UPDATE 3-Ex-SAC fund manager indicted in insider trading scheme

* Martoma is seventh former SAC employee charged or

implicated

* Indictment means he is not likely to be a cooperating

witness

(Updates with details on class action lawsuit against SAC)

NEW YORK, Dec 21 (Reuters) - Federal prosecutors on Friday

lost one opportunity to build a case against hedge fund manager

Steven A. Cohen when a grand jury indicted one of Cohen's former

employees on charges related to an insider trading scheme,

severely reducing the possibility he would cooperate as a

witness against Cohen.

The grand jury in New York returned an indictment against

Mathew Martoma, a former portfolio manager at CR Intrinsic

Investors, one of SAC Capital Management's funds, in what

prosecutors have called the "most lucrative" insider trading

scheme ever.

Martoma, 38, of Boca Raton, Florida, was indicted on three

counts of conspiracy to commit securities fraud and securities

fraud related to trades made in Elan Corp Plc

and Wyeth - now part of Pfizer Inc - based on tips

prosecutors say he received from a doctor.

The trades allegedly helped CR Intrinsic avoid losses and

reap profits totaling $276 million in the summer of 2008. The

indictment followed an earlier criminal complaint federal

prosecutors filed Nov. 20.

Martoma is the seventh former employee of Cohen's to be

charged or implicated in insider trading schemes, and the

criminal complaint against him is the first to refer to Cohen.

Cohen appears as "Hedge Fund Owner" in the criminal

complaint and "hedge fund manager A" in the corresponding civil

complaint against Martoma, filed by the U.S. Securities and

Exchange Commission, according to a source familiar with the

case.

"Though disappointing, today's events come as no surprise,"

said Martoma's lawyer, Charles Stillman, founding member of

Stillman Friedman in New York.

"The simple fact is that Mathew Martoma did not trade on

inside information, is innocent of all these charges, and we

look forward to his ultimate vindication."

The same day as the indictment, investors in Elan's American

depositary receipts sued SAC Capital, Cohen and Martoma, among

others, for federal securities law violations related to the

alleged the insider trading.

The lawsuit, filed in the U.S. District Court in New York,

appears to be be the first private action against SAC stemming

from the insider trading criminal case. The lawsuit seeks class

action status and unspecified damages.

After the Federal Bureau of Investigation arrested Martoma

in late November, federal prosecutors filed a criminal complaint

against him but did not formally charge him, a move widely seen

as leaving the door open for Martoma to "flip." Had he flipped,

he would have had to agree to a plea deal in exchange for

becoming a cooperating witness for the government.

"The reports have been that the government has made

significant efforts to enlist Mr. Martoma as a cooperating

witness and he has refused," said Tom Gorman, a partner at

Dorsey & Whitney in Washington.

"The fact that they've incited him probably means that

they've given up on that, but he could still change his mind."

Gorman added defendants often grow more willing to make a

deal as the time of their trial nears.

"The process looks a lot different when you're sitting there

looking at jury selection," he said. "By that time, everybody

starts to get true religion. It's the pressure of the process."

A spokesman for SAC Capital declined to comment for this

story. Spokeswomen for the FBI and for Preet Bharara, U.S.

Attorney for the Southern District of New York, both declined to

comment.

The charges against Martoma stem from the U.S. government's

long-running investigation of improper trading in the $2

trillion hedge fund industry.

The investigation has led to more than 50 convictions so far,

most notably that of 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.

Recently, a top Cohen deputy, 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.

TIP FROM A DOCTOR

The criminal complaint filed by federal prosecutors and the

SEC's civil suit 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's accomplishments in medical education and

research speak for themselves," said Gilman's lawyer, Mark

Mukasey, a partner at Bracewell & Giuliani. "He has been a

leader in the fight to find a cure for people suffering from

debilitating neurological diseases. Going forward, he will abide

by the terms of his agreements with the US Attorney's Office and

the SEC."

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 GLG spokesman 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 clinical trial.

According to the criminal complaint, Gilman scheduled

meetings and phone calls with Martoma that allowed him to pass

on new information about the clinical trial soon 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

positions.

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, more than $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.

(Reporting By Emily Flitter and Nate Raymond in New York;

Editing by Nick Zieminski)

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