Hedge fund manager Lampert gains $160 million on Sears shares acquired from Ziff family

Edward Lampert, the hedge fund manager who controls Sears Holdings Corp., has more than $160 million in paper profits on shares of the retailer acquired last month from a long-standing client, the Ziff family.

The billionaire paid $130 million in early January to personally acquire Sears shares from ESL Investors LLC, a partnership he runs for the Ziffs that follows the same strategy as his hedge fund, according to court documents and regulatory filings. The retailer's stock has more than doubled since then, rebounding from a three-year low and ranking as the best-performing member of the benchmark Standard & Poor's 500 index.

The Ziffs, heirs to a publishing fortune who backed hedge fund managers Jim Chanos and Bill Ackman early in their careers, provided Mr. Lampert with some of the capital he used to buy and then merge Kmart Corp. with Sears, Roebuck & Co. to create Sears Holdings. Mr. Lampert revamped his investment partnership with the Ziffs and bought back some of their Sears stock after the retailer faltered in 2011, regulatory filings show.

“The client wants out of the fund and he is choosing to reduce their exposure personally,” said James Hedges, a former money manager who said he knows Mr. Lampert and now runs Montage Finance, a New York-based art finance firm. “Or they want liquidity and he still likes the position.”

Representatives for Mr. Lampert and Ziff Brothers Investments LLC declined to comment. The Ziff brothers, including Dirk, Robert and Daniel, set up their New York-based firm in 1993, prior to the $1.4 billion sale of their father William Ziff's magazine company, the onetime publisher of titles such as Car and Driver, PC Magazine and PCWeek.

Mr. Lampert, who has never publicly identified the clients in ESL Investors, set up the limited liability company in 1999 for the Ziffs to invest alongside his main hedge fund, ESL Partners LP, in stocks such as AutoZone Inc., Gap Inc. and Sears, court records and government documents show. The Ziff partnership provided $14 million in cash and $235 million of the Kmart debt that Mr. Lampert used to acquire a controlling stake in the discount chain through its 2003 bankruptcy reorganization, according to a regulatory filing.

Two years later, Kmart bought Sears Roebuck for $12.3 billion and Mr. Lampert, now 49, became chairman of the combined company. Mr. Lampert and his Greenwich, Conn.-based firm, ESL Investments Inc., currently control about 57% of Sears common stock.

Sears shares have lost more than two-thirds of their value since peaking at $188.94 in April 2007, even after rallying 19% on Thursday to $61.80 in New York. The drop has made it difficult for Mr. Lampert to replicate the average annual returns of about 25% that he produced at ESL Partners during its first 14 years of operation, according to two people with knowledge of the fund's results.

ESL Partners fell 4% in the first nine months of 2011, according to the people who requested anonymity because the information is confidential, besting the S&P 500's 8.7% decline after dividends. The fund rose 16% and 55% in 2010 and 2009, respectively, after slumping 33% in 2008 and 27% in 2007, the people said.

The hedge fund reported that some investors were cashing out at the end of 2011, a step that's difficult to take at ESL Partners because Mr. Lampert requires clients to wait at least five years before withdrawing any money, according to three people familiar with the firm, who asked not to be named because its terms aren't public. Mr. Lampert disclosed a restructuring of the Ziff partnership, including the “termination” of his management firm's financial interest in the vehicle, through a Jan. 3 filing with the Securities and Exchange Commission.

Mr. Lampert's investors got more bad news on Dec. 27, when Sears said its same-store sales fell 5.2% during the holiday season and that management would shutter as many as 120 locations. The stock dropped 27% that day to $33.38, and declined to $29.20, the lowest closing in more than three years, on Jan. 6, a day after Standard & Poor's cut the company's credit ratings two notches into deeper junk territory.

On the following Monday, Mr. Lampert bought 4.46 million Sears shares from ESL Investors at the $29.20 price for about $130 million, according to a Form 4 with the SEC on Jan. 11. The Ziff partnership also paid Mr. Lampert's management fee on Jan. 11 by transferring an additional 573,184 Sears shares, with a market value of about $18.9 million, to his firm in lieu of cash, the filing showed.

