Punishment

Insider-trading scandal costs 3 hedge funds a combined $9 billion

U.S. attorney's investigation has wary institutions pulling money

Three hedge funds that were brushed by federal insider-trading investigations in the past three months will lose a collective $9 billion, the result of high redemptions from nervous institutional investors, hedge funds of funds and others.

As sources predicted when news of two separate investigations broke in November, being included within the probes cast enough of a cloud over hedge fund managers Level Global Investors LP, Diamondback Capital Management LLC and FrontPoint Partners to prompt institutional investors and hedge fund-of-funds managers to ask for their money back. None of the firms has been charged with wrongdoing.

Level Global Investors has not disclosed the level of the redemption requests it received, but has announced it is closing and returning all of the $4 billion it manages in its funds to investors by the end of the quarter.

Diamondback Capital was hit by $1.3 billion of redemptions for the quarter ended March 31, about 17% of its $5.8 billion of assets under management. Diamondback Capital will remain open.

Executives of both long/short equity hedge fund managers have acknowledged their offices were searched by the FBI and are cooperating with Preet Bharara, the U.S. attorney for southern New York, in connection with an investigation into insider-trading tips that allegedly were passed to hedge fund managers by expert-network consulting firms. Charges have not been leveled against either firm, and executives at both firms said the government has confirmed they are not targets of the probe.

Multistrategy hedge fund manager FrontPoint Partners, touched by a separate insider-trading investigation, received redemption requests for an additional $500 million for the first quarter, confirmed a source who asked not to be identified.

Its latest redemptions combined with withdrawals of about $3 billion in the fourth quarter of 2010 will pull assets down about 47% from the $7.5 billion it managed at the beginning of November. FrontPoint told clients in a Nov. 26 letter obtained by Pensions & Investments that it would begin 2011 with about $5 billion under management.

About half of the fourth-quarter redemption requests involved FrontPoint's health-care hedge funds, which were closed and liquidated at the end of November after news broke of a separate insider-trading scandal conducted by Mr. Bharara.

On Nov. 2, Yves Benhamou, a former adviser to Human Genome Sciences Inc., was charged with insider trading and conspiracy after allegedly passing insider tips to Chip Skowron, the co-portfolio manager of FrontPoint's health-care funds. FrontPoint placed Mr. Skowron on leave pending the outcome of the inquiry. Neither FrontPoint nor Mr. Skowron has been charged with wrongdoing.

Steven G. Bruce, a FrontPoint spokesman, declined to comment on the latest round of redemptions.

FrontPoint's executives are due to complete a management buyout before the end of March from parent company Morgan Stanley (MS). Morgan Stanley will retain an undisclosed minority stake in FrontPoint Partners.

“As we publicly disclosed in January, we continue to move forward on the restructuring of our ownership of FrontPoint and expect to close in the first quarter of 2011,” said Erica Platt, a Morgan Stanley spokeswoman.

In the case of Level Global, the amount of redemption requests, coupled with the uncertainty and distraction of dealing with a major federal probe, caused David Ganek, the firm's co-founder, managing partner and a portfolio manager, to announce he would close the firm.

In a Feb. 11 letter to clients that was obtained by P&I, Mr. Ganek wrote that after an external legal counsel review of Level Global, “I remain highly confident that my conduct in leading the firm and its investment process was lawful and ethical at all times.”

He added that with quarterly liquidity — 75% of the firm's investors could redeem by March 31 and 100% by June 30 — “we simply would not be able to run Level Global in a manner meeting our high standards if our capital base were to be significantly reduced. ... (W)ith that in mind and embracing our fiduciary responsibility, we have decided to wind down Level Global on our own terms and in a way that best protects our investors.”

Level Global spokesman Andrew Merrill declined to comment.

Institutions with direct investments in Level Global include the $132.8 billion New York State Common Retirement Fund, which had $100 million with the firm; the $100.8 billion Teacher Retirement System of Texas, with $104 million; the $70.8 billion New Jersey Division of Investment, with $83 million; the $10.3 billion School Employees Retirement System of Ohio, with $35 million; and the $14.3 billion Indiana Public Employees' Retirement Fund, with $50 million.

Timothy Barbour, an Ohio School Employees spokesman, said investment staff members there are evaluating the fund's whole hedge fund portfolio before deciding where to reinvest the assets that will be returned by Level Global.

“We have a number of other managers in the long/short equity strategy so we're probably covered in that area,” Mr. Barbour said.

At Diamondback, several large investors “have expressed their current intention to remain invested at or close to their current levels,” according to a Feb. 1 client letter from Richard Schimel and Lawrence Sapanski, co-chief investment officers, that was obtained by P&I. Also, according to the letter, about 19% of Diamondback's assets are “hard-locked” and can't be redeemed on March 31.

Monica Everett, a Diamondback Capital spokeswoman, declined to comment.

Staying put

Among investors staying put by choice is hedge fund-of-funds manager Blackstone Alternative Asset Management LP, the Diamondback investor with the largest pool of unlocked capital, confirmed a source who asked not to be identified.

Diamondback's direct investors include the $11.8 billion Public Employees' Retirement Association of New Mexico; the $7.7 billion Missouri State Employees' Retirement System; New York State Common Retirement Fund; School Employees Retirement System of Ohio; the $3.8 billion Philadelphia Public Employees Retirement System; and the New Jersey Division of Investment.

New Mexico PERA is following the advice of its consultant, Cliffwater LLC, and is not seeking to redeem its $43.9 million direct investment, said Joelle B. Mevi, CIO of the Santa Fe-based fund.

“We still are subject to a lockup, but we are content to stay invested,” Ms. Mevi said.

“We reviewed the company's history and its outflows in 2008, how they were managed, how well the firm came back and the performance, and Diamondback did well during that period. Cliffwater is confident about ... (New Mexico PERA) remaining invested in the funds,” she added.

Ohio School Employees' Mr. Barbour said the fund is “remaining invested. Performance has been good, and we're not taking action that this time.”

The actions and intentions of the other investors could not be learned by press time.

Asked for a redemption

The $48 billion Massachusetts Pension Reserves Investment Management Board, Boston, which will start direct hedge fund investment in the fall with a $500 million pilot program, had $11.7 million invested in Diamondback Capital as of Dec. 31 through hedge fund-of-funds manager Arden Asset Management. Michael G. Trotsky, executive director, said Arden asked for a redemption and will reinvest the assets.

MassPRIM also had $47.8 million invested in Level Global through Grosvenor Capital Management LP ($10.5 million); K2 Advisors LLC ($24.2 million); and The Rock Creek Group ($13.1 million). Mr. Trotsky said those managers will reinvest the returned assets.

In the case of FrontPoint Partners, institutional investors include the $24 billion South Carolina Retirement System Investment Commission and the $6.6 billion Arizona Public Safety Personnel Retirement System.

For Robert L. Borden, CEO and chief investment officer of the South Carolina investment commission, Columbia, the insider-trading scandal that touched the company's health-care funds was just too much to ignore. He pulled the fund's $300 million investment in FrontPoint's multistrategy approach in the fourth quarter.

“We were concerned about the obvious, that the scandal could cause major outflows from the multistrategy fund, and unfortunately, that proved to be true. One isolated event that affected just one of FrontPoint's investment teams rippled across the rest of the strategies,” Mr. Borden said.

James M. Hacking, administrator of the Arizona Public Safety plan, on the other hand, said the Phoenix-based fund has about $100 million invested with FrontPoint and will remain invested, although he stressed that “we continue to closely monitor the company's situation. The decline in assets is fairly large and many become a cause for concern.” n