Insider trading probe fallout

Institutional investors are assessing their investments in hedge fund managers caught up in a wide-ranging insider trading investigation by federal law enforcement officials.

A large swath of institutional investors might have small exposures to two long/short equity managers that are being investigated, Diamondback Capital Management LLC and Level Global Investors LP. That's because some of the largest hedge funds-of-funds managers that manage most of their money for institutional investors are invested in the hedge funds of one or both firms.

In addition, institutional investors — including the $124.8 billion New York State Common Retirement Fund, the $9.4 billion Ohio School Employees Retirement System and the $70.2 billion New Jersey state pension fund, managed by the New Jersey Division of Investment — invested directly in Diamondback and/or Level Global.

Charges of wrongdoing have not been leveled at Diamondback, which manages about $5.3 billion, or Level Global, which manages about $3.5 billion.

Offices of both firms, along with a third hedge fund manager, Loch Capital Management LLC, were searched by FBI agents last week.

Steve Bruce, a spokesman for Diamondback, and Andy Merrill, a spokesman for Level Global, confirmed the FBI searches and said executives at their firms are cooperating.

Among the firms that sources said have received requests for documents from federal investigators looking into insider trading are SAC Capital Advisors LP, Wellington Management Co. LLP, Janus Capital Group Inc. and Citadel LLC.

Janus confirmed in an e-mailed statement that it got a request for general information and will cooperate with the inquiry.

Executives of SAC, Citadel and Wellington declined to comment.

Leonard A. Pierce, a partner in the law firm of Wilmer Cutler Pickering Hale and Dorr LLP, could not be reached by press time for comment about his client, Loch Capital Management.

Despite the lack of formal charges, pension fund executives and their consultant, along with hedge funds-of-funds managers, say they are very closely watching Diamondback and Level Global as events unfold.

Officials at Albany-based New York State Common Retirement Fund are “very concerned about reports of the investigation. ... We're staying in touch with both companies and are monitoring them carefully,” said Dennis Tompkins, spokesman for State Comptroller Thomas P. DiNapoli, sole trustee of the fund.

Mr. Tompkins said New York State Common has $250 million invested in Diamondback's long/short equity strategy and $100 million in a similar strategy managed by Level Global.

“We're not going to be making any sudden moves, but we are in conversation with both companies because we do have constraints on the liquidity of our investments with them as per our contract agreement,” Mr. Tompkins said.

The New York fund's assets are subject to a two-year lockup in the Diamondback hedge fund strategy and a one-year lockup in the Level Global strategy.

Investment staffers at the Ohio school fund are monitoring both Diamondback, which managed about $72 million for the pension fund, and Level Global, which managed about $35 million as of Oct. 31, said spokesman Tim Barbour.

Andrew Pratt, a spokesman for the New Jersey Division of Investment, investment staff at the Trenton-based division “will monitor the events connected with these hedge funds in order to do everything we can to protect our investments.” The New Jersey fund has $83 million invested directly in the Level Global LP hedge fund.

Mr. Pratt said the New Jersey pension fund also has small investments in both SAC and Diamondback through an $85 million investment in Arden Alternative Advisers, a hedge fund of funds managed by Arden Asset Management.

Ohio's Mr. Barbour said executives at both hedge fund managers have been in contact with the Ohio fund to explain the situation and to reassure clients that they are cooperating with the investigation by the FBI.

The fund's board hasn't taken formal action “because we really don't have enough information,” he said.

Consultants say a large number of institutional investors have relatively small exposure to Diamondback and/or Level Global through hedge funds-of-funds managers including K2 Advisors LLC, Rock Creek Group, Grosvenor Capital Management LP and Blackstone Alternative Asset Management.

Except for David C. Saunders, K2's managing partner, executives at these hedge funds-of-funds managers declined to comment or did not return a call.

Mr. Saunders said K2 officials are ”aggressively monitoring developments” at both firms. Mr. Saunders declined to say how much K2 has invested with Diamondback and Level Global.

Arden Asset Management also is “actively monitoring the situation,” said Jonathan Gasthalter, a spokesman. He added, “Arden has a very small allocation to both firms,” but declined to be more specific.

Specialist alternative investment consultant Cliffwater LLC, Marina del Rey, Calif., still is in “fact-finding” mode, said CEO Stephen L. Nesbitt. “It's not clear exactly what federal authorities are looking for. There's more unknown than known at this point. The real question is how systemic this insider trading really is.”

Cliffwater is in close communication with both Diamondback and Level Global executives and will continue to monitor the situation, Mr. Nesbitt said. The firm is not recommending clients with direct investments in either firm redeem, he said.

Other consultants are taking a different approach.

“We don't have clients (invested in) these funds, but our advice would be for those who are invested directly to put in redemption notices. Where there is smoke there is fire, in my view, and even if some ... allegations are proved to have no substance, the damage to the funds' reputation has already been done, and redemptions are inevitable ... such investigations can lead to a long slow death,” said Aoifinn Devitt, principal at hedge fund and private equity consultant Clontarf Capital, London.

“These firms face an existential threat because investors have been backed into a corner. ... If you are a fiduciary and you choose to do nothing, and illegal activities are proven, you're out of a job and maybe out of a career,” said hedge fund consultant Howard B. Eisen, managing director, FletcherBennett Capital LLC, New York.

“If, however, you choose to take action by redeeming and the alleged activities are disproven, big deal: You can always reinvest. Or find some other similar product ... it isn't as if any one fund or money manager is irreplaceable.”

Bloomberg contributed to this story.