5 million. “This kind of conduct can’t go unpunished,” Judge Sullivan said at the sentencing on May 13. “I’m so sorry for your family and I’m so sorry for your wife.”

In this real world setting, “judges in white collar cases give very tangible credit for cooperation,” said Gary Naftalis, co-chairman of Kramer Levin Naftalis & Frankel, who has represented many defendants who cooperated as well as those who didn’t. One of those who didn’t was Rajat Gupta, the retired head of the consulting firm McKinsey & Company and former Goldman Sachs director, who was convicted of leaking inside information to Raj Rajaratnam, a billionaire hedge fund manager. “A fair number of people have gotten probation as opposed to years in prison. No one in their right mind wants to spend years in jail.”

But as Professor Picker pointed out, other participants may try to change the rules, and the outcome of the game. “A central premise of the game is that the prisoners can’t communicate,” he noted. “But in the real world, they communicate all the time, both directly and through their lawyers.” Given that Mr. Cohen is a billionaire, “he has all sorts of ways to make you very comfortable if you don’t cooperate. You change the payoff so that people see the situation differently.”

Financial incentives may also complicate the game. Cooperating and telling the truth might require forfeiting gains that would otherwise be beyond the government’s reach. “Let’s say that the individual has $150 million personal exposure on another scheme or another aspect of the scheme under investigation that the government is either not aware of, not focusing on or otherwise unlikely to be able to prove without the client’s cooperation, and coming clean means they have to sacrifice that,” said Andrew Levander, a white-collar defense specialist at Dechert L.L.P. “Even if they get convicted, they might decide that four to six years is worth it if they and their families have something to live on when they get out.”

Nor are real world participants equally important to prosecutors, as they are in the game. Situated as he is at the top of SAC, Mr. Cohen has no one above him to implicate. In theory, he could betray Mr. Martoma, but probably at the cost of implicating himself. Given Mr. Cohen’s importance to prosecutors and Mr. Martoma’s low-level status, Mr. Cohen’s reward for cooperation would probably be minimal, if anything at all.

Lawyers may also influence the outcome, especially when their fees are being paid by another participant, as they routinely are in white-collar cases. Mr. Martoma’s fees are being paid by SAC. SAC surprised many defense lawyers recently when it said it would no longer cooperate itself. (Most businesses at least pay lip service to cooperation, even when they hope the government will fail to make a case.)

Mr. Martoma has already switched counsel, from Charles A. Stillman to Richard M. Strassberg. Both are prominent white-collar defense lawyers with reputations for opposing the government rather than cooperating, although their strategies naturally vary depending on the interests of their clients. Mr. Savarese said he couldn’t comment on the Martoma case, but in general, refusing to cooperate is “bolder, riskier and takes intestinal fortitude.” Still, he added, “that can be a smart strategy.”

It’s especially smart when a defendant is innocent and can’t implicate anyone else, which may turn out to be the case with Mr. Martoma. Mr. Cohen, too, may be innocent of any wrongdoing with nothing of value to offer prosecutors. The prisoner’s dilemma game assumes that both prisoners are guilty and in a position to incriminate the other prisoner.

Mr. Strassberg didn’t respond to a request for comment. A spokesman for SAC and Mr. Cohen declined to comment.

On the other hand, if potential defendants are in a position to incriminate someone else, it can be risky to rely solely on someone else’s failure to cooperate. Mr. Strassberg represented Martha Stewart’s broker, Peter E. Bacanovic, in what is often cited as an example of the prisoner’s dilemma. Both Ms. Stewart and Mr. Bacanovic told the same innocent but false story about Ms. Stewart’s well-timed sale of ImClone Systems stock. Both refused to cooperate and went to trial, accused of making false statements. But this turned out to be more than a two-prisoner game. A third participant, Mr. Bacanovic’s assistant, cooperated and testified against them. Both were convicted and went to jail.

Other pressures may weigh on the decision: a sense of honor and loyalty; of not wanting to betray a colleague or someone who has made them wealthy; a fear of retribution. Several white-collar defense lawyers told me that it’s an anguishing decision, but ultimately most defendants act in their own best interests, not that of someone else they’re trying to protect.

All of which would seem to point to Mr. Martoma’s deciding to cooperate. The problem is that “game theory can offer important insights, but it doesn’t dictate the results,” Professor Picker said. “Game theorists will say that if you don’t like an outcome, you change the rules of the game. You change the payoffs so people see the situation differently. Then, all bets are off.”

A version of this article appears in print on  , Section B, Page 1 of the New York edition with the headline: SAC Case Is Testing A Classic Dilemma. Order Reprints | Today’s Paper | Subscribe

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