Since then, Sears has soared amid speculation Mr. Lampert might take the company private and Thursday's announcement that the retailer would raise as much as $770 million by selling real estate and separating some smaller-format businesses. The 5 million shares that Mr. Lampert and his management unit received from the Ziffs are now valued at about $309 million.

A precedent for this type of internal transaction occurred five years ago. After peaking on April 17, 2007, Sears shares began to slip and then plunged 10% on July 10, the largest decline in more than four years, as the company said profit for the second fiscal quarter would fall as much as 46% from the same period in 2006.

Three weeks later, on Aug. 1, Mr. Lampert transferred 3.41 million shares held by the Ziff partnership to his main hedge fund, according to a Form 4 filed with the SEC. In return, the hedge fund sent $466.7 million to the partnership, or $136.79 a share. The fund has an unrealized loss of almost $256 million on the stock received from the Ziffs.

ESL said in its Form 4 filing that the 2007 transfers were made “in connection with a portfolio rebalancing,” a term money managers use when they shift securities between funds to balance their respective holdings in a particular company, industry or asset class. With Mr. Lampert's main fund about to receive a $3.5 billion investment from Goldman Sachs Group Inc. clients, the transfer of Sears shares helped Mr. Lampert balance the stakes that ESL Partners and ESL Investors held in the retailer, according to a person familiar with the situation who requested anonymity because the transactions were private.

When an adviser has one of his funds sell assets to another in what is known as a “cross trade,” such as the 2007 transfer between ESL Partners and ESL Investors, securities rules generally mandate advance disclosure and consent, unless approval is given on a blanket basis when clients sign up. The rules also say managers should ensure the price is fair for both the buyer and the seller.

Greenlight Capital Inc., the firm run by David Einhorn, may rebalance portfolios when its hedge funds have accepted new “material” contributions or experienced net withdrawals or other capital changes, according to a Jan. 25 brochure on file with the SEC. Greenlight “generally will not rebalance any security or position,” the firm said, if it is affiliated with the company that issued the security or any of its funds own more than 10% of that company “for passive positions.”

ESL Investments disclosed the 2007 transfer between the main hedge fund and the Ziff partnership to its clients ahead of time and received their approval, according to the person familiar with the transaction. The firm also said the transfer would lead to a temporarily high concentration of Sears stock in the hedge fund, exceeding 30% of net assets, until the cash from Goldman Sachs clients came in.

Mr. Lampert's purchase of Sears shares from the Ziff partnership in January was carried out within the framework of an existing agreement between the money manager and his client, said two people with knowledge of the transaction. That purchase helped Mr. Lampert maintain a balance between his personal stake in Sears and his hedge fund's holding in the retailer, one of these people said.

Open-market sales could have hurt the share price for two reasons. An average of only about 714,000 Sears shares traded on a daily basis last year, less than one-tenth of Target Corp.'s volume, according to data compiled by Bloomberg. Securities rules would require Mr. Lampert to report sales by ESL Investors under his own name as well, potentially making it appear as if the company's chairman was bailing out.

“He controls so much that any transparent trading activity will move the market,” said Jay Gould, head of the investment funds practice in the San Francisco office of the law firm Pillsbury Winthrop Shaw Pittman LLP. “You could make a pretty good case to say that doing it in a private transaction is the most fair way” to sell the Ziffs' shares.

Before starting his hedge fund in April 1988, Mr. Lampert worked under former U.S. Treasury Secretary Robert Rubin in the risk arbitrage department of Goldman Sachs, as did Daniel Och, the CEO of Och-Ziff Capital Management Group LLC, and Richard Perry, the head of Perry Corp. Dirk Ziff, the oldest of the three brothers, was an intern at Goldman Sachs and later provided capital to all three managers through the family investment firm.