Federal authorities charged a former hedge fund manager in what they are calling the most lucrative insider trading scheme in U.S. history, resulting in more than a quarter of a billion dollars in illegal profits surrounding the results of an Alzheimer’s disease drug trial.

Mathew Martoma was charged Tuesday in U.S. District Court in Manhattan with conspiracy to commit securities fraud and two counts of securities fraud in a scheme that began in 2006 while he worked for CR Intrinsic Investors LLC of Stamford, Conn.

“The charges unsealed today describe cheating coming and going – specifically, insider trading first on the long side, and then on the short side, on a scale that has no historical precedent,” U.S. Attorney Preet Bharara said.

The Securities and Exchange Commission and the Justice Department say Martoma and Dr. Sidney Gilman hatched a plan to trade ahead of a negative public announcement involving the clinical trial results of an Alzheimer’s drug being developed by Elan Corp. and Wyeth. According to court records, Martoma got confidential information about the drug trial results from Gilman who he met through paid consultations arranged by an expert-networking firm.

Gilman, a professor of neurology at the University of Michigan Medical School, served as chairman of the Safety Monitoring Committee overseeing the clinical trial. He was selected to present the final clinical trial results of the drug at a July 2008 medical conference.

Before a pharmaceutical company can release a new drug, it has to conduct clinical trials to determine whether the drug is safe and effective. The trials usually happen in three phases. During the first, the drug is tested on a small group, usually anywhere between 20 and 80 people to determine its safety, dose range and to identify any side effects that might occur. During phase two, the drug is given to a larger group ranging from about 200-300 and the results are evaluated. During phase three, the drug is tested on several hundred people to confirm its effectiveness and safety and to monitor any side effects. Phase three of the trial for the Alzheimer’s drug was unexpectedly negative.

“As Martoma allegedly got sneak peeks at drug data, he first recommended that the hedge fund build up a massive position in Elan and Wyeth stock, and then caused the fund to shed those shares after getting a secret look at the unexpectedly bad results of a clinical drug trial,” Bharara said. “And so, overnight, Martoma went from bull to bear.”

According to court documents, the leaks by Martoma caused hedge fund portfolios managed by CR intrinsic to liquidate their combined long positions in Elan and Wyeth, which was more than $700 million. The SEC says Martoma’s tip caused them to take substantial short positions and to sell more than $960 million in Elan and Wyeth securities in just over a week. This reshuffling allowed CE Intrinsic and other hedge funds tied to Martoma to reap illicit profits and avoid losses of over $276 million.

“A competitive advantage gained through superior research and analysis is one thing,” said FBI Special Agent April Brooks. “Cheating is another matter altogether. If the information isn’t public, you can’t trade on it.”

Martoma’s attorney Charles Stillman called his client “an exceptional portfolio manager who succeeded through hard work and the dogged pursuit of information in the public domain.” He added, “What happened to day is only the beginning of a process that we are confident will leave to Mr. Martoma’s full exoneration.”